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 onprofit 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

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  commerciallyrational 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

increasedcapacity 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 has affected profitability of businesses 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

Thegeneral 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:

1.  To  examine the  impact  of interest  rate  deregulation on profit  before tax of quoted manufacturing firms in Nigeria.

2.  To examine the impact of   interest rate deregulation on net working capital of quoted manufacturing firms in Nigeria and

3.  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:

1.  To  what  extent  has  interest  rate  deregulation  impacted  profit  before  tax  of quoted manufacturing firms in Nigeria?

2.  To what extent has interest rate deregulationimpacted net working capital of quoted manufacturing firms in Nigeria?

3.  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;

1.  Interest rate deregulationdoes not have a significant positive impact on profit before tax of quoted manufacturing firms in Nigeria.

2.  Interest rate deregulation does not have a positive significant impact on net working capital of manufacturing firms in Nigeria.

3.  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 presentconditions.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:

1.  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.

2.  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.

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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