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The importance of investment in economic growth cannot be overemphasized. This has led to an upsurge in the study of its determinants. This research therefore, seeks to investigate the impact of interest rate liberalization on investment in Nigeria from 1970-2012. Using the Error Correction Model (ECM), the result indicates that a long run relationship exists among the variables. The result further reveals that all the variables have significant impact on investment. The study equally shows that there is no differential impact of interest rate liberalization on investment in Nigeria during the pre and post-liberalization regimes. Also, the impulse responses of these variables to shocks in theextraneous variables were verified; using the Multiple-Equation VAR models. In addition, the variance decomposition result shows thatPeriod 2 shows a standard deviation value of 97.23 in investment resulting from own shock, 2.44 to a response to a shock from interest rate, 0.0186 to a response from market capitalization rate,0.205900 to a response to public expenditure and 0.101933 to response to trade openness. In period 10, investment responds positively with a standard deviation of 18.77 originated from own shock and standard deviation values of 8.05, 7.94, 12.43 and 15.59 arising from a shock from interest rate, market capitalization rate, public expenditure and trade openness respectively. It is recommended that polices to make interest rate attractive to investors as well as improve trade should be encouraged. Also broadening the capital market and improving infrastructure through increased capital expenditure should be pursued. In addition to these, there should be consistency in policies so that policy summersaults does not affect investment.


Title page

1.1       Background to the study
1.2       Statement of the problem
1.3       Research Questions
1.4       Research Objectives
1.5       Research Hypotheses
1.6       Policy Relevance of the study
1.7       Scope of the study

2.1 Management of Interest Rate prior to 1986
2.2Management of Interest Rate since 1987

3.1       Conceptual framework
3.2Theoretical framework
3.2.1 Theories of Interest Rate
3.2.2 Theories of Investment
3.3 Empirical Literature
3.4       Limitation of previous studies

4.1       Theoretical framework
4.2       Model specification
4.3       Method of estimation
4.4       Justification of the model
4.5 source of data

5.1       Descriptive analysis of variable
5.2       Pre-Diagnostic tests
5.2.1    Unit root test result
5.2.2    Co-integration test
5.3       Presentations of regression result and interpretation
5.3.1    Error correction model
5.3.2    Innovation accounting
5.4       Evaluation of research Hypothesis
5.4.1    Test of working Hypothesis i
5.4.2    Test of working Hypothesis ii
5.4.3    Test of working Hypothesis iii
5.5       Chapter summary and prospects

6.1       Summary of research finding
6.2       Policy recommendation
6.3       Conclusion
6.4       Recommendation for further studies



1.1 Background of the Study

The Nigerian economy has at different times witnessed enormous interest rate swings in different sectors of the economy since the 1970s and mid 1980s under a regulated regime. The preferential interest rates were based on the premise that the market, if freely applied would exclude some priority sectors. Thus, interest rates were adjusted through the market forces in order to promote increased level of investment in the various preferred sectors of the economy. Prominent among the preferred sectors were the agricultural, manufacturing and solid mineral sectors which were accorded priority and deposit money banks were directed to charge preferential interest rates on all loans to encourage the upsurge of small-scale industrialization which is a catalyst for economic development (Udoka, 2000). According to Mckinnon (1973) and Shaw (1973), this situation can ignite financial repression which occurs mostly when a country imposes ceiling on deposit and lending nominal interest rate at a low level relative to inflation. The resulting low or negative interest rates discourage savings mobilization and the channelling of mobilized savings through the financial system. This has a negative effect on the quantity and quality of investment and hence economic growth.

Closely followed by the regulated interest rate regime was the interest rate reform, a policy evolved under the financial sector liberalization. The policy was put in place to achieve efficiency in the financial sector, thus, engendering financial deepening. In Nigeria, financial sector reforms started with the deregulation of interest rate in August, 1987 (Ikhide & Alawade, 2001). Since then, the Nigerian government has been pursuing a market determined interest rate which does not permit a direct state intervention in the general direction of the economy (Nyong, 2007).

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 regards 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.....

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