Citation
Pius Effiong Akpan and Alex Oisaozoje
Iriabije
Department
of Economics
University
of Uyo, Uyo.
Abstract
This study examined the impact of
interest rate liberalization on investment in Nigeria from 1986-2023 using data
from the CBN Statistical Bulletin. The data were subjected to various
diagnostic tests such as Unit Root, ARCH, Normality, among others, and the
result revealed that the data were suitable for estimation. The dependent
variable was represented by Gross Fixed Capital Formation used as a proxy for
investment, while Exchange Rate, Government Expenditure, Interest Rate,
Inflation and Money Supply were the independent variables. The Auto Regressive
Distributed Lag (ARDL) estimation technique was employed to test the short and
long run impact of the independent variables on the dependent variable. The
ARDL long and short run results revealed that Government Expenditure and
Interest Rate significantly impacted on investment during the period under
review showcasing the importance of these variables in promoting investment in
Nigeria. The result further revealed the need to. strengthen policies that would
promote stable exchange and inflation rate that would enhance domestic
investment. Based on the findings of this study, it is pertinent to maintain
macroeconomic stability through sound monetary and fiscal policies as well as
strategic investments in infrastructure, education, and regulatory reforms, for
a more robust and diversified economy.
Keywords: Investment,
Interest Rate Liberalisation, and Auto Regressive Distributed Lag.
1.1 Introduction
Over
the past years, interest rate liberalisation has played a significant role in
Nigeria's economic policy changes. In an effort to promote a more
market-oriented financial sector and deregulate interest rates, the Central
Bank of Nigeria (CBN) has put in place a number of initiatives. These actions have
included the introduction of the Monetary Policy Rate (MPR) and the Cash
Reserve Ratio (CRR) as the main instruments for monetary policy, as well as the
Treasury Single Account (TSA), (CBN, 2022). Nigeria's liberalisation of
interest rates has a complex justification. Since market-determined interest
rates are intended to represent the real potential cost of capital, proponents
contend that loosening interest rate regulations can boost the efficiency with
which financial resources are allocated. It is thought that resources will flow
to their most productive uses if interest rates are allowed to freely fluctuate
in response to market conditions, which will encourage investment and economic
progress. The possible effects of interest rate liberalization on income
distribution, small and medium-sized businesses (SMEs), and financial stability
are frequently brought up by opponents of the policy (Anyanwu, 2014).
Furthermore, variables such as the macroeconomic environment, the depth and
efficiency of the financial markets, financial institutions and regulatory
frameworks may have an impact on how well interest rate liberalisation
stimulates investment in Nigeria (Ezejiofor, 2018).
Interest
rate liberalisation has been a frequently adopted policy instrument worldwide,
especially in developing nations such as Nigeria, with the objective of
promoting the growth of the financial sector and encouraging investment. Due to
its importance for economic growth and development, policy makers have paid
close attention to the link between interest rate liberalisation and investment
in recent years. Theoretically, interest rate liberalisation should encourage
investment by lowering capital costs and expanding credit availability, but
empirical research from recent studies has produced contradictory results.
According
to empirical studies, interest rate liberalisation and investment in Nigeria
are positively correlated. Ajide, Lawanson, and Ogundipe (2020), for instance,
discovered that interest rate liberalisation encouraged private investment in
Nigeria, which raised capital creation and spurred economic expansion. Ajide,
Lawanson, and Ogundipe (2020), contend that interest rate liberalisation
encourages financial institution rivalry, which lowers lending rates and improves
investor access to credit. Other
research, however, has drawn attention to the difficulties and ambiguities
surrounding the effect of interest rate liberalisation on foreign direct
investment in Nigeria. According to Umar and Opeyemi (2021), interest rate
liberalisation lessens the monetary policy's ability to influence investment
choices by complicating the process by which it is transmitted. Umar and Opeyei
(2021), contend that interest rate swings, which are impacted by a number of
internal and external variables, make investors uneasy and have a detrimental
impact on their choice of investments.
The
study of Onifade and Alamu (2022), drew attention to the possible dangers of
interest rate liberalisation in the absence of sufficient regulatory frameworks
and macroeconomic stability measures. These risks include; the possibility for increase
in interest rate, inflation rate, and exchange rate volatility, all of which
might discourage investment. Given these
conflicting results, it is pertinent that more empirical investigation is
required to fully comprehend the relationship between interest rate liberalisation
and investment in Nigeria.
Policymakers
may improve the efficacy of interest rate liberalisation policies and encourage
sustained investment development in Nigeria by looking at the fundamental
causes of the inconsistent results seen in empirical research. In many emerging economies,
including Nigeria, interest rate liberalisation has been a crucial policy
change intended to promote the growth of the financial sector and encourage
investment. While interest rate liberalisation theoretically encourages competition
among financial institutions, resulting in lower lending rates, Ajide,
Lawanson, and Ogundipe (2020) contended that in actuality, the transmission
mechanism is frequently inefficient, suggesting that investors' borrowing costs
remain high. Additionally, data from the Central Bank of Nigeria (CBN) shows
that lending rates are still high, which limits investment activity, even after
interest rate liberalisation measures have been implemented (CBN, 2022).
Also, there
are major barriers to interest rate liberalization's ability to effectively
encourage investment due to the makeup of the Nigerian financial system.
According to Ogunmuyiwa and Aluko (2020), investment is hampered by the
dominance of risk-free government securities and the weakness of the capital
market, which prevents the positive effect of a lower interest rate from
reaching the real sector of the economy. Thus, this study aims to offer a
thorough examination of the relationship between interest rate liberalisation
and investment in Nigeria as well as the causal link between interest rate
liberalisation and investment in Nigeria. The study analyses data spanning from
1986 to 2023.
2.0 Review of Related Literature
2.1 Conceptual Framework
2.1.1 Interest
Rate
Irving
Fisher (1930), defined interest rate as the price paid for the use of money
over time, represented as a percentage of the principal amount borrowed or
lent. According to Fisher's definition, interest rates are a measure of the
cost of borrowing or the return on investment related to using money. A
percentage of the transaction's principle is used to express this cost or
return. Fisher's concept also emphasizes the time value of money, implying that
variables like risk, opportunity cost, and inflation affect how much money is
worth over time. Interest rates therefore function as a tool to reimburse
borrowers for the expense of obtaining funds and to compensate lenders for
delaying investment or consumption. All things considered, Fisher's concept emphasizes
the basic function of interest rates in enabling resource allocation, impacting
investment choices, and determining an economy's overall performance.
Keynes defined
interest rates as the reward for parting with liquidity, with higher rates
compensating for the risk of holding fewer liquid assets, as outlined in
"The General Theory of Employment, Interest, and Money" (Keynes,
1936). In "The General Theory of
Employment, Interest and Money," John Maynard Keynes states that interest
rates can be defined in relation to the liquidity preference theory. The term
"liquidity preference," coined by Keynes, describes people's
preference for holding liquid assets like cash as opposed to illiquid ones like
bonds or securities.
According to Keynes' (1936), the
relationship between the money supply and demand in the economy sets the
interest rate. Interest rates are especially driven by people's demand for
liquidity, which is impacted by a range of variables including opportunity cost
of holding money, projections about the future, and uncertainty. People who
have a strong desire for liquidity may tolerate lower interest rates in
exchange for the option to hold onto their money rather than invest in volatile
assets. On the other hand, when consumers have a low preference for liquidity,
they are more likely to accept poorer returns on their investments in exchange
for parting with their money, that is, to demand higher interest rates.
Overall, Keynes' definition suggests that psychological and behavioural
elements that affect people's demand for liquidity also have an impact on
interest rates, in addition to the cost of borrowing and return on investment.
Obi (2015) defines interest rate as
the cost of borrowing money from financial institutions or the payment made for
lending money to borrowers in the context of the financial market in his study
on interest rate dynamics and economic growth in Nigeria. Obi's definition
indicates that interest rates regulate economic funding. Higher interest rates
increase the cost of borrowing, which may discourage borrowing and investment
and limit economic growth. However, lower interest rates cut borrowing costs,
which may boost investment and ultimately affect economic growth.
2.1.2 Investment
Keynes (1936) defines investment as
the expenditure on new capital goods that are expected to provide returns over
time. This concept says that investment involves allocating resources towards
the production or acquisition of assets with the anticipation of earning future
income or profits. Keynes' concept argues that investment is crucial for
generating aggregate demand and driving economic expansion. When businesses
invest in new capital goods, they stimulate demand for goods and services, ultimately
enhancing economic activity. Additionally, investment leads to the expansion of
productive capacity, innovation, and technical improvement, which are vital for
long-term economic development.
The
cornerstone of Keynes' theory of investment is the concept of the Marginal
Efficiency of Capital (MEC). The marginal efficiency of capital refers to the
projected rate of return on an additional unit of capital invested. In other
words, it refers to the increased profit margin or effectiveness that arises
from the purchase of one more capital good. According to Keynes, businesses
evaluate potential investments by contrasting the current interest rate with
the predicted return on a project. An investment is considered financially
viable if its marginal earnings curve (MEC) exceeds the interest rate,
indicating the possibility of generating returns higher than the financing
costs. On the other hand, if the MEC is less than the interest rate, businesses
can decide to put off or abandon investment projects since the returns wouldn't
be high enough to cover the financing costs.
Many
variables, including market conditions, technology developments, profitability
projections for the future, and uncertainty levels, all have an impact on the
marginal efficiency of capital. Keynes proposed that changes in the MEC might
cause changes in investment spending, which would then cause changes in
aggregate demand and economic instability.
2.2 Theoretical
Literature
2.2.1 The Classical Theory of Interest
Rates
Economists like Adam Smith (1776), David Ricardo
(1817), and John Stuart Mill (1848), promoted the classical theory of interest
rates, which provides an essential understanding of how interest rates are set
in financial markets. The classical
viewpoint shows that interest rates indicate the expense of borrowing money as
well as the reward for saving. A portion of an individual's income is saved by
them and deposited in financial institutions, where it is lent to borrowers for
investment reasons. Interest rates, which represent the opportunity cost of
using resources now rather than putting money aside for future use, encourage
people to save. According to the
traditional view, interest rates change to balance saving and investing. When
saving outpaces investment, the financial market has an excess supply of money,
pushing interest rates lower. On the other hand, when investment outpaces
saving, there is an excess demand for money, which drives up interest rates.
Interest rates adjust until it reaches a point where saving and investing are
equal, or market equilibrium.
2.2.2 The Loanable
Funds Theory of Interest Rate
The loanable funds or Neo-Classical Theory of interest
rates, pioneered by economists like Irving Fisher (1930), provides valuable
insights into how interest rates are determined in financial markets. This
theory extends the classical economic framework and underscores the
significance of saving and investment in shaping interest rate dynamics.
According to the loanable funds theory, interest rates adjust to equate the
supply of savings (loanable funds) with the demand for investment. Individuals
and institutions supply funds to financial markets by saving a portion of their
income, while borrowers demand funds for investment purposes. Interest rates
are the price that balances supply and demand for loanable funds.
The loanable funds theory implies that changes in
factors such as time preference, productivity of capital, and government
borrowing can influence the supply and demand for loanable funds, thereby
affecting interest rate dynamics in the economy. For example, an increase in
savings rates may lead to a higher supply of loanable funds, a decrease in
interest rates, stimulating investment and economic activity.
Furthermore, the loanable funds theory underscores the
importance of financial intermediaries, such as banks and other financial
institutions, in facilitating the transfer of funds between savers and
borrowers. These intermediaries play a crucial role in channeling savings into
productive investments, thereby contributing to economic growth and
development.
2.2.3 Keynes Liquidity Preference Theory of
Interest Rate
The
Keynesian Liquidity Preference Theory of Interest Rate, proposed by John
Maynard Keynes (1936), presents a departure from the traditional views of
interest rate determination. Rather than focusing solely on the supply and
demand for loanable funds, Keynes emphasizes the role of individuals'
preference for liquidity, or the desire to hold money rather than other assets.
Keynes
identifies three main motives for holding money: the transactions motive,
precautionary motive, and speculative motive. The transactions motive refers to the need to hold money for
everyday transactions, such as buying goods and services. The precautionary
motive arises from the desire to hold money as a buffer against unforeseen
expenses or emergencies. Finally, the speculative motive involves holding money
in anticipation of changes in asset prices, with the aim of profiting from
future market movements.
According to the Liquidity Preference Theory, interest
rates adjust to balance the demand for money, driven by these motives, with the
supply of money in the economy. When individuals have a strong preference for
liquidity, they are reluctant to part with their money, leading to a decrease
in the supply of loanable funds available for lending. As a result, interest
rates rise to entice lenders to part with their money. Thus, when liquidity
preference is low, individuals are more willing to invest their money,
increasing the supply of loanable funds and driving interest rates down.
2.3 Theories of Investment
2.3.1 The Accelerator Theory of Investment
In Dale's (1967) exposition of the
accelerator theory of investment, the central idea revolves around the
relationship between changes in the level of aggregate demand and fluctuations
in investment expenditure. The accelerator theory posits that changes in the
rate of growth of aggregate demand, particularly in consumer demand, directly
influence the level of investment spending by firms. According to this theory, variations in consumer demand,
which are generally driven by changes in income levels, translate into swings
in the demand for goods and services. Firms respond to these fluctuations in
demand by altering their investment expenditures in line with the projected
level of demand for their products. Specifically, when there is a surge in
consumer demand, firms anticipate bigger sales volumes and, subsequently,
increase their investment in capital goods to expand production capacity and
fulfill the increased demand. Conversely, if consumer demand weakens or falls,
enterprises may scale back their investment spending to avoid excess capacity
or inventory building. This dynamic link between changes in aggregate demand
and investment expenditure provides the basis of the accelerator theory.
2.3.2 The Classical Theory of Investment
According to Jhingan (2010), the
classical theory of investment places significant emphasis on the pivotal role
of savings, capital accumulation, and productivity in shaping investment
decisions and fostering economic growth. The theory emphasizes that savings
constitute a portion of income set aside for future utilization rather than
immediate consumption. These saved funds are subsequently directed towards
various investment avenues, including the acquisition of capital goods and the
financing of infrastructure projects. Such investments contribute to the
overall accumulation of capital within the economy. Furthermore, the theory
underscores the critical importance of enhancing productivity through
investments in technology, innovation, and education. These efforts are aimed
at enhancing efficiency and competitiveness, thereby resulting in heightened
output and long-term economic prosperity.
2.3.4 The Neo-Classical Theory of Investment
Jorgenson (1967)
presents a neoclassical theory of investment that extends classical economic
principles to elucidate investment decisions in contemporary economies. This
theory emphasizes the pivotal role of expected rates of return and the cost of
capital in driving business behavior. According to this theory, firms make
investment decisions based on their assessment of the potential profitability
of investment projects, comparing the anticipated returns from additional
capital investment with the associated costs, including interest rates,
technological advancements, and prevailing market conditions. Central to the
Neo-Classical framework is the idea of the marginal productivity of capital,
which denotes the incremental output produced by each unit of capital
investment. Firms allocate resources to various investment efforts based on
marginal productivity, prioritizing projects with higher expected returns.
Additionally, the theory underscores the significance of the cost of capital,
encompassing both borrowing prices and the opportunity cost of utilizing funds
for investment rather than alternative uses. Fluctuations in the cost of
capital exert an impact on firms' investment decisions, with lower costs
stimulating greater investment activity and higher costs dampening investment
enthusiasm.
Keynes (1936),
on the other hand, posits that investment decisions are primarily driven by
expectations and uncertainty rather than objective assessments of expected
returns and costs. Investment performed by private sector enterprises is
determined by the interest rate. Accordingly, investment decisions are made by
comparing the marginal efficiency of capital (MEC) or yield with the real rate
of interest. As long as the MEC is greater than the interest rate, new
investment in plants, equipment, and machinery will take place. However, when
more and more capital is used in the production process, the MEC will reduce
due to the diminishing marginal product of capital.
2.4 Empirical
Literature
Mackinnon (1973) and Shaw (1973)
conducted a groundbreaking study that paved the way for a significant amount of
empirical research into the functioning of financially suppressed economies and
the positive impacts of financial liberalization. The primary contention in the
research was that a financial system that is repressed is detrimental to growth
and development because of the negative consequences that it has on the mobilization
of savings and the distribution of capital. The liberalization of the financial
sector, on the other hand, will result in an increase in savings, will boost
investment, and will cause economic growth. In a number of empirical research,
it has been demonstrated that higher real interest rates can increase the
amount of money invested. The supply of domestic funding to finance investment
is increased by higher rates. According to the McKinnon and Shaw doctrine,
financial repression occurs primarily when a country imposes low-level ceilings
on nominal deposits and lending interest rates relative to inflation, resulting
in low or negative real interest rates that discourage savings mobilization and
the channeling of mobilized savings through the financial system.
The study by Effiong (2020) has
explored how interest rate affects the real sector output growth in Nigeria.
With data from 1985 to 2019 which was analyzed using error correction model,
there was a long run relationship between interest rate and economic growth.
The estimate showed that interest rate exerted a negative and significant
effect on real sector output in Nigeria. The study recommended that monetary
policy should be geared towards keeping interest rate at a favourable level.
Also, Effiong, Ukere and Ekpe (2024)
examined how fiscal policy and interest rate affects the manufacturing sector
of the Nigerian economy. The study utilized the autoregressive distributed lag
(ARDL) technique on data from 1981 to 2021. It was observed that while
government spending negatively affected manufacturing sector’s performance in
the short run, value added tax had a positive effect. However, the short run
effect of interest rate was positive and significant. The study recommended
that government spending should be channelled to productive sectors of the
economy; and that interest rates should be managed effectively to enhance
productivity in the manufacturing sector.
Inyang (2018) conducted a study that
looked at the effects of interest rate liberalization in Nigeria over a 31-year
period, from 1986 to 2016. The study looked at the short-term relationships
between the study's variables,
investment, inflation, interest rates, and exchange rates. The impact of interest rates on
investment in Nigeria was investigated using ordinary least square regression,
and the causal relationship between interest rates and investment in Nigeria
was ascertained through the pairwise Granger causality test. The findings
indicated that interest rates had a negative and negligible effect on
investment in Nigeria. The study suggested that interest rates be set so as not
to discourage investors from taking out loans in order to start profitable
investment projects.
Davis
and Emerenini (2015) conducted a study to analyse the influence of interest
rates on investment in Nigeria during the period from 1986 to 2012. The study
used multiple regressions as a statistical method, demonstrating that high
interest rates have a detrimental impact on investment. Based on the results,
the study proposed several recommendations. These include the need for the
appropriate monetary authority to develop policies that promote savings and
decrease the prime lending rate for legitimate investors, among other
suggestions.
Udonsah
(2012) conducted a study on the effect of interest rates on investment
decisions made in Nigeria. An econometric study was conducted for the time span
from 1981 to 2010. Secondary data was gathered from the Central Bank of
Nigeria's (CBN) statistical bulletin (volume 21) in December 2010. Data was
collected, and an empirical analysis was done. Multiple regression was used in
assessing the data on the influence of the interest rate on Nigeria prior to
interest rate regulation in 1986 and served as guidance on how the interest
rate can be fixed to enhance the effective accumulation of savings that can be
directed to investment. According to the research, CBN should be autonomous and
not under government control. The CBN has the ability has the ability to
establish an open market operation for government borrowing. This would not
only limit government expenditure to its revenue, but it would also help stabilize
the investment rate according to the principles of the free market. As a
result, the traditional link between the interest rate and public investment
will be reestablished.
Onwumere,
Okore and Imo (2012) were of the view that interest rate liberalization causes
interest rates to rise, thereby increasing savings and investment. The research
covered the period of 1976 to 1999 and adopted the OLS technique using SPSS
statistical software. The study reveals that interest rate liberalization has a
negative significant impact on investment in Nigeria; only real lending rate
was used in estimation of investment. Thus, interest rate liberalization,
though a good policy was counterproductive in Nigeria. This might be as a
result of improper pace and sequencing.
Eregha (2010) examined variations in
interest rate and investment determination in Nigeria between the periods of
1970 to 2002, using instrumental variable technique. The study showed that
investment has an indirect relationship with interest rate variation and other
variables that was employed. These variables such as debt burden, economic
stability, foreign exchange, shortage and lack of infrastructure affect gross investment,
and the OLS technique was employed.
Akintoye & Olowlaju (2008)
examined optimum macroeconomic investment decision in Nigeria. The study
employed OLS and VAR frameworks to simulate and inter-temporarily private
investment response to its principal shock namely public investment, domestic
credit and output shock. The study found low interest rates have constrained
investment growth. The study resolved that only government policies produce
sustainable output, steady public investment and encourage domestic credit to
the private sector will promote private investment.
Akiri & Adofu (2007),
investigated the effect of interest rate deregulation on investment in Nigeria
between 1986-2002 and uses OLS regression model to authenticate the proficiency
of interest rate deregulation on gross domestic investment in Nigeria. The
study also identified other factors which impede investment in Nigeria namely,
political instability, exchange rate, inflation rate, unawareness of investment
opportunities and corruption in order to bring out the level of influence of
exchange rate and inflation on investment.
Chuba
(2005), investigated the validity of the proposition that the high internet
rate observed during the era of post liberalization on interest rate have been
frequently blamed for the investment contraction in Nigeria. The study makes
use of descriptive and analytical tools; the findings shows that real lending
rate have a negative but insignificant impact on gross domestic investment
(GDI) and that interest rate liberalization does not negative impact GDI as
usually claimed.
The
findings of Givoannini (1983, 1985), Corbo& Schmidt-Hebbel (1992),
Schmidt-Hebbel, Webb &Corsetti (1992) and Edwards (1994) found that savings
is insensitive to real interest rate and are in direct contradiction to real
life experiences and empirical evidence in Nigeria. Soyibo and Adekanye (1992),
in their investigation of the relationship between aggregate and interest rate
in Nigeria used OLS regression model but in a log form and found aggregate
savings to be positively correlated with real interest rates.
2.5 Justification
of the study
Despite the extensive research on Interest rate
liberalization and investment in Nigeria, there still remains a notable gap
regarding the role of public expenditure in this context. Existing studies have
predominantly focused on variables such as interest rates, investment,
inflation, exchange rates, and savings rates. However, the impact of public
expenditure, particularly its interaction with financial liberalization
policies, has not been thoroughly investigated.
To this end, this research incorporates public
expenditure variables into the analysis of interest rate liberalization and
investment in Nigeria. Public expenditure can significantly influence economic
activity, affecting both the supply and demand sides of the economy. By
including variables such as government spending on infrastructure, education,
healthcare, and other public services, the research aims to provide a more
comprehensive understanding of how financial liberalization interacts with
public sector activity to influence investment in Nigeria. Also, this study
uses the Auto Regressive Distributed Lag (ARDL) estimation technique to
investigate the long and short run relationship between interest rate
liberalization and investment in Nigeria.
3.1 Research Methodology
3.1.1 Model Specification
The model in a functional form is
stated thus;
GFCF = F(INRLEND, EXR, LNPUBEXP, INF, MS)……………………………(1)
Where:
GFCF = Growth rate of Gross Fixed Capital
Formation (a proxy for
Investment)
EXR = Exchange rate
INRLEND = Interest
rate
LNPUBEXP = Public expenditure as a percentage of
GDP
INF = Inflation
MS = Money Supply as a percentage of GDP
Transforming equation (1) to a linear
econometric model gives;
GFCF
= β0 + β1INRLEND + β2EXR + β3LNPUBEXP + β4INF
+β5MS+ µ………...(2)
A
priori, β0, >0; β1 <0; β2<0; β3>0;
β4<0; β5.>0
3.1.2 Technique Employed
The Auto Regressive
Distributed Lag model is employed in this study due to its ability to capture
the short-term and long-term relationships of the dependent and the independent
variables. This makes it the ideal method to achieve the objective of the
research work, ensuring accurate and meaningful results. The study also uses
the Granger Causality Test in order to determine the causal relationship among
the variables employed in the study.
The Unit root test and the F-Bound
testis are used to test for the stationarity and cointegration of the variables
respectively.
3.2 Description of variables
i.
Gross Capital Formation:
This is the total value of a country's
new investments in fixed assets, such as
buildings,
machinery, and equipment, excluding land purchases. It represents the net
increase in physical assets within an economy and includes expenditures on both
replacement and new additions to these fixed assets.
ii. Interest Rate
Interest
rate refers to the cost of borrowing or the return generated on savings or
investments, expressed as a percentage of the principal amount. It reflects the
compensation provided by borrowers to lenders for the use of their fund, or the
benefit obtained by savers or investors for postponing consumption or taking on
risk. Interest rates have a vital role in determining borrowing and lending
decisions, investment choices, and general economic activity
iii. Exchange
Rate:
This is the rate at which one country’s
currency is exchanged for another. For the purpose of this study, the exchange
rate used is the naira/dollar exchange rates in the formal market.
iv. Public
Expenditure:
This refers to the
spending made by the government or public sector institutions on goods,
services, and obligations. Public expenditure can either be capital or
recurrent. For the purpose of this study, an aggregate of both capital and
recurrent expenditure is used.
v. Inflation Rate:
Inflation is a sustained increase
in the price level of goods and services in an economy over a period of time.
The inflation rate is the annual percentage change in a general price index,
usually the consumer price index over time.
vi. Money Supply(M2):
Money supply refers to the total
amount of money available in an economy at a particular point in time. It
includes various forms of money, such as cash, coins, and balances held in
checking and savings accounts.
4.1
Data Presentation and Discussion of
Result
4.1.1 Stylized Facts
Figure 4.1: Trend Analysis of Gross
Fixed Capital Formation and Exchange Rate.
The
graph of Gross Fixed Capital Formation (GFCF) typically represents investment
levels for the years under review. The trend shows a decline from 2010 onwards as
possibly due to global financial instabilities and internal economic
challenges. The sharp drops around 2016 coincide with Nigeria's economic
recession, exacerbated by falling oil prices and foreign investment
withdrawals. Figure 4.1 also shows that Exchange Rate (EXR) has been
significantly volatile, especially during major economic downturns. From its
stability in 1987, it soared to over N425/dollar in 2022, reflecting persistent
inflationary pressures on the Nigerian economy.
Figure 4.2: Trend Analysis of Public
Expenditure, Interest Rate and Inflation
Figure
4.2 shows that Public Expenditure indicates a gradual increase, reflecting
government efforts to stimulate the economy through public spending. However,
this also indicates a growing dependency on government spending to drive
economic activities, which can lead to unsustainable fiscal deficits if not
properly managed. Interest Rates (INR.LEND) as seen in the Figure 4.2,
initially decreased, which should theoretically encourage borrowing and
investment. However, the high rates from the 2000s onward, combined with economic
uncertainty, could stifle private investment. Inflation (INF) has been erratic,
with periods of extreme inflation noted in the late 1980s and mid-2010s. High
inflation erodes real earnings and savings, reducing the disposable income
available for investment.
4.2 Analysis
and Interpretation of Result
4.2.1 Unit Root Test Result
Table 4.1 Result of Unit Root Test
|
Variable
|
ADF
t-statistics |
Probability
value |
Level
of integration |
|
GFCF |
-5.672281 |
0.0000 |
I(1) |
|
EXR |
-3.628575 |
0.0100 |
I(1) |
|
LNPubExp |
-3.108582 |
0.0359 |
I(0) |
|
INR.LEND |
-4.327772 |
0.0078 |
I(0) |
|
INF |
-3.533848 |
0.0012 |
I(0) |
|
MS |
-4.949762 |
0.0003 |
1(1) |
Source: Computed by the Researcher from E-VIEWS 10
The unit root test results as shown
in Table 4.1 provide a critical examination of the stationarity of the
variables included in the model. The result showed that the variables are
stationary at levels and first difference., suggesting potential use of
techniques such as the ARDL (Autoregressive Distributed Lag) to capture both
short-term dynamics and long-term relationships
of the variables.
4.2.2 The F - Bound
Test Result
|
Table
4.2 The F-Bounds Test |
Null Hypothesis:
No levels relationship |
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Test Statistic |
Value |
Signif. |
I(0) |
I(1) |
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|
|
|
F-statistic |
3.246046 |
10% |
2.08 |
3 |
|
K |
5 |
5% |
2.39 |
3.38 |
|
|
|
2.5% |
2.7 |
3.73 |
|
|
|
1% |
3.06 |
4.15 |
|
|
|
|
|
|
Source:
Computed by the
Researcher using E-VIEWS 10
The F-bounds test is a key component
of the ARDL (Autoregressive Distributed Lag) approach, used to determine
whether there is a long-run equilibrium relationship among the variables in the
model. The result suggests that there is existence of cointegration
relationship
4.2.3
The ARDL Long Run Result
Table 4.3 Long run
Estimate (ADRL)
|
Variable
|
Coefficient
|
Std.
error |
t-Statistics
|
Prob. |
|
EXR |
0.005933 |
0.022777 |
0.260477 |
0.7983 |
|
LNPubExp |
4.427038 |
2.165816 |
2.044051 |
0.0402 |
|
INR.LEND |
0.580099 |
0.210826 |
2.751555 |
0.0156 |
|
INF |
-0.065268 |
0.064277 |
-1.015412 |
0.3271 |
|
MS |
-0.252055 |
0.203405 |
-1.239174 |
0.2357 |
|
C |
5.929588 |
24.55195 |
0.241512 |
0.8127 |
Source:
Computed by the
Researcher from E-VIEWS 10
4.3 Long-Run ARDL Results
The long run result in Table 4.3
shows that government expenditure and interest rate showed significant impacts on investment measured by
Gross Fixed Capital Formation. However, exchange rate, inflation and money
supply displayed insignificant relationship with investment in the long
run.
4.4
Short Run ARDL Result
Table
4.4: Short run Estimate (ARDL)
|
Variable |
Coefficient |
Std. error |
t-Statistics |
Prob. |
|
EXR |
0.005933 |
0.012162 |
0.487842 |
0.6332 |
|
LNPubExp |
4.427038 |
1.300695 |
3.403595 |
0.0043 |
|
INR.LEND |
0.580099 |
0.125250 |
4.631545 |
0.0004 |
|
INF |
-0.065268 |
0.032345 |
-2.017856 |
0.0632 |
|
MS |
-0.696538 |
0.390498 |
-1.783718 |
0.0962 |
|
ECM (-1) |
-0.361868 |
0.063515 |
-5.697408 |
0.0001 |
|
R-squared |
0.871701 |
Mean
dependent var |
-0.966481 |
|
|
Adjusted
R-squared |
0.788307 |
S.D.
dependent var |
3.009759 |
|
|
S.E.
of regression |
1.384793 |
Akaike
info criterion |
3.781879 |
|
|
Sum
squared resid |
38.35302 |
Schwarz
criterion |
4.410381 |
|
|
Log
likelihood |
-50.29195 |
Hannan-Quinn
criter. |
3.996216 |
|
|
Durbin-Watson
stat |
2.001871 |
|
|
|
Source:
Computed by the
Researcher from E-VIEWS 10
The
short-run ARDL results in Table 4.4 provide insights into the effects of
changes in the independent variables on dependent variable in Nigeria. These
results highlight the dynamic adjustments that occur before reaching the
long-run equilibrium. The error correction model which measures the speed of
adjustment from disequilibrium to equilibrium showed 0.36. This means that
approximately 36% of the disequilibrium is corrected within a year. The result
further indicates that government expenditure and interest rate were
significant at 5% level in the short run, while inflation and money supply were
significant at 10% during the same period. However, exchange rate showed an
insignificant relationship with investment within the period under review.
The result showed the explanatory power of the
independent variables on the dependent variable to be 87%. This means that 87% variation in the
dependent variable is explained by the independent variable, while the remaining
13% is captured by the error term. The DW d-statistic showed the absence of
autocorrelation in the model. The Diagnostic test result in Table 4.5 confirms
that the variables used in this study are suitable for estimation and the model appears robust with no
significant issues detected.
4.5 The Diagnostic Test Result
Table 4.5
Diagnostic Test
|
Test
|
F-statistics
|
Probability
value |
|
ARCH |
0.3758 |
0.9786 |
|
LM
TEST |
2.3694 |
0.1357 |
|
NORMALITY
TEST |
1.8373 |
0.3991 |
|
RESET
TEST |
0.7240 |
0.4102 |
Source: Computed
by the Researcher using E-VIEWS 10
4.6 The Granger Causality Test
TABLE 4.6 Granger
Causality Test Results
|
Pairwise Granger Causality Tests |
|||
|
Sample: 1986 2023 |
|
||
|
Lags: 2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Null Hypothesis: |
Obs |
F-Statistic |
Prob. |
|
|
|
|
|
|
|
|
|
|
|
EXR does not Granger Cause GFCF |
36 |
0.87349 |
0.4275 |
|
GFCF does not Granger Cause EXR |
1.22434 |
0.3078 |
|
|
|
|
|
|
|
|
|
|
|
|
INF does not Granger Cause GFCF |
36 |
2.59008 |
0.0912 |
|
GFCF does not Granger Cause INF |
6.85041 |
0.0034 |
|
|
|
|
|
|
|
|
|
|
|
|
INR_LEND does not Granger Cause
GFCF |
36 |
0.38804 |
0.6816 |
|
GFCF does not Granger Cause INRLEND |
3.91282 |
0.0305 |
|
|
|
|
|
|
|
|
|
|
|
|
LNPUBEXP does not Granger Cause
GFCF |
36 |
3.62122 |
0.0386 |
|
GFCF does not Granger Cause
LNPUBEXP |
0.05224 |
0.9492 |
|
|
|
|
|
|
|
|
|
|
|
|
MS does not Granger Cause GFCF |
36 |
0.57140 |
0.5706 |
|
GFCF does not Granger Cause MS |
1.82032 |
0.1789 |
|
|
|
|
|
|
|
|
|
|
|
|
INF does not Granger Cause EXR |
36 |
1.28295 |
0.2915 |
|
EXR does not Granger Cause INF |
0.96032 |
0.3939 |
|
|
|
|
|
|
|
|
|
|
|
|
INR_LEND does not Granger Cause
EXR |
36 |
0.46255 |
0.6339 |
|
EXR does not Granger Cause INRLEND |
4.78849 |
0.0154 |
|
|
|
|
|
|
|
|
|
|
|
|
LNPUBEXP does not Granger Cause
EXR |
36 |
1.99658 |
0.1529 |
|
EXR does not Granger Cause
LNPUBEXP |
0.17217 |
0.8426 |
|
|
|
|
|
|
|
|
|
|
|
|
MS does not Granger Cause EXR |
36 |
0.78347 |
0.4657 |
|
EXR does not Granger Cause MS |
1.19135 |
0.3173 |
|
|
|
|
|
|
|
|
|
|
|
|
INR_LEND does not Granger Cause
INF |
36 |
1.42829 |
0.2551 |
|
INF does not Granger Cause INRLEND |
3.05153 |
0.0617 |
|
|
|
|
|
|
|
|
|
|
|
|
LNPUBEXP does not Granger Cause
INF |
36 |
4.35708 |
0.0215 |
|
INF does not Granger Cause
LNPUBEXP |
0.72184 |
0.4938 |
|
|
|
|
|
|
|
|
|
|
|
|
MS does not Granger Cause INF |
36 |
0.94606 |
0.3992 |
|
INF does not Granger Cause MS |
3.29145 |
0.0506 |
|
|
|
|
|
|
|
|
|
|
|
|
LNPUBEXP does not Granger Cause
INRLEND |
36 |
6.46468 |
0.0045 |
|
INR_LEND does not Granger Cause
LNPUBEXP |
0.05019 |
0.9511 |
|
|
|
|
|
|
|
|
|
|
|
|
MS does not Granger Cause INR_LEND |
36 |
2.29913 |
0.1172 |
|
INR_LEND does not Granger Cause MS |
1.99887 |
0.1526 |
|
|
|
|
|
|
|
|
|
|
|
|
MS does not Granger Cause LNPUBEXP |
36 |
0.31457 |
0.7324 |
|
LNPUBEXP does not Granger Cause MS |
2.24864 |
0.1225 |
|
|
|
|
|
|
|
|
|
|
|
Source:
Computed by the
Researcher using E-VIEWS 10
Table
4.6 presents the causality analysis of the variables employed in the study. The
result reveals that some variables displayed unidirectional causality, while
others showed absence of causality relationship. The result reveals
unidirectional causality on Gross Fixed Capital Formation and Inflation; Gross
Fixed Capital Formation and Interest Rate; Government Expenditure and Gross
Fixed Capital Formation; Exchange Rate and Interest Rate; Government
Expenditure and Inflation; Inflation and Money Supply, and Government
Expenditure and Interest Rate.
4.2 Discussion
of Finding
The
findings of this study reveal important insights into the impact of interest
rate liberalization on investment in Nigeria,. The results suggest a complex
relationship between variables like interest rates and investment, highlighting
both the potentials and limitations of interest rate liberalization as a policy
tool. In examining the long-term effects, the regression analysis indicates
that interest rates (INR.LEND) and public expenditure (PubExp) significantly
influence investment, suggesting that these factors are crucial for stimulating
economic activity. This aligns with Keynesian theory, which posits that fiscal
policy and financial market efficiency can drive investment and economic growth
(Blanchard & Johnson, 2013). However, the lack of significant impact from
exchange rates (EXR), inflation (INF), and money supply (MS) on investment
challenges traditional economic assumptions and points to the unique
characteristics of the Nigerian economy.
The
short-run dynamics provide further clarity, revealing that public expenditure
and interest rates have immediate and significant effects on investment. The
significant error correction term indicates that deviations from the long-run
equilibrium are quickly corrected, underscoring the stability of the investment
model. This suggests that while interest rate liberalization can enhance
financial efficiency, its effectiveness in promoting investment relies heavily
on complementary fiscal policies (Broner and Ventura, 2010). This highlights
the importance of a coordinated policy approach that addresses both monetary
and fiscal dimensions to effectively stimulate investment.The high R-squared
value of the model further supports this, indicating that the selected
variables effectively capture the dynamics of investment. However, the findings
also suggest that interest rate
liberalization alone may not be sufficient to drive investment growth,
necessitating a broader policy framework that includes fiscal measures and
structural reforms.
The
Granger causality tests provide valuable insights into the causal links between
the variables, revealing that investment Granger-causes both inflation and
interest rates. This finding suggests that investment decisions in Nigeria have
broader macroeconomic implications, influencing key economic indicators over
time. The causality from public expenditure to investment underscores the
critical role of government spending in driving economic activity, aligning
with the Keynesian view that fiscal policy is essential for stimulating growth.
Despite
these findings, the absence of significant causality from interest rates to
investment challenges the efficacy of interest rate liberalization as a
standalone policy measure. This indicates that while liberalization efforts can
improve financial market efficiency, there should be complemented by supportive
fiscal policies and structural reforms to effectively stimulate investment.
This highlights the importance of a comprehensive policy approach that
addresses the underlying constraints facing the Nigerian economy, such as
infrastructural deficits and limited access to finance.
It
is crucial to recognize that the Nigerian economy faces structural challenges
that limit the effectiveness of interest rate liberalization. For instance,
infrastructural deficits, such as inadequate transportation networks and
unreliable energy supplies, increase the cost of doing business and deter
investment, even in a liberalized financial environment (Adeoye and Elegbede,
2012). Additionally, limited access to finance, especially for small and
medium-sized enterprises (SMEs), constrains their ability to invest and expand,
undermining the potential benefits of interest rate liberalization (Onakoya and
Somoye, 2013).
Moreover,
the regulatory environment plays a significant role in shaping investment
outcomes. A stable and transparent regulatory framework is essential for
building investor confidence and ensuring that financial market liberalization
translates into tangible economic benefits. This includes strengthening
financial institutions, improving governance, and ensuring the rule of law,
which are critical for creating a favorable investment climate (Ibrahim
&Sare, 2018).
Furthermore,
addressing macroeconomic stability is vital for maximizing the impact of
interest rate liberalization. High inflation and exchange rate volatility can
erode investor confidence and reduce the attractiveness of investment
opportunities. Policymakers should therefore, focus on implementing sound
monetary policies that stabilize prices and, provide a conducive environment
for investment. The study has highlighted the multifaceted nature of the
relationship between interest rate liberalization and investment in Nigeria.
While the findings underscore the potential of liberalization efforts to
enhance financial efficiency, they also point to the need for a coordinated
policy approach that integrates monetary, fiscal, and structural reforms. This
is crucial for maximizing the benefits of interest rate liberalization and
fostering a conducive environment for investment and economic growth.
5 Conclusion
and Recommendations
This
research investigates the influence of interest rate liberalization on
investment in Nigeria, exploring the dynamic of various economic factors that
shape investment. The study's findings are rooted in extensive econometric
analysis, including unit root tests, F-bounds tests, and both long- and
short-run models, complemented by Granger causality tests. The objective is to
determine whether interest rate liberalization has substantially influenced
investment in Nigeria within the period under review. Utilizing a robust
econometric model, the research analyzed data spanning multiple decades to
assess the relationships between gross fixed capital formation (GFCF) and key
economic indicators, including exchange rate (EXR), public expenditure
(PubExp), interest rate (INR.LEND), inflation rate (INF), and money supply
(MS). The results revealed that interest rate liberalization has an impact on
investment in Nigeria. The long-run analysis indicated that while interest
rates and public expenditure significantly affect investment, the roles of
exchange rate, inflation, and money supply are less pronounced. This complexity
reflects Nigeria's unique economic space, characterized by its reliance on oil,
fluctuating fiscal policies, and varying levels of economic stability. Short-run
dynamics further illuminated these relationships, showing that public
expenditure and interest rates have immediate and significant impacts on
investment, with deviations from long-run equilibrium quickly corrected. This
highlights the critical role of government spending and effective interest rate
policies in shaping the investment climate.
Despite the potential of interest rate liberalization
to enhance financial market efficiency, the study concludes that it cannot
single-handedly drive investment growth. The absence of significant causality
from interest rates to investment emphasizes the need for a comprehensive
policy framework that incorporates fiscal measures and structural reforms. This
is particularly relevant given Nigeria's infrastructural deficits, regulatory
challenges, and limited access to finance, which constrain investment opportunities.
Based
on the findings of this study, the following recommendations were proffered;
i.
Policymakers should prioritize stabilizing prices of goods and services, and
exchange rates to foster a conducive environment for investment.
ii. Given
the finding that interest rate liberalization alone does not significantly
drive investment, the government should focus on improving its financial
infrastructure. This involves expanding access to credit for businesses, particularly
small and medium-scale enterprises (SMEs), which often face hurdles in
obtaining financing. By strengthening credit facilities and reducing
bureaucratic barriers, the government can create a more inclusive financial
system that empowers businesses to invest and grow..
iii. It
is crucial for policymakers to develop fiscal policies that complement interest
rate liberalization. This includes increasing public investment in
infrastructure such as transportation, energy, and telecommunications, which
can reduce operational costs for businesses and enhance productivity.
iv. Fiscal
incentives, such as tax rebate or subsidies for sectors with high growth
potential, can attract both domestic and foreign investment, fostering a more
vibrant economy and promoting investment.
v. The
government should prioritize policies that are aimed at controlling inflation
through effective monetary policy and fiscal discipline. There is need to
establish a clear, transparent, and consistent economic policies that will
build investor confidence, and reduce the perceived risk of investing in
Nigeria.
vi.
Policy framework and reforms to streamline regulatory processes, eliminate
corruption, and enhance the efficiency of legal and institutional frameworks that
will encourage investment in Nigeria should be put in place.
vii. Macroeconomic
stability is vital for sustaining investor confidence. Volatile inflation and
exchange rates can deter investment by increasing risk and uncertainty.
Therefore, maintaining macroeconomic stability through sound monetary and
fiscal policies as well as strategic investments in infrastructure, education,
and regulatory reforms, for a more robust and diversified economy.
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