THE IMPACT OF INTEREST RATES ON THE DEVELOPMENT OF AN EMERGING MARKET: EMPIRICAL EVIDENCE OF NIGERIA.

ABSTRACT

The study reveals that interest rate is always difficult to forecast. Interest rates will probably rise with the removal of public sector funds from the industry. The interest rate (MPR) is the rate at which banks borrow from Central Bank to cover their immediate cash shortfall. The higher the cost of such borrowing, the higher also will be the rate banks will advance credit to the real sector. However, in the long-term, with re-capitalization on

banks, insurance companies’ e.g. could begin to exploit economies of scale to compete on pricing and improve their deposit mobilization capabilities, which could positively affect interest rates. The Central Bank of Nigeria (CBN) has not formulated a model that will reduce interest rate, inflation and stabilize the exchange rate.

However, a time series analysis was adopted for 40 years (1970- 2010).The Error Correction Modelling (ECM) was adopted to reconcile fluctuations or changes both in the short and long run between the variables. The result shows that due to the ability to estimates the parameters of Error Correction Mechanism (ECM), which is generally consistent, sufficient, significant and negative. The non-zero coefficient of ΔINTt and INFt in both ways, if statistically significant, will indicate a short-run causality from ΔINTt to ΔGcft as well as ΔINFt to ΔGDPt. The paper recommends that pragmatic approach needs to be adopted to ensure that the lending rates are reduced to single digit in order to reduce production cost, high unemployment rate and encourage Foreign Direct Investment (FDI). The monetary policy rate (MPR) at 12% (CBN, 2013) is too high for a developing economy

such as Nigeria because it will have a negative impact on the naira exchange rate. Monetary and fiscal policies remain necessary and sufficient conditions for attaining a realistic interest rate performance. Interest rate management in a depressionary economy needs regular fine-tuning of relevant instruments by the monetary authorities.

Keywords: Interest rate, Capital formation, Inflation, Monetary and fiscal policy, Central bank.

 INTRODUCTION

The financial systems of most developing nations have come under stress as a result of the economic shocks of the 1980s and early in 2008 in Nigeria. Financial repression shows through indiscriminate distortions of financial prices to reduce the real rate of growth and size of the financial sector to non-financial magnitudes. It is obvious in recent times, that financial repression has retarded the development process as envisaged by (Shaw, 1973; Ephraim, 2001). Undoubtedly, governments’ past efforts to promote economic development by controlling interest rates and securing “inexperience” funding for their own activities have undermined financial

development. Capital formation can lead to increase in size of national output, income and employment thereby solving the problems of inflation and balance of payment and making the economy free from the burden of foreign debts (Agagi 1990).

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