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Nigeria Journal for Engineering
In this study, an attempt was made to investigate the impact of interest rate liberalization on the Nigerian economy. The study covered the periods 1981-2014 and the time series data were sourced from CBN, NBS and WDI. The OLS technique was employed and the result show that interest rate liberalization impacted negatively on the economy because high loan rate have increase the cost of capital which discourages capital and productive investment, raises inflation and encourages capital flight.
In the light of adverse effects of interest rate liberalization on the economy, this paper recognizes the fact that a well developed financial market remains a pre-requisite for the use of interest rate as a major monetary instrument. Promotion of equity markets, raising of corporate savings and encouraging the inflow of foreign capital are needed as complements to interest rate liberalization. The financial market will be efficient only if government controls prices in the market such as interest rates and transaction fees. The high interest rate will lead to excess liquidity which may result into unnecessary credit expansion. Therefore, the wide spread between deposit and lending rates should be controlled and actively managed. Increase in interest rate may lead to increase in inflation, high cost of funds, increase in domestic debts, weaker exchange rate, rising unemployment rate in Nigeria. There is the need for strong capital account policy to regulate short-term capital flow and exchange rate volatility. The Nigerian government should re-examine and improve on the incentives structure by making investment available in labor intensive projects in area of agriculture, manufacturing, small scale enterprises and easy access to loan. So, government should encourage private sector-led economic policies by reducing the interest rate to a single digit. The current economic reforms are desirable and should be sustained. Government should also formulate and implement financial policies that enhance investment-friendly rate of interest and take into consideration those other factors, like corruption, which negatively affect investment in the country, in order to maintain sustainable economic growth.
Complementary policies such as industrial incentives to cushion the effects of interest rate liberalization on industrial operations and investment returns are desirable. Efficient and well functioning payment systems will improve the transmissions of monetary policy, financial sector stability and transactions velocity of money. In order to deal with the problem of weak economic structure, the banks should seriously encourage the establishment of small and medium enterprises that will enhance linkages between agriculture and the rest of the economy.
In conclusion, it requires an enabling economic environment, consistent macroeconomic policies and socio-political stability to effectively manage the Nigerian economy. Lastly, we recommend a guided liberalization.