IMPACT OF INTEREST RATES ON SAVINGS AND INVESTMENT IN NIGERIA
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IMPACT OF INTEREST RATES ON SAVINGS AND INVESTMENT IN NIGERIA
Chapter One: Introduction 1.1 Background of the Study
Interest is the compensation paid to those who supply funds for the purchase of capital goods (Soyibo and Adekanye, 1992). Interest is also described as a payment made to a lender by a borrower for the usage of a sum of money for a set period of time.
The charging of interest on loans was initially outlawed during mediaeval times, but it was later legalised by King Henry VIII in 1545 when he removed the usury laws, which were denounced.
These usury laws were enacted during the mediaeval period, when the paying of interest rates was fiercely criticised and labelled usury. During that period, it was believed that a loan constituted an aid to a distressed individual or neighbour; hence, they felt that charging interest on a loan was improper.
Interest rate deregulation was later implemented in the monetary system by the Central Bank of Nigeria as part of the Structural Adjustment Programme (SAP) launched in July 1986 by then-President Gen Ibrahim Babangida (Osofisan, 1993).
Interest can also be defined as the charge levied for the usage of money. It can also be defined as “the payment made to owners of capital funds that they are willing to put at the disposal of others;
thus, interest rates function as a price that balances the demand for resources to invest with the willingness to establish from current consumption.” The force of demand and supply of capital determines interest rates, assuming that demand and supply of funds are equal.
Thus, interest rates are determined by the junction of savings and investment (Luckett, 1984). Savings are defined as the portion of income after taxes that is not spent on consumption items.
Savings can alternatively be defined as the portion of income that is not spent on home goods and services (McKinnon, 1973). Investment, on the other hand, can be described as the expenditure of funds to create net additions to the stock of physical capital; it is virtually entirely carried out by firms.
When interest rates are low, investors benefit. The main element determining investment is interest rate, which is controlled by savings. Investors will also benefit when the marginal efficiency of capital is high.
Marginal efficiency is defined as the projected rate of return on an additional unit of capital asset. It refers to the predicted annual profit rate on real investment of the most efficient type, which is determined by the entrepreneur’s anticipation of future return.
However, there will be no investment based on poor profit expectations, which is why investment falls to a low level during a depression despite all of the encouragement to increase private investment (Revel, 1975).
When interest rates are high, saving is viewed as beneficial to both individuals and society as a whole. Thus, an increase in savings will eventually result in an increase in the community’s savings. This influence led classists to believe in thriftiness (Ritter and Siber, 1986).
They believed that individual saving was both a private and societal virtue. Keynes held a different perspective, arguing that individual savings are a societal evil rather than a virtue. Individual savings will result in a reduction in overall consumption.
When savings rise, investment becomes increasingly important for an economy’s growth. Increased investment will inevitably lead to increased employment, which will raise demand, pricing, profit, and production expansion.
If correctly utilised, this expansion will contribute to a country’s economic development (Shaw 1973). Investment is the product of capital accumulation, which is dependent on savings (Ndulu, 1990). Savings made by profit earners and converted into investment were the primary drivers of Great Britain’s economic expansion in the nineteenth century.
Recognising the importance of interest rates in achieving monetary policy objectives, Nigeria’s central bank opted to implement a uniform rate of interest on loans for all commercial banks in Nigeria, as outlined in its credit advice of 1969.
The Central Bank of Nigeria’s credit advice was later revised in 1987. It implemented an interest rate strategy based on free market forces in response to the government’s efforts to deregulate the economy following the establishment of the second-tier foreign currency market.
This interest rate deregulation scheme allows the forces of demand and supply to determine the current interest rate. This implies that the bank will not charge a set rate on loans and advances, nor will it pay a given rate to depositors (Soyibo and Adekanye 1992).
In economics, interest rates are determined using three main processes. These theories differ in their views on interest rates, albeit they share some commonalities.
They include the classical theory of interest (loanable fund), the liquidity reference theory (Keynesian Approach), and the general equilibrium approach (modern).
An overview of these interest rate theories reveals that interest rates can influence the growth of savings and investment in an economy; therefore, understanding the nature, meaning, and role of interest rates in the same economy is critical.
In a nutshell, interest rates are given a prominent position as a catalyst for growth in the economy, particularly as a factor in determining the growth of savings and investment (Osofisan, 1993).
1.2 Statement of the Problem
Many developing countries, burdened by debt and other external imbalances, have implemented economic restructuring initiatives. A fundamental component of such adjustment schemes is the liberalisation of financial markets and a wider role for market forces in the allocation of financial resources, which often includes interest rate deregulation and the relaxation or cancellation of the policy of directed credits.
The McKinnon-Shaw financial intermediation hypothesis, which states that interest rates respond positively to savings and economic growth, appears to have influenced interest rate policy in emerging countries.
According to the McKinnon-Shaw theory, investment serves as the link between interest rate responsiveness and savings. However, savings and investment differ behaviorally and operationally (Bhatia and Khatkhate, 1975; Fry, 1978),
with the transfer of savings to investment determined by a variety of factors other than the real interest rate. Such considerations include the availability of investment opportunities with returns that exceed the cost of money,
the existence of profitability inequalities between private and social sectors, institutional limits, and the cost of fund administration. Thus, the McKinnon-Shaw hypothesis alone cannot be used to investigate the relationship between real interest rates and investment.
Unfortunately, studies of financial liberalisation policies accepted the link between savings and investment as given and/or found it difficult to specify the influence of real interest rates on investment (Mwega et al., 1990).
Furthermore, studies of the impact of adjustment programmes on economic growth frequently assume the existence of the Keynesian savings and investment macroeconomic balance (Ndulu 1990).
Nonetheless, it is widely acknowledged that resource constraints limit economic progress in poor countries. The successful implementation of financial liberalisation measures in developing nations goes beyond showing whether or not the McKinnon-Shaw hypothesis holds true.
There is a need to explore the behavioural links between investment and savings (possibly through real interest rates) in order to uncover the determinants of the savings-to-investment mechanism.
Soyibo and Adekanye (1992a) established the applicability of the McKinnon-Shaw hypothesis to Nigeria, however Shaw’s hypothesis appears to be more strongly supported. This shows that the debt intermediation hypothesis is valid in Nigeria.
To have a beneficial impact on economic growth, the extra savings generated by financial system liberalisation must be channelled into investment. Understanding the savings-investment dynamic, then, can assist inform policy decisions aimed at boosting economic growth. At least two techniques can be taken in this regard.
First, the supply side’s characteristics can be established by analysing the factors influencing portfolio management decisions of credit suppliers based on their opinions and objective data. Second, demand features can be investigated, identifying demand factors using both perceptions and objective facts.
This research focuses on the first technique, which involves analysing bankers’ perspectives primarily through primary data. The limits of this technique will be addressed later.
However, research into banking system operators’ opinions of the influence of various regulatory regimes on system performance has its own value. It can highlight areas of universal agreement regarding the success of government policies.
a study can also serve as an ex post review of the impact of government policy on the banking sector as perceived by individuals directly affected.
1.3 Objectives of the Study
The primary goal of this research comprises the following:
1. Determine the impact of interest rates on savings in Nigeria.
2. Determine how interest rates affect investment rates in Nigeria.
3. Determine the effect of savings on investment in Nigeria.
1.4 RESEARCH QUESTIONS.
Following up on the above aims, the following questions are asked:
1. How do interest rates affect savings in Nigeria?
2. How does the interest rate affect investment in Nigeria?
3. Do savings affect investment in Nigeria?
1.5 Hypotheses.
The following hypotheses have been developed based on the study’s aims and research questions;
Ho: In Nigeria, interest rates have no significant positive impact on savings levels.
Ho: Interest rates have no positive or significant impact on investment in Nigeria.
Ho: Is there no positive major impact of savings on investment in Nigeria?
1.6 Scope of the Study
In order to conduct extensive and significant research on the essential role of interest rates as a determinant of savings and investment growth in Nigeria.
This work was mostly focused on the Central Bank of Nigeria (CBN), which governs interest rates, savings, and investment, as well as Intercontinental Bank Plc. The data used spans a ten-year period (1970–2008), allowing the influence of interest rates on savings and investment to be compared using interest policies.
1.7 Significance of the Study
The worsening of the Nigerian economy necessitates a review of economic policies. Nigeria, like all other developing countries, is faced with the challenge of determining the best effective policies to achieve economic growth.
Identification of the elements impacting the economy becomes required; the level of investment being a major influence on economic growth leads us to the study of interest rates, which are one of the factors influencing investment as well as savings.
To avoid decisional myopia, economic planning must be efficient and proper.
The need for this study derives from the importance of interest rates in determining the growth of savings and investment. This will greatly assist commercial banks, the CBN, the overall economy, and future interest rate researchers.
1.8 Definition of Terms
Osofisan (1993) defines marginal efficiency of capital as the rate at which an investment yields a return.
Interest Rate: This is the rate at which the Central Bank of Nigeria lends to financial institutions, hence determining supply and demand for funds Mwega, Ngola, and Mwangi, (1990).
Interest rate policy: The Central Bank’s policy for controlling inflation in the economy. The monetary authorities also utilise it to control the money supply in order to achieve the declared or intended aims. Ndulu (1990).
Savings: The total sum deposited with financial institutions. Fry (1978).
Investments: Investible funds used to boost economic growth. Elliot(1984).
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