University of Nigeria Virtual Library

Serial No Author 1 AGU, Cletus Chike Author 2 Author 3

Title Interest Rates Policy in Nigeria and its Attendant Distortions

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Description Interest Rates Policy in Nigeria and its Attendant Distortions

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Social Sciences

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IXTERES'T FIATES POLICY - IN - - N I G E R I A LVD ITS ATZNDANT

DISTORTIONS. - I, INTRODUCTION. 'By C. C. Agu,. Department of

Economics, Universi ty o f Nigeria , Nsuk~a.

'Our knowledpe of macroeconomics i s n o t so secure t h a t ?-. .. . , . . . . 4 . . I

p-e;udgernerit can'& attempted l i g h t l y . . Economics i s net theology,

where the a r t i ~ i e ~ of f a i t h must b e supported t o the end of t imet

( W i n t r a u b 'I 977). C:onsequen-kly, the re fo re , macroeconomic theory is . . 1:

. . pervaded with a number bf u n s e t t l e d is i ixs. . k gjod exanple i s - the cont inuing controversy, over t h e years , abont t h e detnrrninants

.. .:-. of the ''1eye.i gf i n t e r e s t r a t e , ..: . . v . , . ,. . .

.,;$$$,erest rate- ' de terminat ion c ~ q be.: analykk8~' I n e i t h e r 'stock - . . . - , . . ....,.

or figu-dbnensich&. ?h6 s tock dimension considers* the'dernand f o r

and supply of t h e s tock of .'money as an a s s e t an2 t h i r b f o r e 'argues . . : , -.;, - 7 . . . . .- y r r - .- - -. . . 2 .

t ha t interest r a t e i a determined by t h e demand f o r and supply of .. :. f '

money;' On f n e &her hend, ' the flow dimension t h e c l a s s i c a l '

loanable fund& theory cons iders t h e r e n t i n g ~f money o r t h e demand

- for and. supply of f i n a n c i a l claims o<er a period of time and I . - contends th'at the l ewel 'o f i n t e r e s t r a t e i s determined by t h e

. . , ' r

demand f o r and supply of c r e d i t generated by renting:money, o r '

t h e demand f o r and supply of f i n a n c i a l claims on t h e prirniry an& . , B

secondary parket's i n a p a r t i c u l a r per iod of time.

Hicks (1939); ' took a middle course o r . cornpromise s tand and . .

. . ,

contends t h a t Ln te res t . r a t e , . i + . . a . . p r i c e which, l i k e o the r p r i c e s

i s determined wl th them as mutually interdependent system.

With i n f l a t i o n a r y pressure , many f i n a n c i a l nbscrvers ,

r e i e a r n i n g t h e lesson t augh t by Irving Fisher at. t h e beginning

o f t h e century gradual ly accepted that while t h e l i q u i d i t y

preference and loanable funds t h e o r i e s both genera te t h e same

equi l ibr ium i n t e r e s t rate, they bath f a i l e d to consider a f a c t o r

that has becohe inc reas ing ly important i n r e c e n t yea r s - t h e 8

. p r i c e e x p e c t a t i o n s . . ~ I n other words , . there has been a growing

awareness tha* spending and saving dec i s ions are important ly

a f fec ted by r e a l i n t c r m t ratrs,

?more , i n the . 1970 Amendment, the CBN was authorized t o

re i n t e r e s t r a t e s f o r various c lasses of l iccnsed banks . ... . ' - : -.. - I . . ' . 5

\tu~~t.rdrnent Decree 1970, sect ion 40).

The CEN h a s ~ c m s t a n t l y use'd the power r e s t e d on it by

prescr ib ing .year ly in te ' res t r a t e s on various types . , @f f inanc ia l . $

a s s e t s and loal? instruments o f . d i f f e r e n t banking insditut iofis bh . -- e,.- I

t h e country, I t is , therefore , co r r ec t t o say t h a t i n t e r e s t

r a t e s . . s t ruc tu re i n Nigeria i s i n s t i t u t i o n a l l y determined and

administered or . managed. This implies that..ther s t ruc ture of *,

i n t e r e s t r a t e s i n the economy does not have any bearing t o the . . .*

theore t i , ca l i n t e r e s t r a t e s s t ruc ture a s generated by the loanable + ' . .

funds snd. theiJ iquidi ty preference theories. Consequently i n t e r e s t '

r a t e s s t ruc tu re i n Nigeria i s not a good indicator of the scarc i iv

or a v a i l a b i l i t y of c a p i t a l i n the economy. 1

Table 1 shows a spectrum of selected i n t e r e s t r a t e s cover

Y J p b ~ V I A - L I A U I A L . A ~ J . a . 3 . 3 ~ ~13 alAu .

m o f f i c L ~ 1 rediscount ra te t o

v a ~ f o ~ s . +naa n+ ~ ' i ~ ~ ~ ~ - 1 -1 loan instruments. These I."

range frl: various deposi t r a t e s , '4 I

borrowing and lending r a t e s .for the beriod 1970-1'~85. An . . _,...

eiamination ,&f the t a b l e shows a general ly very low and s t a t i c

i n t e r e s t r a t e s t ruc ture . For example i n t e r e s t r a t e s paidgon

over 12 inonths deposi ts remained l o w and s t e t i c n t 4 per cent

from I971 t o 1975 and was as low' as 2 per cent i n 1.977. For the

three years 1979-1981 'it remained a t a l o w l e v e l of 6.5. per

cent . I t was revised upwards t o 8.0 per cent i n 1382 and fu r the r

t o 10.0 per cent i n 1985. Savings deposi ts r a t e s a l so remained

a t a low and stable r a t e of 3.0 per cent f o r f i ' v e years 1970-1974,

I t rose marginally t o 4.0 per cent i n 1975 and remained the same I '

u n t i l 1978, By 1982 it went up t o 7.25 per cent and.was 9.5 per cent

by 1984 and 1985. The same i s t r u e of t h e various .*Me deposi ts ..

r a t e s and other Lending and borrowing rates.

This reason accounts f o r thd generally low ra tes bn gavernment

s e c n ~ i t i e s , ' No wonder then that the opponents o f tbe f i xa t ion + .

a of the r a t e s of i n t e r e s t ' o n government stocks argue " tha t it

perper tuates .an u n r e a l i s t i c i n t e r e s t r a t e s s t ruc ture i n the

"gilt-edged market1!. -The argumect ' i s t r u e if it i s real ised nommal

nrnent 3td&ks would. make7.future s e c u r i t i e s market w i a t t ~ a c t i v e . .

t o Xnvestors. '

. . :. The 'sicond reason t h a t has been' a@-rlucecito justify the

po1ic.y of b ~ w and stable Snteras t rates s t ruc tu i - e regardless '

of' economic 'circumntances $ L . ,$s $ . . tine Keynesian postula te t h a t a '

low i n t e r e s t r a t e iniplies' '$ 'high r a t e of intkstrnent. T ~ U S

tfiat:-Melped determine. &he pace of economic ac t iv i t y . Thus

Keyn@&in bos tu la te has served as a donvonient ro t ibna le f o r '

many -develdping countr ies , 'Nigeria being a goad case, wishing

t o a t t r a c t a l w g e por t ion o f -the scarce aavings ctwarcSs the t

.I I .

publ io ' aec tor a t & low cost; Thb justification of the

. . Keynesian postula te i s based. on the unc r i t i ca l acceptance' and

mis interpre ta t ion of the Ke-ynesian investment theory, kkkch''!~.ri . I . . -. r- I

n o t -necessari ly appl icable under f u l l employment. with'inflation; . .

how eve^:. 'the controvers ia l ~ k y n e s i a n model, eve3 Lf ~ p p r d p m t e

fdr a mature indt&trisli;ed econorhy with sa tu ra t ion of invest- b

menC 'opportuni t i e s i s not applicable t o Nigeria. Nigeria

l i k ' e h m t ' developing countr ies , ib characterized not by o w e a s

.'savtngs and lack of investment opp6h.ani t ies but, on the

contrary, by numerous producti& oppor tuni t ies that cannot

be taken advantage of becausk of insuff ic ien& o f savings.

* There a r e o ther l e s s p laus ib le j u s t i f i c a t i o n f o r the policy

beoauae low interdst 'rates on their i i a b i l i t i & h&lp t o '

I ' ,

8 .

p ro tec t t h e i r earnings, This j u s t i f i c ~ t l o n tends '20 fdcus

xable 2, ESTIMATED REAL RATES OF INTEREST -- ON.OVER I 2 ' MONTHS TiME .-- DE%SZS AKD SNIKCS DEPOSIT

I N NIGERIA 1970 - 1985.. .. . . . ..

Year.:. Changc i n Real i n t e r e s t r a te 1 - Real i n t e r e s t on over 32 months r a t e on savings

deposits . i i

. . ,. i

in moblizing savings e i ther dn.the nationel account sense or . . , ! ' . . , . .

. . a , inith'e f inancia l , . . form. (see Wilii.amson 1968; .Gupta 1970 for

> . . . . . .,. i !

.::. inconcpasivc ana confl ic t ing rebul t s ) . :ib. examination of 0 -, .. . . , . . v

, 1

Table 2;above depicts the same inconclusive.result . For. . :. , ,

instande, i n t e r e s t r a t e on savings deposits was constant . '

a t ; i per, cent fo r the peri6&' 1970-74 but savings .index , . . ... . . . . . ; , . .

. > , . '

showed ..an increasing trend f o r the period. 'Q,e same, can -- .,.I. .! 0 ' . : ' " I ,; "

, . be !said of the period 1975 - 78 when the i n t e r e s t r a t e was . . . r . .

stable a t 4.0 per cent. On the other hand, the increasing

,;$rend in savings index was very-much higher i n the period ... :., I

.1980,.,,~5 when interest re turn on savihgs deposits was adjusted ! . ,

upwards. every two years. These inconclusive resul ts . notwith- . , . . . . .

s t and i r .~ , what is however not i n doubF i s t h a t i n t e r e s t r a t e s

gnjficant in determining where savings

.s in determining . . . how .much will. be saved.

len established. for -.b~:th developed and , . '

-, .L,l,A .., v,-... -es that when interest rate differentials

occur, exi~ting savings are transferred from.10~ to high

yielding , I nccounts (Hifiris and Wiseman 1981 ). It is very

well known that n l a t of savings are waeted ei ther i n form

of hodrding o r o i n wproduotive.ventures in Nigeria because

of the Low relative retwns'offered by the3.banks, and

convenient financial in~.trmen&k ylelding.'positive retqr.s. I . I, .- .

Various studies have sh&n th'at the effect ~f reguiatidn . . .- . , - .

, . . . . I

o f interest rates has, been to foster monopolistic' pro.?ll-' ' "

I . . ' .<. . .. making and that many of the alleged shortcomings ofo the

f f nsncial system stemming. from competition. are: actualiy the

result of d l stortlons introduced by regulations (R'aazzi 1 981 )

(b).R@allacation of Resources:

In the administration of interest rates in Nigeria

monetary authorities ,conduct discriminatory interest. rate

policy for different sectors of the economy. Ihe specific .+ - .

interest 'rate policy like $he one prevailing inl .our , , , . . I a .

agricultwal sector have been Justified on a num3er of b

grounds. The notion 5 s widespread that Investments in

agriculture do not produce a high yield, requiring cheap' . . . . ,.- " ,credit to encourage producti.on , . . and innovation. 1% is

4 -

els6.8elfeved that poor farmers ownot afford high , .

L ' . . - . , . _ I .

interest rates. These stereotypes and asSumptZons are '.' . . .

supposed to apply partiGularly: ,tp sm& farms' and srnal!.

farmers, many of whom are assumed to be eiploitgd 'by money . .

lenders. Without interest subsidy, Lt Js claimed, such . .

activities (farm activi-~ies) would not-. take, place, ., . .

' . Q

p ~ ~ b a b i y because such projects are not .sufficiently profit- , @ . , ,, .,-t? :.: . .

g b l e . But the argument remainsbthat if an, acti+ity is . . . . .

sufficiently profitable $0 be worthwhile, its returns will

adequately cover the c o s t 01 resources enp.Loyea. A n r ; r i l s case

subsidy is tinnecessary t o pxoniote the a c t i v i t y and it becomes

merely an a r b i t r a r y gifD..Sor indome d i s t r i b u t i o n (Gonzalez-Vega

1982.);:. f-f however-the activity subsidized by' 'ow i n t e r e s t r a t e

i s n o t ',sufficiently. pro f i t ab l e , the subsidy o,bscurcs t h i s fact.

Tha:.subsi'dy does h o t . remove the cause of sthe b n p r o f i t a b i l i t y

.tin&' informal markets d dams and Nehzian 1977). While the

i nke re s t r a t e i s lower a t the banks, the .other costs of 0

.obtain&ng a loan and the r i s k of n o t ge t t ing the loan a t a l l " I , . ' .- <

x e so ' high t h a t barrawebs are aften served b e t t e r and more

. - 7

L- '"'&er'&cw.t;h of unorganised mmey markets should thererore, . . . - '

be c:or-is&itcid f r o n an ec ~nornic p o i n t of view ss a healthy

reac t ion against unfortunate i n t e r e s t Fates regulations and

i t s attendant d i s t o r t i o n s t ha t prevent f inancial equilibrium.

To t ha t extent t h ~ c r e d i t extended i n the unorganised money

-markets is of g r ea t eeononLc importance. Although the lenders

i n t h e rnark~ts a re alleged t o make monopoly p r o f i t s and use the

debt re la t ionsh ip t o exp lo i t t h e i r c l i e n t s , there i s stunning

lac^ of empirical evidence t o support the t h e s i s , However,

i n s p i t e of i n t e r e s t rates regula t ions i n the formal financial -

markets, the i n f o r m 3 money markets are less efficient ;thaa

. t he f i nanc i a l intermediaries and therefore - ,are .. not ,533421 ,sub= _.__._.-. - I

s t i t u t e s f o r arganised financial m'arkets. i$ will &a& mwh . time and ingenuity t o develop v i ab l e alternatives t o o ~ g a n i ~ ~ d

fLnancial markets ( ~ a l b i s 1982). Furthermore, noninstitutiono~ . #

c r e d i t i s l h a r h l y adequate f o r l a rge investrnei5t plans and ' b -

informal. money markets cannot' e a s i l y provide - and l o n g ~ t e r m loans . for such. plans.

IV. POLICY OPTZGN

- The first bes t policy option that w i l l remove distortions

in the savings, investment, reeouroe allocation and money mark& operations in Nigeria, created by i n a t 2 t u t l o n a ~ l y determ$~ed

low nominal and negative rea l interest r a t e s i s Lo l iberal ize

i n t e r e s t r a t e s . Unfortunately, ava i lab le s tud ies indicate t h a t . .

interest ra tes l i b e r a l i z a t i o n does n o t work when nconditione l o r . ! .

the existence 0 f . a competitive . rnarke* . a r e no t present and cannot . . be readily established because of i n s t i t u t i ona l , , legal and other

impediments (Ga2bIs 1981, 1982), . . , .. . . . I . t

structure inspite of the indigenization of the financial~system.

I prevailing* condbtions, , therefore, one cannot .

poU.cy,of interest rates liberalization will

t conducive to achieving a s t a t e of interest rate-

The reason is that, under a more or less severe

. . ! . !..- ?

in i n t e r e s t r a t e - i i $ required ('as i s the case i n ~ i g e r i a )

.-, * ... ..., c, ........ ' 2 - . . . . 5 ., . ., - . ... . ., . reas&ably .h@h$ositxve ren, - i k " r e ~ t rat3"strudture,

" . . . . . . . .:..,... . discret&Gy f l ex ib le ' i n t e res t rate p'olicy can b e more ' ~

' 5 app~o$riates'i?han immediate interest r a t 6 lidcralizatiori.

- - . . As Galbit 1 2 1 a 'rgkd: . idis~retionary nction oculd,

..,. . - . < . . . . . . . . . . . , I . . For ikktance discret ionary action could "educe the sear'ch'-

. . . ..., . .< . L . . ., . . L . i ,.!

costs of themarkets groping toward equilibri~m and redu6e : .r.

the risK 'of formation of unstable expectations i n ' t h e short- [ ' ? . , . !' ; ,.,

run, the Xkelihoo2 of which &ght be directly 'related t o

the magnitude of the i n i t i a l di~equilibrium '. ' p as ti^, t h e ' I

:,, des i re f o r aiigopa~:i-ist financial ine t l tu t ions t o r a i se loan

rates substantially above the deposi t rates, t o qaxirnize their . . I ..

spread, might beb'cbunter' balanced by a sharp d e & ' , l m in the

denand for loans as a resblt of hi&h posi t ive r d h interest - . ' .

r a t e charges. I

A.discretionary f l e x i b l e i n t e r e s t r a t e s policy needed L .

to r a i s e the l e v e l and s t ructure of i n t e r e s t r a t e s fihould be,