International Journal of Development and Economic S ustainability [621981]

International Journal of Development and Economic S ustainability
Vol. 1, No.2, pp.73-85, June 2013
Published by European Centre for Research Training and Development UK (www.ea-journals.org)
73
REAL INTEREST RATE AND SAVING MOBILIZATION IN NIGER IA

Simon-Oke, O. Olayemi
Department of Project Management Technology, Federa l University of Technology,
Akure, Nigeria

Jolaosho, O. Michael
Department of Economics, Ekiti State University, Ad o-Ekiti, Nigeria

Abstract This study empirically assessed the impact of real interest rate on savings
mobilization in Nigeria. The Vector Auto Regression (VAR) was employed, using the
time series data from 1980 to 2008. The study revea led that real interest rate has
negatively impacted on the level of savings mobiliz ation in Nigeria. The need for
government in Nigeria to bridge the existing gap be tween the lending and savings rates
and increase per capita income level of the populac e, to stimulate savings for
investment and economic growth were revealed by the study. Therefore, efforts should
be geared towards reducing domestic inflation rate to arrest its negative impact on real
rates in Nigeria.

Keywords: Vector Auto Regression , Real Interest rate, Lending rate, Inflation rate,
Savings Mobilization and Nigeria.

INTRODUCTION
Banks are statutorily vested with the primary resp onsibility of financial intermediation in
order to make funds available to all economic agent s. The intermediation process
involves moving funds from surplus sectors or units of the economy to deficit sectors or
units (Uremadu, 2002; Nnanna, Englama and Odoko, 20 04). The extent to which this
could be done depends on the level of development o f the financial sector as well as the
savings habit of the populace. The availability of investible funds is therefore regarded as
a necessary starting point for all investments in t he economy which will eventually
translate into economic growth and development (Ure madu, 2006).

In Nigeria, the level of funds mobilization by bank s is quite low due to a number of
reasons, ranging from low savings deposit rates to the poor banking habits or culture of
the people (Nnanna, Englama and Odoko, 2004). Also, another disincentive to funds
mobilization according to these authors is the atti tude of banks towards small savers. That

International Journal of Development and Economic S ustainability
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is most banks target corporate customers and govern ment deposits and pay little or no
attention to the small savers. Admittedly, the serv ices rendered to the small savers are
more tasking on the banks, but there is need to enc ourage them to save. As a matter of
fact, the funds from household savings are relative ly cheaper and more stable than
government deposits that are very volatile and expe nsive. However, the role of savings in
the economic growth of any country cannot be over-e mphasized.

Conceptually, savings represent that part of income not spent on current consumption.
When applied to capital investment, savings increas e output (Olusoji, 2003). Institutions
in the financial sector like deposit money banks (D MBs) or commercial banks mobilize
savings deposit on which they pay certain interest. To effectively mobilize savings in an
economy, the deposit rate must be relatively high a nd inflation rate stabilized to ensure a
high positive real interest rate which motivates in vestors to save from their disposable
income. In Nigeria, the problem of mobilizing savin gs and deposits has always been the
bane of economic growth and development. In develop ing economies, savings rate has
been declining since the first oil shock and in the early 1990s (Chete, 1999).

However this trend conceals a large and increasing dispersion of savings rate, particularly
among developing countries. The large heterogeneity in savings behavior is associated to
country and time differences in levels of developme nt, growth performance, and fiscal
and financial policies. The interest rate reform po licy under financial sector liberalization
was also to achieve efficiency in the financial sec tor and engendering financial
deepening. In Nigeria, financial sector reforms beg an with the deregulation of interest
rates in August 1987 (Chete, 1999). Prior to this p eriod, the financial system operated
under financial regulation and interest rates were said to be repressed. According to
McKinnon (1973) and Shaw (1973), financial repressi on arises mostly when a country
imposes ceiling on deposit and lending nominal inte rest rates at a low level relative to
inflation. The resulting low or negative interest r ates discourage saving mobilization and
channeling of the mobilized savings through the fin ancial system. This has a negative
impact on the quantity and quality of investment an d hence economic growth. Therefore,
the expectation of interest rate reform was that it would encourage savings and make
loanable funds available to the banking institution s. But, the criticism has been that the
“tunnel-like” structure of interest rate in Nigeria is capable of discouraging savings and
retarding growth in view of the empirical link betw een savings, investment and economic
growth (Ojo, 1976). The link between them has been emphasized such that if individuals
or firms save, that means there is a greater possib ility of investing in the near future. The
more you save, the more resources available for inv estments i.e. the disposable income is

International Journal of Development and Economic S ustainability
Vol. 1, No.2, pp.73-85, June 2013
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75
either saved or consumed. Consequently, a higher le vel of investment is capable of
creating brighter chances of economic growth.

Problem Identification
Over two decades ago, Nigerian economy witnessed th e introduction of Structural
Adjustment Program (SAP) which shifted emphasis fro m public sector to private sector.
The goal was to, among other things, encourage priv ate domestic savings, private
domestic investment and capital formation in order to enhance economic growth. By
encouraging savings, resources were diverted from c urrent consumption and invested in
capital enterprises. Unfortunately things have not worked out as expected. The initial
optimism expressed about public sector reforms has not been met. Although the reform
programme led to privatization and commercializatio n of many state enterprises and
improvement in some macroeconomic variables like th e nominal interest rate and money
supply, but not without its disappointing performan ces. For example, Nigeria continues to
be confronted with low rate of real economic growth . Besides, the aggregate supply
continued to diminish leading to demand-pull inflat ion. One worrisome aspect of the
result of liberalization of the public sector in Ni geria is the extent of distress in the real
sector as well as high rate of unemployment. This d istress syndrome in the economy
remains inadequately detected and controlled. There fore the need for putting the
economy back on track through savings mobilization for investment and economic
growth became necessary.

In view of the stated research problem, the study b roadly aimed at examining how to
mobilize savings through real interest rate in Nige ria, while specifically dwell on the
effects of some macroeconomic variables like intere st rate, inflation rate, exchange rate,
gross domestic products among others on savings mob ilization capacity of Nigerian
economy. This study is important because the behavi or of interest rates, to a large extent,
determines the investment activities and hence econ omic growth of a country. It is
therefore relevant and timely in view of the fact t hat there is still much ado empirically on
the effects of interest rates on savings mobilizati on in Nigeria. It is obvious according to
Umoh (2003) that an understanding of the nature of aggregate national savings behavior
is critical in designing policies to promote saving s, investment and growth.

THEORETICAL AND EMPIRICAL REVIEW
Theoretical Review
The classical theory of interest otherwise called t he demand and supply theory of interest,
maintained that the rate of interest is determined by the demand for and the supply of
funds by businessmen and households respectively. T he supply of funds is governed by

International Journal of Development and Economic S ustainability
Vol. 1, No.2, pp.73-85, June 2013
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76
the time preference and the demand for capital by t he expected productivity of capital.
The classical theory fails to proffer solution henc e indeterminate. Meanwhile, the
Keynesian liquidity preference theory is a stock th eory. The theory determines the
interest rate by the demand for and supply of money . It emphasizes that the rate of
interest is purely a monetary phenomenon as distinc t from the real theory of the
classicals. It is a stock analysis because it takes the supply of money as given in the short-
run and determines the interest rate by liquidity p reference or demand for money.

In discussing the modern theory of interest, the Hi cks-Hansen ISLM model evidently
shows that no single theory of interest rate is ade quate and determinate. An adequate
theory to determine interest rate must take into co nsideration both the real and monetary
factor that influences the interest rate. Recall th at Md = Ms (i) + M t (Y) . Thus, money
demand is also a function of output Y. When output rises, the money demand curve will
also rise and therefore the equilibrium level of in terest rate (r*) rises as well. In like
manner, the McKinnon-Shaw Hypothesis expressed in M cKinnon and Shaw (1973)
argued that financial repression and indiscriminate distortions of financial prices
including interest rates reduces real rate of growt h. One of the basic tenets of McKinnon-
Shaw model is that investment function responds neg atively to the effective real loan rate
and interest, and positive to the growth rate. McKi nnon-Shaw school expects financial
liberalization to exert a positive effect on the ra te of economic growth in both the short
and long run.

In addition to the classical theory of interest rat e, the study also reviews the loanable
funds theory to provide the theoretical justificati on for the relationship between real
interest rate and savings mobilization. The concept of loanable funds in economics is
central to the theory of interest rate. It explains how the demand for and supply of credit
decides the financial market interest rate. Bannock s, et al (1998) defined loanable funds
as money available for lending to individuals, gove rnment and institutions in the financial
markets. It comprises the current savings of privat e individuals and firms, as well as any
increase in money supply made available by the acti ons of depository institutions,
governments and monetary authorities in the financi al markets.

Thus, loanable funds represent a flow of money into the financial markets for loans of all
kinds. According to Pearce (1992), loanable funds o r credit is strictly the term used for
funds that are available for lending in the money a nd capital market, and is usually
considered within the context of the theory of inte rest rate. According to Uremadu
(2005), loanable funds results out of planned and m obilized savings. Accumulated

International Journal of Development and Economic S ustainability
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savings when invested translate into capital format ion which is a stock of real productive
asset.

Empirical Review
A number of authors have investigated the effects o f real interest rate on savings
mobilization. In Nigeria and other developing econo mies, interest rate has shown
significant effect on financial savings especially time and savings deposits while the
structure of deposits was determined by differentia ls in deposits rates (Ndekwu, 1991).
Through further investigation using monthly data, N dekwu discovered that interest rate
deregulation in Nigeria have a positive impact on f inancial savings between 1986 and
1988 and in Ghana between 1976 and 1980. Consequent ly, negative real interest rates
resulted in decline of financial savings in real te rms. But on the contrary, the Malaysian
economy witnessed a steady policy of positive infla tion-adjusted interest rates which led
to growth in real term savings deposits. Also in Tu rkey, the deregulation of interest rate
in 1981 resulted in a substantial increase in time and savings deposits in real terms
(Ndekwu, 1991). Apart from the above evidences, som e other studies have shown
negative relationship between the rate of interest and the volume of savings through
financial intermediaries For instance Ogaki, Jonath an and Reinhart (1995), in a study of
personal savings in developing countries argued tha t high real interest rate increased
savings while Ajayi (1978) in his own study conclud ed that savings deposits rate in a
deregulated regime is not necessary in explaining t he demand for savings deposit. Also,
Abu (2006), using two partial models to investigate the impact of investment on GDP
growth rate and the relationship between interest r ate and investment in the case of the
Romanian economy, found out that the behavior of th e national economic system and the
interest rate-investment-economic growth relationsh ip tend to converge to those
demonstrated in a normal market economy. But the st udy of Oosterbaan, et al. (2000)
estimated the relationship between the annual rate of economic growth and the real rate
of interest and shows the effect of a rising real i nterest rate on growth and equally
claimed that growth is maximized when the real rate of interest lies within the normal
range of say -5% to +15%.

However, the World Bank reports, cited in Oosterbaa n et al. (2000), show a positive and
significant cross-section relationship between aver age growth and real interest rates over
the period 1965 to 1985.While From the study of Gri lli and Milesi-Ferretti (1995),
Rodrick (1998) and Kraay (2000), on the effect of f inancial liberalization on savings and
growth, it was discovered that financial liberaliza tion does not affect savings and growth,
but Levine(2001), Bekaert et.al.(2003) and Bonfigli oli and Mendicino (2004),found that
the effect was positive. Also, in a similar study, Eichengreen and Leblang (2003), found

International Journal of Development and Economic S ustainability
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78
the effect to be negative while Bakaert et. al. (20 03), Chinn and Ito (2003) and Edwards
(2001), discovered those effects to be heterogeneou s across countries at different macro-
economic frameworks. Modigliani (1966), argues that a higher income raises aggregate
savings because it would increase the aggregate inc ome of those working relative to those
not earning labour income (i.e. retired persons liv ing off their accumulated assets).
Carroll and Weil (1994), also confirmed that lagged values of income growth seem to
explain higher saving rates; they argue that the us ual consumption models with either
uncertainty or liquidity constrains are not suffici ent to explain this result and advance
instead the hypothesis of habit persistence, accord ing to which higher income takes some
time to be reduced when income falls back. Moreover , empirical research has reported
mixed results, paralleling the theoretical ambiguit y. For instance, Bosworth (1993) found
a positive interest rate coefficient in time-series estimation for individual countries, but a
negative coefficient in a panel (cross-country) est imation for developing countries.
Giovannini (1985) also concludes that in most cases the real interest elasticity is zero but
given that financial liberalization may have change d the interest rates effects, it is not too
surprising that results are not robust.

METHODOLOGY
The Model
In line with the classical theory of interest rate which emphasized savings as a function of
interest rate with the modifications of Giovannini (1985), in Bwire et. al. (2009) in a
model where they predicted that nominal national sa vings, (measured as the ratio of
domestic savings to GDP) is determined by financial intermediation ratio, (FR)
(measured by the ratio of M3 to GDP), the real depo sit rate of interest, (RDR) (measured
as nominal deposit rate of interest minus inflation ). Therefore, the model specified for
this study is explained functionally as follows;
GNS = ᶂ (INT, EXR, INF, GDP, µ). Explicitly, the model to determine the core
determinants of gross national savings in Nigeria i s written as follows;
GNS = βo + β1INT + β2EXR + β3INF + β4GDP + µi
Where; GNS = Gross national savings which is simply defined as the sum of private and
public savings in the economy. It is equal to a nat ion’s income minus consumption and
government purchases. It could be referred to as th e amount of remaining money that is
not consumed.
INT = Real interest rate. This also is the rate of interest an investor expects to
receive after allowing for inflation. It is approxi mately the nominal interest rate minus the
inflation rate.

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EXR = Exchange rate. In finance, the exchange rate (also known as the foreign
exchange rate, forex trade) between two currencies specifies how much one currency is
worth in terms of the other.
INF = Inflation rate. This has been referred to as the rise in the general level of
prices of goods and services in an economy over a p eriod of time. This basically reflects
erosion in the purchasing power of money.
GDP = National Income. This has been regarded as th e monetary value of all
goods and services produced in a country over a par ticular period of time usually a year.

Analytical Method
In order to establish the relationship among the va riables used in this study, the Vector
Auto Regressive Analysis (VAR) was employed.

From the literature, different techniques have been adopted to capture the impact of
various macro-economic indicators on particular var iables. For example, Nyong (1997),
used ordinary least square regression analysis (OLS ) to analyse the impact of real interest
rate which later failed to distribute the response of industrial production to the various
macro-economic variables used.

A better technique suggested by Gujarati (2007), is the vector auto regression technique
(VAR). The superiority of the VAR model over the OL S is quite clear. The OLS assumes
a particular variable to be endogenous while the re st are exogenous. Vector
Autoregression (VAR) is a statistical model used to capture the linear interdependencies
among multiple time series. All variables in a VAR model are treated symmetrically in a
structural sense; (although the estimated quantitat ive response coefficients will not in
general be the same) each variable has an equation explaining its evolution based on its
own lags and the lags of the other model variables.

Data Requirements, Sources and Limitations
The data for this study include sum of private and public savings to capture GNS, GDP at
current market prices, Gross national savings (i.e. Mirror of total institutional savings),
inflation rates and interest rates (i.e. Lending an d savings deposit rates), and exchange
rate. Other required secondary data were obtained f rom CBN Statistical Bulletin and
Annual Reports and Statement of Accounts specifical ly between 1980 and 2009.
Moreover, the data used in this study is limited to those available and accessible within
official statistical limitations.

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RESULTS AND DISCUSSION
Table 1: Vector Auto Regression (VAR) Estimates
GNS INT EXR INF GDP
GNS(-1) 1.109521 -8.30 -7.29 3.81 0.644175
GNS(-2) 0.759096 6.03 2.08 1.23 -4.377242
INT(-1) -1111.398 0.402384 1.114240 0.359883 7629.4 59
INT(-2) 1806.114 0.403280 -0.479699 1.261062 -19911 .23
EXR(-1) -479.8823 -0.057288 0.886566 -0.293071 1266 2.96
EXR(-2) -2511.470 0.062192 0.072467 0.189841 4459.8 88
INF(-1) 126.3931 0.053120 -0.083346 0.458980 11619. 83
INF(-2) -586.1276 -0.107338 -0.142755 -0.503501 19. 45101
GDP(-1) 0.024959 -1.98 -9.72 3.71 0.761791
GDP(-2) -0.019387 2.65 1.89 -1.11 0.674569
C -3476.046 6.031319 0.042603 4.529813 -203176.6
R2 0.996625 0.605547 0.958707 0.539087 0.996293
F-stat . 472.4215 2.456252 37.14732 1.871373 429.9983
Source: Author’s computation, 2012.

Vector Auto Regression (VAR) Analysis
From the VAR estimates above, the result portrays t he level of endogeneity or direction
of causality of the endogenous variables, comparing the F-statistic values and the
coefficient of multiple determinations ( R2). From the result, it was revealed that GNS,
GDP and EXR are more endogenous than exogenous havi ng the R2 of about 99.6%,
99.6%, and 95.9% and F-statistics of 472.4, 429.998 and 37.15 respectively. However,
INT and INF are less endogenous as they have R 2 of about 60.6% and 54% respectively.
This is further analysed, using the impulse respons e and the variance decomposition.
The impulse response analysis of the VAR traces the effect of one standard deviation
shock to one of the innovations on current and futu re value of the endogenous variables.
The impulse response table is presented below and i t’s used to forecast the behaviour of
the endogenous variables to a standard deviation sh ock on the gross national savings in
Nigeria.

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4.2 The Impulse-Response Analysis
Table 2: Impulse Response to One S.D. of GNS
PERIOD GNS INT EXR INF GDP
1 54314.27 0.000000 0.000000 0.000000 0.000000
2 60999.77 -4335.963 -7556.585 4068.003 9886.467
3 115329.4 -5872.952 -36113.67 1752.996 13725.09
4 184873.4 -23721.58 -72710.13 13045.34 35617.09
5 314576.4 -41448.96 -130642.9 29755.13 56648.53
6 519008.4 -78019.74 -226088.2 58695.86 94724.22
7 867020.2 -130578.8 -382958.0 95722.66 150518.5
8 1442317 -221645.9 -641854.3 155808.3 238947.8
9 2406753 -372263.8 -1055610 251475.1 381135.7
10 4020043 -627214.7 -1801543 409609.0 613353.3
Source: Author’s Computation, 2012.

From the impulse response table, a standard deviati on shock on gross national savings
(GNS) brings about a gradual increase in the gross national savings (GNS) in the ten
periods under consideration. This implies that all other factor hold constant, the value of
the gross national savings in Nigeria will continue to increase. Also, the response of GNS
revealed the innovation in GNS, as the INT reduces from about -4335.96 in the second
period to about -627214.7 in the tenth peri od. Also, the innovation will also lead to a
persistent reduction in EXR up to the tenth period as it reduced from -7556.585 in the
second period to about -1801543 in the tenth period . However, inflation and gross
domestic product tends to increase positively from an initial value of 4068.003 and
9886.467 to about 409609 and 613353.3 respectively in the tenth period.

The variance decomposition measures the proportion of forecast error variance in one
variable explained by innovations in it and other v ariables. But it should be noted that the
VAR was estimated with sets of contemporaneous stru ctural restriction specified in the
equation. The result of the variance decomposition is therefore presented below.

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The Variance Decomposition Analysis.
Table 3: Variance Decomposition of GNS
PERIOD S.E GNS INT EXR INF GDP
1 54314.27 100.0000 0.000000 0.000000 0.00000 0.000 000
2 82832.40 97.22799 0.274013 0.832244 0.241192 1.42 4563
3 147283.4 92.06852 0.245672 6.276363 0.090454 1.31 8988
4 251314.2 85.73633 0.975328 10.52625 0.300516 2.46 1568
5 430114.3 82.76203 1.261645 12.81948 0.581822 2.57 5025
6 723870.7 80.62730 1.607109 14.28116 0.862913 2.62 1512
7 1212946 79.81042 1.731322 15.05456 0.930127 2.473 578
8 2023362 79.49403 1.822152 15.47304 0.927228 2.283 546
9 3374978 79.42549 1.871556 15.71841 0.888465 2.096 074
10 5633308 79.43392 1.911434 15.86921 0.847604 1.93 7833
Sources: Author’s Computation, 2012.

From the result, it was observed that the variation in the gross national savings (GNS)
explained by the inflation rate (INF) assumed a pea k of 93% in the seventh period and
thereafter decline to about 84.8% in the tenth peri od. In the same vein, the variance in
GNS explained by GDP reached its peak in the sixth period with 2.62% which later
declined to 1.93% in the tenth period.

On the other hand, the influence of INT and EXR to gross national savings in Nigeria
easily observed to be increasing slightly from the first period to the tenth period. The
result also indicates in itself weakened continuous ly from 100 per cent in the first period
to 79.4% in the tenth period. The result implies th at the gross national savings (GNS) will
continue to decline in future. The implication of t he results analysed above however, is
that the level of income exert a greater and signif icant influence on the level of Gross
national savings as evident from the VAR estimates, Impulse response and variance
decomposition analyses. The outcome is in line with the findings of Carroll and Weil
(1994) who confirmed that previous level of income growth seems to explain the higher
savings rates. The result also depicted that the in terest rate (INT) is less endogenous in
the VAR estimates which could be tandem with the fi ndings of Grilli and Milesi-Ferretti
(1995), Rodrick (1998) and Kraay (2000) where it wa s revealed that financial
liberalization does not affect savings. Likewise, t he relative but not significant influence
of exchange rate and inflation rate as evident from the VAR estimates and variance
decomposition could be argued that while the introd uction of various economic policy
reforms in the economy encouraged the growth of the nominal savings and widened
sophistication of financial institutions, the real interest rates show possibility of not

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having a significant impact on savings as earlier h ypothesized. This may be as a result of
high nominal interest that indeed influences savers in Nigeria rather than the real rate.
This is in-line with Uchendu (1993) findings that “ nominal savings interest rate is the
main determinant of financial savings in Nigeria”.

CONCLUSION AND RECOMMENDATIONS
This study summarily concludes that the interest ra te liberalization vis-à-vis real interest
rates has really contributed to the current declini ng level of savings mobilization in
Nigeria and consequently the low level of capital f ormation in the economy. It could also
be concluded that real rate is still significant in impacting on savings mobilization in
Nigeria.

It is therefore recommended that efforts should be geared towards reducing domestic
inflation rate to arrest its negative impact on bot h real rates and spread; these could also
bring improvement in per-capita income of the peopl e via reducing unemployment rate
and improved investment in the country. The moneta ry authorities should also embark
on routine efforts at bridging the widened gap betw een lending and savings rates to foster
a moderate rise in nominal rates and stabilize infl ationary pressure. This encourages
savings and generates needed loanable funds for inv estment in Nigeria.

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