CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND TO STUDY
In Nigeria, interest rate policy is among the emerging issue in current economic policy as regard the role of it is expected to play in the deregulated economy in inducing savings which can be channeled to investment and thereby increasing employment, output and efficient financial resources utilization. The administration of low interest rate which was intended to encourage investment was witnessed in the 1950s to mid 1960s. In the third quarter (3/4) of 1986, Structural Adjustment Programme (SAP) was introduced by the then head of state General (Rtd) Ibrahim Gbadamosi Badangida. This programme ushered in an era when fixed low interest rate was gradually replaced by a deregulated interest rate regime where rates were more influenced or determined by market forces. The policy shift de-emphasized direct investment stimulation through the low interest rates.
The mobilized fund was intended for investment. In Nigeria, the pursuit of the two interest rate regime provide a case study for Keynesian interest rate investment relationship and the McKinnon Shaw interest rate saving and investment hypothesis. Several reason have been given as to why people invest and save. Some of these reasons are; the direction of interest rate, the returns that is expected from such an investment, the interest accrues to savers and some other developmental reasons. It is obvious that the higher the rate of interest the lower the level of investment and also the lower the rate of interest, the higher the level investment. However, this work is also directed toward understanding the kind of relationship that exist between interest rate, savings and investment McKinnon and Shaw conclude that higher interest rate induce savings which can be utilized is investment therefore these two transmission channeled through which interest rate affect investment, the relate to interest rate as a cost of fund (capital). Also, interest rate encourage financial savings, which can be invested (self-finance) or lent out to borrow as loan (external finance).
1.2 STATEMENT OF RESEARCH PROBLEM
The upsurge in real interest rate observed worldwide in the early 1980’s raised a widespread concern about their possible detrimental economic effects. Numerous studies were carried out to measure the impact of high interest rates on key economic variables such as growth of output, investment factor productivity and relative factor returns in response to these concerns. An empirical regularity observed in several cross-country studies e.g. World Bank (1989) and Galbis in 1992 that countries with high real interest rate generally intended to exhibit faster output growth but not higher investment, encourage a more efficient allocation of resources which raises overall productivity such that the nit impact on growth is positive while other studies e.g. (Khatkate 1998) have questioned the empirical robustness of these findings. A basic lesson from this literature skill hold namely higher interest rate on investment and growth mainly depends on what has caused interest rate rise in the first place.
In Nigeria case, in 1986, interest rate was extensively prior to the adoption to SAP. The economic rational behind this extensive control of interest rate and other elements of financial market have been motivated by a variety of factors including the desire to influence the flow of credit to preferred sectors of the economy and the concern that market determined interest rate could result in a serious imperfection in lending rate that would increase the rate cost of capital and thereby discourage investment. Moreover, such high normal investment rate would also increase the cost of servicing the public debt. Thus, interest rate policy should be used to increase the availability of credit in order to encourage the accumulation of domestic financial assets by offering holders of these asset sufficiently attractive rates. The deregulation of interest rate during the SAP period seems to be justified by this consideration. The market determined interest rate is meant to mobilize financial savings and for efficient channeling of such savings into productive investment. This deregulation which resulted to concurrent increase in interest rate and savings seem to lay credence to McKinnon and Shaw interest rate, saving and investment hypothesis. What happened to saving mobilized during this period is the key issue, which is the focus of the study. The study will try to find out the following. i. Whether the savings generated during this period was transformed into real investment. ii. What is the relationship between interest rate, savings and investment in Nigeria?
