THE EFFECT OF INTEREST RATE VARIATION ON INVESTMENT DECISION IN NIGERIA


THE EFFECT OF INTEREST RATE VARIATION ON INVESTMENT DECISION IN NIGERIA

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ABSTRACT

Interest rate variation has actually posed a big threat to the trend of direct investment in all world economy. In the light of this, this study used OLS model, to study the relationship or impact of interest rate variation on investment in Nigeria from 1980 to 2008. The study employed a linear regression methodology. In this study, numerous theoretical and empirical literatures were reviewed. Most importantly, the findings of the regression model showed a strong relationship between investment and interest rate and some other variables like capacity utilization, exchange rate and Gross Domestic Product. Therefore the study used four variables to regress on investment for the study period. From the findings, all variables were significant and the R2 showed a good fit of the model i.e. a 99% impact from the independent variables. From the findings we also proffered policy recommendation that could enhance future investment with policies that check interest rate trend.

CHAPTER ONE

INTRODUCTION

1 .1 BACKGROUND OF THE STUDY

Interest rate variability is one of the emerging issues in economic policy. This is basically as a result of the role it plays in inducing savings as well as investment in the economy.

Evidence has shown that the determinants of investment are on the increase in recent times. As a result, it has become difficult for researchers to come up with a general acceptable investment function. Irrespective of the controversy in trying to determine what should be part of investment, there has been a point of reconciliation and this point of reconciliation centers on interest rate.

According to (Mankiw, 2000), interest rate is the market price at which resources are transferred between the present and the future; the return to saving and the cost of borrowing. The quantity of investment goods depends on the interest rate, which measures the cost of the funds used to finance investment. For an investment project to be profitable, its return (the revenue from increased future production of goods and services) must exceed its cost (the payments for borrowed funds). If the interest rate rises (variability), fewer investment projects are profitable, and the quantity of investment goods demanded falls.

Therefore, interest rate can be seen as the reward for parting with liquidity for a specified period. It is the inverse proportion between a sum of money in exchange for a debt for a stated period of time.

(Anyanwu, 1995) and (Dernburg, 1983) defined interest rate as the cost of borrowing as well as the implicit cost of holding it. This definition agrees with the (CBN Briefs 1997), definition where interest rate is regarded as the rental payment for the use of credit by borrowers and return for parting with liquidity by lenders.

Furthermore, interest rate is not only primarily to help in the mobilization of financial resources, but also to ensure the efficient utilization of such resources in the promotion of economic growth and development. Interest rates affect the level of consumption on one hand and the behavior of savings on the other hand. They are crucial in financial intermediation, which involves the transfer of funds from the surplus unit to the deficit unit in the economy. (CBN Brief 1998).

Between 1960s and mid 1980s, Nigeria witnessed a low interest rate regime, which was aimed at encouraging investment. With the introduction of Structural Adjustment Program (SAP) in the third quarter of 1986 by Babangida’s regime, fixed and low interest rates were replaced with dynamic interest rates determined by the market forces. Interest rates were therefore allowed to be determined by the forces of demand and supply in order to compete favorably with the ever-rising inflation rate since 1986. This policy shift laid emphasis on direct investment stimulation through low interest rate but encouraged savings mobilization by decontrolling interest rates.

1.2 STATEMENT OF RESEARCH PROBLEM.

Following statistics, investment has been on the increase from 1975 to 1980 despite a decline from $9420.6 in 1977 to $9094.5 in 1979. (Central Bank of Nigeria, Investment journal. 2001. Vol. 24). Correspondingly, interest rate had averaged about 4.79% during this period. However, investment expenditure has shown a relative from 1982 to 1985. Investment started reducing, reaching an all time low of 5417 in 1984, indicating a negative relationship. Conversely, between 1986 and 1990, interest rate increased from 10% to 18.5% as investment also increased. Also, interest rate increased from 17.5% in 1992 to 26% in 1993 during which investment still increased by 38%. (Central Bank of Nigeria, Investment Journal. 2001. Vol. 24).

Finally, the variability of interest rate has been stable between 1994 and 1997 before the swings occurred between 1998 and 2001. Correspondingly, investment increased during this period of 1994 to 1997, before declining in 1998 and 1999. (CBN Bulletin, 2003). From the foregoing, investment expenditure have shown an irregular relationship with interest rate as some years has related positively with investment while others have correlated negatively with changes in interest rate.

Against this backdrop, this study seeks to empirically investigate interest rate variation and its effect on investment decision in Nigeria.

These questions will help in analyzing the issue.

1. What has been the correlation between interest rate and

investment?

2. How has investment decision improved or worsened the

economic situation in Nigeria?

1.3 OBJECTIVES OF THE STUDY

The objectives of the study are as follows:

a. To determine the effect of interest rate variation on investment decision in Nigeria.

b. To discover the robust factors that influenced investment

decisions in Nigeria.

1.4 STATEMENT OF HYPOTHESIS

The following statement of hypothesis will guide this study.

a. Interest rate has no significant influence on investment.

b. Total investment does not have significant effect on aggregate economic growth.

1.5 SIGNIFICANCE OF THE STUDY

This study is very important because it focuses on the role of interest rates in mobilizing savings and how savings, if well channeled into productive investment can lead to sustained economic growth.

The study is also important to the entire Nigeria economy because it directs the economy on when to invest more or less considering the interest rate variations.

Investors and business tycoons will benefit solely from this research because it will serve as a guideline to know the suitable environment to either increase or decrease investment with respect to interest rate.

Borrowers will also be on the gaining side as a result of this research work. It tells them when to borrow more or less funds for investment considering the variations in interest rate

1.6 SCOPE OF THE STUDY

This study covers the period 1980-2008, which is a period of twenty-nine years. It is principally limited to estimating the patterns of investment decisions and how they are affected by interest rate.

1.7 LIMITATIONS OF THE STUDY

This research work is limited to Nigeria alone and the year under study is from 1980 to 2008. It was observed that the recorded data for interest rate significantly underestimated the trend of investment of the studies conducted. This can be attributed to the method applied in generating such data. Also, because of time constraint, the researcher resorted to using these published data from Central Bank of Nigeria. Another constraint worthy of mentioning is the financial constraint. The process of typing and printing before approval actually posed a challenge to the research

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