CHAPTER ONEINTRODUCTION1.1 Background of the StudyInvestment is the change in capital stock during a period. Consequently, unlikecapital, investment is a flow term and not a stock term. This means that capital ismeasured at a point in time, while investment can only be measure over a periodof time.Investment plays a very important and positive role for progress and prosperity ofany country. Many countries rely on investment to solve their economic problemsuch 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 theopportunity cost of borrowing money from a lender to finance investment project.It can also be seen as the return being paid to the provider of financial resources,for going the fund for future consumption. Interest rates are normally expressedas a percentage rate. The volatile nature of interest is determined by manyfactors, which include taxes, risk of investment, inflationary expectations, liquiditypreference, market imperfections in an economy etc.Banks are given the primary responsibility of financial intermediation in order tomake fund available for economic agents. Banks as financial intermediariesmove fund. Surplus sector/units of the economy to deficit sector/units byaccepting deposits and channeling them into lending activities. The extent towhich this could be done depend upon the rate of interest and level ofdevelopment of financial sector as well as the saving habit of the people in thecountry.Hence, the availability of investible funds is therefore regarded as a necessarystarting part for all investment in the economy which will eventually translate toeconomic growth and development (Uremadu, 2006).Many researchers have done a lot of study on the impact of interest rate oninvestment. In Nigeria, Ologu (1992) in a study of “The Impart of CBN MoneyPolicy on aggregate investment behavior”. Found out only few of the variableswere significant at both the 95% and 90% confidence limits in explaining thebehavior of investment during the (1976-90) period of student”. Specifically, hefound out that:1. Contrary to expectation and to change’s stock adjustment hypothesis, theexisting stock of capital goods (plants and machinery) was not a majordeterminant of investment behavior of forms in Nigeria.2. Interest rate was significant in influencing investment decision nothingthat” this is not surprising since in a situation of limited residual funds as inNigeria, the cost of capital should exert significant influence on both thefrequency and volume of demand for invisibles funds by investors.Lesotho (2006) studied “An investigation of the determinants of privateinvestment “the case of Botwana”. Among his independent variable were realinterest rate, credit to the private investors, public investment and trade credit tothe private investors, real interest rate affect private investment positively andsignificantly. Other variable do not affect private investment level in the shorttermas they show insignificant co-efficient. GDP growth and conform similarfinding sin studies by Oshikoya (1994), Ghura and Godwin (2000) and Malmboand Oshikoya (2001).Aysam et al (2004) in their study “How to Boot Private Investment in the MENAcountries. The role of Economic Reforms”. Among their independent variableswere accelerator, real interest rate, macroeconomic stability, structural reform,external stability, macroeconomic volatility, physical infrastructure. Their studiesranged from 1990 to 1990 comprising of panel of 40 developing countries. Theyused co-integration technique to determine the existence of a long-termrelationship between private investment and its determinants. They fund out thatalmost all the explanatory variables exhibit a significant impact on privateinvestment, with the exception of macroeconomic stability and infrastructures.The accelerator variable (ACC) has the expected positive sign, which implies thatthe anticipation of economic growth induce more investment. Similarly, interestrate (r) appears to exert a negative effect on firm’s investment projects, which isconsistent with the user cost of capital theory.In the U.S, Evans, estimated that net investment would rise by anything between5% and 10% for a 25% fall in interest rate. These percentage changes werecalculated to occur over a two year period after a one year log.A study by Kham and Reinhart (1990) observe that there is a close connectionbetween the level of investment and economic growth. In other words, a countrywith low level of investment would have a low GDP growth rate. The use of ryidexchange rate and interest rate controls in Nigeria in low direct investment, theleads to financial impressions in the early 1980. Fund were inadequate as therewas a general lull in turn leads to the liberalization of the financial system Omoleand Falokun (1999). This may have an adverse effect on investment andeconomic growth.As already discussed so far, it is quite clear that an understanding of the natureof interest rate behavior is critical and crucial in designing policies to promotesavings, investment and growth. It is pertinent to note that this research attemptsto investigate and ascertain the impact of interest rate volatility on investmentdecisions in Nigeria using time series data covering from 1981-2010.1.2 Statement of the ProblemThe financial systems of most developing countries (like Nigeria) have cameunder stress as a result of the economic shocks of the 1980s. The financialrepression, largely manifested through indiscriminate distortions of financialprices including interest rates, has tended to reduce the real rate of growth andthe real size of financial system, more importantly, financial repression has(retarded) delay development process as envisage by Shaw (1973). This led toinsufficient availability of investible funds, which is regarded as a necessarystarting point for all investment in an economy. This declines in investment as aresult of decline in the external resource transfer since 1982, has been especiallysharp in the highly indepted countries, and has been accompanied by aslowdown in growth in all LDCs. Both public and private investment rate havefallen, although the latter more drastically than the former. If this trend ismaintained, it will lead to a slowdown in medium term growth possibilities inthese economies and will reduce the level of long-term per capital consumptionand income, endangering the sustainability of the adjustment effort. Theobserved reduction in investment in LDCS seems to be the result of severalfactors. First, the lower availability of foreign savings has not been matched by acorresponding increase in domestic savings. Secondly, the determinating offiscal conditions due to the cut of foreign lending, to the rise in domestic interestrate, and the acceleration in inflation forced a contraction in public investment.Thirdly, the increase in macroeconomic instability associated with externalshocks and the difficulties of domestic government to stabilize the economic hashampered private investment.Finally, the debt overhand has discourage investment, through its implied creditconstraints in international capital markets Luis Serven and Falokun (1989).
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