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A PROPOSAL ON THE EFFECT OF INTEREST RATE ON INVESTMENT AND MONEY DEMAND IN NIGERIAN ECONOMY

Abstract

This study will assess the effect of interest rate on investment and money demand in Nigeria economy. The following objectives will also help in successful of the study: To ascertain the effect of interest rate on investment decision in Nigeria, to ascertain the trend profile of investment in Nigeria and to investigate the effect of interest rate on demand for money in Nigeria using statistical tools of Simple Linear Regression model because it is utilizing for the purpose of prediction where the independent variable is used to obtain a better prediction of dependent variable (Ozo, Odo, Ani and Ugwu, 2007).

 

Chapter one

Introduction

Background of the study

Investment plays a vital role for development of any country. Many countries depend on investment to solve their economic problem such as poverty, unemployment etc (Muhammad and Mohammed 2004).

Interest rate on the other hand is the price paid for the use of money. It is the opportunity cost of borrowing money from a lender to finance investment project. It can also be seen as the return being paid to the provider of financial resources, for using the fund for future consumption (Sleka, 2004). Interest rates are normally expressed as a percentage rate. The volatile nature of interest is determined by many factors, which include taxes, risk of investment, inflationary expectations, liquidity preference, market imperfections in an economy etc.

Banking sectors are the primary responsibility of financial intermediation in order to make fund available for economic agents. Banks as financial intermediaries move fund from surplus sector/units of the economy to deficit sector/units by accepting deposits and channeling them into lending activities (Afolabi, 2003). The extent to which this could be done depend upon the rate of interest and level of development of financial sector as well as the saving habit of the people in the country.

The availability of investible funds is regarded as a necessary starting part for all investment in the economy which will eventually translate to economic growth and development (Uremadu, 2006).

As already discussed so far, it is quite clear that an understanding of the nature of interest rate behavior is critical and crucial in designing policies to promote savings, investment and growth. It is based on this background the researcher wants to investigate the effect of interest rate on investment and money demand in Nigeria economy.

Statement of the problem

Nigeria is among the developing countries which have come under stress as a result of the economic shocks. The financial repression largely manifested through indiscriminate distortions of financial prices including interest rates, has tended to reduce the real rate of growth and the real size of financial system, more importantly, financial repression has (retarded) delayed development process as envisage by Shaw (1973). This led to insufficient availability of investible funds, which is regarded as a necessary starting point for all investment in an economy. The result of decline of the investment in the external resource transfer since 1982 has been sharp in the highly indebted countries, and has been accompanied by a slowdown in growth in all Least Developed Countries (LDCs) Cole and Obstraid (2005). Both public and private investment rate have fallen, although the latter more drastically than the former. The observed reduction in investment in LDCS seems to be the result of several factors. The lower availability of foreign savings has not been matched by a corresponding increase in domestic savings. Secondly, the determinating of fiscal conditions due to the cut of foreign lending to the rise in domestic interest rate and the acceleration in inflation forced a contraction in public investment. Thirdly, the increase in macroeconomic instability associated with external shocks and the difficulties of domestic government to stabilize the economic has hampered private investment.

Finally, the debt at hand has discouraged investment, through its implied credit constraints in international capital markets (Omole and Falokun, 1999).

Declining investment ratio and level are problems; first of all, because investment matters for growth. Secondly, because low investment increases vulnerably in the economy (Niambon and Oshikoya, 2001). The main challenge Nigeria is facing is to make policies that will help revive and raise investment in the country in order to stimulate and sustain economic growth.

The problem of volatility of interest rates affects personal investments and governmental decision making of any nation, Nigeria cannot be an exception as affirmed by Schwartzman (1992) that the movement of interest rates in one direction or another is influenced by a multitude of factors, including economic, inflationary, monetary, fiscal, global, and political factors.

The rate of interest paid by banks to depositors is on the high, investors cannot patronize the banks the more and fewer investors invests on the capital market. This leads to decrease in money demand and capital investment in the economy

Objective of the study

The following objectives will be assessed:

  1. To ascertain the effect of interest rate on investment decision in Nigeria
  2. To ascertain the trend profile of investment in Nigeria
  3. To investigate the effect of interest rate on demand for money in Nigeria

 

Research hypotheses

For the successful completion of the study, the following research hypotheses were formulated by the researcher;

H0there is no significant effect of interest rate on investment decision in Nigeria

H1: there is significant effect of interest rate on investment decision in Nigeria

H02:   there is no significant trend profile of investment in Nigeria

H2:   there is no significant trend profile of investment in Nigeria

 

H03:   there is no significant effect of interest rate on demand for money in Nigeria

H3:   there is significant effect of interest rate on demand for money in Nigeria

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