IMPACT OF INTEREST RATE ON MANUFACTURING SECTOR OUTPUT IN NIGERIA

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

Every good or service has a price. So also is the service of lending money to others, a service which is critical to the survival and growth of businesses, households and individuals. The price of this service is called interest rate.

        Like every price, interest rate is determined by the law of demand and supply of the commodity, which in this case is money. In the economy, the level of interest rate is chiefly determined by the amount of money or funds available for lending and borrowing.
        On the supply side are businesses, households and individuals that save. On the demand side are the individuals, households businesses, including government that borrow either to augment income or invest in income generating projects.
Between these groups are the banks and other financial institutions that mobilizes savings in the form of deposits and investment products and lend the funds mobilized to those who want to borrow.
As in the determination of other prices, those who supply the funds, the savers desire and demand for high interest rates while those who borrow desire low interest rate. Meanwhile the banks also want to ensure that the lending interest rate covers the cost incurred for their operations, and adequate profit for their shareholders.
If the interest rate is too low, especially lower than the rate at which prices of goods and services are increasing (inflation), it would discourage people from saving, and it can make them to take their money out of the country to where the interest rate is high. But if the interest rate is too high, a lot of households and businesses would find it unprofitable to borrow or pass the high interest rate to consumers of their products.

Also, where the nature of the funds available for lending are short term, that is below one year, businesses would not be able to borrow to fund projects that have long gestation period. In this situation, the manufacturing sector and the agricultural sector would be at disadvantaged while the services sector would be at advantage. And that is the case in Nigeria, where 80 per cent of bank deposits are for tenures below one year.

In every country, the role of ensuring that the interest rate is not too low to discourage savings or too high to discourage borrowing for activities that indirectly increase investments and employment is entrusted to the central bank.

The primary objective of central banks is price stability or stable prices of goods and services. This they do by regulating the money supply in the economy. If the money is too much it can cause a situation where too much money chases few goods, and hence cause prices to rise persistently leading to inflation.

But sometimes in an attempt to ensure this does not happen the central bank introduces measures that reduce volume of money in supply, and this indirectly reduces money available for lending and thus increased the price of money, which is interest rate.

        The manufacturing sector plays a significant role in the transformation of the economy. For example, it is an avenue for increasing productivity related to import replacement and export expansion, creating foreign exchange earning capacity; and raising employment and per capital income which causes unique consumption patterns (Imoughele and Ismaila, 2014). Furthermore, Ogwuma (1995) opines that it creates investment capital at a faster rate than any other sector of the economy while promoting wider and more effective linkages among different sectors. Loto (2012) revealed that the Structural Adjustment Programme (SAP) introduced in May 1986 was partly designed to revitalize the manufacturing sector by shifting emphasis to increased domestic sourcing of inputs through monetary and fiscal incentives. The deregulation of the foreign exchange market was also effected to make non-oil exports especially manufacturing sector more competitive even though, this also resulted in massive escalation in input costs (Loto, 2012).

Examining the growth of the manufacturing sector over the years in Nigerian, the share of the manufacturingsector in gross domestic product has not been impressive.Over the thirty five (35) years of this study, the percentage of the manufacturing sector in GDP averaged 18% inthe 80s’ (i.e. between 1981 and 1989). In 1994, the manufacturing sector contributed above 20% into theNigeria’s GDP but have been on the decline afterwards. In the recent times,specifically from 2002, the manufacturing sector contributes less than 10% to gross domestic product and wasalmost but averaging 9% between 2013 and 2015. The highest growth rate of the Nigerian manufacturing sector of 60.3% was recorded in1994 and although negative in 1984. The whooping 60% growth rate recorded in 1994 dropped drastically to16.7% in 1995 and growing by a paltry 3% in 2015. This implies that the Nigeria manufacturing sector has notimproved in terms of its growth rate from 1995.

This dismal performance of the sector in Nigeria could be attributed to massive importation of finished goodsand inadequate financial support for the manufacturing sector, which ultimately has contributed to the reductionin capacity utilization of the manufacturing sector in the country. The insignificant contribution of the sector togross domestic product could be as a result of continued deterioration in infrastructural facility as well as lackof access to cheap finance. Obamuyi, Edun and Kayode (2010) asserted that the growth rate of manufacturingsector in Nigeria has been constrained due to inadequate funding, either due to the inefficient capital market orthe culture of the Nigerian banks to finance mainly short term investment. The long term funds from the bankingsector are not easily accessible as a result of the stringent and restrictive credit guidelines to the sector as well ashigh interest rates. All these could be the reason why the Nigerian manufacturing sector has failed to serve as anavenue for increasing productivity in relation to import replacement and export expansion, creating foreignexchange earning capacity, rising employment and per capita income, which causes unique consumptionpatterns.

The manufacturing sector in Nigeria is faced with the problem of accessibility to funds. Even the financial sectorreform of the Structural Adjustment Programme (SAP) in 1986, which was meant to correct the structuralimbalance in the economy and liberalize the financial systemsdid not achieve the expected results (Obamuyi,Edun and Kayode, 2010). As Edirisuriya (2008) reported, financial sector reforms are expected to promote amore efficient allocation of resources and ensure that financial intermediation occurs as efficiently as possible.

This also implies that financial sector liberalization brings competition in the financial markets, raises interestrate to encourage savings, thereby making funds available for investment, and hence lead to economic growth (Asamoah, 2008). However, these seem not to be the case in Nigeria.

Since the inception of the Central Bank of Nigeria (CBN) on 1^stJuly, 1959, monetary policy has been under the control of the Bank(CBN). Before 1st August 1987, interest rate was under theregulation of the central Bank. This regulation was achieved byfixing the range within both deposits and the lending rates are tobe maintained.

According to the CBN, interest rateof orderly growth of the financialregulation is for the promotionmarket, to combat inflation and to lessen the burden of internal debt servicing of the government.

Since the deregulation, interest rates have been rising almostuninterruptedly especially in recent years. From the average of12.6 percent at the end of July, 1987, which marked the end of’ theera of administrative determination of the rates, lending ratesmoved to 17.6 percent in August 1987 – the immediate monthcommencing the period of deregulation of the rates.

The rapid upward movement in the interest rates was not favourableto production, growth and infact the manufacturing sector of theeconomy. Although the deposit rate seemed high enough to promoterising flow of saving, the high lending rate appeared to havehindered the usage of the resources mobilized. In an attempt toeconomize on a resource that was getting increasingly expensive,many firms especially the manufacturers abstained from borrowingfrom banks while the bulk of those who borrowed made losses orprofit margins that could not support production initiatives. Thiscould have resulted in sharp curtailment of output. Long-termfinancial requirements for expansion was largely met through thefloatation of new equity and debenture. This was confirmed by thelarge boost in the amount of new issue s of stocks and debenturesduring the period. While distribution trade and other quickyielding activities were able to obtain bank financing, investmentin equipment and machinery for prosecuting expanding productiveactivities reduced sharply.

Although the high interest rate encouraged inflow of funds, thebulk of the inflow went to distributive trade and businessservices.

It is crystal clear that since the introduction of the policy oninterest rates deregulation in the banking industry in August,1987, the levels of the rates have persistently increased.

In particular, the lending rates of commercial and merchant banks assumed a sharp upward trend. This dealt a serious devastating blowto the manufacturing sector and the economy as a whole.

However, all the regulations and deregulations of interest rate in Nigeria were all in a bid to manage the country’s capital allocation through the financial sector. The essence of managing interest rates were based onthe premise that the market, if freely allowed to determine the rate of interest would exclude some priority sectors. Thus, interest rates were adjusted through the “invisible hand” in order to promote increased level of investment in the various preferred sectors of the economy. Prominent among the preferred sectors were the agricultural, manufacturing and solid mineral sectors which were accorded priority and deposit money banks were directed to charge preferential interest rates on all loans to encourage the upsurge of small-scale industrialization which is a catalyst for economic development (Udoka and Roland, 2012). Thus, this study therefore examines the effect of interest rates on the performances of the Nigerian manufacturing sector.

1.2 Statement of the Problem

The observed reduction in manufacturing sector output in Nigeria is attributed to the instability of the interest rate in the country which discourages foreign and local investors to carry out investment activities which would be beneficial to the country.The dismal performance of the Nigerian manufacturing sector could be attributed to inadequacy of financialsupport for the manufacturing sector, which ultimately has contributed to the reduction in capacity utilization ofthe manufacturing sector in the country. The insignificant contribution of the sector to gross domestic productcould be as a result of continued deterioration in infrastructural facility as well as lack of access to cheapfinance characterized by rising lending rate. Also, the debt overhang has also discouraged investment in the manufacturing sector, through its implied credit constraints in international capital markets as a result of flawed interest rate policies by successive monetary authorities in Nigeria.

Have seen the series of problems that can emanate from flawed interest rate policy, the researcher therefore seeks to unravel further influence of interest rate on the manufacturing sector output in Nigeria.

1.3 Objective of the Study

The broad objective of this study is to determine the impact of interest rate on manufacturing sector output in Nigeria. The specific objectivesof the study include:

1. To determine the impact of interest rate on manufacturing sector output in Nigeria.
2. To examine the impact of commercial bank total loan volume on manufacturing sector output in Nigeria.
3. To determine the impact of inflation rate on the manufacturing sector output in Nigeria.
4. To evaluate the direction of causality between interest rate, inflation rate, commercial bank total loan and manufacturing sector output in Nigeria.

1.4 Hypotheses of the Study