Effect of interest rate on investment and money demand in nigerian economy

Thesis Overview

<p> </p><p><strong>INTRODUCTION</strong></p><p><strong>1.1 &nbsp; &nbsp; Background to the Study</strong></p><p>Investment plays a very important and positive role for progress and prosperity of any country. Many countries rely on investment to solve their economic problem such as poverty, unemployment etc (Muhammad and Mohammed 2004).</p><p>Interest rate on the other hand is the price paid for the use of money. It is the opportunity cost of borrowing money from a lender to finance investment project. It can also be seen as the return being paid to the provider of financial resources, for using the fund for future consumption (Sleka, 2004). Interest rates are normally expressed as a percentage rate. The volatile nature of interest is determined by many factors, which include taxes, risk of investment, inflationary expectations, liquidity preference, market imperfections in an economy etc.</p><p>Banks are given the primary responsibility of financial intermediation in order to make fund available for economic agents. Banks as financial intermediaries move fund from surplus sector/units of the economy to deficit sector/units by accepting deposits and channeling them into lending activities (Afolabi, 2003). The extent to which this could be done depend upon the rate of interest and level of development of financial sector as well as the saving habit of the people in the country.</p><p>Hence, the availability of investible funds is therefore regarded as a necessary starting part for all investment in the economy which will eventually translate to economic growth and development (Uremadu, 2006).</p><p>As already discussed so far, it is quite clear that an understanding of the nature of interest rate behavior is critical and crucial in designing policies to promote savings, investment and growth. It is pertinent to note that this research attempts to investigate and ascertain the effect of interest rate on investment and money demand in Nigeria.</p><p><strong>1.2 &nbsp; &nbsp; Statement of the Problem</strong></p><p>The financial systems of most developing countries (like Nigeria) have come under stress as a result of the economic shocks. The financial repression largely manifested through indiscriminate distortions of financial prices including interest rates, has tended to reduce the real rate of growth and the real size of financial system, more importantly, financial repression has (retarded) delayed development process as envisage by Shaw (1973). This led to insufficient availability of investible funds, which is regarded as a necessary starting point for all investment in an economy. This decline in investment as a result of decline in the external resource transfer since 1982 has been especially sharp in the highly indebted countries, and has been accompanied by a slowdown in growth in all Least Developed Countries (LDCs) Cole and Obstraid (2005). Both public and private investment rate have fallen, although the latter more drastically than the former. The observed reduction in investment in LDCS seems to be the result of several factors. First, the lower availability of foreign savings has not been matched by a corresponding increase in domestic savings. Secondly, the determinating of fiscal conditions due to the cut of foreign lending to the rise in domestic interest rate and the acceleration in inflation forced a contraction in public investment. Thirdly, the increase in macroeconomic instability associated with external shocks and the difficulties of domestic government to stabilize the economic has hampered private investment.</p><p>Finally, the debt at hand has discouraged investment, through its implied credit constraints in international capital markets (Omole and Falokun, 1999).</p><p>Declining investment ratio and level are problems; first of all, because investment matters for growth. Secondly, because low investment increases vulnerably in the economy (Niambon and Oshikoya, 2001). The main challenge that Nigeria is facing is to make policies that will help revive and raise investment in the country in order to stimulate and sustain economic growth.</p><p>The problem of volatility of interest rates affects personal investments and governmental decision making of any nation, Nigeria cannot be an exception as affirmed by Schwartzman (1992) that the movement of interest rates in one direction or another is influenced by a multitude of factors, including economic, inflationary, monetary, fiscal, global, and political factors.</p><p>The rate of interest paid by banks to depositors is on the high, investors can not patronize the banks the more and fewer investors invests on the capital market. This leads to decrease in money demand and capital investment in the economy.</p><p>The above identified problems can be summarized as follows;</p><p>i. &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; High Interest rate which affects investment decision</p><p>ii. &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; Interest rate has lowered the demand for money in Nigeria</p><p><strong>1.3 &nbsp; &nbsp; Objective of the Study</strong></p><p>The aim of this research project is to examine the effect of interest rate on investment and money demand, while the specific objectives are:</p><p>1. &nbsp; To determine the impact of interest rate on investment decision in Nigeria.</p><p>2. &nbsp; To empirically investigate, the effect of interest rate on demand for money in Nigeria.</p><p><strong>1.4 &nbsp; &nbsp; Research Questions</strong></p><p>In order to achieve the purpose of this research study, the study will attempt to provide answers to the following research questions in order to arrive at a logical conclusion:</p><p>1. &nbsp; &nbsp;What is the impact of interest rate on investment decision in Nigeria?</p><p>2. &nbsp; &nbsp;To what extent does interest rate affect money demand in Nigeria?</p><p><strong>1.5 &nbsp; &nbsp; Statement of Hypotheses</strong></p><p>Based on the above stated research objectives, the following hypotheses were formulated:</p><p><strong>Hypotheses One</strong></p><p><strong>Ho</strong><strong>:</strong>&nbsp;Interest rate does not have significant impact on investment decision.</p><p><strong>H1</strong><strong>:</strong>&nbsp;Interest rate has significant impact on investment decision.</p><p><strong>Hypotheses Two &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp;</strong></p><p><strong>Ho</strong><strong>:</strong>&nbsp;There is no significant relationship between Interest rate and money demand.</p><p><strong>H1</strong><strong>:</strong>&nbsp;There is significant relationship between Interest rate and money demand.</p><p><strong>1.6 &nbsp; &nbsp; Significance of the Study</strong></p><p>This work is mainly for academic purpose. However, it will be of great importance to researchers who would want to embark on any research on interest rate and investment decision.</p><p>Also this piece of research work would go a very long way in assisting any person or organizations in making investment decisions in Nigeria.</p><p><strong>1.7 &nbsp; &nbsp; Scope of the Study</strong></p><p>The study focuses on the effect of interest rate on investment and demand for money in Nigeria. The population of this research covers the entire country as secondary data was used. The study area of this research is Nigeria. Data were gathered from Central Bank of Nigeria (CBN) and Federal Office of Statistics (FOS). The research last for an academic session.</p><p><strong>1.8 &nbsp; &nbsp; Limitations of the Study</strong></p><p>Upon the assertion that every pros have some cons, this study cannot be exception. Some hitches and setback are foreseen. First among the list is data unavailability. For this reason, investment variable would be provided by Gross Fixed Capital Formation (AFCF).</p><p>Secondly, time and financial construct cannot be left out in the list setback and hitches.</p><p>The cost of sourcing materials from the internet is exorbitant because of epileptic and erratic power supply of the Power Holding Company of Nigeria (PHCN). Thus, the cyber café power their systems with power generating sets which increases their cost of production which they eventually pass to us (the consumers of their services).</p><p>Despite all these hitches and setbacks mentioned above, this research work would have been a perfect work.</p><p>1.9 &nbsp; &nbsp; Operationalization of Variables MODEL 1 MD = ba &nbsp;+ b1INF + b2 INTR + b3 INV + µ</p><p>Y = b0 + b1X1 + b2 X2 + b3 X3 + µ</p><p>Where MD = Real money demand.</p><p>INF &nbsp; = &nbsp; &nbsp; &nbsp; Inflation rate.</p><p>INTR = &nbsp; &nbsp; &nbsp; Interest rate and</p><p>INV &nbsp; = &nbsp; &nbsp; &nbsp; Investment</p><p>bo, b1, b2 and b3 are coefficients</p><p>MODEL 2</p><p>INV = b0 + b1 INTR + b2 INF + b3 GDP + EXTR + µ</p><p>Y = b0 + b1x1 + b2 x2 + b3 x3 + &nbsp;b4 x4 + µ</p><p>Where INV = investment</p><p>INTR = Interest Rate</p><p>GDP = Gross Domestic Product</p><p>EXTR = Exchange Rate</p><p>And b0, &nbsp;b1, &nbsp;b2, b3 &nbsp;and b4 are coefficients.</p><p><strong>1.10 &nbsp; Definition of Terms</strong></p><p><strong>Interest Rate: </strong>It is the opportunity cost of borrowing money from a lender to finance investment project</p><p><strong>Investment: </strong>is a monetary asset purchased with the idea that the asset will provide income in the future or appreciate and be sold at a higher price</p><p><strong>Demand for Money:</strong>&nbsp;Is the desired holding of financial assets in the form of <em>money</em></p><p><strong>Economic Growth: </strong>An increase in the capacity of an <em>economy</em>&nbsp;to produce goods and services, compared from one period of time to another.</p><p><strong>Financial Market: </strong>is a <strong>market</strong>&nbsp;in which people and entities can trade <strong>financial</strong>&nbsp;securities, commodities, and other fungible items of value at low transaction costs and at prices that reflect supply and demand.</p> <br><p></p>