IMPACT OF INTEREST RATE DEREGULATION ON PERFORMANCE OF QUOTED MANUFACTURING FIRMS IN NIGERIA
ABSTRACT
Amongst the major economic reforms
that were introduced in 1986 is the deregulation of interest rates in
the Nigerian financial market. The theoretical base for deregulation is
largely attributable to the Keynesian investment theory. The overall aim
of deregulating interest rates is to encourage savings mobilization and
make it possible for adequate flow of financial resources to the
productive sectors of the economy. Undoubtedly, interest rate
deregulation could have an impact on the manufacturing sector of the
economy. With limited resources and the upsurge in foreign exchange
demand, the trend has been an upward movement of interest rate which a
deregulated interest regime has helped to escalate. In the same context,
the inefficiencies in government controls and regulation have
introduced increased concerns about the government’s ability to manage
deregulation to achieve positive results. Thus, the effect of
deregulation can be seen in the high borrowing costs which have
negatively affected profitability of businesses coupled with inadequate
working capital and low shareholders’ fund. It is in line with the above
that this study sought to: (i) examine the impact of interest rate
deregulation on profit before tax of quoted manufacturing firms, (ii)
determine the impact of interest rate deregulation on net working
capital of quoted manufacturing firms, and (iii) ascertain the impact of
interest rate deregulation on shareholders’ fund of quoted
manufacturing firms in Nigeria. The study adopted the ex-post facto
research design to enable the researcher make use of secondary data.
Panel data series for a 26 year period 1987-2012 were collated.The
Ordinary least square (OLS) regression analytical technique was adopted
using E-View statistical software to test the three hypotheses
formulated for the study. The parameters for performance of quoted
manufacturing companies were Profit Before Tax, Net Working Capital and
Shareholders’ fund which were adopted as dependent variables, while the
parameter for interest rate deregulation was interest rate between 1987
to 2012 (period within which interest rate deregulation prevailed in
Nigeria). It was used as independent variable. Exchange rate and
inflation rate were adopted as control variables for the three
hypotheses respectively. Descriptive statistics on the dependent as well
as the independent variables was conducted before the regression
analyses. The results reveal that interest rate had positive and
non-significant impact on profit before tax of quoted manufacturing
firms in Nigeria, interest rate had negative and significant impact on
net working capital of quoted manufacturing firms in Nigeria, and
interest rate had positive and significant impact on shareholders’ fund
of quoted manufacturing firms in Nigeria after deregulation. However,
interest rate deregulation, though a good policy, did not produce the
required result in Nigeria. This might probably be as a result of
improper pace and sequencing.This study recommends that manufacturing
companies should restructure and diversify their funding sources to
reduce much emphasis on borrowing so as not to fall victim of the
negative effects of deregulation. Also, government emphasis should be
towards a guided deregulation. With extensive monitoring and directing,
it therefore follows that the policy of interest rate deregulation in
Nigeria needs periodic fine-tuning.
CHAPTER ONE
1.0 INTRODUCTION
1.1 BACKGROUND TO THE STUDY
Financial sector reform (FSR) became a
major component of the structural adjustment programme in Nigeria with
the deregulation of interest rates in August 1987. Today, one of the
most regulated sectors in the Nigerian economy is unarguably the
financial industry. Akiri and Adofu (2007) opine that the banking
industry owing to the nature of activities, role, and function it
performs in the economy, is also one of the widely and heavily regulated
sector in both developing and developed countries of the world. As
financial intermediary, banks help in channeling funds from surplus
economic regions to the deficit one’s in order to facilitate business
transaction and economic development in general. Bearing in mind that
funds are owned by other people (the investing public/depositor) the
banking ethics demand that such funds should be efficiently and
effectively managed in order to build and maintain the confidence of
depositors/investors in the banking system and also uphold the
competence and continued soundness of the banking system to reduce
drastically the risk or possibility of bank failure or distress.
The government most often may think it is
necessary to intervene in the operation of the banking system with the
intention of correcting the short comings of the price fixing mechanism
to ensure that what is commercially rational for an individual bank is
approximately rational for all. Socially, interest rate charged by banks
could be regulated to encourage savings mobilization, ensure and foster
adequate investment for rapid growth anddevelopment, bearing in mind
the view of Goldsmith (1969) that the financial superstructure of an
economy accelerates economic performance to the extent that it
facilitates the migration of funds to the best user i.e to theplace in
the economic system where the funds yield the highest social return.
Akiri and Adofu (2007) again opine that the existence of externalities
and imperfection in the financial markets of most developing economies
has often called for intervention by the government through its
appropriate agent (the Central Bank of Nigeria in the case of Nigeria)
to encourage investment and to re-channel credit to those economic units
with high social rate of returns but low commercial rate of returns. In
the (1987) budget announcement of the then president, General Ibrahim
Babangida, it was observed that the pegging of interest rate contrary to
expectation, did not achieve its desired goal of stimulating new
investments nor did it result in an increased capacity utilization of
industry and hence the resolve for deregulation. The resolve for
deregulation is informed by the Keynesian investment theory and by
Mackinnon (1973) and Shaw (1973), saving and investment hypothesis. The
Keynesian theory implies that low interest rate as a component of cost
administered, is detrimental to increase savings and hence investment
demand. They argue that increase in the real interest rate will have
strong positive effects on savings which can be utilized in investment,
because those with excess liquidity will be encouraged to save because
of the high interest rate, thus banks will have excess money to lend to
investors for investment purpose thereby raising the volume of
productive investment. Under the deregulated interest rate system, the
market forces of demand and supply play a very prominent role in the
determination of interest i.e banks and their customers are free to
negotiate to arrive at a suitable interest rate on both deposit and
loans.Despite the deregulation, a number of challenges still arose. The
approach to banking was the use of direct control by the central bank.
The degree of compliance varied among banks. At times, withdrawal of
privilege or facilities was the case with banks that failed to comply,
for example most banks defaulted on ceilings imposed credit expansion
and allocation on sectional basis (Ibimodo, 2005).
The regulation of the rate of interest is
often regarded as a key monetary policy instrument for the
stabilization of a nation’s economy. Along with exchange rate and the
rate inflation, interest rate is often used as the gauge of the
performance of a nation’s economy. Within the context of
Nigeria, it has been used along with
other monetary instruments to streamline and make more efficient the
nation’s financial system. The basic goal at each point in the
application of these monetary policies have always included the
regulation and control of the volume and cost of money as well as the
direction in which credits should follow in order to achieve
macroeconomic policy objectives.
1.2 STATEMENT OF THE PROBLEM
The deregulation of interest rate in 1987
has resulted into a plethora of problems for corporate organizations in
Nigeria. These have led to increase in cost of borrowing which affected
profitability of businesses has coupled with inadequate working capital
and low shareholders; fund.
In the reports of the Central Bank of
Nigeria (CBN 1986) the macro-economic objectives underlying the policy
of interest rate regulation include the maintenance of low and stable
price levels within the economy as well as the achieving of a high level
for employment. Since its inception in 1959, the Central Bank of
Nigeria has largely been responsible for initiating and managing the
monetary policies of the country. More specifically, the control of
interest rate was given to the bank.
The regulation was achieved by fixing the
rates at which both deposits and lending shall be undertaken within the
nation’s financial system. With the Central Bank of Nigeria stipulating
the deposit and lending rates, it was indeed possible to ascertain
beforehand the cost of capital and to plan a firm’s operations
accordingly. It was also easy to infer that poor fixture of the rate
tended to affect the quantum of capital available for lending and even
the basic motivation to lend or borrow. The owners of loanable funds in
some ways were often denied the opportunity of deriving the full
benefits accruable from such ownership and this inhibited their
disposition to lend. Capital could thus not be channelled efficiently
and by market forces especially into the productive sector of the
economy.
But the approach of direct fixture of the
rates was hinged on the desire for “social profitability” rather than
“individual profitability. In other words, it was based on the
conviction that it was better to direct the allocation of resources to
these sectors that would promote social welfare. In implementing this
policy, the sectors of the economy were classified into the preferred,
less preferred and other categories. The preferred category included
agriculture, manufacturing and residential housing, while the less
preferred sectors consist of imports and general commerce. In the group
of “others” were credit and financial institutions, government, personal
and professionals sectors.
With the sectors of the economy
classified as aforementioned, it was easy for the regulatory authorities
to direct the giving of concessionary loans to the preferred sector. In
other words, interest charged on loans given to this sector was lower
than that of others. In addition, a specified proportion of the
available loanable fund was to be dedicated to the borrowers in the
preferred sectors. With time it became obvious that the concessionary
rates did not keep pace with inflation resulting in negative real
interest rates. Furthermore, the demand for credit often exceeded the
rate of savings. Thus, the financial institutions were unable to
adequately raise sufficient loanable funds through savings. The problems
encountered both by lenders and borrowers brought to critical focus the
many inadequacies of direct regulation of the interest rate by the
central bank. This pattern of regulation was however to change with the
introduction of the structural Adjustment programme (SAP) in 1986. SAP
was introduced to restructure the nation’s economy, especially the
consumption and production pattern of the economy. One area that the new
regime of SAP addressed was the regulation of interest rate.
As the Central Bank in 1986 stated in its
notice announcing the change in the policy of interest rate and
addressed to banks and other financial institutions. “In order to
further enhance the development of the financial system and to
accelerate the attainment of the objectives of the ongoing Structural
Adjustment Programme (SAP) some amendment to the monetary policy
circular No 21 issued in January 1987 has become necessary with effect
from August 1, 1987, all controls on interest are hereby abolished”
(Central Bank of Nigeria monetary policy circular 21, 1987). The bank
also indicated in the circular that the deregulation of interest rate
was made in recognition of the fact that interest rate controls has had
more adverse than favourable effects in the development of the financial
system.
With the implementation of circular 21,
primacy was given to the forces of supply and demand in the
determination of the prime lending and deposit rates. It was presumed
that these market forces would result in more efficient allocation of
credit to the productive sectors of the economy, as well as lead to a
big increase in the volume and availability of loanable capital.
1.3 OBJECTIVES OF THE STUDY
The general objective of this study is to
examine empirically the pattern and direction of influence of interest
rate deregulation on performance of quoted manufacturing companies in
Nigeria. However, the specific objectives are:
- To examine the impact of interest rate deregulation on profit before tax of quoted manufacturing firms in Nigeria.
- To examine the impact of interest rate deregulation on net working capital of quoted manufacturing firms in Nigeria and
- To examine the impact of interest rate deregulation on shareholders’ fund of quoted manufacturing firms in Nigeria.
1.4 RESEARCH QUESTIONS
As a follow-up to the objectives above the following research questions arose. These are:
- To what extent has interest rate deregulation impacted profit before tax of quoted manufacturing firms in Nigeria?
- To what extent has interest rate deregulation impacted net working capital of quoted manufacturing firms in Nigeria?
- To what extent has interest rate deregulation impacted shareholders’ fund of quoted manufacturing firms in Nigeria?
1.5 RESEARCH HYPOTHESES
Consequently, the following research questions were tested in this study. There are;
- Interest rate deregulation does not have a significant positive impact on profit before tax of quoted manufacturing firms in Nigeria.
- Interest rate deregulation does not have a positive significant impact on net working capital of manufacturing firms in Nigeria.
- Interest rate deregulation does not have a positive significant impact on shareholders’ fund of quoted manufacturing firms in Nigeria.
1.6 SCOPE OF THE STUDY
The study period cover data on the
variables for the period 1987 to 2012. This period is chosen because in
the economic history of Nigeria, it is a period characterized by
fundamental reforms in the Nigerian financial sector. The study is only
limited to quoted manufacturing firms in
Nigeria. Again since the data sought
relate essentially to the financial performances of quoted manufacturing
firms in Nigeria, the problem of access to such information, especially
against the traditional unwillingness of most firms to part with them
was foreseen. However, it is known that the basic financial information
statutorily required to assess operating performances are public records
for public companies and are thus contained in the annual reports of
firms. Finally, the data utilized is mainly the annual reports of
companies. By law, companies are allowed to produce their annual reports
six months after the year end. This means that this study is utilizing
financial information that are several months old and are not indicative
of present conditions. One can only draw an inference from the trend of
the company’s performance to make a statement.
1.7 LIMITATIONS OF THE STUDY
Obtaining annual reports of these
manufacturing companies from Nigerian Stock Exchange is one of the
challenges the researcher encountered during the study. Other
limitations are time and financial constraints.
1.8 SIGNIFICANCE OF THE STUDY
The policy of deregulation is established
in Nigeria especially in relation to the financial sector of the
economy. With the interest rate being one critical area which has
experienced a considerable application of the policy, it becomes germane
that empirical studies be undertaken to ascertain its impact on the
operating results of corporate organizations. Thus this study will be
significant to the following:
- ACADEMIA
Essentially, this research intends to
contribute significantly to the volume of literature available in this
area of finance. In academics, the unknown is never exhausted, as the
list of what we do not know could go on forever. Therefore, as a
contribution to this area, hints, recommendations about interest rate
deregulation and its impact on performance of quoted manufacturing firms
in
Nigeria will be highlighted. Localizing
the research to the Nigerian settings and environment is particularly
important in this research.
- MANAGEMENT
In large firms, there is a divorce
between management and ownership. The decision taking authority in a
company lies in the hands of managers. This study will therefore be most
valuable in appraising the nature of the effect the deregulation of
interest rate has had especially on the critical indicators of operating
performance of management. It will thus be a veritable means of
ascertaining if the deregulation has been impacting decision making of
management.
3. POLICY MAKERS
Furthermore, the study has the potential
of serving as a veritable base upon which modification of interest rates
can be made. It will point out directions where such reviews may be
made following its appraisal of the effect so far on operating results
of the sampled firms.
The study will contribute to the
formulation of an improved policy package designed to limit the adverse
side-effects of liberalization.
4. FINANCIAL MARKET REGULATORS
The study will offer useful guide in designing appropriate regulations for the market.
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