CHATER ONE

INTROUCTION
1.1 Background to 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 of investment. According to Jhingan (2003), if interest rate is high, investment is at low level and when interest rate falls, investment will rise. 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. The financial system of most developing countries came under stress as a result of economic shocks of the 1980s. Additionally, financial repression, largely manifested through indiscriminate distortion of financial prices including interest rates has tended to reduce the real rate of growth and the real size of the financial system relative to the non-financial magnitude. More importantly, financial repression has retarded the development process as envisaged by Shaw (1973). Undoubtedly, Governments past efforts to promote economic development by controlling interest rate and securing inexpensive fund for their own activities have undermined financial development.

Prior to the deregulation of interest rates in Nigeria, the financial sector operated under financial regulations and interest rate were said to be repressed. According to Mckinnon (1973) and Shaw (1973), financial repression arises mostly where a country imposes ceiling on deposit and lending nominal interest rates at a low level relative to inflation. The resulting low or negative interest rates discourage savings mobilization and channeling of mobilized savings through the financial system. This has negative impact on the quantity and quality of investment and hence economic growth in view of the empirical link between savings, investment and economic growth. In realization of these, the Nigerian government took steps to liberalize interest rates as part of the reform of the entire financial system. Financial sector reforms began with the deregulation of interest rates in August 1987 Ikhinde et al (2001). The Nigerian government in 1994, in a policy reversal, however introduced some measure of regulations into the interest rates management. It was claimed that there were wide variations and unnecessarily high rates under the complete deregulation of interest rates. Immediately, deposit rates were once again set at 12%-15% per annum while a ceiling of 21% per annum was fixed for lending rate. By the end of 1994, the weighted average lending and deposit rates were 21% and 13.5% respectively. The cap for interest rate was retained in 1995 with minor modification to allow for flexibility. The cap

was maintained until it was lifted in 1996. This made possible a flexible interest rate regime in which bank lending and deposit rates were largely determined by the forces of demand for and supply of funds. But despite these efforts, the level of economic growth in Nigeria is still very low. It is against this background that the researcher assesses the impact of interest rate deregulation on economic growth in Nigeria.

1.2 Statement of the Problem

Prior to the deregulation of interest rate in Nigeria, the prevailing rates of interest were regulated by government through the Central Bank of Nigeria (CBN). This was meant to guide the economy to follow the desired direction. However, it was soon realized that, the low rates of interest that prevailed could not be sustained. On the other hand, the very low and sometimes negative real interest rates discouraged savings. Also, the low rates did not only increase the demand for loanable funds but also misdirected credit. Consequently, the demand for credit soon exceeded the supply of funds while essential sectors of the economy were starved of funds. It was against this background that the Nigerian financial system was deregulated in the second half of the 1980s. A major objective of the deregulation exercise was to increase savings for investment and economic

growth. The deregulation exercise has been met with mix feelings in Nigeria. While some believe it would enhance economic performance in Nigeria, others have contrary opinion. Nwankwo (1989) believes that interest rate deregulation will definitely lead to more efficient allocation of financial market resources. His position is in line with the arguments of Mckinnon (1973) and Shaw (1973). Abiodun (1988), on the other hand believed that deregulation of interest rate is like a double-edged sword, which will either stimulate or mar the economy. He asserted that the deregulation of interest rate will lead to an increase in interest rate, which will increase savings. However, he opined that high cost of borrowing might bring about cost-push inflation as borrowers of funds will pass the high cost of borrowing to the customers by pushing up prices. Ojo (1988) and Ani (1988) are both of the opinion that interest rate deregulation would mar the Nigerian economy. In their separate papers, they flawed the deregulation exercise, claiming it would discourage investment and hence economic growth, by pushing up interest rates. Ojo and Anis position are supported by Soyimbo and Olayiwola (2000) and Akpan (2004) who all pointed out the low positive impact of deposit rate on economic growth after interest rate liberation in Nigeria. These contrary opinions about the effectiveness of the deregulation exercise in Nigeria raises the issue of the effectiveness of the deregulation

exercise. There is therefore the need for a comprehensive evaluation of the role of interest rate deregulation in promoting economic growth in Nigeria through savings and investment. It is against this backdrop that this research work sets out to evaluate the effect of interest rates deregulation on economic growth in Nigeria.

1.3

Research Questions

The basic questions the research attempts to answer are: i. What is the impact of interest rates deregulation on economic growth in Nigeria?
ii.

What is the impact of interest rate deregulation on savings in Nigeria?

iii.

What is the impact of interest rates deregulation on investment in Nigeria?

iv.
v.

What is the impact of Investment on economic growth in Nigeria? What is the relationship between economic growth and other explanatory variables such and government expenditure in Nigeria?

vi.

Between regulated and deregulated interest rates, which has better impact on economic growth?

1.4

Objective of the Study

The main objective of the study is to examine the impact of interest rate deregulation on economic growth in Nigeria. The specific objectives of the study are: i.

To investigate the impact of interest rate deregulation on savings in Nigeria.

ii.

To investigate the impact of interest rate deregulation on investment in Nigeria.

iii.

To investigate the impact of investment on economic growth in Nigeria.

vii.

To investigate the relationship that exists between economic growth and government expenditure in Nigeria?

viii. Make a comparative analysis between the impact of regulated interest rates and deregulated interest rates on economic growth in Nigeria.

1.5

The Significance of the Study The relationship between interest rates deregulation and economic growth

in Nigeria has been analyzed in many empirical studies. Obamuyi (2009) used a single equation model to investigate this relationship. This approach was also employed by Adofu (2010) and Amassoma (2011) when they separately investigated the impact of interest rates deregulation on agricultural productivity in Nigeria. But the relationship between interest rates and economic growth is indirect as interest rates affect economic growth by first of all affecting savings and investment. There is therefore a need to investigate the impact of interest rate deregulation on economic growth by first of all looking at its relationship with savings and then investment. This approach was lacking in most empirical studies. This study shall investigate the interest rates deregulation and economic growth relationship by taking into consideration the transmission mechanism through which interest rate affects economic growth. This research is also significant because it will make a comparative analysis between the impact of deregulated interest rates on economic growth and that of regulated interest rates on economic growth. As a result, the outcome of this research will shed more light on the role of interest rates in economic development in Nigeria. Consequently, this work will be useful to Government and monetary policy makers in their quest to improve financial

intermediation in the economy. Also, by raising specific issues concerning the link between interest rates and economic growth in Nigeria, this work will provide a basis for further in-depth investigation in this area.

1.6

Research Hypothesis The research will test one main hypothesis which is as follows: -

HO:

Interest rate deregulation has no significant effect on economic growth in

Nigeria. The Real Lending Rate (RLR) shall be used as proxy for interest rate deregulation, while the Real Gross Domestic Product (RGDP) shall be used as a measure of economic growth. The hypothesis above forms the bedrock of this research. The hypothesis is to test the extent of relationship between interest rates deregulation and economic growth in Nigeria.

1.7

Scope of the Study This research covers a period of 46 years (1964-2009). The period will be

divided into two parts for a comparative study between the regulation era (19641986) and the deregulation era (1987-2009). The terminal data of 2009 is because data after 2009 were not available at the time of this study.

1.8

Organization of the Study This research work comprises five chapters

Chapter one provides the introduction to the study, which basically includes the background to the study, statement of the problem, research questions,

objective of the study, significant of the study, hypothesis and scope of the study. Chapter two contains the review of related literature. This chapter contains the conceptual framework, the theoretical framework and the empirical literature review. Chapter three focuses on the research methodology. This chapter provides the design for the research work. It contains the data required and their sources, data collection procedure and analysis techniques. This chapter also contains the model specification and the explanation of the variables of the model. Chapter four is concerned with the presentation of data collected, analysis of the data using the model formulated and a detailed discussion on the findings of the research work. Chapter five contains the conclusion of the study. It gives a concise summary of the study findings, draw a conclusion on the bases of the findings and finally, proffer recommendations.

CHAPTER TWO
LITERATURE REVIEW 2.1 Conceptual Framework 2.1.1 The Meaning of Economic Growth ` Economic growth is the process by which national income or output is

increased. An economy is said to be growing if there is a sustained increase in the actual output of goods and services per head. The rate of economic growth therefore measures the percentage increase in real national output, during a given period of time, usually a year, over the preceding years level Anyanwoncha (1993). Jhingan (2003) defines economic growth as a process whereby the real per capital income of a country increases over a long period of time. According to him, economic growth is measured by the increase in the amount of goods and services produced in a country. Economic growth occurs when an economys productive capacity increases which, in turn, is used to produce more goods and services. A nations economic growth can be measured in terms of its national income and the real per capital income. Economic growth is a very important goal of macro- economic policy because of the role it plays in economic development.

10

2.1.2 Determinants of Economic Growth One major determinant of economic growth is the availability of natural recourses. This factor determines the capability of an economy to grow. Countries with high natural endowments have higher growth potentials than those that are less naturally endowed. Another important factor that determines economic growth is capital accumulation. The process of capital formation according to Jhingan (2003) is cumulative and self feeding and includes three interrelated stages. (a) (b) The existence of real savings and rise in them. The existence of credit and financial institutions to mobilize savings and to divert them in desired channels. And
(c)

To use these savings for investment in capital goods.

Since savings is an increasing function of interest rate, rising interest rates help to mobilize savings for investment while an increase in investment, by multiplier effect, leads to economic growth. Organization, which relates to the optimum use of factors of production in economic activities, is also a determinant of economic growth. This emphasizes the role of the entrepreneur in economic growth. A high level of organization implies efficient use of factors which invariably enhances economic growth. Furthermore, economic growth depends on technological progress. An improvement in the techniques of

11

production enhances economic growth by facilitating improvement in the productivity of other factors of production.

2.1.3 Meaning of Interest Rate According to Keynes, interest is the reward for not hoarding but for parting with liquidity for a specific period of time. Keynes definition of interest rate focuses more on the lending rate. Adebiyi (2002) defines interest rate as the return or yield on equity or opportunity cost of deferring current consumption into the future. Some examples of interest rate include the saving rate, lending rate, and the discount rate. Professor Lerner, in Jhingan (2003), defines interest as the price which equates the supply of Credit or savings plus the net increase in the amount of money in the period, to the demand for credit or investment plus net hoarding in the period. This definition implies that an interest rate is the price of credit which like other price is determined by the forces of demand and supply; in this case, the demand and supply of loanable funds.

2.1.4

Determinants of Interest Rate Interest rate is the price for loanable funds. Like every other commodity

price, interest rate is determined by the forces of demand and supply for loanble

12

funds. Among the other factors that determine interest rates are savings, investment, inflation, government monetary policy, and taxation. Savings represents the major supply of credit while investment represents the demand for credit. Whenever savings falls, while investment remains constant, there is pressure on interest rate to rise. Similarly, a fall in investment with savings remaining constant usually pushes up interest rate. Inflation is another factor that influences interest rates. Expectation about inflation influence interest rates movements. Government monetary policy is another factor that influences interest rates. An expansionary monetary policy which increases credit in circulation would pull down interest rate while contractionary monetary policy usually pushes up interest rates. Furthermore, income tax consideration has some influence on market interest rates. For example, when borrowers are allowed to deduct interest payments in deriving taxable income, the after tax costs of fund would be lower than the prescribed rate. This would cause the demand for credit to be larger than would have been the case in the absence of tax provision. The resultant effect would be an increase in short-term interest rates. On the other hand, if lenders are expected to include interest received as taxable income, the after tax return will be less than the contract note, reducing, as it were, the supply of loanable funds, which would also lead to a rise in short-term interest rates. The

13

term of maturity of financial assets also affects interest rates; long term funds tend to attract higher interest rates than short term funds because of future uncertainties. Other factors that affect interest rates include speculation, expected changes in exchange rate and differentials between domestic and international interest rates. More recently, the influence of the global economic crisis, its influence on the banking system and the consequent government intervention have affected interest rates in Nigeria.

2.1.5

Structure of Interest Rate The various interest rates are generally classified into deposit and lending

rates. Deposit rates are paid on savings and time deposits of different maturities. Examples of such rates include savings, deposit, and fixed deposit rates. Lending rates are interest rates charged on loans to customers and they vary according to perceived risks, duration of loans, the cost of loanable funds and lending margins. Other rates of interest in the financial system include the treasury bills rate, the inter-bank and minimum rediscount rates. Treasury bills rate is the discount offered by the government to savers who purchase treasury bills. The inter-bank rate is the rate paid when banks borrow and lend to one another to adjust their liquidity positions. The monetary policy rate, previously called the

14

Minimum Rediscount Rate (MRR) in Nigeria, refers to the rate at which the Central bank lends to banks in the performance of its function of lender of last resort. The concept term structure of interest rates refers to a situation where the time of maturity is assumed to be the major factor affecting the rate of interest. In this instance, Short-term securities attract lower rates of interest than long-term securities. Occasionally, long term securities attract lower rates of interest than short-term ones, a phenomena referred to as an inverse field curve. The situation may arise when there is acute shortage of funds in the financial system or when the rate of inflation is rising.

2.1.6 Meaning of Financial Repression Financial repression refers to the notion that a set of government regulations, laws, and other non-market restrictions prevent the financial intermediaries of a country from functioning at full capacity. The policies that cause financial repression include interest rates ceiling, liquidity ratio requirements, high bank reserve requirements capital controls, restrictions on market entries into the financial sector, credit ceilings or restrictions on directions of credit allocation, and government ownership or domination of banks.

15

Economists argue that financial repression prevents the efficient allocation of capital and thereby impairs economic growth. Ronald Mckinnon (1973) and Shaw (1973) were the first to explicate the notion of financial repression.

2.1.7 Meaning of Interest Rates Deregulation Interest rates deregulation is an economic term used to refer to a situation where by forces of demand and supply are allowed to determine the value of interest rates rather than its value being administered directly by monetary authorities. Interest rates deregulation in seen as a deviation from financial repression. It has been advocated by many economists that interest rate deregulation helps to enhance savings, boost investment and consequently help to enhance economic growth.

16

2.2

Theoretical Framework

2.2.1 Theories of Economic Growth For the purpose of this research work, the following theories of economic growth will be considered. They are; Arthur Lewis Structural Transformation Model, Harrod-Domar Growth Models, Robert Solow model of long-run growth and Romers model of endogenous growth.

Arthur Lewis Structural Transformation Model In the mid 1950s, Arthur Lewis designed a two sector growth model

which focused on the mechanism by which less developed countries could enhance their economic growth. As emphasized by Todaro and Smith (2009), Lewis model consisted of two sections: a traditional overpopulated rural subsistence sector characterized by zero marginal labor productivity a situation that Lewis classified as surplus labor in the sense that it can be withdrawn from the traditional sector without any loss of output- and a high productivity modern urban industrial sector into which the subsistence sector is gradually transferred. The model focuses on both the process of labor transfer from the rural to the modern sector, and the growth in the modern sector. Both labor transfer and modern sector employment and growth depend on output expansion in the

17

modern sector, while output expansion depends on the rate of industrial investment and capital accumulation in the modern sector. On the assumption that businesses reinvest all their profits, such investment is possible by the excess of modern sector profit over wages. According to Lewis, the modern sector employers would hire the surplus labor from the traditional labor until their marginal physical product equals the real wage. As total output rises alongside wages and profit, these larger profits are reinvested, increasing total capital stock and consequently, increasing total product and raising the level of modern sector employment. This process of modern-sector self sustaining growth and development expansion is assumed to continue until all surplus rural labor is absorbed in the new industrial sector. Thereafter, additional workers can be withdrawn from the agricultural sector only at a higher cost of loss of food production because the declining labor-toland ratio means that the marginal productivity of rural labor is no longer zero. The structural transformation of the economy will have taken place, with the balance of economic activity shifting from traditional rural agriculture to modern urban industry. As cited in Jhingan (2003), Arthur Lewis model was criticized on the grounds that it assumed the rate of labor transfer and employment creation in the modern sector to be propositional to the rate of capital accumulation in the

18

modern sector without giving consideration to a situation where the Capitalist reinvest their profits in labor-saving capital equipments rather than duplicating the existing capital. The model also assumes the notion that surplus labor exists in rural areas while there is full employment in the urban areas. This contradicts modern research findings by development economists that surplus labor does not exist in developing countries. Some other unrealistic assumptions made by Lewis which formed the basis for the criticisms against his model is that there exist a competitive modern sector labor market that guarantees the continued existence of constant real urban wages up to the point where the supply of rural surplus labor is exhausted.

Harrord-Domar Growth Models The growth models propounded by Harrod and Domar are based on the

experiences of the advanced capitalist economies. They both emphasize the role of investment in economic growth based on the dual characteristics of investment. Firstly, it creates income and secondly, it augments the productive capacity of the economy by increasing its capital stock. The former is regarded as the demand effect while the later is the supply effect of investment. The Harrod and Domar models are based on the assumptions of full employment, absence of government interventions, open economy, equality

19

between average propensity to save APS and marginal propensity to save MPS, savings and investment relates to income of the same year and constant ratio of capital stock to income. Based on these assumptions, Domars model tries to explain the rate of growth in investment that would cause income to rise by a size equal to the rise in productive capacity, so that full employment is maintained. In his work titled The Theory of Economic Growth (1957), Domars Model as cited by Jhingan (2003), was given as DI/I = Where I= Investment, DI= Change in I, = Net potentials social average productivity of investment (=DY/I) =MPS His model shows that to maintain full employment, the growth rate of net autonomous investment (DI/I) must equal (the MPS times the productivity of capital). This is the rate at which investment most grow to ensure the use of potential capacity in order to maintain a steady growth rate of the economy at full employment. According to Domar, any divergence between the two will lead to cyclical fluctuations. When DI/I is greater than , the economy would experience boom and when DI/I is less than , it would suffer from depression.

20

Professor Harrod tries to show how steady growth may occur in the economy. Once the steady growth rate is interrupted, and the economy falls into disequilibrium, cumulative forces tend to perpetuate this divergence thereby leading to either secular deflation or secular inflation. Harrods model is based upon three growth rates; the actual growth rate (G) which is determined by the savings ratio and the capital output ratio. The actual is given as G=S/C where G is the rate of growth of output in a given period of time, C is the net addition to capital and its given as the ratio if investment to the increase in income (I/DY) and S is the average propensity to save, APS. The second is the warranted growth rate GW which is given as GW=S/Cr where Cr= the capital requirement needed to maintain GW. This equation shows that if the economy is to grow at the steady rate of G what will fully utilize its capital; income must grow at the rate of S/Cr per year. The third is the natural growth rate. This is the rate of increase in output at full employment as determined by a growing population and the rate of technological progress, Jhingan (2003). Harrods equation for the national growth rate is Gn. Cr = or S where Gn is the natural full-employment rate of growth. For full employment equilibrium growth, Gn=GW=G. Any divergence between the three rates of growth would cause condition of secular stagnation or inflation in the economy.

21

The Harrod- Domar growth models were criticized on the ground of their unrealistic assumptions such as the existence of full-employment, non-government intervention in the economy, constancy of MPS (s) and the capital output ratio (). Jhingan (2003).

Robert Solows Model of Long-Run Growth

The model of growth developed by Robert Solow is an alternative to Harrod-Domar models without its critical

assumption of fixed proportions of production. He postulates a fixed production function linking output to the inputs of capital and labour which are substitutable. Solows key modification from the Harrod - Domar model is that Solows model allows for substitution between capital and labour. In the process, it assumes there are diminishing returns to the use of these inputs. In his equation DK = SF(K) (j + n)k, Where K is capital labour ratio, (which depends on savings sf(k)), jk is depreciation and nk is after capital widening (providing the existing amount of capital per worker to net new workers joining the labour force).

22

On the assumption that DK = O, sf (ki) = (j + n) ki, Where Ki = The level of capital per worker when the economy is in its steady state, a temporary increase in the rate of output growth is realized as we increase K by raising the rate of savings. The key implication is that unlike in the Harrod - Domar analysis, in the Solow model an increase in S will not increase growth in the long run; it will only increase the equilibrium K that is after the economy has time to adjust. The capital labour ratio increases and so does the output labour ratio but not the rate of growth. An increase in saving(s) does raise equilibrium output per person which is a valuable contribution to development.

Romars Model of Endogenous Growth According to the neo-classical theories of economic growth

the prevailing low capital labour ratio of developing countries is an impetus for high investment which in turn enhances growth. But the situation in these countries leaves more to desired. It is based on this abnormal behavior of developing countries that the concept of endogenous growth theory or

23

more simply, the new growth theory was developed. This theory provides a theoretical that is framework for by analyzing system

endogenous

growth,

determined

the

governing the production process rather than by forces outside that system. The modern growth theory seems to explain the factors that determine the size of the GDP growth rate that is unexplained in the Solows neo-classical growth model. The modern theory of growth is hereby discussed within the context of the Romars endogenous growth model. Romars Model of growth addresses technological

spillovers (in which one firms or industrys gain lead to productivity gains in other firms or industries) that may be present during industrialization (Todaro, 2009). It is valuable to think of each firms capital stock as including its knowledge. The knowledge part of the firms stock is essentially a public good that is spilling over instantly to the other firm in the economy. As a result, this model treats learning by doing as learning by investment. You can think of Romars model as spelling out endogenizing the reason why growth might

24

depend on the rate of investment as in the Harrod Domar model.

2.2.2

Theories of Interest Rate Determination In this section, four theories of interest rate determination shall be

considered in this study; namely, the classical theories of interest rate which sees interest rate determination as real force effect, the loanable funds theory, the Keynesian theory of interest rate which focuses on the interaction of demand and supply of money as the major determinants of interest rate, and HicksHansen synthesis of the classical and keynsian theories of interest rate.

The Classical Theory of Interest Rate Determination The Classicals believe that the rate of interest is determined by the supply

of and demand for capital. The supply of capital depends upon the savings. The Classicals believes that while some categories of savers could save regardless of the level of interest rate, others are induced to save when interest rate rises. The total community savings thus depends positively on the level of interest rate.

25

On the other hand, the demand for capital consists of the demand for productive and consumptive purposes. To the Classicals, capital is demanded for its productivity. But this productivity is subject to the law of variable proportions. Based on this, the rate of interest is just equal to the marginal productivity of capital to the investor. With the application of more capital, its marginal productivity falls. This shows that the demand for capital is inversely related to the rate of interest. The level of interest rates according to the Classicals, is determined by the interactions of demand and supply of capital (Jhingan, 2003). Given a particular level of income, and an initial equilibrium between demand and supply of capital, a rise in interest rate will raise the supply of capital and reduce the demand for capital. The gap created between the demand and supply of capital would then put pressure on interest rate to fall until the equilibrium between the demand and supply of capital will be restored back at the initial level of investment. The reverse of this analysis is used to explain a situation of a fall in the interest rate. This process shows that, given flexible interest rates, there exists a self adjustment mechanism in the model that would always ensure equality of demand and supply of capital in the economy. Since savings also depend on other factors like the standard of living of the community, it then means people can become thrifty even when interest rate

26

remains constant. When this happens, the supply of capital curve would shift to the right, while interest rate would fall since demand for capital is constant. The reverse of this analysis can be used to explain a situation of a fall in savings at a fixed interest rate. Keynes led the team of critics of the Classicals approach to the determination of interest rate. He flawed the argument of the Classicals on the grounds that they assumed the existence of full-employment in the economy, they neglected other sources of savings which could affect the supply of capital, and they neglected the multiplier effect of investment on income. Jhingan (2003).

The Loanable Funds Theory of Interest The loanble funds theory, also known as neo-classical theory of rate of

interest as put forth by Knut Wicksell and Dennis Robertson was developed as an improvement over the classical theory of rate of interest. This theory emphasizes the role of monetary factors in determining rate of interest. As pointed out by Vaish (2005), this theory believes the long run equilibrium rate of interest is determined at the point of intersection of the demand curve for and supply curve of loanable funds. The supply of loanable funds consists of current savings, dishoarding of existing cash balances and newly created money.

27

Similarly, borrowing for investment, hoarding (to accumulate cash balances) and reduction in money supply caused by the banking system constitute the demand for loanable funds in the economy. The demand for loanable funds has primarily three sources: government, businessmen and consumers. These three units need funds for both purpose of investment, hoarding and consumption. The summation of demand for money for these three purposes (that is, for investment, hoarding and consumption) by all trio of government, businessmen and consumers, gives the aggregate demand for laonable funds. This aggregate demand for loanable fund is interest elastic and inversely related to interest rate. This shows that more will be demanded at lower interest rate and vice versa. The supply of loanble funds on the other hand comes from savings, dishoarding and bank credit. The primary sources of savings being private, individual and corporate savings. Though personal savings depend on income level, taking the level of income as given, they vary positively with the level of interest rate. Corporate savings are the undistributed profits of firms. It also varies positively with the level of interest rate. The other two sources of loanable funds; dishoarding and bank credit, are also positively related to interest rate.

28

The aggregate supply of loanable funds function is the summation of dishoarding, corporate savings and bank credit functions. This function is positively related to interest rate. Interest rate is therefore determined at the point of intersection of the both demand for loanable funds and the supply of loanable functions.

- Keynes Liquidity Preference Theory Keynes defines the rate of interest as the reward of not hoarding but the reward for parting with liquidity for a specific period. According to him the rate of interest is determined by the demand and supply of money. The supply for money according to Keynes, refers to the total quantity of money in the country for all purposes at any point in time. Though it is interest rate elastic to some degree, Keynes assumed it to be fixed by the monetary authorities.

The demand for money is the desire to hold cash. Keynes identified three motives why people desire to hold cash. They are: Transactionary motive: - This is the desire to hold cash for daily transactions in goods and services. This motive depends on the level of income.

29

Precautionary motive: - This is the desire to hold money so as to meet sudden expenditure and for unforeseen opportunities of advantageous purchases. This motive is also dependent on the level of income.

Speculative motive: - This is the desire to hold money so as to take advantage of investment opportunities that may arise in future. The speculative demand for money is a decreasing function of the rate of interest. Based on the three motives above, Keynes derived the total demand for

money function which is a combination of the three. The total demand for money is positively related to income and inversely related to the level of interest rate. The rate of interest is determined at the equilibrium point of both the demand and supply of money. Given a flexible interest rate, there exists a selfadjustment mechanism in the model that would also ensure equilibrium between the supply and demand for money. If the money supply is increased by the monetary authorities, for example, the demand for money becomes greater than the supply of money at the going interest rate. This will cause people to adjust their portfolios by investing in bonds. The value of bonds will raise and the interest rate will fall (since there is an inverse relationship between the value of interest yielding assets and interest rate) until demand and supply becomes

30

equal at a new but lower interest rate. The reserve of this analysis is used to explain a situation of a fall in the money supply. Similarly, any increase in the demand for money, given the supply of money, would cause interest rate to rise and vice versa. Keynes approach to the determination of interest rate was severely criticized by Hanson and Robertson on the grounds that he does not give regards to the important role played by savings in mobilizing funds in investment but considered interest rate as the reward for parting with liquidity (Jhingan, 2003). Keynes was also criticized on the grounds that his theory neglects other factors aside from the demand for and supply of money, which affects interest rate. These factors include level of savings and the level of investment.

Modern Theory of Interest Rate The modern theory of interest also known as the Hicks-Hansen Synthesis

of the classical and Keynesian theories was developed by John Hicks by synthesizing the classical and Keynesian liquidity preference theories. As

31

pointed out by Vaish (2005), its merit lies in its successful integration of savings, investment, and liquidity preference money supply. The theory makes use of the IS curve, which is the locus of points of those combinations of interest rate and income at which investment and savings are equal and consequently the real (product) sector of the economy is in equilibrium and the LM curve, which is the locus of all those combinations of interest rate and income at which the demand for and supply of money are equal and consequently the monetary sector of the economy is in equilibrium. Following the classical doctrine, investment is inversely related to interest rate while savings is positively related to interest rate. Equilibrium in the product market occurs where savings equals investment. Given savings, increase in investment would cause income to rise while interest rate falls and vice versa. This shows an inverse relationship between interest rate and income in the product market. The IS curve thus slopes downward from left to right showing an inverse relationship between interest rate and income level. This position is pointed out in Jinghan (2003).

The LM curve on the other hand, represents the equilibrium in the money market where demand for money (Md) equals the supply of money (Ms). Whenever income rises, given Ms, interest rate will rise and vice versa. This

32

shows a positive relationship between income and interest rate in the money market. The LM curve therefore, has a positive slope. Both the IS and LM curves do not separately determine the rate of interest. This is because it is possible for the product and money market not to be in equilibrium at the same time. To determine the equilibrium level of interest rate therefore, a general equilibrium model of the economy was developed. The model integrates the equilibrium in the money market with that of the product market. This is determined at the point of intersection of both the IS and LM curves. At this point, the equilibrium level of interest rate is determined simultaneously with the equilibrium level of income. The merit of the modern theory of interest rate is that it is devoid of all those criticisms which were valid in the case of the classical and Keynesian theories of interest rate. The equilibrium rate of interest under the modern theory is a fully determinate rate because it corresponds to the double conditions of equilibrium involving savings and investment, and demand for and supply of money Md and Ms.
2.2.3

Theoretical Link Between Interest Rate and Economic Growth This sub-section of the research reviews theories that consider the

relationship between interest rate and economic growth. The review is carried out within the contexts of the Keynesian theory of income, output and

33

employment, and the Financial Liberalization Theory of Mckinnon (1973) and Shaw (1973).

The Keynesian Theory of Income, Output and Employment In the Keynesian theory of income, output and employment, employment

depends on effective demand while effective demand depends on aggregate supply, and aggregate demand. The former depends on technical conditions of production, while the latter depends on consumption demand and investment demand. In his work titled The General Theory of Employment, Interest and Money (1936), Keynes established a positive relationship between investment and economic growth. Since investment is a component of aggregate demand, an increase in investment would by multiplier effect increase output and income. Investment depends on the level of interest rate; the relationship being inverse. It then follows that the interest rate is inversely related to economic growth. If interest falls, investment will rise and output rises. On the other hand, if interest rate rises investment and output will fall. The rate of interest according to Keynes is determined by the demand and supply of money. Keynes theory of income, output and employment explains how interest rate, through

34

changes in investment, influences economic growth in the economy (Jhingan, 2003).

The Financial Liberalization Theory The Financial Liberalization Theory put forth by Mckinnon (1973) and

Shaw (1973) postulates that financial liberalization in financially repressed developing countries would induce higher savings, especially financial savings, increase credit supply, stimulate investment and hence help to boost economic growth. They both claim that interest rate regulations usually lead to low and sometimes negative real interest rates, which is the cause of unsatisfactory growth performance of developing countries. They claim that financial repression through interest rates ceiling keeps real interest rates low and thus discourages savings and consequently, stifles investment. Thus investment is constrained as a result of low savings resulting from financial repression. The quality of investment will also be low because the projects that would be undertaken under a regime of repression would have a low rate of yield.

With interest rate deregulation, real interest rates would rise thereby increasing both savings and investment. The increased investment results in the rationing out of low-yielding projects and subsequent undertaking of high-

35

yielding projects. This would therefore boost economic growth. Both Mckinnon and Shaw advocated that interest rates deregulation was needed to remedy the problems caused by financial repressive policy of developing countries. The researcher hereby adopts this theory as the main theoretical framework of this research.

2.3 `

Empirical Review The relationship between interest rate and economic growth has been a

subject of discussion among economic scholars. This relationship has stimulated a lot of empirical investigations. Khalid (2007), used four separate equations to measure the relationship between interest rate deregulation and economic growth in Pakistan between 1981 and 2002. There are;
TSt = 0 + 1RGDPt + 2RIRt + 3 CFt + 4 INFt + 5TSt-I + et (1) FSt = 0 + 1RGDPt + 2RIRt + 3 CFt + 4 INFt + 5TSt-I + ut (2)

INVt = 0 + 1RGDPt-1 + 2RIRt + 3 DCt + 4 FSt + 5INVt-1 + vt (3) RGDPGt = 0 + 1RGDPt-1 + 2INFt + 3 FSt + 4 Sgt + 5Sft + 6 CFt + t (4)

Where (TS) is total savings, (FS) financial saving, (INV) is investment, (RGDP) is real income, real interest rate (RIR), (Rf) is foreign interest rate, (e) is expected appreciation of domestic currency, inflation rate (INF), (CF) is a

36

measure of capital flight, (DC) is domestic credit, (Sg) is government saving, (Sf) is foreign. The level of total savings is proxied by gross domestic savings (GDS). Foreign reserves to GDP ratio is used as a measure of foreign saving (Sf). While equation 1 and 2 are to measure the impact of real interest rate on total savings and financial savings respectively, equation 3 measures the impact of real interest rate on investment, and equation 4 measures the impact of total savings and financial savings on economic growth. His findings were that real interest rate (RIR) has a positive effect on total savings (TS) (equation 1). The estimate of equation 2 revealed that RIR has an insignificant impact on financial savings (FS). From equation 3, while RIR was found to have an insignificant and negative impact on investment, the relationship between (FS) and investment was also negative. Similarly, the estimate of equation 4 also revealed a negative impact of FS on real GDP. His conclusion was that interest rate liberalization has not impacted positively on economic growth in Pakistan as most of the indicators of the financial liberalization do not show any significant impact on saving, investment or growth. Albu (2006), used two separate partial models to investigate the impact of investment on GDP growth rate and the relationship between interest rate and economic growth in the Romanian economy. The models are specified as; r () = a + b

37

 (I) = c/(d + i) Where r = GDP growth rate, = investment rate; i = interest rate, p= inflation, while a, b, c, and d are parameters to be estimated. Albus study revealed that while the investment-interest rate relationship is negative, the investmenteconomic growth relationship is positive. A study by Omar et al (2007) on the impact of interest rate liberalization on the economy of Bangladesh revealed that long-run economic growth in Bangladesh is largely explained by physical capital and real interest rate. They went on to state that financial liberalization has had significant negative impacts on economic growth implying that financial reforms failed to attract new investment. This they believe is due to the adverse investment climate existing in that country. Oshikoya (1992) used time series econometrics to investigate the impact of interest rate deregulation on economic growth in Kenya. Using data from 1970 to 1989, he found real interest rate to have a significant and negative impact on economic growth. The sample was then split into sub-periods 19701979 (regulation era) and 1980-1989 (deregulation era). The real interest rate

38

had a negative and significant coefficient for the 1970-1979 period, but was positive and significant for the 1980-1989 period; thus offering no robust result of the impact of interest rate deregulation on economic growth of that country. In their work titled The impact of Interest Rate Liberalization: Empirical Evidence for Sub- Saharan Africa (SSA) (2002), Charlier and Oguie found the real interest rate to have a significant and positive relationship with economic growth. A study conducted by Drees and Parabasioglu (1998) on the impact of interest deregulation on economic growth of Norway, Finland and Sweden revealed that with interest rates deregulation, interest rates surged in these countries leading to and increased economic growth. Osterbaan et al. (2000) estimated the relationship between the annual rate of economic growth (YC) and the real rate of interest (RR) using the basic equation YC = Bo + B1 (RR + B2) (RR + B2), he showed the effect of a rising real interest rate on growth. He also showed that growth is maximized when the real rate of interest lies within the normal range of say, -5 to + 15%. De Gregorio and Guidotti (1995) suggest that the relationship between real interest rates and economic growth might resemble an inverted U-curve. Very low and negative interest rates tend to cause financial disintermediation and hence to reduce growth. However, a World Bank report, cited in

39

Oosterbaan, et al (2000), showed a positive and significant cross-section relationship between average growth and real interest rate over the period 1965 to 1985. The relationship between interest rate and economic growth as recognized in the literature on growth can be found in the neoclassical growth frame work and the Mckinnon-Shaw hypothesis. For instance, McKinnon-Shaw (1973) argued that financial repression indiscriminate distortions of financial prices including interest rates reduces real rate of growth. One of the basic arguments of Mckinnon-Shaw model is an investment function that responds negatively to the effective real loan rate of interest and positively to the growth rate. Mckinnon Shaw school of thought expects financial liberation to exert a positive effect on the rate of economic growth in both the short and medium term. Obamuyi (2009), analyzed the relationship between interest rate and economic growth in the regulation and deregulation era in Nigeria. His model was in the form: GDPt=o+1RLRt+2RDR+3FID+4INFt+5DSGt+6FPSt+t Where GDP is real GDP growth rate, RLR is real lending rate, RDR is real deposit rate, INF is inflation rate (measuring macro-economic instability), FID is ratio of broad money to GDP, M2/CDP (index of financial depending), DSG

40

is ratio of gross domestic savings to GDP and FPS is dummy variable to capture the shift in financial policy from regulation to deregulation of interest rate in 1987, is a white noise disturbance term and 1, 2,------- 6 are parameters to be estimated. His findings were that there existed a unique long run relationship between interest rate and economic growth. However, according to Obamuyi, deregulation of interest rate in Nigeria may not optimally achieve its goal, if those other factors which negatively affect investment in the country are not tackled. ` Eregha (2010) investigated the relationship between interest rate and

investment in Nigeria between 1970 and 2002. His study revealed that variations in interest rate played a negative and significant role in investment decision in the economy and demand for credit also has negative and significant influence on interest rate variations in both the short-run and long-run. Akintoye and Olowalaju (2008), in their work titled Optimizing Macro Economic Investment decisions lesson from Nigeria revealed that low interest rate have constrained investment decisions in Nigeria. This revelation does not support Eregha (2010) whose study showed an inverse relationship between interest rate and investment rate in Nigeria.

41

Adofu et al (2010) Assessed the effect of interest Rate Deregulation in Enhancing Agricultural Productivity in Nigeria Their model was in this form; Ao = Bo + B1 IR + B2 ER + U Where, Ao = Agricultural output Bo = Intercept B1 = Parameter estimate of interest rate IR = Interest rate B2 = Parameter estimate of Exchange rate ER = Exchange rate U = Stochastic error term The study discovered that deregulated interest rate has a significant but positive impact on Agricultural production in Nigeria. Similarly, Amassoma et al (2011) investigated the impact of interest rate deregulation on agricultural productivity in Nigeria. Using Agricultural output (AGRIC), on Bank Lending (BKLD), Credit to Agricultural Sector (CRAG), Credit to Private Sector (CRPR), Direct Investment (DINVT), Exchange Rate (EXH), Interest Rate (INT) and Stochastic error (U1), the explicit form of his model was in this form;

42

AGRIC = $0 + $1 BKLD + $2 CRAG + $3 CRPR + $4 DINVT + $5 EXH + $6 INT + U1. His finding was that interest rate deregulation (represented by INT) does not have significant impact on agricultural output in Nigeria. As a recommendation, he called on the government to encourage total deregulation of interest rate in other to avoid financial disintermediation which may lead to low credit, investment and growth. The significance of Adofu et al (2010) and Amassoma et al (2011)s studies is informed by the fact that agriculture forms a significant part of GDP in Nigeria.

2.4

An Analysis of Interest Rate and Economic Growth in Nigeria Prior to the deregulation interest rates in 1986, the level of interest rates

was administered by the Central bank of Nigeria (CBN). Okpe (1998) opined that, before the introduction of the Structural Adjustment Program (SAP), interest rate was institutionally and administratively determined by the monetary authorities, in line with the federal government macro-economic objectives such as price stability. The power to control the structure of interest rate was contained in the Banking amendment act of 1969. This act states that the rate of interest charged on advance, loans and credit facilities or interests

43

paid on deposits by licensed bank shall be linked to the minimum rediscount rate of the central bank. According to Agu (1988), the 1969 bank decree (section 14) gave the bank of Nigeria (CBN) power not only to control but to determine and prescribe minimum and maximum interest rates chargeable by the banks. The advent of the structural adjustment program resulted in radical departure from the regime of control of interest rate and monetary management. It introduced market oriented development process with emphasis on small government, efficient resources allocation and market-determined price. The major policies of the structural adjustment program include trade liberalization, deregulation of interest rates, public sector reforms, privatization and commercialization Okpe (1998). The pre-reform period (1960-1986) is considered a period of financial repression and was characterized by a highly regulated monetary policy environment in which policies of directed credits, interest rate ceiling and restrictive monetary expansion were the rule rather than exception (Soyibo and Olayiwola, 2000). Although the rate policy instruments remain fixed, there were marginal increases. For instance, the deposit rate was increased from 4% in 1975 to 9.5% in 1986, while the lending rate rose from 6 to 10.5% within the same period.

44

For the reform period, deposit and lending rates were allowed to be determined by market forces and the interest rate actually increased as envisaged. For instance, the nominal deposit and lending rate rose from 9.5% and 10.5% in 1986 to 14% and 17.5% respectively in 1987 as a result of the interest rates reform in Nigeria. By 1990, the deposit and lending rates have risen to 18.8% and 25.5% respectively. The government intervened in 1991 and pegged the deposit and lending rates at 14.29% and 20.01% respectively. Unfortunately, between 1997 and 2006, the lending rate did not show a significant trend in reduction, with an average of about 22%. The real GDP growth rate which was 4.7% in 1964 increased to 199.8% in 1974, but was negative for 1978, 1982-1984. The introduction of interest rate reform in 1987 brought a positive change in real GDP growth rate to a peak of 21% in 2002. For most of the reform period, real GDP growth was positive. However, as an instrument of monetary policy the central Bank of Nigeria CBN (2000) indirectly influenced the level and direction of change in interest rate movement through its invention rate on various money market assets especially the Minimum Rediscount Rate (MRR) as well as the stop rate of weekly tender for treasury bills. The MRR as the nominal anchor of CBNs interest rate policy continued to be used proactively in line with prevailing economic conditions while the rate of treasury bills is made market related and

45

competitive with comparable money market instruments CBN (2006). Further, the MRR has undergone some fluctuations since 1987 to date as a result of the changes in the CBN policies which in turn have changed the overall economic conditions. In August 1987, was 15.0% and was reduced to 12.75% in december of 1987 with the objective of stimulating investment and growth in the economy. In 1989, the MRR was raised to13.25% in order to contain inflation. To further liberalize interest rate management, the cap on interest rate was lifted in 1992 and re-imposed in 1994 when inflationary spiral could not contained. However, in October 1996, interest rates were fully deregulated with the banks given freedom to determine the structure of interest rates in consultation with their customers. The CBN however, retained its discretionary power to intervene in the money market to ensure orderly developments in interest rates. The policy of interest rate deregulation has been retained since 1997. Interestingly, the MRR was replaced with the Monetary Policy Rate (MPR). Again, the MPR was brought down to 10% from 14% MRR, with a lending rate of 13% and a deposit rate of 7% which stood as a standing facility intended to stem volatility in interest rates especially that of the interbank rates.

46

CHAPTER THREE RESEARCH METHODOLOGY 3.1 Introduction This chapter discusses in detail the method and techniques to be used in carrying out the research work. The purpose of this methodology adopted here is to enhance the data collection and analyzing procedures all with the objective of producing a comprehensive research work.

3.2

Study Area The study covers all the sector of the Nigerian economy within the period

of 1964-2009. This is to enable the researcher measure quantitatively, the performance in terms of economic growth of the entire economy within the period under review.

3.3

Kinds/Types of Data Required and Source The data required for this study are the Real Gross Domestic Product

(RGDP) growth, within the period under review (1964-2009). This is because the RGDP will serve as proxy for collective growth of all sectors of the economy. The study will also use the Lending Rate (LR), the Deposit Rate (DR), the inflation rate, investment, total savings, money supply (M2),

47

population and government expenditure. Clearly, all these constitute secondary data. These data will be sourced from the Central Bank of Nigeria (CBN) publications, particularly the Statistical Bulletin and World Bank data base. Others are journals, magazines, reports, related text books and Federal Office of Statistics (FOS) review of the economy.

3.4

Method of Data Analysis The study will adopt both descriptive and analytical method of data

analysis. The descriptive tools will consist of tables, ratios and percentages. The analytical tool will consist of Ordinary Least Square (OLS) regression. Four separate regressions shall be estimated for each of the deregulation era (19872009) and the regulation era (1964-1986). The first regression would attempt to measure the relationship between real deposit rate and total savings before and after the deregulation exercise in Nigeria, the second would measure the relationship between real lending rate and investment before and after the deregulation of interest rates. The third would separately capture the impact of investment on economic growth within the two periods. And the last would express the relationship between real lending rate on economic growth before and after the deregulation exercise. The essence is to enable the researcher reveal the interest rate and economic growth relationship by looking at the

48

transmission mechanism through which this relationship exists, and also to make a comparative analysis between deregulated and regulated interest rates in terms of their contribution to economic growth. However, the variables in

question will first of all be tested for unit root using the Augmented DickeyFuller (ADF) test. This is to avoid spurious regressions. According to Gujarati (2009), regressing a non-stationary time series on another non-stationary time series produces a nonsense regression. The ADF test will be conducted at level, first difference and second difference using the models: n yt=1+yt-1+1 yt-i+t........................(1) i=1 n yt=1+ 2t+yt-1+1 yt-i+t.................(2) i=1 where, t is a pure white noise error term, y is a time series, t is a linear time trend, is the first difference operator, 1 is the intercept and n is the optimum

number of lags in the dependent variable.

3.5

Decision Rule

The usual tests of significance and goodness-of-fit will be employed to decide whether or not the interest rate deregulation has a significant impact on the economic growth in Nigeria. These include the t-values, the coefficient of

49

determination (R2) and adjusted R2, the F test, and the Durdin-watson test for autocorrelation. The t-test and F-test shall both be conducted at 5% and 10% level of significance. As a result, using their respective probability values, if their probabilities are below 10%, they shall be considered as being statistically significant.

3.6

Model Specification According to the financial liberalization theory, interest rate deregulation

would cause real deposit rate to rise and impact positively on total savings. While real lending rate would be negatively related to investment, investment would be positively related to economic growth. Thus real lending rate would be inversely related to economic growth. This methodology was employed by Khalid (2007) in specifying his model. The model specification for this research improves upon that of Khalid by attempting to also measure the relationship between economic growth and real lending rate. These models are;

TS=a0+a1RDR+a2MS+U1.(1) INV=b0+b1RLR+b2TS+b3POP+U2..(2) RGDP=c0+c1INV+U3...(3) RGDP=d0+d1RLR+d2+U4....(4)

50

Where; TS=total savings INV=investment RGDP=real gross domestic product POP=population MS=money supply (M2) GE=government expenditure RDR=real deposit rate (defined as deposit rate-inflation rate) RLR=real lending rate (defined as lending rate-inflation rate) a0, a1 and a2=parameters to be estimated for model (1) b0, b1, b2 and b3=parameters to be estimated for model (2) c0 and c1=parameters to be estimated for model (3) d0, d1 and d3=parameters to be estimated for model (4) U1, U2, U3 and U4=stochastic error terms for model 1, 2, 3 and 4 respectively. Model 1 captures the relationship between real deposit rate and total savings; model 2 will attempt to measure the impact of real lending rate on investment; model 3 would capture the relationship between investment and economic growth; and model 4 will measure the relationship between real lending rate and economic growth. The inclusion of all explanatory variables in

51

their respective model is in line with Obamuyi (2009), Jhingan (2003) and Mckinnon (1973) who claim these variables are explanatory variables as used in the models specification.

3.7

A Priori Expectation It is expected that;

For Model 1: Both RDR and MS should be positively related to TS. That is, a0, a1 and a3 >0. For Model 2: RLR should be negatively related to INV while POP and TS should be positively related to INV. That is b0 > 0, b0 < 0, b2 and b3 > 0. For Model 3: INV should be positively related to RGDP. That is, c0 and c1 should > 0. For Model 4: RLR should be negatively related to RGDP, while GE should be positively related to RGDP. That is, d0 > 0, d1 < 0 and d2 > 0.

52

CHAPTER FOUR DATA PRESENTATION AND ANALYSIS OF RESULT 4.1 Introduction

This section presents the results of the findings of the study from the data collected. Every attempt was made to ensure that this analysis is based on the activities of the variables under consideration, within the scope of the study.

4.2

Data Presentation The data presented in appendices A-E data are Lending Rate (LR), Real

Lending Rate (RLR), Deposit rate (DR), Real Deposit Rate (RDR), Inflation Rate (IF), Real Gross Domestic Product (RGDP), Real Gross Domestic Product Growth Rate (RGDPR), Investment (INV), Investment Growth Rate (INVR), Total Savings (TS), Total Savings growth rate (TSR), Government Expenditure (GE), Government Expenditure growth rate (GER), Population (POP), Population growth rate(POPR) Money Supply (MS), Money supply growth rate (MSR). From Appendix A, between 1964 and 1974, LR was fixed at 7% while DR was 3.5% between 1964 and 1967, and 3% between 1968 and 1974. LR and DR were then changed to 6% and 4% respectively between 1975 and 1977. From 1978 to 1986, LR and DR maintained an upward movement with LR

53

rising from 7.5% in 1978 to 10.25% in 1982. LR however dropped to 9.25% in 1985 before rising again to 10.5% in 1986. DR on the other hand, rose from 5% in 1985 to 7.5% in 1982 before closing at 9.5% in 1986. RLR and RDR however experienced a decrease from 1964 to 1968. RLR fell from 5.9% in 1964 to 3.3% in 1968 while RDR fell from 2.4% in 1964 to 0.7% in 1968. Both RLR and RDR rose to 6.1% and 2.1% in 1968 respectively. For the most of 1973 to 1986, both RLR and RDR were negative. This is why it is said that during the regulation era, interest rates were repressed. Inflation rate (IF) which was 1.1% in 1964 was 18.55% 1n 1973 and rose to 43% in 1975 where it experienced its peak. It then fell to 31.27% in 1977 but finished at 13.6% 1n 1986. From appendix B, Real GDP (RGDP) shows an increasing trend from 1964 to 1986. It was 2947.6 million in 1984 with a growth rate of 4.3%, it however dropped by -7% from 31520 million in 1977 to 29212.4 million in 1978. Between 1982 and 1984, RGDP maintained a negative growth rate. RGDP later rose to 205971 million in 1986 with a growth rate of 2.46%. Investment (INV) rose from 223 million in 1964 to 245.6 million in 1966 with a growth rate (INVR) of 5.59%. Between 1968 and 1969, it maintained a negative growth rate. For the rest of the regulation era, INV maintained an

54

upward trend with a positive growth rate before closed at 18299.9 million in 1986 rate. Total savings (TS) rose from 133.1 million in 1964 to 17.94 million in 1966 before dropping to 181.3 with a growth rate (TSR) of -12.16%. For the rest of the regulation era, TS maintained a positive growth rate which was at its highest in 1975 where it was 59.69%. Government expenditure (GE) was 220.34 million in 1964 with a growth rate (GER) of 20.07%. It maintained an increasing trend until 1968 where it fell by -3.15%. Between 1969 and 1977 GER was positive but became negative in 1978, 1979, 1981 and 1983. The Nigerian population (POP) has always been on the increase. It started at 49.3 million in 1964 and by 1970 it was 57.79 million. Its value stood at 87.64 million in 1986.The population growth rate (POPR) as a result is positive between 1964 and 1986 with an average of about 2.5 %. The data on money supply (MS) and its growth rate (MSR) show that MS has also been on the increase from 430.5 million in 1964 with MSR of 18.99% but dropped by -12.89% in 1967. For the rest of the regulation era, MSR stayed positive and closed at 27389.8 million in 1986. For the deregulation era (19872009) lending rate (LR) and deposit rate (DR) rose immediately after deregulation to 17.5% and 14% respectively in

55

1987 and by 1990 they were 20.01 % and 14.29%. Real lending Rate (RLR) however did not show any sign of improvement as they were both negative for the most part of 1988 to 1995. Inflation rate (IF) also experienced an increasing trend and perhaps it is the reason for the negative RLR and RDR experienced after deregulation. For the most part of 1996 to 2009, RLR became positive both RDR was negative even though inflation rate (IF) dropped below 15%. Real GDP (RGDP) dropped by -0.56% to 204804 million in 1987 and maintained an increasing trend with a positive growth rate (RGDPR) between 1988 and 1990. By 1991 its value dropped by -0.8% to close at 265379 million. It then rose by 2.25% in 1992 and by 2000, its value was 329179 million with a RGDPR of 5.4%. By 2009 it is 674889 million with a growth rate of 6.4%. Investment (INV) maintained an upward movement with positive growths after deregulation in 1987 except in 1996 where INV recorded a negative growth rate (INVR) of about -87.657%. Between 1997 and 2009 INV grew at positive rates to close at 596002 million. The data for Total savings (TS) shows that TS maintained a positive trend even after deregulation. It rose from 18676.3 million in 1986 to 385110 million in 2000 and by 2008 it was 4118173 million with a growth rate (TSR) of 52.89%. Both government expenditure (GE) and Money supply (MS) maintained an increasing trend after deregulation in 1987. They both had positive growth

56

rates (GER and MSR respectively) between 1987 and 2009 except for 1994 where GE fell from 191229 million in 1993 by -15.86% to 160893 million in 1994. Population also increased between the same periods, rising from 89.85million in 1987 to about 154.7 million in 2009.

4.3

Result of ADF test

Table 4.1 ADF test for deregulation era (1986-2009) Variable ADF RGDP -6.19(-3.02) INV 19.9(-3.01) TS -4.12(-3.71) RLR -4.87(-3.01) POP -4.92(-3.02) GE -4.9(-3.02) MS -3.58(-3.05) RDR -3.35(-3.01) Source: Data Analysis, 2011 Order of integration 1(2) 1(0) 1(1) 1(0) 1(0) 1(1) 1(2) 1(0)

Table 4.2 ADF test for regulation era (1964-1986) Variable ADF Order of integration RGDP -4.7(-3.01) 1(1) INV -4.14(-3.05) 1(2) TS 7.3(-3.01) 1(0) RLR -4.8(-3.01) 1(0) POP -4.16(-3.67) 1(0) GE -5.48(-3.01) 1(1) MS -2.69(-2.64) 1(1) RDR -4.11(-3.01) 1(0) Source: Data Analysis, 2011

57

Table 4.1 above represents the result of ADF test for deregulation era (19872009). The critical values (in parenthesis) are at 5% level of significance. This result shows that while INV, RLR, RDR and POP are stationary at levels, TS and GE are stationary at 1st difference, and, RGDP and MS are stationary at 2nd difference. For the regulation era (1964-1986) in table 4.2, while TS, RLR, RDR and POP are stationary at levels RGDP, MS and GE are stationary at 1st difference, and INV is stationary at 2nd difference.

4.4

Analysis of Regression Result The results of the estimated models are presented in appendices E-H.

Model 1 The result of model 1 in the deregulation era (1987-2009) shows that Real Deposit Rate (RDR) has a negative and insignificant impact on Total Savings (TS) in Nigeria with a coefficient -450.75 and a probability value of 0.87. Money Supply (MS) however has a positive and significant impact on TS as its coefficient is 0.357 with a probability value of 0.00. The model shows a good fit with an R2 0f 89%, adjusted R2 of 88%, Durbin Watson statistic of 1.78 and an F statistic of 75.9 with a probability value of 0.00.

58

For the regulation era (1964-1986), the estimated model reveals a positive but insignificant relationship between RDR and TS as the coefficient is 13.44 with a probability value of 0.28. As in the case of the deregulation era, Money Supply (MS) also showed a positive and significant impact on TS with a coefficient of 0.41 and a probability value of 0.00. The estimated model also showed a good fit as both the R2 and adjusted R2 lie above 96%, the Durbin Watson statistic is 0.81, while the F statistic is 339.78 with a probability value of 0.00.

Model 2 The result of model 2 in the deregulation era (1987-2009) shows that Real Lending Rate (RLR) has a negative but insignificant impact on investment (INV) in Nigeria as its coefficient is -0.0000091 with a probability value of 0.9. Similarly, population (POP) has a negative but insignificant impact on INV as its coefficient is -5006.7 with a probability value of 0.3. However, Total savings (TS) has a positive and significant impact on INV as its coefficient is 1.348 with a probability value of 0.00. The estimated model shows a good fit as both its R 2 and adjusted R2 are above 98%, its F statistic is significant with a probability value of 0.00, and its Durbin Watson statistic is 1.62.

59

The situation is however different in the regulation era (1964-1986). Here, the estimated model shows an insignificant but positive relationship between RLR and INV. This is not in line with a prior expectation as its coefficient is 1.079 with a probability value of 0.48. However, both Total Savings (TS) and population (POP) were found to have positive and significant impact on INV as their respective coefficients are 1.09 and 207.97 with respective probabilities of 0.00 and 0.0035.

Model 3 For the deregulation era (19872009) the estimates of model 2 shows a positive and significant relationship between investment (INV) and Real GDP (RGDP). The coefficient is 0.113 with a probability value of 0.00. The R2 and adjusted R2 are 67% and 65% respectively while the Durbin Watson is 1.76. The F statistic is significant with a probability value of 0.000005. This shows the estimated model has a good fit. The estimates of model 3 in the regulation era (1984 1986) also show that INV has a positive and significant impact on RGDP. The coefficient is 12.81 with a probability value of 0.000.The model also has a good fit in the regulation era as both its R2 and adjusted R2 are above 79%, its Durbin Watson statistic is 1.27, and its F statistics is significant with a probability value of 0.00.

60

Model 4 The estimate of model 4 in the deregulation era shows that Real Lending Rate (RLR) has a negative but insignificant impact on Real GDP (RGDP) as its coefficient is -0.0000061 with a probability value of 0.93. Government expenditure (GE) however, shows a positive and significant impact on RGDP as its coefficient is 0.168 with a probability value of 0.000. Both the R2 and adjusted R2 lie above 89%, the Durbin Watson statistic is 1.77, while the F statistic is significant with a probability of 0.00. This shows that the estimated model has a good fit in the deregulation era. For the regulation era, the estimate of model 4 shows an insignificant and positive relationship between RLR and RGDP as the coefficient of RLR is 7.61 with a probability of 0.64. Government expenditure (GE) shows a positive and significant impact on economic growth (RGDP) with a coefficient of 11.72 and a probability of 0.0001. The model also shows a good fit with R2 of 54%, adjusted R2 of 49%, Durbin Watson statistic of 1.81 and F statistic of 11.37 which is significant at 0.00056 level of significance.

4.5

Test of hypothesis From Appendix I, the estimate of model 4 for deregulation era (1987

2009) shows that the coefficient for Real Lending Rate (RLR) is -0.000001 with

61

a t-value of -0.08 and a probability value of 0.91 which is greater than 10%. We hereby accept the null hypothesis (H0) and state that interest rate deregulation has no significant impact on economic growth in Nigeria. 4.6 Discussion of Findings This study reveals that Real Deposit Rate (RDR) has an insignificant impact on Total Savings in Nigeria before and after the deregulation of interest rates (Model 1). For a lot of the periods within the scope of this study, RDR was negative. This has been attributed to the facts that interest rates have been repressed in Nigeria and also due the high inflation rate in the country. The implication is that low and sometimes negative RDR, discourages funds mobilization as people would prefer to consume their current income rather than saving at a rate lower than the inflation rate. The result of model 2 shows that Real Lending Rate (RLR) does not have significant impact on investment (INV) in Nigeria in both deregulation and regulation era. This shows that the deregulation exercise has not been effective in enhancing the role of RLR in promoting investment in Nigeria. The model also shows that Total Savings (TS) has a significant and positive impact on Investment (INV) in Nigeria before and after the deregulation exercise. TS represents loanable funds for investment. So as these funds rise, it is expected that investment would rise. However, population (POP) was found to constrain

62

INV after the deregulation exercise. A high population can cause overcrowding which promotes social vices such as crime and insecurity, thereby making the economic environment less conducive for investment. This study also revealed from the result of model 3 that Investment is significant in promoting economic growth in Nigeria. For both the regulation and deregulation era, INV shows a positive and significant impact on economic growth (RGDP). Similarly, Government expenditure (GE) has a positive and significant impact on Real GDP (RGDP) before and after the deregulation of interest rates in Nigeria. This is captured by model 4. The implication is that for a sustained economic growth in Nigeria, both Investment and Government expenditure must be rising. This would by multiplier effect, boost income in Nigeria. The post deregulation era witnessed an insignificant and negative relationship between RLR and RGDP (Model 4). This is understandable as RLR revealed an insignificant impact on investment (INV) in the deregulation era (Model 1). Since RLR does not significantly affect INV, then it cannot significantly affect RGDP since RLR affects RGDP through INV. This shows that interest rate deregulation has not had any significant impact on economic growth in Nigeria. This may be due to the incomplete deregulation exercise. As

63

pointed out by Amassoma et al (2011), interest is still being tied to monetary policy rate in Nigeria. The results also show that RLR did not impact significantly on investment (INV) and hence economic growth (RGDP) during the regulation era (19641986). And since interest rates have not been effectively deregulated, the situation did not change for the post deregulation era (19872009).

4.7 -

Summary of Major Findings Real Deposit Rate (RDR) has no significant impact on savings before and

after the deregulation of interest rates in Nigeria. Real Lending Rate has no significant impact on investment and hence

economic growth in Nigeria. Investment has a positive and significant impact on economic growth in

Nigeria.

64

CHAPTER FIVE SUMMARY, CONCLUSION AND RECOMMENDATION 5.1. Summary This study critically examined the impact of interest rate deregulation on economic growth. With Real Deposit Rate (RDR) and Real Lending Rate (RLR) chosen as major interest rates, four separate models were estimated to capture the relationship between; RDR and Total Savings (TS) (Model 1), RLR and investment (INV) (Model 2), INV and economic growth (Model 3), and, RLR and economic growth (RGDP) (Model 4). Model 1 revealed an insignificant relationship between RDR and TS for both the deregulation and regulation era. Model 2 showed an insignificant relationship between RLR and investment before and after the deregulation exercise. Model 3 showed a positive and significant relationship between economic growth and investment for both periods. While model 4 revealed a negative and insignificant relationship between RLR and economic growth after the deregulation exercise. The implication is that, RLR before and after deregulation has not been significant in promoting investment and hence economic growth in Nigeria.

65

5.2

Conclusion In conclusion, the study was able to show that interest rate deregulation

has no significant impact on savings, investment and economic growth in Nigeria. This contradicts the widely established significant relationship between interest rate deregulation and these variables, as presented by the Mkckinnon Shaw financial liberation hypothesis. This may however, be due to the incomplete deregulation exercise as the value of interest rates in Nigeria are still tied to the monetary policy rate of the central bank. As a result, real interest rates are still being repressed, thereby limiting its role in financial intermediation for investment and economic growth. This calls for reforms in the money market to enable it effectively play its role of financial intermediation.

5.3

Recommendations Based on the findings of this study, the following recommendations are

hereby made;
-

Since interest rate deregulation has no significant impact on savings,

investment and economic growth in Nigeria, there is need for authorities to carry out far reaching reforms that would enhance the role of money market in funds mobilization and disbursement for investment

66

purposes. This may include the complete deregulation of interest rates which would allow their values to be determined absolutely by market forces and not by any administratively determined rate. This would enable the economy reap the full benefits of the deregulation exercise which was introduced about 25 years ago with little satisfactory results
-

The high inflation rate in the country has adversely affected real interest rate in Nigeria. As a result, real interest rates are so low and sometimes negative. This has had adverse effects on funds mobilization in the economy. Government should therefore implement policies that would help curb the present level of inflation in the economy to a level lower than interest rates.

Also, population control policies should be implemented to control the rising population. The estimates of model 1 show a negative and insignificant relationship between population and investment. This means the rising population in Nigeria constrains investment hence economic growth. Birth control policies that would limit the number of child birth per family should be implemented to curtail the adverse effects of population on investment in Nigeria.

67

Lastly, government should improve the countrys infrastructural base. Power and access roads should be improved upon to create an enabling environment for investment to strive. Also, government should work with the informer financial sector by granting interestfree loans for investment purposes. These efforts would help to boost investment and economic growth in Nigeria.

68

Reference Abebiyi, A and Babatope-Obasa, B (2004). Institutional Framework, Interest Rate Policy and the Financing of the Nigerian Manufacturing Sub-sector African Development and Poverty Reduction. The Macro Micro Linkage Abebiyi, M.A. (2002). The Role of Real Interest Rates and Savings in Nigeria. First Bank of Nigeria Plc, quarterly review, March, 2002. Abiodun (1988). Cited in Adofu et al (2010) An Assessment of the Effects of Interest Rates Deregulation in Enhancing Agricultural Productivity in Nigeria. Current Research Journal of Economic Theory. PP. 82 86. Adofu. I, Abula. M and Audu. S. I (2010) . An Assessment of the Effects of Interest Rate Deregulation in Enhancing Agricultural Production in Nigeria. Current Research Journal of Economic Theory. PP. 82 86 African Institute for Applied Economic (AIAE) (2005) Sustainability of Economic Growth in Nigeria: The Role of the Renewable Natural Resources. Summary of Research Findings and Policy Implications, Enugu, Nigeria

69

Agu, C.C (1988). Interest Rate Policy in Nigeria and its Attendant Distortion. Arnwldo Manri (ed) Saving and Development Quarterly Review Vol.XII (1) PP. 19 30. Agu, C.C. (1988). Interest Rate Policy in Nigeria an Attendant Distortion. Sav. Dev. J, 12 (1). Akintoye, I.R and P.S. Olowolaju, (2008). Optimizing Macroeconomic Investment Decision: Lesson from Nigeria. Eur. J. Sci. Res. 22:469 479. Akpan (2004). Financial Liberalization and Endogenous Growth: The case of Nigeria. African Institute for Economic Development and Planning (IDEP). Albu, L (2006). Trends in the Interest Rate-Investment-GDP Growth Relationship. Romaniand. Econ Forcast. No. 3 Amassoma J.D, Nwosu P.I and Ofere A.F (2011). The Nexus of Interest RTE Deregulation, Lending Rate and Agricultural Productivity in Nigeria. Current Research Journal of Economic Theory. Ani (1988). Cited in Adofu et al (2010) An Assessment of the Effects of Interest Rates Deregulation in Enhancing Agricultural Productivity in Nigeria. Current Research Journal of Economic Theory. PP. 82 86 Anyanwoncha, R.A.I (1993) Fundamentals of Economics. Africana first Publishers Limited, Onitcha, Nigeria. Anyawu, J.C (1997) The Structure of the Nigerian Economy (19601997). Joaneci, Onitsha. CBN Statistical Bulletin, 2008 Edition. Challier, F. and Oguie, C.N. (2002). The Impact of Interest Rate Liberalization:

70

Empirical Evidence from Sub-saharan Africa, Savings and Development, vol.26 no.4, pp.355 379. Domar, E. (1957), The Theory of Economic Growth. Cited in Jhingan (2003). Macro Economic Theory. Vrinda Publication (P) Ltd, Dehi. Eregha, P.B (2010). Interest Rate Variation and Investment Determination in Nigeria. International Business Management 4(2): 41-46 Gujarati, D. N and Porter. D. C (2009). Basic Econometrics. McGrawHill/Irvin, New York. IMF (2009) Interest Rate Liberalization in China. IMF Working Paper WP/09/171. Ikhinde, S,I. Alawode, A.A (2001). Financial Sector Reforms, Micro Economic Instability and the order of Economic Liberation. The Evidence from Nigeria, Afr. Econ. Res. Paper 112: ISBN 9966 944 52 2 Jhingan, M.L (1997). The Economic of Development and Planning. Vrinda Publications (P) Ltd, Delhi. Jhingan, M.L. (2003) Macro-Economic Theory. Vrinda Publication (P) Ltd, Delhi. Khalid A.M (2007). Macroeconomic Effects of Financial Liberalization in Pakistan: An Assessment. Pakistan Institute of Development Economics. Keynes (1936). The General Theory of Employment, Interest and Money. Cited in Jhingan (2003) Macro Economic Theory. Vrinda publications. Kontsoyiannis, A (1977) Theory of Econometrics 2nd Edition. Palgrave, New York. Mark M.R and Habibullah K. (2007). Liberalization and Growth: An

71

Econometric Study of Bangledash. Graduate School for Global Leaders. Mckinnon, R.I (1973). Money and Capital in Economic Development. Washington, D.C. brooklings Institution Nwakwo, G.O (1989) Nigeria Financial System. Macmillan Publishers Ltd. Obamuyi, T.M (2009). An investigation of the Relationship between Interest Rates and Economic Growth in Nigeria, (1970-2006) Journal of Economic and International Finance Vol. 1(4), pp. 093-098. Ojo M.O, (1988). Agricultural and Policy under Structural Adjustment Programme in Nigeria. A paper Presented at the 1988 Annual Conference of the Economic Society at Obefemi Awolowo University, Ile Ife, Nigeria. Okpe. I (1998): Interest Rate and Savings mobilization: An Empirical Investigation of Financial Repression Hypothesis. An Unpublished M.Sc Thesis, Department of Economics, Ahmadu Bello University, Zaria. Oosterbaan, M.S, Der Windt, N.V, Stevewick TRV (2000). Determinants of Growth (Ed). Available at http://book.google,co.uk/books Oshikoya, T. W. (1992) Interest Rate Liberalization, Savings, Investment and Growth: The Case of Kenya, Savings and Development, vol. 16, no.3, pp. 305-320. Shaw, E (1973). Financial Deepening in Economic Development. New: Oxford University press. Soyinbo, A. Olayiwola, K (2000). Interest Rate policy and the Promotion of Savings, Investment and Resources Mobilization in Nigeria; Research Report 24. Development Policy Centre, Ibadan. Todaro and Smith (2009). Economic Development. Pearson Education

72

Limited, England. World bank(2011). Available at http://data.worldbank.org/country/nigeria. Vaish, C.M (2005) Monetary Theory. Vikas Publishing House PVT. Ltd

73