THE IMPACT OF INTEREST RATE ON DOMESTIC INVESTMENT

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

The behaviour of interest rates, to a large extent, determines the investment activities and hence economic growth of a country. Investment depends upon the rate of interest involved in getting funds from the market, while economic growth to a large extent depends on the level investment. According to Jhingan (2003), if the rate is high investment is at low level. A low rate of interest leads to an increase in investment. There is therefore a need to promote an interest rate regime that will ensure “inexpensive” spending for investment and consequently enhancing economic growth at low financial cost.

Interest rate is a critical variable in the loanable funds market, given its role in the mobilization and efficient allocation of financial resources. Prior to the adoption of the Structural Adjustment Programme (SAP) in 1986, the authorities in Nigeria fixed the level and structure of interest rate. The major reasons for regulating interest rates were the desire to obtain the social optimum in resource flow to the preferred sector; promote an orderly growth of the financial markets; combat inflation and lessen government’s debt service burden. In order to facilitate the flow of domestic credit to the priority sectors, discriminatory and below market interest rates were fixed for credit to agriculture, manufacturing and residential housing construction. This policy generally led to the unintended consequences of moral hazard and adverse selection.

The financial sector reforms, which commenced in July 1986, relied on market forces. Its objective was the elimination of financial repression in order to improve the incentive structure and ensure allocative efficiency. The policy stance of the regulatory authorities has been guided by the general economic conditions and developments in the financial markets. At various times, there had been policy shifts induced by the need to deal with emerging problems. However, by October 1996, all forms of control on interest rates had been removed, following further liberalization of the financial sector, thus the Central Bank of Nigeria’s minimum rediscount rate became the nominal anchor of its interest rate in the flow of banks credit, which averaged 19.8 percent in 1980 – 1986, 28.6 percent in 1987 – 1996 and averagely 42.9 percent in 1997 – 2000s respectively. However, the unintended consequence of the policy shift from controls to liberalization has been the rise in interest rates, especially between 1986 and 1993. Interest rate was relatively stable between 1994 and 1997 and, thereafter, became volatile (CBN, 2015)

Based on the foregoing, this study is aimed at carrying out an empirical analysis on the impact of interest rate on domestic investment in Nigeria covering the period 1980-2016.

1.2 Statement of the Problem

The influence of interest rate in determining the level of domestic investment in an economy cannot be overemphasized. However, over the years in Nigeria, interest rate has always been fluctuating and this has adversely affected the level of domestic andforeign investmentin the economy. Various measures have been taken by the government to stabilize the level of interest rate in the economy but these steps and policy strategies were ineffective in the economy. Firstly, through the Central Bank of Nigeria (CBN), the interest rate has been pegged at various rates so as to prevent fluctuations and volatility movements. This was facilitated by the policy of interest rate deregulation in the economy in 1986. However, despite these policies, the level of interest rate has not been impressively stable and the level of domestic investment has not been optimally on the increase. This study is thus focused on the evaluation of the impact of interest rate on domestic investment in Nigeria.

1.3 Research Questions

In the course of this study, the following research questions will be addressed:

1.     To what extent has interest rate affected the level of domestic investment in Nigeria?

2.     To what extent has inflation impacted on the level of domestic investment in Nigeria?

3.     To what extent has money supply impacted on the level of domestic investment in Nigeria?

1.4 Objectives of the Study

The general aim of this study is to evaluate the impact of interest rate on domestic investment in Nigerian economy. The specific objectives of the study include:

1.     To ascertain the impact of interest rate on domestic investment in Nigeria.

2.     To evaluate the impact of inflation on domestic investment in Nigeria.

3.     To evaluate the impact of money supply on domestic investment in Nigeria.

1.5 Hypotheses of the Study

The following hypotheses of the study will be tested:

Ho: Interest rate has no significant impact on domestic investment in Nigeria

Ho: Inflation has no significant impact on domestic investment in Nigeria

Ho: Money supply has no significant impact on domestic investment in Nigeria

1.6 Significance of the Study

A research draws its relevance from the present and prospective beneficiaries and its contribution(s) to academia at large. The pertinence of this research is justified on the grounds that it will show the impact of interest rate on domestic investment in Nigeria for the years under review; and thus provides a framework for policy prescriptions and interventions. In furtherance to the above, this research will find its relevance as made evidence in the following:

The Banking Sector: The banking sector will benefit significantly from this study as it will reveal the impact of interest rate on domestic investment in Nigeria. This is because the banking sector use interest rate as an instrument of lending and this study will show the impact it has on domestic investment in Nigeria over the years.

Government: The federal government will find this study highly relevant as it will provide a picture of the relative impact of interest rate on domestic investment and thus motivate relevant policy reforms or sustenance. This research will also find its relevance in the coffers of financial variable analysts given that the subject under study is purely a monetary phenomenon.

Subsequent Analysts: This investigation will also serve as a stepping stone for researchers who develop interest in carrying an empirical analysis on the concept of interest rate and domestic investment.

Scholars: Students will find this piece highly relevant as it will undeniably increase their knowledge horizon on the concept of interest rate and domestic investment.

The Academia: The education sector is also considered as one of the significant beneficiaries because it is believed that this research will be an addition to the existing stock of knowledge.

1.7 Scope and Limitations of the Study

The primary focus of this study is to carry out an empirical analysis of the impact of interest rate on domestic investment in Nigeria between 1980 and 2016. In the course of carrying out this research, the researcher was confronted with a lot of limiting threats which amongst others included time constraint, the dearth of data and some discouraging attitudes from the staff of some statistical agencies. However, despite these limitations, the researcher will ensure that the objectives of the study are duly met and actualized.