Tuesday 2 December 2014

Interest Rate Volatility and Investment Determination in Nigeria.



CHAPTER TWO


2.0      LITERATURE REVIEW

2.1     THEORETICAL LITERATURE

2.1.1  Interest Rate Volatility and Investment Determination in Nigeria.


The variation of short-term and long-term interest rate is a prominent feature of the economic events such as changes in Federal Policy. Crises in domestic and international financial market in the prospects for long-term economic growth and inflation. However, economic event such as these, tends to be irregular (Keith

1996). There is a more regular volatility of  interest rate associated with  the business cycle. The expansions and contraction that the economy experience overtime. For instance, short- term interest rate rise in expansions and fall in recessions. Long-term interest rate do not appear to be the term cyclical volatility of interest rates which refers to the variability of interest rate over periods that correspond to the length of the typical business cycle.


The variation of interest rates affects decision about how to save and invest. Investors differ in their willingness to hold risky assets such as bonds and stocks. When the holding stocks and bonds are highly volatile, investors who rely on these assets to provide their consumption faces a relatively large chance of having low consumption at any give time. For example, before retirement, people receive a steady stream of income that helps to buffer the changes in wealth associated with changes in the returns of their investment portfolios. This steady return from working helps them maintain a relatively steady level of consumption.


After retirement, people no longer have steady portfolios stream incolme from working  hence  a  less  volatile  investment  portfolios  is  called  for.  The  lower volatility of investment returns allows retiree to maintain a relatively even level of consumption overtime. Nigeria experienced severe macroeconomic problems towards the end of 1970s through the first half of 1980s when output declined substantially. The real GDP growth rate averaged only 1.5% per annum during the period 1973-1980 (registering negative growth rate in 6 years during the period) (CBN, 1990) In response of this deteriorating economic situation, the Nigeria authorities launched policy programmes contained in the Structural Adjustment Programme (SAP). Several forms of corrective measures were undertaken including financial sector reform policies.


Prior to 1986 in Nigeria, a common practice has been the support of certain economic  projects  considered  to  be  essential  part  of  development  strategy. Government adopted policies aimed at accomplishing specified objective such as interest rate ceilings and selective sectoral policies. Those policies were introduced with the intension of directing credit, to priority sectors and securing in expensive funding for their activities. The ceiling on interest rates and quantity restrictions on loanable funds for certain sectors ensures that a larger share of funds is made available for favoured sectors. Such a practice hinders financial intermediation since the financial markets will only be accommodating the credit demands of the government plan ad ignoring risk. The practice has been disfavoured as a growth policy by the repressionist school led by Makinnoa (1973) and Shaw (1973).


According  to  the  Mckinnon  (1973)  and  Shaw  (1973)  financial  repression paradym, governments effort to promote economic growth by such indiscriminate measure have repressed financial system. This discourages financial intermediation. Thus, the repressionist schools calls for financial liberalization the removal of ceiling on interest rates among others as a growth promoting policy. According to the removal of interest rates ceiling because the interest elasticity of private savings is positive.


The interest rate policy in Nigeria perhaps one of the most controversial of all financial policies. The reason for may not be fetched because interest rate policy has direct bearing on many other economic variables such as investment decision. Interest rates play a crucial role in the efficient allocation of resources aimed at facilitating growth and development of an economy and such as a demand management technique for achieving both internal and external balance.


According to Ocnenon (1973), interest rate policy is among the emerging issues in current economic policy in Nigeria in view of the role it is expected to play in the  deregulated  economy  in  inducing  savings  which  can  be  channel  to investment and thereby increasing employment, output and efficient financial resource utilization. Also, interest rates can have a substantial influence on the rate and pattern of economic growth by influencing on the volume and disposition of saving as well as the volume and productivity of investment (Leahy, 1993).


Rema (1990) investigated the theoretical and empirical determinant of private investment   in   developing   countries   and   identified   macroeconomic   and institutional factors such as financial repression, foreign exchange shortage, lack of infrastructure and economic instability as important variables that explained private investment.
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