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THE IMPACT OF INTEREST RATES ON SAVINGS AND INVESTMENT IN NIGERIA

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CHAPTER ONE:                

   INTRODUCTION

1.1 BACKGROUND OF THE STUDY

Interest is the reward that accrues to people who provide the fund with which capital goods are bought (Soyibo and Adekanye, 1992).  Interest can also be defined as the payment made to a lender by a borrower for the use of a sum of money for certain period of time.  The charging of interest on loan was initially abolished during medieval days, both was later legalized by King Henry VIII in 1545 when he abolished the usury laws in it was condemned.  These usury laws were established during the medieval time when the payment of interest rate was strongly condemned and termed usury.  During that time it was believed that loan was an aid to an individual or neighbour who is distressed, for such reason, they felt charging of interest on loan was not proper (Bhatia and Khatkhate, 1973).

 

Interest rate deregulation was later introduced into the monetary system by Central Bank of Nigeria, which was part of the Structural Adjustment Program (SAP), which was introduced in July 1986 by the head of state then-Gen Ibrahim Babangida (Osofisan, 1993). Interest can also be said to be the charge assessed for the use of money.  It can also be seen as “the payment made to owners of capital fund which they are ready to put at the disposal of others; thus, interest rate is like a price which bring into equilibrium the demand for resources to invest with the readiness to establish from present consumption.  Interest rate is determined by the force of demand and supply of capital and for the condition that demand and supply of fund are equal. Hence, interest level is arrived at by the intersection between savings and investment (Luckett, 1984). Savings is defined as that portion of income after tax, which is not spent on consumption goods.  Savings can also be seen as that part of income, which is not devoted to the purchase of household items and firm (McKinnon, 1973). Investment on the other hand can be defined as the expenditure of funds lending to the creation of net additions to the stock of physical capital; it is done almost exclusively by firms.  Interest rate favours the investors when the interest rate is low.  The major factor that determines investment is interest rate and this is influenced by savings.  The investors will also be favoured when the marginal efficiency of capital is high.  Marginal efficiency is defined as the expected rate of returns from additional unit of capital asset.  It refers to the expected rate of profit per year on real investment of the most efficient type, it depends upon the entrepreneur expectation of future return.  However, there will be no investment of profit expectation which are not very bright, this is the reason why investment falls to a low level during a depression despite all the encouragement to stimulate private investment (Revel, 1975).

 

Interest rate favours savers when the rate is high, savings were looked upon as beneficial both for the individual and the society at large.  Thus, an increase in savings will ultimately lead to an increase in savings of the community.  It was due to this effect that the classists believed in thriftiness (Ritter and Siber, 1986).  They were of the view that an individual saving was a great private as well as social virtue. The Keynes were at a different view, which they advocate that individual savings is a social virtue but rather supported the view that individual savings is greatly a social vice.  Increase savings on the part of individuals will result in a general curtailment in the expenditure.  When savings increase, investment is very essential for the economic development of an economy.  With increase investment, employment is bound to increase which will in turn increase demand, prices, profit and more production expansion.  This expansion if properly utilized will lead to economic development of a country (Shaw, 1973).

Investment results as a consequence of capital accumulation, which in turn depends upon savings (Ndulu, 1990).  Savings by profit earners and their conversion into investment was the main actor responsible for the economic development of Great Britain in the 19th century. The realization of the role of interest rate in the attainment of monetary policy objectives, the central bank of Nigeria decided to have a uniform rate of interest on loan for all the commercial banks in Nigeria, as contained in its credit guidance of 1969. The credit guidance of the Central Bank of Nigeria was later changed in 1987.  It introduced an interest rate policy based on free market forces in view of the effort of government to deregulate the economy in the wake of the second-tier foreign exchange market.  This interest rate deregulation is a system where the forces of demand and supply determine the prevailing interest rate.  This implies that there is no fixed rate to be charged by the bank on their loans and advances and no given rates to be paid to depositors (Soyibo and Adekanye, 1992).

 

There are three main approaches in economics to the determination of interest rates.  These theories vary in their views on interest rate, although there are some similarities among them, these theories include the following; the classical theory of interest (loanable fund), the liquidity reference theory (Keynesian Approach), the general equilibrium approach (modern). An overview of these theories of interest rate reveals that interest rate can influence the growth of savings and investment in an economy, the understanding of the nature, meaning and role of interest rate in the same economy is crucial, in a nutshell, interest rate is a given prominent position as a catalyst for growth in the economy and particularly a factor in determining the growth of savings and investment (Osofisan, 1993).

  • STATEMENT OF THE PROBLEM

Many developing countries, under a crushing burden of debt and other external disequilibria, have adopted programmes to restructure their economies. A major cornerstone of such adjustment programmes is the liberalization of financial markets and a greater role assigned to market forces in the allocation of financial resources, and generally involves interest rate deregulation and relaxation or cancellation of the policy of directed credits.

The policy of interest rate in developing countries seems to have been backed by the McKinnon-Shaw financial intermediation hypothesis which postulates that interest rates have a positive response to savings and economic growth (McKinnon, 1973; Shaw, 1973). The link between interest rate responsiveness and savings, as postulated by the McKinnon-Shaw hypothesis, is investment. However, behaviourally and operationally, savings and investment differ (Bhatia and Khatkhate, 1975; Fry, 1978); the transfer of savings to investment being dependent on a host of factors other than the real interest rate. Such factors include the availability of investment opportunities at rates of return exceeding cost of funds, the existence of private and social profitability differences, institutional constraints and the cost of administering funds. Thus, a study of the link between real interest rates and investment cannot be done solely via the McKinnon-Shaw hypothesis. Unfortunately, studies of financial liberalization policies assumed the link between savings and investment as given and/or regard specification of the effect of the real interest rate on investment as difficult (Mwega et a!., 1990).

Also, studies of the effect of adjustment programmes on economic growth tend to assume the existence of the Keynesian savings and investment macroeconomic balance (Ndulu, 1990). Yet, it is known that resource gaps constrain economic growth in developing countries. The successful application of financial liberalization policies in developing countries, therefore, goes beyond demonstrating the applicability or otherwise of the McKinnon-Shaw hypothesis. There is a need to investigate the behavioural relationships between investment and savings (perhaps via the real interest rate) to identify the determinants of the mechanism of transmission of savings to investments.

In Soyibo and Adekanye (1992a), the applicability of the McKinnon-Shaw hypothesis to Nigeria was established, though Shaw’s hypothesis seems to be more strongly supported. This suggests that the debt intermediation hypothesis holds in Nigeria. To influence economic growth positively, the increased savings mobilized as a result of financial system liberalization would need to be transmitted to investment. An understanding of the savings-investment process therefore, can help inform policy decisions aimed at promoting economic development.

At least two approaches can be adopted in this regard. First, the characteristics of the supply side can be determined, with an analysis of the factors affecting portfolio management decisions of suppliers of credit using their perceptions and objective data. Second, the characteristics of the demand can be studied, establishing the determinants of demand using perceptions as well as objective data. This paper concerns itself with the first approach, using principally primary data to analyse the perceptions of bankers. The limitations of this approach will be discussed later. However, a study of banking system operators’ perceptions of the impact of the different regulatory regimes on the performance of the system has its own merits. It can spotlight the areas of general consensus as to the effectiveness or otherwise of government policy. Such a study can also be a type of ex post evaluation of the impact of government policy on the banking system from the point of view of those directly affected.

  • OBJECTIVES OF THE STUDY

The main objective of this research includes the following:

  1. To determine the impact of interest rate on savings in Nigeria.
  2. To determine how interest rate impact on the investment rate in Nigeria.
  3. To determine the impact of savings on Investment in Nigeria
  • RESEARCH QUESTIONS

As a follow up to the above objectives, the following questions are asked;

  1. What is the impact of interest rate on savings in Nigeria?
  2. What is the impact of interest rate on investment in Nigeria?
  3. Do savings have an impact on Investment in Nigeria?

 

  • HYPOTHESES

The following hypotheses have been formulated based on the objectives of study and the research questions;

HO:    There is no positive significant impact of interest rate on savings in Nigeria.

HO:    There is no positive significant impact of interest rate on Investment in Nigeria.

Ho:    There is no positive significant impact of Savings on Investment in Nigeria?

  • SCOPE OF THE STUDY

In order to carry out a comprehensive and meaningful research work on the critical effect of interest rate as a determining factor in the growth of savings and investments in Nigeria.  This work was based mainly on Central Bank of Nigeria (CBN), which regulates the employment of interest rate, savings and investment and on the Intercontinental Bank plc. Data used covers a period of ten years (1970 – 2008) so that the impact of interest rate on savings and investment can be compared using the interest policies.

  • SIGNIFICANCE OF THE STUDY

The deterioration of the Nigeria economy calls for a scrutinization of the economic policies.  This Nigeria like all other developing countries is faced with the problem of choosing the most appropriate policies, which will be employed to attain economic growth.  An identification of the factors, which influence the economy, becomes necessary, the level of investment being a major influence of economic growth lead us to the study of interest rate which is one of the factors influencing investment as well as savings (which provides funds for investment). In order to avoid decisional myopia there is a need for efficient and proper economic planning.  The need for undertaking this study stems from the important role the rate of interest plays in determining the growth of savings and investment.  This shall be of immense benefit to commercial banks in general, the CBN, the general economy and to future researchers in the field of interest rate.

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