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The study examined the effects of real interest rate on savings in Nigeria from the period of 1980-2014.specifically the study analysed the relationship between real interest rate and savings with secondary data using the ordinary least square econometric technique. The empirical findings of the study provide evidence that there is a negative relationship between real interest rate and savings in Nigeria. Thus recommended that policy makers should focus on maintaining and ensuring interest stability as this should positively impact in the Nigeria economic growth.
1.1 BACKGROUND OF STUDY
Interest rate and savings are among the economic variables that are important to a broad number of people, business firms, the government, entrepreneurs, foreign investors, the household and the financial sector because they determine the extent of economic growth and development that an economy can achieve (Udude, 2015). Fuller (1990) described interest rate as the factor reward or price paid for capital and further state that this source of finance will only be available if other people are willing to forgo current consumption and provide a pool of financial resources from which loans can be advanced. Real interest rate which is adjusted for inflation shows the real cost of borrowing money by a borrower and the real returns accrue to an investor unlike tshe nominal interest rate that is not adjusted for inflation. It is intuitive that real interest rate, savings and investment are all linked. According to Professor Soludo (2008), every economy is always interested in the level of its real interest rate as this can lead to either high or low savings or investment. Real interest rates are regarded as ‘high’ or ‘low’ relative to some economic fundamental: the level of inflation rate; the degree of uncertainty and risk the economy face; the structure and competitiveness in the banking system; the level of development of the nation’s financial markets; the cost of funds to the bankand the demand for credit by government when it runs deficit and whether it competed with the private sector.
Generally, interest rates can be seen as a price paid for capital that is desirable to both the investor and borrower, in other to reward depositors and encourage long-term savings and also to reward lenders. Desroches and Francis, (2007) pointed out that some economists agree that real interest rate which has been adjusted for inflation is determined in the market for investment and savings and thus by the forces of productivity and thrift. However, it is proper to say that real interest rate adjusts to equilibrate desired savings (providing the net supply of funds) with desired investment (generating the demand for funds) and that investment and savings decisions are made by each of the three sectors of the world economy: households, firms and government.
Recall that real interest rate is nominal interest rate adjusted for inflation and the Nigerian economy has experienced some movements in these two variables. As at 26th January, the CBN kept its benchmark interest rate at 11 percent following a previous 13 percent benchmark. The reason behind this decision is believed to be to boost economic activities as business firms would now be able to borrow loanable funds at a lower cost. On the other hand, inflation rate which can be also measures using the Consumer Price Index (CPI) went up 9.6 percent year-on-year in December compared to the 9.4 percent rise in the previous month (Trading Economics, 2016). This shows that in as much as the interest rate is being lowered by the CBN, a continues rise in the inflation rate means an expectation of a negative real interest rate because real interest rate which is subtracting inflation from nominal interest rate will have a negative value as inflation exceeds nominal interest rate. The real interest rate can be computed by the difference between inflation rate and nominal interest rate.
The graph below represents the trend of real interest rate in Nigeria, sloping from left to right from 1971 to 2014.
Figure 1: Real Interest Rate in Nigeria from 1971- 2007
The above shows that real interest rate began with a negative figure and this could be assumed to be because inflation rate exceeded the nominal interest rate. It also shows that the real interest rate has an upward trend irrespective of some peak and trough periods. This figure graphically shows that real interest rate is the difference between nominal interest rate and inflation.
The relationship between real interest rate and savings is however established in economic theory. Keynes (1936) highlighted this relationship in his liquidity preference theory where he opined that the quantity of money which people desire to hold for speculative purpose is a function of (real) interest rate. At higher (real) interest rate, people would prefer to hold their wealth in one form of interest bearing asset or another, it can thus be deduced from this statement that higher interest rate encourages people to save because the inflation rate is at a low rate and lower (real) interest rate produces the opposite effect because the rise in inflation would reduce their purchasing power (Udude, 2015).
This study is to determine the effects of real interest rate on savings in the Nigerian economy and therefore, make recommendations on how to influence interest rate in other to achieve the desired level of savings in Nigeria.
1.2 STATEMENT OF PROBLEM
From intuition, the major function of real interest rate in Nigeria and also other countries of the world is to ensure a rate of interest capable of leading to savings mobilization and as well as encourage investment by borrowers in the economy after taking into consideration movements in general price level. Real interest rates play an important role in the economy because real interest rates affect the demand for goods and services through borrowing costs. Changes in real interest rates affect the public’s demand for goods and services mainly by altering borrowing costs, the availability of bank loans, the wealth of households, and foreign exchange rates (Catáo and Terrones, 2001) as cited in Umoru and Oseme (2013). If the inflation rate is zero, then nominal interest rates should equal real interest rates. Most economies experience some inflation and failure to anticipate future inflation when lending, especially on long-term securities or loans, can be costly either in terms of lost interest or discounted value, or both (Alesina and Arazen, 1991; CBN, 2000; Orubu, 2009; Mordi, 2009).
The use of real interest rates as stimulants in savings mobilization has not been very effective in Nigeria (Udude, 2015). The argument put forwards as the cause is that financial sector is weak and the volatility of general price level poses a major risk factor. For this reason, people prefer their money outside the banking system, which many believe is shallow and prone to distress. The reason why saving is not responsive to real interest rates as highlighted by Acha (2011) are; lack of confidence in the banking system; low income and preference for cash.
A priori, there is an expected negative relationship between interest rate and investment and a positive relationship between interest rate and savings. The question is, does this relationship still hold when we consider real interest rate in Nigeria?
Most economies experience some inflation and failure to anticipate future inflation when lending, especially on long-term securities or loans, can be costly either in terms of lost interest or discounted value, or both (Alesina and Arazen, 1991; CBN, 2000; Orubu, 2009; Mordi, 2009).When prices rise, consumers cannot buy as much as they could previously. This discourages savings due to the fact that the money is worth more presently than in the future. This expectation reduces economic growth because the economy needs a certain level of savings to finance investments which boosts economic growth. Also, inflation makes it harder for businesses to plan for the future. It is very difficult to decide how much to produce, because businesses cannot predict the demand for their product at the higher prices they will have to charge in order to cover their costs.
1.3 RESEACH OBJECTIVES
The broad objective of this study is to determine the effects of real interest rate on savings in Nigeria. The specific objectives are:
1.3.1 To investigate the existence of any possible relationship between real interest rate and savings in Nigeria
1.4 RESEARCH QUESTIONS
1.4.1 Is there any significant relationship between real interest rate and savings Nigeria?
1.5 RESEARCH HYPOTHESIS
In this study, the hypotheses below shall be tested:-
1.5.1 H0: There is no significant relationship between real interest rate and savings in Nigeria
1.5.2 H1: There is significant relationship between real interest rate and savings in Nigeria
1.6 SCOPE OF STUDY
As regards geographical scope of this work, the work will be centred on the Nigerian economy. In terms of context, this work will attempt to consider the relationship between the variables of interest entailed in this study, which are real interest rate and savings in Nigeria. Furthermore, the period of 1980 to 2014 will be covered in this study. The short period covered is as a result of the unavailability of data.
1.7 JUSTIFICATION/SIGNIFICANCE OF THEY STUDY
This study is relevant for several reasons. First it will be relevant in the sense that it will provide the basic understanding of real interest rate and its effect on savings in Nigeria. This study will seek to evaluate economic literature’s a priori expectation on the existing relationship between the variables of interest. This knowledge will help Economic stakeholders in gaining an insight on the intricacies of the variables of interest in their economy and what to expect from policy makers and also to authorities in various countries to make policies that would efficiently achieve its macroeconomic goals geared towards growth and development.
More so, this study will be of use to other researchers as a point of reference for further research studies.
1.8 ORGANIZATION OF THE STUDY
The work is in five sections; the first chapter is the introduction of the work. Chapter two is the review of related literature and definition of terms, chapter three gives an insight of the methodology the work will be adopting, chapter four reports result analysis and findings and the work closes with conclusion, summary, policy implication and recommendation in chapter five. References and appendix follows afterwards.