Interest rate, exchange rate on investment decision in Nigeria economic (2015-2020)


Price: 2000 Naira (BSC, MSC)




1.1      Background of the Study

Investment is the current commitment of specific amount of cash (in any currency/legal tender) into an income yielding asset with the sole aim of deriving future inflow of cash which will compensate the investor for the following:

  1. The time of releasing the fund for the use of another
  2. The changes in interest rate and the purchasing power of money and
  3. The uncertainty of future payment.  (Oluwatusin 2017)

Unlike capital, investment is a flow term and not a stock term. This means that capital is measured at a point in time, while investment can only be measure over a period of time. Investment plays a very important and positive role for progress and prosperity of any country. Many countries rely on investment to solve their economic problem such as poverty, unemployment etc (Muhammad Haron and Mohammed Nasr 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. Interest is the reward that accrues to people who provide the fund with which capital goods are bought (Soyibo and Adekanye, 1992).  Interest can also be defined as the payment made to a lender by a borrower for the use of a sum of money for certain period of time.

Interest can also be said to be the charge assessed for the use of money.  It can also be seen as “the payment made to owners of capital fund which they are ready to put at the disposal of others; thus, interest rate is like a price which bring into equilibrium the demand for resources to invest with the readiness to establish from present consumption.  Interest rate is determined by the force of demand and supply of capital and for the condition that demand and supply of fund are equal. Hence, interest level is arrived at by the intersection between savings and investment (Luckett, 1984). 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.

Historically, economic theories have suggested negative relationship between investment and interest rates. Changes in either nominal or real interest rates translate into a direct impact on investment spending leading to desired movements in the real economy. Specifically, the Keynesian framework suggests that a decrease in lending rate reduces the cost of investment resulting in higher profit margin for the investors.

Interest rate reform, a policy under financial sector liberalization, was to achieve efficiency in the financial sector and engendering financial deepening (Obamuyi, 2009). In Nigeria, financial sector reforms began with the deregulation of interest rates in August 1987 (Ikhide and Alawode, 2001). Prior to this period, the financial system operated under financial regulation and interest rates were said to be repressed. 

The seminar works of McKinnon (1973) and Shaw (1973) attributed financial repression as the cause of the unsatisfactory growth performance of developing countries. They argued that countries characterized by financial repression; raising nominal interest rates relative to inflation would increase saving and the supply of investible resources in the economy. The productivity of investment also rises as these resources are channeled to projects that have higher rates of return. They argued further that financial repression arises mostly when a country imposes ceilings on nominal deposit and lending interest rates at a low level relative to inflation. The resulting low or negative real interest rates discourage savings mobilization and the channeling of the mobilized savings through the financial system. This has a negative impact on the quantity and quality of investment and hence on economic growth. Both McKinnon and Shaw advocated that financial liberalization was needed to remedy the problems caused by the financial repressive policies of developing countries.

Since the introduction of the interest rate liberalization concept in the 1980s, many countries such as Angola, Burundi, Congo, Ivory Coast, Ghana, Malawi, Nigeria, China, India etc. have made attempts at liberalizing their financial sectors by deregulating interest rate, eliminating or reducing credit controls, allowing free entry into the banking sector, giving autonomy to commercial banks, permitting private ownership of banks and liberalizing international capital flows financial repression has retarded the development process as envisaged by Shaw (1973).  Undoubtedly, government past efforts to promote   economic development by controlling interest rate and securing inexpensive funding for their own activities have undermined financial development. (Arturo, Fabio, & Andrew, 2003).

The liberalization of the interest rate system, mainly by raising interest rates, was a policy measure adopted by the Nigerian Government to increase private saving. The objective was to make and maintain positively in real terms as the upsurge in inflation in the 1970s had rendered them negative and there were rigid exchange and interest rate controls resulting in low direct investment.  Funds were inadequate as there was a general lull in the economy.  Monetary and credit aggregates moved rather sluggishly. Consequently, there was a persistent pressure on the financial sector, which in turn necessitated a liberalization of the financial system (Soyibo & Olayiwola, 2000). 

In response to these developments, the government deregulated interest rate in 1987 as part of the Structural Adjustment Program (SAP). The official position then was that interest rate liberalization would, among other things, enhance the provision of sufficient funds for investors, especially manufacturers (a priority sector), who are considered to be the prime agents of investment, and by implication, promotes  economic growth (Odhiambo, 2009).  However, in a dramatic policy reversal, the government in January, 1994 out-rightly introduces some measures of regulation into interest rate management. It was claimed that there are more wide variations and unnecessarily high interest rate under the complete deregulation of interest rate immediately, deposit rate were once again set at 12% – 15% per annum while a ceiling of 21% per annum was fixed for lending (CBN 2012). 

The high interest rate observed in Nigeria during the era of interest rates deregulation has been frequently blamed for the country‟s slow growth and pointed out as a major failing of the Adjustment Program initiated in August, 1986. The believe is premised on the assumption that the demand for funds is for the purpose of investment and that investment demand will be larger at a lower lending rate. This study gawks that such blame is largely for obvious reasons. First interest rate deregulation lead to an increase in saving mobilization in Nigeria (Chuba, 1997).  While it is impossible to achieve economic growth without adequate investment, saving generates investment. 

Secondly, investment does not depend upon interest rate alone, for instance investors may be prepared to borrow more and invest more, even if interest rate are high provided they anticipate a higher margin of profits. On the other hand, investors are not tempted to borrow even if interest rate are very low, or even zero if they  are afraid that they may lose even their capital.  In other words, investment depends upon risk and the prospects of profits in a particular industry-or what Keynes (1936) calls the marginal efficiency of capital rather than upon interest rates.  Thirdly, interest rate is just one among many factors that have negative effects on investment. For example, the deregulation of Nigerian economy went beyond interest rates reform policies rather than interest rate deregulation to be the major obstacle   to investment expansion in Nigeria. 

The policy on interest rate introduced in 1994 was retained in 1995 with a minor modification to allow for flexibility. The policy stayed in place until it was lifted in October 1996. This remained in force till date, thus enabling the pursuit of a flexible interest rate regime in which bank deposit and lending rate were largely determined by the forces of demand and supply for funds (Omole & Falokun, 1999).   

1.2 Statement of the problems 

Over three decades ago, Nigerian economy witnessed the introduction of Structural Adjustment Program (SAP) which shifted emphasis from public sector to private sector. The goal was to, among other things, encourage private domestic savings, private domestic investment and capital formation in order to enhance economic growth. By encouraging savings through increase in income, resources were diverted from current consumption and invested in capital enterprises. Unfortunately things did not worked out as expected. Although the reform programme led to privatization and commercialization of many state enterprises and improvement in some macroeconomic variables like the nominal interest rate and money supply, but not without its disappointing performances. For example, Nigeria continues to be confronted with low rate of real economic growth. Besides, aggregate supply continued to diminish leading to demand-pull inflation. One worrisome aspect of the result of liberalization of the public sector in Nigeria is the extent of distress in the real sector which has affected the financial industry with the cost of fund (Interest rate). 

 Changes in interest rates can reflect the basic situation of the operation of macro economy; it also affects all the macroeconomic variables such as GDP, price level, the level of employment, international balance of payments, the rate of economic growth, etc. Obviously the interest rate is an important economic variable that plays an important role in both macro and micro economy activity.

A change in interest rates is one of the main factors to judge the macroeconomic situation and the interest rate trend analysis is the main method to predict the macroscopic level of economic situation. Western economists believe that the market rate of interest, the total social savings and investment are closely linked. Therefore, the current interest rates affect the investment activities. At the same time, current interest rates also affect the scale of investment in the future by adjusting the savings. If the interest rate rises, bond prices fall, if the interest rate falls, bond prices rise. (Wuhan, 2015).

A number of studies have been conducted on the impact of interest rate volatility on investment decision in Nigeria. Among these studies is the work done by Ekwenem (2005), who studied interest rate and investment behavior in Nigeria from the period 1976- 2006 using time series data, he found out that the behavior of investment have significant influence on interest rate and inflation rate.   

Ojo (1988) & Ani (1988) are both of the opinion that interest rate deregulation would mar the Nigerian economy. In their separate studies, they noted that the deregulation exercise is faulty, claiming it would discourage investment and hence economic growth, by pushing up interest rates. They believe that since domestic financial markets are to some extent structurally oligopolistic, if interest rate is left uncontrolled, it might lead to a sharp increase in lending rate which will translate to increase in cost of capital and discourages investment. This position is supported by Soyibo & Olayiwola (2000) and Akpan   (2004) whose work observe the existence of low positive impact of deposit rate on investment after interest rate liberalization in Nigeria.

 This change of interest rate policy is a problem because of two main reasons, first, investment contraction in Nigeria may not have any connection with the increase in lending rate that accompanied interest rate liberalization. Just as it was in 1987 when interest rate is 17.5% and investment was 19.835%, an increase in interest rate in 1989 (i.e. from 17.5% to 26.8%) was also accompanied by increase in investment (i.e. from 19.835% to 19.879%). Secondly, low interest rate policy, which the regulation of interest rate implies could discourage saving mobilization. However, it is impossible to achieve economic growth without adequate investment, saving generates investment. (Chuba, 2005).

According to Lesotho (2006) interest rate is believed to be the key determinant of the level and direction of investment spending, non-economic factors have had significant influence on investment potential of Nigeria. Also, studies carried out by (Wuhan, 2015) to evaluate the effect of interest rate on investment in Jiangsu province, China found out that there’s a positive long-run relationship between interest rate and investment. Based on the aforementioned, this study attempts to conduct a simple analysis on the direction of the relationship between interest and exchange rate on investment decisions in Nigeria over the period of 2017 – 2020 following the procedures in Wuhan’s study and to make a comparison which would reveal if the same occurrence in china can be observed in Nigeria over the same period of 2017 – 2020. 

1.3 Objectives of the Study 

The major objective of this research is to analyze the interest and exchange rate impact on investment decision in Nigeria. The specific objectives are:- 

  1. To examine the responses of investment decision to changes in interest and exchange rate in Nigeria during the period of interest rate deregulation between the period of 2017 – 2020
  2. To assess if there’s a  long run relationship between interest rate and investment within the period of 2017 – 2020
  3. To analyze if there’s a short-run association between interest and exchange rate and investment within the period 2017 – 2020.
  4. To make recommendations that will help in terms of interest rate policy as well as improving investments that promotes economic growth in Nigeria.

1.4     Research Hypotheses 

Based on the objective of the study, the following null hypotheses are proposed. 

Ho1: There’s no significant and positive long run relationship between interest and exchange rate and investment in Nigeria. 

Ho2: There’s no significant and positive short run relationship between interest and exchange rate and investment in Nigeria.  

1.5     Scope of the Study

In order to carry out a comprehensive and meaningful research work on the critical impact of interest and exchange rate on investment decision in Nigeria. This work uses data mainly from the Central Bank of Nigeria (CBN), which regulates the employment of interest rate which is the focus of this study in relation to investment decision in Nigeria. 

Data used covers a period of ten years (2017-2020) so that the impact of interest rate on investment can be compared using the interest policies. The decision for the period in view is based on the problem which this research work intends to solve and also the availability of data.

1.6     Relevance of the Study 

This study will be helpful in analyzing how the impact of interest rate on investment decisions in Nigeria has been before the regime of interest rate deregulation and after the regime. It also investigates the interest rate deregulation and investment relationship by taking into consideration the transmission mechanism through which interest rate affect investment. As a result, the outcome of this study should shed more light on the role of interest rate in economic development in Nigeria. Consequently, this work will be useful to Government and monetary policy makers in their   quest to improve economic situation. Also, by raising specific issues concerning the link between interest rate and economic performance (investment) in Nigeria, this study provides a basis for further in-depth investigation in this area.

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