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THE GROWTH OF CAPITAL MARKET AND ITS CONSEQUENCES ON A DEVELOPING ECONOMY

CHAPTER ONE

INTRODUCTION

1.1  BACKGROUND OF THE STUDY

The capital market is a subset of the financial system that is involved in the provision of long-term funds for productive use. The capital market drives any economy’s economic growth and growth because it is necessary for long term growth capital formation (Osaze, 2000) but evidences from past studies have revealed a growing concern and controversies on the role of the capital markets on economic growth and growth. The capital market is a network of financial institutions and infrastructure that interact to mobilize and allocate long-term funds in the economy. The market affords business firms and governments the opportunity to sell stocks and bonds, to raise long-term finds from the savings of other economic agents. The capital market is a highly specialized and organized financial market and indeed an essential agent of economic growth because of its ability to facilitate and mobilize saving and investment.

The sourcing of long-term finance through the capital market is essential for self-sustained economic growth, which is consistent with external adjustment and rapid economic growth (Iyola, 2004). The capital market effectively started operations in Nigeria on 5th June, 1961 under the provision of the Lagos Stock Exchange Act 1961, which transformed into the Nigerian Stock Exchange in December 1977 as a result of the review of the Nigerian financial system (CBN, 2007). The Securities and Exchange Commission (SEC) was established in 1979 through the SEC Act 1979, to regulate the capital market, but it commenced actual operation in 1980. It took over regulatory functions from Capital Issues Commission, which was established in 1973. Since then, various forms of financial instruments have been issued in the capital market by new and existing business to finance product growth, new projects or general business expansion. The capital market, no doubt, is pivotal to the level of growth and growth of the economy.

Chinwuba and Amos (2011) note that capital market is one of the major institutions that acts in propelling a prostrate economy for growth and growth. Nyong (1997) sees it as a complex institution imbued with inherent Mechanism through which long-term funds of the surplus sectors of the economy are mobilized, harnessed and made available to deficit sectors of the economy.

The growth of the capital market has generated two major sets of economic benefits. First, it has improved the allocation of capital, because the prices of corporate debt and equity respond immediately to shifts in demand and supply, changes in the outlook for an industry (and/or company) are quickly embodied in current asset prices. The signal created by change in price of a security encourages investors as a result of higher prices or discourages them due to lower prices; this is because the investors often used the prices of securities to predict the likely trend of the market as either bullish or bearish. Businesses with high returns attract additional capital quickly and easily. When there is decline in demand, prices drop, and this signal makes investors to cut the flow of capital to the industry which leads to a decline in economic growth. The ability of companies in their early stages of growth to raise funds in the capital markets is also beneficial because it allows these companies to grow very quickly. This growth in turn results into general increase of output in the economy (Abdullahi, 2005).

The capital market contributes to economic growth through the specific services it performs either directly or indirectly. Notable among the functions of the capital market are mobilization of savings, creation of liquidity, risk diversification, improved dissemination and acquisition of information, and enhanced incentive for corporate control. Improving the efficiency and effectiveness of these functions, through prompt delivery of their services can augment the rate of economic growth (Okereke-Onyiuke, 2000; Levine and Servos, 1996; Obadan, 1995; McKinnon, 1973).

Osaze and Anao (1999), assert that capital market is the cornerstone of any financial system since it provides the funds needed for financing, not only business and other economic institutions, but also the programs of government as a whole. Ilaboya and Ibrahim (2004), stress that capital market functions as an economic barometer for galvanizing economic activities. The journey to the present democratic experience in Nigeria commenced on May 29, 1999, when the military government returned power to civilian administration. The agitation for the exit of the military was embarked upon because of the popular belief among the stakeholders in the economy that, democracy, among other things, promotes economic growth. Supporters of democracy also argue that the motivation of citizens to work and invest, the effective allocation of resources in the market place, and profit-maximizing private activity can all be maintained in a climate of liberty, free-flowing information and secured control of property (North, 1990).

Moreover, businesses rise and collapse so easily in the history of Nigeria for many other reasons including non-availability of long term finance. Using short term finances to pursue long term capital projects can cripple any business and or project considering the match maturity concept that most financial institutions operate wherein they ensures that loans given and debts incurred mature at the same time. Various studies have looked at the role of Capital market in economic growth. This research is aimed at establishing that Capital Market actually impacts on the general economy of a nation using Nigeria Stock Exchange (NSE) as a case study. We are aware that the economy of a nation to what extent its production, utilization and exportation of goods and services affect the national income and the standard of living of its people. Good and strong economies require strong domestic infrastructure with a good foreign relationship (Smathers 2014).

The importance of the capital market as an efficient channel of financial intermediation has been well recognized by the researchers, academicians, and policy makers as a primary determinant of the economic growth of a country, both developed and developing. Economic growth in a modern economy hinges on an efficient financial sector that pools domestic savings and mobilizes foreign capital for productive investments. Underdeveloped or poorly functioning capital markets typically are illiquid and expensive which deters foreign investors. Furthermore, illiquid and high transactions costs also hinder the capital raising efforts of lager domestic enterprises and may push them to foreign markets (Mishra, et al., 2010). Theoretical literature on financial development and growth identifies three fundamental channels through which capital markets and economic growth may be linked (Pagano, 1993). First, capital market development increases the proportion of savings that is funnelled to investments. Second, capital market development may change the savings rate and hence, affect investments. Third, capital market development increases the efficiency of capital allocation.

According to Riman, et al., (2008), the Nigerian capital market has witnessed obvious transformation over the years, evident by the increased level of participation of the private and public investors at the floor of the stock exchange and in various public offers of quoted companies. The emerging market has also attracted and embraced the attention and the interest of international investors, thus increasing capital inflow. For example, the overall market capitalisation had risen from 1,698.1 million naira in 1980 to 7030.8 billion naira in 2009, thus signifying an increase within the period. Transaction at the floor of NSE has risen to a total of 685,716.2 million naira in 2009 from a previous value of 16.6m recorded in 1970. The number of deals from all market participants at the floor which recorded a mere 634 deals in 1970 had also witnessed a remarkable increase to 1,739,365 million naira in 2009. The total number of listed companies had also increased from 91 as was listed in 1980 to 213 listed in 2008 (CBN, 2009).

 Strong domestic infrastructures are capital intensive projects including industries and corporate entities that require good capital financing to be able to survive. The research question is that to what extent can the Nigerian Capital Market impact on the economy of Nigeria? .The objective of the study are to examine the impact of the capital market on the economy of Nigeria, that is to evaluate the effect of Market Capitalization on the Inflation rate, Gross Domestic Product (GDP), Total number of New Issues, Transaction Value, Total listing and Foreign Direct Investment (FDI).

The capital market mobilizes long-term debt and equity finance for investments in long-term assets. Capital markets also help in boosting the financial system as well as improving the economic growth of a country. The capital market supplements traditional lending activities of the financial institutions such as banks by providing risk capital (equity) and loan capital (debt). By means of these instruments, the market is able to mobilize long- 4 term savings and provide capital to investors to finance long-term investments thereby broadening ownership of productive assets (Daniel, 2004).

Dealers in the securities segment of the capital market include banking institutions, stockbrokers, investment and merchant bankers and venture capitalists that intermediate between the market and the public. Well-functioning financial markets are very crucial for the promotion of global financial integration. An efficiently functioning domestic financial market can better position a country’s competitiveness in the markets for global capital (Senbet & Otchere, 2005). Accessing global markets for capital, through a well-functioning financial system, lessens a country’s reliance on foreign aid and other forms of external borrowing. It has been pointed out by a number of financial analysts that financial globalization allows for the sharing of local security risks.

Thornton (1995) argues that economic activities in a country constitute the key drivers of capital market growth. Growth in the capital market spurs economic growth (Yartey 2008) and empirical evidence shows that there is no sharp demarcation existing between growths in the capital market and economic growth [Filer 2002).

Yartey and Adjasi (2007) argue that the establishment of capital markets in Africa is expected to boost domestic saving and increase the quality and quantity of investments. They emphasize that in principle the capital market is expected to accelerate economic growth by providing a boost to domestic savings and increasing the quality and quantity of investments. Equally, capital markets can increase economic growth by making available information on firms’ prospects and redistributing investable capital.

Thus, the capital market has contributed to the financing of the growth of large corporations in certain African countries and those large corporations in Africa have made considerable use of the capital market to finance their growth (Yartey and Adjasi 2007). The fact, essentially, is that no matter the extent of argument that exists, the main essence of the capital market is to consolidate growth in the financial system and enhance the consequent impact of the later on economic growth in the country. Nigerian capital market started rolling from 1960 when Nigerian Stock Exchange (Lagos stock) exchange was opened. At present the market is gaining depths and becoming steady. This stock exchange is the pivot of the Nigerian capital market. This exchange is providing different types of funds to bring the accumulated public wealth into the stock market. At the same time, the large-scale industries of Nigeria are listed on this exchange. There is also another stock exchange in Nigeria that is working with the medium and small-scale industries of the country and providing good support to strengthen the Nigerian capital market.

The impact of the capital market is determined by a number of elements, which include how financial assets are priced, such as the size of the stock market, market capitalization, number of listed equities, transactions in buying and selling of securities (liquidity) which in this case refers to the volume of transactions and new issues of securities. This study therefore poses to examine the impact of capital market growth on economic of Nigeria.

1.2 STATEMENT OF THE PROBLEM

Nigerian capital market has undergone a series of reforms all with the hope of creating a stable economic growth. The most recent reform was carried out in order to provide opportunities for greater fund mobilization, improved efficiency in resource allocation and provision of relevant information for appraisal. In recent times there has been a growing concern on the role of capital market in economic growth and thus the capital market has been the focus of economic policies and policy makers because of the perceived benefits it provides for the economy. The capital market provides the fulcrum for stock market activities and it is often cited as a barometer of business direction. It is expected as a result of the reform the market can provides variety of financial instruments capable of enabling economic gents to pool, price and exchange risk. In spite of these vital roles that the reform is expected to play, there is however a great concern on the performance of the Nigerian capital market in relation to the economic growth and growth which when viewed from the nature of activities taking place in the market appeared superficial. This may probably be attributed to lack of providing enabling framework that sustained confidence and investors’ protection and also thorough evaluation of factors that are of significance relevance in determining capital market performance.

1.3  OBJECTIVES OF THE STUDY

The study has the main specific objective which is to ascertain the impact of the capital market on economic growth of Nigerian. Other specific objectives were raised:

       i.          To determine the relationship between the capital market and Nigerian Economy

     ii.          To determine or rather to evaluate if the deficiencies of the market affect Nigerian Economy

   iii.          To establish the effect of the Nigerian stock exchange crisis on Nigerian capital market

   iv.          To ascertain if there are challenges of the Nigerian stock exchange in developing the capital market

     v.          To determine the role of capital market in developing the Nigerian Economy.

1.4 RESEARCH QUESTIONS

To achieve the above objectives, the following research questions were raised:

       i.          Is there relationship between capital market and Nigerian Economy?

     ii.           How do the deficiencies of the Nigerian stock exchange affect the Nigerian economy?

   iii.          How does the crisis in the Nigerian stock exchange affect Nigerian Capital market?

   iv.           What are the challenges of the Nigerian stock exchange in developing the capital market?  

     v.          What are the roles of the capital market in developing Nigerian economy?

1.5  RESEARCH HYPOTHESES

In line with the objectives of the study the following hypotheses have been formulated in null form:

       i.          There is no significant relationship between capital market and Nigerian economy.

     ii.           The deficiencies of Nigerian stock exchange market do not affect Nigerian economy.

   iii.          The crises of Nigerian stock exchange negatively affect Nigerian capital market.

   iv.          The Nigerian stock exchange does not face any challenge in developing capital market.

     v.          Capital Market did not play a significant role in developing Nigerian Economy.

1.6 SIGNIFICANCE OF THE STUDY

The study will be of immense significance to regulatory authorities such as the CBN, NSE and SEC in coming up with sound financial policies and reforms that will boost the performance of the capital market. This would strengthen public companies by ensuring that corporate governance practices in Nigerian public companies are aligned with international best practices through improved financial disclosure of information and adoption of International Financial Report Standards. Finally, future studies may want to share this experience by extrapolating some of the data as well as the statistical inferences that this study has come up with.

1.7 SCOPE OF THE STUDY

The Nigerian economy is a large component with a lot of diverse and sometimes complex parts. In this regard the study looks at a particular part of the economy by focusing particularly on the financial sector. Even then, the study does not cover all the parts of the financial sector, but focuses only on the capital market and its activities as such its impact on Nigerian economic growth. This is informed by the importance of the capital market to the economic growth of the country because it provides long term funds needed for investment for the growth of the economy. This is in terms of its operational activities, increase in the number of quoted companies and securities, as well as market capitalization. Although, new issues and volume of transactions have all recorded significant increase during the period of study but there have been records of downturn in some years as a result of the global financial crisis.

1.8 LIMITATIONS OF THE STUDY

The limitation of this study is difficulties in getting relevant information from the various areas of the study such as the Nigeria Stock Exchange of Nigeria who in most cases regards the needed information as secret that could not be divulged to outsiders. These problems, however, were overcome through the use the enormous information on the capital market, in the news media, journals and Internet.

1.9 DEFINITION OF TERMS

 To ensure comprehensive understanding of this research work, the under listed terms are defined thus:

Stockbroker: Is agent who purchases and sells securities on a stock exchange market on behalf of clients and receive remuneration for the service in form of a commission.

Stock Exchange: Are a market where securities (bonds, stocks and shares of varying types) are traded openly and where one can purchase or sell any of such securities with relative ease.  Capital Market: Is a market in which long term capital is raised by industry and commerce, the government and local authorities. Simply, it is that part of the financial market that provides facilities for the transfer of medium and long-term funds to various economic units. Stockholders: Individuals, businesses and groups owning stocks in a corporation.

Financial Instrument: Is a contract involving a financial obligation. Examples include stock, bonds, loans and derivatives.

Shares: A share confers on its owner a legal right to have part of the company’s profit and to exercise any voting rights attached to that share.

New Issue Market: Market where stocks are issued for the first time to the members of the public.

The Secondary Market: This is a market where stocks are not being sold for the first time. It can also be referred to as the market for second hand stocks.

Deficit Savings Unit (DSU): An economic unit whose current income is less than its current expenditure.

Savings-Surplus Economic Units: These are units with more funds than they require for current consumption. They are therefore the ultimate savers or fund suppliers to the system

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