The Impact Of Interest Rate On Domestic Investment

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ABSTRACT

The relationship between interest rate and domestic investment has attracted the attention of economists and other economic experts. This study carried out an empirical analysis of the impact of interest rate on domestic investment in Nigeria covering the period 1980-2016. Data for the research was extracted from the central bank of Nigeria statistical bulletin. The methodology adopted in the research is the multiple linear regression with the application of Ordinary least Squares (OLS) technique. Findings from the study reveal that interest rate has a negative and significant impact on domestic investment in Nigeria, inflation has no significant impact on domestic investment in Nigeria and money supply has no significant impact on domestic Investment in Nigeria.  It is therefore the recommendation for the study that the federal government through the Central Bank should boost the level of domestic investment through an optimal reduction in interest rate and the federal government should ensure a conducive and comfortable macroeconomic atmosphere so that domestic investment can strive.

TABLE OF CONTENTS

 

Title page                                                                                                                                i

Certification page                                                                                                                   ii

Approval page                                                                                                                         iii

Dedication                                                                                                                              v

Acknowledgement                                                                                                                  vi

Abstract                                                                                                                                  vii

Table of content                                                                                                                      viii

CHAPTER ONE: INTRODUCTION

1.1 Background of the Study                                                                      1

1.2 Statement of the Problem                                                                     2

1.3 Research Questions                                                                              3

1.4 Objectives of the Study                                                                        3

1.5 Hypotheses of the Study                                                                      4

1.6 Significance of the Study                                                                      4

1.7 Scope and Limitations of the Study                                                     5

CHAPTER TWO: LITERATURE REVIEW

2.1 Conceptual Literature                                                                                     6

2.1.1 The Concept of Interest Rate                                                             6

2.1.2 The Concept of Investment                                                               8

2.2 Theoretical Literature                                                                                     9

2.2.1 The Classical Theory of Interest Rate                                                          9

2.2.2 The Loanable Funds Theory of Interest Rate                                              10     

2.2.3 Keynes Liquidity of Preference Theory of Interest Rate                              11

2.2.4 Accelerator Theory of Investment                                                     11

2.2.5 Tobin Q Theory of Investment                                                          12

2.2.6 Keynes Theory of Investment                                                                     13

2.3 Empirical Literature                                                                             14

2.4 Gap in Literature                                                                                  15

CHAPTER THREE: METHODOLOGY

3.1 Theoretical Framework                                                                        24

3.2 Model Specification                                                                              25

    1. Method of Evaluation                                                                       25

3.3.1 Preliminary Tests                                                                              25

3.3.2 Economic Criterion Test (A priori Test)                                            25

3.3.3 Statistical Test of Significance                                                           26

3.3.3.1 Test for Goodness of Fit                                                                           26

3.3.3.2 T-Test of Significance                                                                     26

3.3.3.3 f-test of Significance                                                                       26

3.3.4 Econometrics Test of Significance                                                     27

3.3.4.1 Autocorrelation Test                                                                      27

3.3.11 Unit Root/Stationary Test                                                               28

3.3.1.2 Co-integration test                                                                          28

3.3.1.3 Error Correction Model (ECM)                                                      28

3.4 Data Required and Sources                                                                             28

CHAPTER FOUR:PRESENTATION AND ANALYSIS OF RESULTS

4.1 Unit Root Test                                                                                                29

4.2 Cointegration Test                                                                                30

4.3 Regression Analysis                                                                             31

4.3.1 Coefficient Interpretation of the Variables                                        31

4.3.2 Coefficient of Determination (R-Squared, R2)                                              32

4.3.3 Autocorrelation Test                                                                33

4.5 Test of Hypotheses                                                                               34

4.6 Implications of the Results                                                                             35

CHAPTER FIVE:SUMMARY, CONCLUSION AND RECOMMENDATION

5.0 Summary of Findings                                                                                     36

5.2 Conclusion                                                                                           37

5.3 Recommendation                                                                                  37

Appendix                                                                                                   39

 

CHAPTER ONE

INTRODUCTION

 

1.1 Background of the Study

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

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

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

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

1.2 Statement of the Problem

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

1.3 Research Questions

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

  1. To what extent has interest rate affected the level of domestic investment in Nigeria?
  2. To what extent has inflation impacted on the level of domestic investment in Nigeria?
  3. To what extent has money supply impacted on the level of domestic investment in Nigeria?

 

1.4 Objectives of the Study

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

  1. To ascertain the impact of interest rate on domestic investment in Nigeria.
  2. To evaluate the impact of inflation on domestic investment in Nigeria.
  3. To evaluate the impact of money supply on domestic investment in Nigeria.

 1.5 Hypotheses of the Study

The following hypotheses of the study will be tested:

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

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

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

 

1.6 Significance of the Study

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

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

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

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

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

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

1.7 Scope and Limitations of the Study

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

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