THE
IMPACT OF INTEREST RATE ON INVESTMENT DECISION IN NIGERIA. AN ECONOMETRIC
ANALYSIS (1981-2010)
CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
Investment is the
change in capital stock during a period. Consequently, unlike capital,
investment is a flow term and not a stock term. This means that capital is
measured at a point in time, while investment can only be measure over a period
of time.
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 Haron and Mohammed Nasr (2004).
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 going
the fund for future consumption. 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.
Banks are given the
primary responsibility of financial intermediation in order to make fund
available for economic agents. Banks as financial intermediaries move fund.
Surplus sector/units of the economy to deficit sector/units by
accepting deposits and channeling them into lending activities. 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.
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).
Many researchers have
done a lot of study on the impact of interest rate on investment. In Nigeria,
Ologu (1992) in a Policy on aggregate investment behavior”. F were significant
at both the 95% and 90% confidence limits in explaining the behavior of investment
during the (1976-90) period of student”. found out that:
Contrary to expectation
and to change’s existing stock of capital goods (plants and machinery) was not
a major determinant of investment
behavior of forms in Nigeria.
Interest rate was
significant in influencing
investment decision nothing that”
this is not
surprising since in Nigeria,
the cost of capital should exert significant influence on both the frequency
and volume of demand for invisibles funds by investors.
Lesotho
(2006) studied “An investigation investment “the case of Botwana”. Among hi
interest rate, credit to the private investors, public investment and trade
credit to the private investors, real interest rate affect private investment
positively and significantly. Other variable do not affect private investment
level in the short-term as they show insignificant co-efficient. GDP growth and
conform similar finding sin studies by Oshikoya (1994), Ghura and Godwin (2000)
and Malmbo and Oshikoya (2001).
Aysam et al (2004) in
their study “How to B countries. The role Among of their Economic independent
variables Reforms”. were accelerator, real interest rate, macroeconomic stability,
structural reform, external stability, macroeconomic volatility, physical
infrastructure. Their studies ranged from 1990 to 1990 comprising of panel of
40 developing countries. They used co-integration technique to determine the
existence of a long-term relationship between private investment and its
determinants. They fund out that almost all the explanatory variables exhibit a
significant impact on private investment, with the exception of macroeconomic
stability and infrastructures. The accelerator variable (ACC) has the expected
positive sign, which implies that the anticipation of economic growth induce
more investment. Similarly, interest rate (r) appears to exert a negative
effect on firm’s consistent with the user cost of capital theory.
In
the U.S, Evans, estimated that net investment would rise by anything between 5%
and 10% for a 25% fall in interest rate. These percentage changes were
calculated to occur over a two year period after a one year log.
A study by Kham and
Reinhart (1990) observe that there is a close connection between the level of
investment and economic growth. In other words, a country with low level of
investment would have a low GDP growth rate. The use of ryid exchange rate and
interest rate controls in Nigeria in low direct investment, the leads to
financial impressions in the early 1980. Fund were inadequate as there was a
general lull in turn leads to the liberalization of the financial system Omole
and Falokun (1999). This may have an adverse effect on investment and economic
growth.
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 impact of interest rate volatility on investment
decisions in Nigeria using time series data covering from 1981-2010.
1.2
Statement of the Problem
The financial systems
of most developing countries (like Nigeria) have came under stress as a result
of the economic shocks of the 1980s. 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) delay 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 declines in investment as
a result of decline in the external resource transfer since 1982, has been
especially sharp in the highly indepted countries, and has been accompanied by
a slowdown in growth in all LDCs. Both public and private investment rate have
fallen, although the latter more drastically than the former. If this trend is
maintained, it will lead to a slowdown in medium term growth possibilities in
these economies and will reduce the level of long-term per capital consumption
and income, endangering the sustainability of the adjustment effort. 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.
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