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IMPACT OF INTEREST RATE DEREGULATION REGIME ON THE NIGERIAN ECONOMY'S REAL (INDUSTRIAL) SECTOR

CHAPTER ONE

INTRODUCTION

1.1     BACKGROUND OF THE STUDY

It is widely recognized that the banking industry by the nature of its activities is among the most heavily regulated sector in both the developed and developing economies. As financial .intermediaries, banks assist in channeling funds from surplus economic units to deficit ones: to facilitate business transactions and economic development generally. Interest rate charges by banks were regulated to encourage savings mobilization and ensure adequate investment for rapid economic growth. The existence of market imperfections and externalities in financial markets especially in developing countries has often induced official intervention not only to boost investment, but also to redirect credit allocation within the economy.

The deregulation of interest rate in the banking industry involves, the systematic removal of regulatory controls, structures and operational, guidelines which may be considered inhibitive of orderly growth, competitive and efficient allocation of resources in the' banking industry. Financial markets are one of the first sectors of the economy to be subjected to deregulation. The campaign for deregulation of financial markets has been vigorously undertaken in many developed economies. In the recent times, a number of third world countries with heavy debt burdens and dwindling foreign earnings had also adopted policies designed to deregulate their economies particularly the financial markets sub-sector.

Thus has virtually been -carried out as part of comprehensive Structural Adjustment Programme (SAP) aimed at ensuring that market forces are assigned greater roles in the allocation of the scare financial resources.

Nigeria as part of the Structural Adjustment Programme (SAP) has commenced the deregulation of its financial system. It was introduced into the Nigerian economy in 1986 during the General Babangida regime. The programme started most earnestly with the liberalization of interest rates trade and exchange rate and the deregulation of the bank interest rate policy.

Prior to the introduction of SAP, the banking system was subjected to strict administrative control and the economy was, characterized by serious structural distortions caused by the oil commodity (crude oil) which constituted over 90% of the country's foreign exchange earnings and over 80% of total government revenue. There was an import syndrome which resulted in a high dependence on imports for both consumer and producer goods.

To reverse this trend, stringent exchange control and import restriction measures including comprehensive import licensing policy were adopted. But as this crisis persisted, it became evident that the ad-­hoc policies of the past could not bring about the desired change in the economy so, a comprehensive Structural Adjustment of the economy was called for. Hence, the structural programme in July 1986.

The overall aim of Structural Adjustment Programme (SAP) was to eliminate the observed distortions in the Nigerian economy. Specifically; its objectives are:

i.       To restructure and diversify the productive base of the economy in order to reduce dependence on the oil sector and Imports;

ii.      To lay basis for sustainable non-inflationary or minimal inflationary growth;

iii.     To achieve fiscal and balance of payment viability over the period; and

iv.     To improve the sector's- efficiency and intensify the growth potential of the private sector.

With the introduction of Structural Adjustment Programme (SAP) into the Nigerian economy, a great deal of interest has been shown in the activities and developments within the banking system.

A central component of the SAP was the restructuring of the national financial system by relaxing some regulations considered inimical for the expansion of the system. The Central Bank of Nigeria (CBN) was established in 1959 to supervise banks and prevent large-scale bank failures. Since inception, the CBN has played major roles in laying the foundation for the establishment of the Nigerian Deposit Insurance Corporation (NDIC) in 1988.

Banks are very important In the economic development of any nation. The banking system as noted by Schumpter (1934) is regarded as a key agent of the process of development. Interest rates were generally fixed by the Central Bank of Nigeria (CBN) within the period white adjustment depends on government sectoral priority till the third quarter of 1986. Thereafter, active interest rate policy started when banks were allowed to negotiate the interests on time deposits.

A further deregulation of interest rates occurred in August 1987 when the Minimum Rediscount Rate (MRR) was increased. Also in 1988, the Minimum Rediscount Rate (MRR) was adjusted upwards. The rate of interest increase was moderate in 1990 as commercial and merchant banks liquidity position improved.

In 1992, the maximum spread between banks average cost of funds and their lending rates revised upwards. The increase in' banks interest rate was as a result of total deregulation of interest in the year budget. In 1993, the market interest rate continued on an upward trend during the year.

In view of the foregoing, this paper examines the impact of interest rate deregulation regime on the real sector of the Nigeria economy (1985-2010)

1.2     STATEMENT OF THE PROBLEM

Within the general framework of deregulating the economy in 1986 to enhance competition and efficient allocation of resources, the Central Bank of Nigeria (CBN) introduced a market based interest rate policy in August, 1987. The decision was not without controversy. While it was gen3rally agreed that low interest rates did not encourage savings, it was feared that high interest rates which were likely to accompany deregulation might retard investment. The deregulation of interest rates allowed banks to determine their deposit and lending rates according to rnar.eet conditions through negotiations with their customers.

Interest rates movement can have significant effects on the other macroeconomic variables. The increased interest rate will encourage savings to earn higher returns. Whereas, interest payments form a significant portion of production costs. Increased interest rate could result in reduced investments, output and employment in the sector of the economy.

Higher interest rates could result in the deterioration of the current account position of the balance of payment arising from increased cap ital inflows from abroad, pressures on the domestic currency and reduced demand for locally produced goods and services. Both output and employment for the domestic economy would be adversely affected.

Higher interest rates can also result in increased higher national debt and a source of more domestic pressures depending on the method of financing new fiscal deficits.

On the whole, higher interest rates will tend to reduce aggregate demand, output and employment, while reduced interest rates will tend to have opportunity effects. But in the conduct of monetary policies, these tendencies are not taken in isolation.

However, in a free market (deregulated) environment, the interest rate is a potent tool for the policy makers. If it is regarded as a target policy all the indicators closely related to it should be manipulated appropriately to achieve the target.

If on the other hand, it is regarded as indicator policy, it only shows the extent to which the authority has been able to attain the appropriate intermediate objectives. Even as an indicator, there must be an acceptable level of the selected interest rate which is linked to the appropriate intermediate goals.

1.3     OBJECTIVES OF THE STUDY

The broad objective of this study is to examine the impact of interest rate deregulation on the real sector of the Nigerian economy. The specific objectives include:

i.       To show the nature and effect of deregulation' on the banking system.

ii.      To show the role of the banking system in economic growth and development.

iii.     To analyze some of the challenges of deregulation in the economy. and

iv.     To make policy recommendations based on the findings of the study.

1.4     STATEMENT OF THE HYPOTHESIS

The hypotheses for this study are stated as follows:

Ho: Interest rate deregulation does not have any significant impact on the real sector of the Nigerian economy.

Hi:    Interest rate deregulation has significant impact on the real sector of the Nigerian economy.

1.5     RESEARCH METHOD

In order to examine the impact of interest rate deregulation regime on the real sector of the Nigerian economy, the multiple regression of the Ordinary Least Squares (OLS) estimation technique would be used. Primary and secondary interest rates would be regressed on the Gross Domestic Product (GDP) which is used as the proxy for the real sector of the Nigeria economy within the period 1986-2010.

1.6    SOURCESOFDATA

Secondary data to be used in this study shall be, sourced from the publication of the Central Bank of Nigeria (CBN) and the National Bureau of Statistics (NBS) formerly Federal Office of Statistic (FOS).

1.7    SCOPE OF THE STUDY

This work aims basically at evaluating the impact of interest rate deregulation on the real sector of the Nigeria economy from 1985 to 2010. It will have to acknowledge the different views shared by various economic schools of thought on interest rate. The research work will examine deregulation as a concept and how the interest operates within an economy. Also, the analysis of this study is going to span the years of deregulation in Nigeria.

1.8    SIGNIFICANCE OF THE STUDY

Various views exist on regulation and deregulation interest rate regimes and its impact on the real sector of an economy. Since 1986 when the deregulation on interest' has been given the attention, it is necessary to investigate the outcomes of the exercise so far. Moreover, the era of deregulation has been for over two decades now, hence, this study is worthwhile and feasible.

It would be of importance as its findings shall be useful to research students, business executives, professionals and policymakers in general.

1.9     STRUCTURE OF THE STUDY

This research work shall; be presented in five chapters.

Chapter 1 is the introduction. It contains the background of the study, objectives of the study, hypothesis of the study, scope and the plan of the study.

Chapter 2 shall contain the review of relevant literature to the study.

Chapter 3 shall contain the research method.

Chapter 4 will contain the estimated results, empirical analysis and interpretation of the results. Chapter 5 shall conclude the research work. It will Include the summary, recommendations and conclusion for the study.

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