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.
Chetty (2004) shown that the investment demand curve is always a backward bending function of the interest rate in a model with non-convex adjustment costs and the potential to learn. At low interest rates, an increase in the rate of return raises the cost of learning and increases aggregate investment by enlarging the set of firms for when the interest rate exceeds the rate of return to delay. An increase in interest rate is more likely to stimulate investment when the potential to learn is larger and in the short run rather than the long run. Akintoye and Olowolaju (2008) examined optimizing macroeconomic investment decision in Nigeria. The study employed both the ordinary least square and rector auto regression frame works to stimulate and project inter inter-temporary private response to its principal stocks namely: public investment, domestic credit and output stocks. The study found low interest rate to have constrained investment growth, the study the resolved that only government policies produce sustainable output, steady public investment and encourage domestic credit to the private sector will promote private investment.
Obanuyi (2009) studies the relationship between interest rate and economic growth in Nigeria. The study employed co integration and error correction
modeling techniques and revealed that lending rate has significant effect on economic growth, the study then postulated that investment friendly interest rate policies necessary for promoting economic growth needs to be formulated and properly implemented.
Aibu (2006), studied trends in the interest rates investment, GDP growth relationship, the study used two partial models to examine the impact of investment on GDP growth and the relationship between interest rate and investment in the case of the Romanian economy. The study found that the behavior of the national economy system and interest rate-investment relationship tend to converge to those demonstrated in the normal market economy. Oosterbanan (2009) examined the relationship between the annual economic growth rate and real rate of interest. The study employed the ordinary least square method of econometric analysis. The study revealed that the relationship between the real rate of interest and economic growth might be a inverted u-curve.
To date, Nigeria has pursued two-interest rate regime. 1960s to mid 1980s with the administration of low interest rates which was intended to encourage investment. However, the advent of the Structural Adjustment Programme (SAP) in the third quarter of 1986 ushered in an era when fixed and low interest rate regime, where rate were more influenced by market forces. Hence, the pursuit of the two interest rate regime in Nigeria provided a case study of the Keynesian
interest-rates investment relationship and Mckinnon (1973) and Shaw (1973)
interest and investment hypotheses.
The gradual deregulation of the Nigeria economy between 1986 and 1992 affected these key economics variable interest rates and investment in the Nigeria context, interest rates, were extensively regulated prior to the adoption of SAP in 1986. But the economic rationale behind this control of interest rate and other elements of financial markets has been motivated by a variety of factors including the desire to influence the flow of credit to preferred sectors of the economy and the concern that market determined interest rate could result in serious imperfection in the market.
Moreover, the upsurge in real interest rate observed Worldwide in the early
1980s has raised wide spread concern about their possible detrimental economic affects. Therefore, in response to these concern, numerous studied were carried out to measured the effect of high interest rate on the key macroeconomic variables. Nevertheless, the concurrent increase in interest rate resulting from the deregulation seem to lay credence to Mcknnon (1973) and Slaw (1973) interest rate and investment hypotheses. The main threst of this study is to examined what happened to investment variation in interest rates and what is the relationship between short-term and long-term interest rate and investment in Nigeria. This is necessitated by the fact. What previous studies in this area never examined variations in interest rate and its effect on investment in Nigeria and the more reason that investment which is the demand for credit might have
impact on the determinant of interest rate and this study intends to examine the impact of investment on interest rate variation 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.
Chetty (2004) shown that the investment demand curve is always a backward bending function of the interest rate in a model with non-convex adjustment costs and the potential to learn. At low interest rates, an increase in the rate of return raises the cost of learning and increases aggregate investment by enlarging the set of firms for when the interest rate exceeds the rate of return to delay. An increase in interest rate is more likely to stimulate investment when the potential to learn is larger and in the short run rather than the long run. Akintoye and Olowolaju (2008) examined optimizing macroeconomic investment decision in Nigeria. The study employed both the ordinary least square and rector auto regression frame works to stimulate and project inter inter-temporary private response to its principal stocks namely: public investment, domestic credit and output stocks. The study found low interest rate to have constrained investment growth, the study the resolved that only government policies produce sustainable output, steady public investment and encourage domestic credit to the private sector will promote private investment.
Obanuyi (2009) studies the relationship between interest rate and economic growth in Nigeria. The study employed co integration and error correction
modeling techniques and revealed that lending rate has significant effect on economic growth, the study then postulated that investment friendly interest rate policies necessary for promoting economic growth needs to be formulated and properly implemented.
Aibu (2006), studied trends in the interest rates investment, GDP growth relationship, the study used two partial models to examine the impact of investment on GDP growth and the relationship between interest rate and investment in the case of the Romanian economy. The study found that the behavior of the national economy system and interest rate-investment relationship tend to converge to those demonstrated in the normal market economy. Oosterbanan (2009) examined the relationship between the annual economic growth rate and real rate of interest. The study employed the ordinary least square method of econometric analysis. The study revealed that the relationship between the real rate of interest and economic growth might be a inverted u-curve.
To date, Nigeria has pursued two-interest rate regime. 1960s to mid 1980s with the administration of low interest rates which was intended to encourage investment. However, the advent of the Structural Adjustment Programme (SAP) in the third quarter of 1986 ushered in an era when fixed and low interest rate regime, where rate were more influenced by market forces. Hence, the pursuit of the two interest rate regime in Nigeria provided a case study of the Keynesian
interest-rates investment relationship and Mckinnon (1973) and Shaw (1973)
interest and investment hypotheses.
The gradual deregulation of the Nigeria economy between 1986 and 1992 affected these key economics variable interest rates and investment in the Nigeria context, interest rates, were extensively regulated prior to the adoption of SAP in 1986. But the economic rationale behind this control of interest rate and other elements of financial markets has been motivated by a variety of factors including the desire to influence the flow of credit to preferred sectors of the economy and the concern that market determined interest rate could result in serious imperfection in the market.
Moreover, the upsurge in real interest rate observed Worldwide in the early
1980s has raised wide spread concern about their possible detrimental economic affects. Therefore, in response to these concern, numerous studied were carried out to measured the effect of high interest rate on the key macroeconomic variables. Nevertheless, the concurrent increase in interest rate resulting from the deregulation seem to lay credence to Mcknnon (1973) and Slaw (1973) interest rate and investment hypotheses. The main threst of this study is to examined what happened to investment variation in interest rates and what is the relationship between short-term and long-term interest rate and investment in Nigeria. This is necessitated by the fact. What previous studies in this area never examined variations in interest rate and its effect on investment in Nigeria and the more reason that investment which is the demand for credit might have
impact on the determinant of interest rate and this study intends to examine the impact of investment on interest rate variation in Nigeria.
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