ABSTRACT
This study evaluates the influence of the monetary policy on the Nigeria Stock Market using selected market indices which span from 1986 to 2014. Augmented Dickey- Fuller (ADF) Test, graphs, multiple regressions and the diagnostic test based on the coefficient of determination (R2)were adopted for the analysis, and mainly the study used secondary data. Evidence reveals thatInterest rate as a monetary policy tool of the Federal Government of Nigeria has a negative influence on all share index and total market capitalisation, and positive influence on total value of securities traded, but none is significant.The monetary policy tool of broad money supply exerts a positive impact on all share index, total market capitalisation and total value of securities traded, but none of the impact is significant at 1% level. Exchange rate as a monetary tool of the Federal Government of Nigeria has a negative effect on all share index, total market capitalisation and total value of securities traded, but none is significant. Inflation rate as a monetary tool of the Federal Government of Nigeria has a negative effect on all share index, total market capitalisation and total value of securities traded, but none is significant at 1% level. The dominance of insignificant negative relationship between the stock market and the monetary policy variables indicates that there is a disconnection between the monetary policy and the stock market. Hence, we recommend thatthere should be more urgent need for the federal legislators to recognize and deal with, through their over-sight functions, the genuine reasons why policy makers do not align the monetary policy rate with the increasing government expenditure; and Government should strengthen prudent monetary policy management in order to keep alternatebetweenpolicies of cheapmoneyandtight money in varyingdegrees to encourage boost in the stock market, and economic growthwhilekeepinginflationundercontrol of not more than one digit.
KEY WORDS:interest rate, broad money supply, exchange rate, inflation rate, all share index, total market capitalisation and total value of securities traded.
CHAPTER ONE
INTRODUCTION
1.1 Background Of The Study
Every year, the Government Authorities set macroeconomic targets, and these targets are usually tied to two principal macro policy frameworks (fiscal and monetary).No wonder, the Punch-Nigeria on 16th July, 2015 maintains that, “capital market awaits government policy direction. The uncertainty over policy direction from the new Government has continued to influence the performance of the nation’s capital market”. Monetary policy is a forward looking economic reform tool specially applied to expand or contract money supply or achieve price stability. The influence of the monetary policy on the Nigeria stock market has been a source of worry for individual(s) and institutional investor(s). This intellectual argument gained ascendancy in the last two decades due to the increasing belief that economic activities often impact on stock prices. Okpara (2010), posits that monetary policy is a significant determinant of long-run stock market returns in Nigerian. Smith (1990), did a study on United States economy, and found that stock prices jump immediately after (and sometimes before) the Federal Reserve announces a cut in the interest rate or discount rate or Chase Manhattan announces a drop in its prime loan rate.
Also, Goswani and Jung (1997), in a study on South Korea economy found that stock prices are negatively correlated to long-term interest rates and positively related to short-term interest rate. Maku and Atanda (2009), argued that these changes are often reflected by the magnitude and movement on stock prices, market index and liquidity of the market.
Mishkin (1997), suggests that lower interest rates increase stock prices, and therefore decrease the likelihood of financial distress. The relationship between stock prices and the economy can be of a reversible model, the stock market may influence the economy as found by Smith (1990), or the economy may influence the stock market (Amadi and Odubo, 2002).
However, the relationship between monetary policy and the stock market has been linked to transmission mechanism of the monetary policy .Goodhart and Hofman (2000), posit that the stock market is a transmission mechanism of the monetary policy actions that affect stock prices.
They are linked to real economy through their influences on consumption spending (wealth effect channel) and investment spending (statement of financial position channel). Napolitano (2006) posits that several proposed transmission mechanisms link changes in Central Bank policy to stock market, which in turn affects output, via consumer expenditure as well as investment spending. All these scholars seem to believe that stock market is a real transmission mechanism for monetary policy. In the world over, the influence of the monetary policy on the stock market varies in accordance with the peculiarity and prevailing economic conditions as well as efficiency of the stock market in response to available news information and inflationary trend. As a matter of fact, the influence of the monetary policy transmission mechanism may differ across countries due to the differences in the extent of financial intermediation, i.e. the size, concentration and health of the banking system, the development of the capital market and structural economic conditions. The effect of the monetary policy tools on stock prices may vary equally across countries. The stock market therefore is expected to establish the price which includes the monetary policy actions (Abaenewe and Ndugbu, 2012).Nigerian Stock Market being an emerging market has its own behaviour due to the changes in the structural economic conditions in Nigeria economy, via under developed nature of the stock market, poor banking and saving habit, etc.
As a result of the above, effort will be made in this study to place greater emphasis on the influence of the monetary policy via interest rate, broad money supply, exchange rate and inflation rate on the stock market indices ,via total market capitalization ,all share index and value of securities traded. Moreover, the topic of the study is titled “the influence of the monetary policy on the Nigeria stock market, a study of selected market indices”
1.2 Statement Of The Problem
In spite of the laudable place of the influence of the monetary policy on the Nigerian stock market, yet there are many possible disturbances that feeds the monetary framework with uncertainty in numerous respects (Mersch, 2006).Presently in Nigeria, we have to deal with terrorist attacks, and extraordinary fall in the oil price, the bearish nature of the capital market, and just to mention a few. All of these events affect and change the structure of the framework Central Bank of Nigeria has to deal with, and add uncertainty to the process of conducting monetary policy.
Kydland and Prescott(1977), held thus, “even if the government and its citizens pursue the same objectives, i.e. maximising the welfare of the population, discretionary policy is subject to a fundamental time consistency problem. The fundamental problem is that a government policy that is optimal at a certain point in time may not be optimal later on. Since individuals form rational expectations, they realize that the government has this incentive to deviate from its previously announced policy, and behave accordingly.”
Hameed, Khaid, and Sabit,(2012) maintain that… “the connection between monetary policy expansions and real economic growth capitalizes on imperfections in the public’s information about prices. People respond inefficiently in the sensethat under perfect information, they would not have altered their behavior. At best, one partygains at another’s expense. A central bank may periodically exploit this connection, but frequentattempts as some seem to advocate, ultimately distort the allocation of resources fromProductive uses to protective enterprises”
This pitiable performance of monetary policy has been apparently responsible for the problems oflack of alignment of the monetary policy rates with the increasing government expenditure, continuous high and increasing government fiscal expenditure, high level of leakages in the use of public funds, wasteful spending, corruption, poor budget management especially in the last decades which supplies more liquidity in the economy(Aziza, 2010). This uncertainty in the adjustment of monetary policy rate has been identified as responsible factor that affects investors’ returns in financial asset investment (Abaenewe and Ndugbu, 2012). .
There is no doubt that the failure of government monetary policies and fiscal policies is the main reason why most of the past developmental programmes undertaken by the Government has come to naught (Ezeoha and Uche, 2010).While a lot of empirical studies have in the past been carried out in the area of assessing the influence of monetary policy on the Nigerian Stock Market, the researcher observed that studies that concurrently examined the influence of monetary policy variables of interest rate, broad money supply, exchange rate and inflation rate on selected stock market indices such as all share index, total market capitalization and total value of securities traded, and using such methods of data analysis as unit root test, co integration, ordinary least square and graph which spans from 1986 to 2014 are at best sparse and insufficient, hence, the need for this research work.
1.3 Objectives Of The Study
The aim of this study is to determine the influence of monetary policy on the Nigerian stock market using selected market indices. In line with this aim, the following are the specifics objectives of the study:
- To examine the influence of interest rate, broad money supply, exchange rate and inflation rate on all share index of the Nigerian Stock Market.
- To ascertain the impact of interest rate, broad money supply, exchange rate and inflation rate on total market capitalisation of the Nigerian Stock Market.
- To examine the effect of interest rate, broad money supply, exchange rate and inflation rate on total value of securities traded on the Nigerian Stock Market.
1.4 Research Questions
The study is designed towards answering the following relevant question:
- To what extent has the interest rate, broad money supply, exchange rate and inflation rate influenced the all share index of the Nigerian Stock Market?
- To what extent has the interest rate, broad money supply, exchange rate and inflation rate impacted onthe total market capitalisation of the Nigerian Stock Market?
- Howhas interest rate, broad money supply, exchange rate and inflation rate affected the total value of securities traded on the Nigerian Stock Market?
1.5 Hypotheses
To achieve the purpose of this study, three hypotheses were formulated and tested. They are stated in null forms, and are as follows:
Hypothesis One
Ho:Interest rate, broad money supply, exchange rate and inflation rate have no significant influence on the all share index of the Nigerian Stock Market
Hypothesis Two
Ho:Interest rate, broad money supply, exchange rate and inflation rate have no significant impact onthe total market capitalization of the Nigerian Stock Market
Hypothesis Three
HO: Interest rate, broad money supply, exchange rate and inflation rate have no significant effect on the total value of securities traded on the Nigerian Stock Market.
1.6 Significance Of The Study
The influence of monetary policy on the Nigerian Stock Market is not well understood by many policy makers and government. This study will enable these Authorities to correct the misconception on the influence of monetary policy tools on the Nigerian stock market.This study will enable policy makers and government to know the relative influence of monetary policy instruments on the Nigeria Stock Market, which will enable them formulate policies that will encourage economic growth with minimal policy conflicts.This study couldn’t have come at a better time than now, when the government is making efforts towards alternative sources of financing the economic activities through the Nigerian Stock Market. This has become imperative now that foreign earnings from oil sale have crashed. Again, this study will serve as a useful reference material to scholars and researchers in related area of study.
1.7 Scope Of The Study
This study focuses on monetary policy tools and variables which include interest rate,broad money supply, exchange rate and inflation rate, as they relate with few selected stock market indices in Nigeria, such as all share index, total market capitalization, and total value of securities traded in the Nigerian Stock Market. The study spans from 1986 to 2014. This is because, this period, in the history of Nigeria’s economic development stages, remains outstanding and significant. Few of these events are: the introduction of Structural Adjustment Program (SAP) in effect from 1986 to 1990, first mooted by the International Monetary Fund and carried out under the auspices of the World Bank, which emphasized privatization, market prices, and reduction in government expenditures. Remarkably in 1986, Nigeria moved from direct to indirect exchange rate regime.In addition, the return of democratic governance in the country in 1999, brought along with it, the introduction of a series of reforms, aimed at redressing the distortions in the economy and restoring economic growth.The National Economic Empowerment and Development Strategy (NEEDS) of 2004 were a home-grown poverty reduction, value-reorientation and socio-economic development strategy for the country.2004 also saw a total rejuvenation of oil production to a record level of 2.5 million barrels per day at $65 per barrel. Development strategies were aimed at increasing production to 4 million barrels per day by the year 2010 which was unrealistic. The bank reform of 2005 cannot be left out of this development stages.Owing to the surge in international oil prices during 2007- 2008, Nigeria managed an annual GDP of US$352.3 billion. The nation ranks 33 in the world in terms of GDP. The GDP per capita was US $2,400. Hence, Nigeria’s Vision 2010 was aimed at ―transforming the country and focusing it firmly on the path to becoming a developed nation by the year 2010 which was unrealistic. According to the document, the private sector was expected to be very active, within a market-oriented, highly competitive, broad-based, private sector-driven development process. Presently, Nigeria is faced with a fall in oil prices with less than $41 which affects’ Federal Government revenue; and massive corruption done by mainly politicians.
1.8 Limitations Of The Study
This study is constrained with the following assumptions of the ordinary least square method:
(i)Normality: That the errors have normal distribution on the regressors. This is not needed for the validity of the ordinary least square method.
(ii)No linear dependence: it is assume also that the regressors have finite moments up to at least the second moment. When this is violated, the regressors are called linearly dependent. In such case, the value of the regression coefficient “B” cannot be learned, although prediction of “Y” values is still possible for new values of the regressors that lie in the same linearly dependent subspace.
(iii)The strict exogeneity: The errors in the regression should have conditional mean zero.
Also the study is inhibited with the following assumptions of the Johansen test:
(i)The Johansen test is subject to asymptotic properties, i.e. large samples.If the samples size is too small, then,the result will not be reliable.
(ii)Co-integration, it also showed that unit root processes have non-standard statistical properties, such that conventional econometrics theory -methods do not apply to them.
(iii)Test for co integration assume that the co integrating vector is constant during the period of study, it is possible that the long-run relationship betweenthe underling variables change, i.e. shifts in the co integrating vector can occur. Thismight be due to technological progress, economic crises, changes in the people’s preferences and behaviour, policy or regime alternation, organisational or institutional developments.This is especially likely to be the case if the sample period is long.Again,this study is guarded with the exclusion of some monetary policy tools such as prime lending rate, bank rediscount rate, treasury bill rate, etc and some Nigerian StockMarket indices such as volume of shares traded, number of deals ,etc, were excluded which otherwise might have led to a more reliable and genuine solution to the problem studied.
Hence, the quality of the data cannot be guaranteed as they are times series data transcribed from Central Bank of Nigeria records which are subject to spuriouscity because economic variables are not stationary.Another factor undermining this research work is the threatening security challenges in the country, which the researcher must point out here with deep pains. This is so because the researcher lives with his family in the Northern parts of Nigeria, Zamfara state precisely, where during the time the research was going on, the issue of bomb blast was no longer “strange news”. This situation undermines the psychological stability of the researcher, travelling as wide from the far North to the South as often as necessitated by this research work was equally restricted. In spite of all these, I was able to do the work successfully.
1.9 Organization Of The Study
This study is divided into five chapters and each of which is subdivided. The first chapter is introduction. This includes: background of the study, statement of problems, objectives of the study, research questions, hypotheses, significance of the study, scope of the study, limitations of the study, organization of the study and definition of terms.
In the second chapter, related literature is reviewed which includes conceptual framework, theoretical foundations and review of relevant models and theories, empirical reviews of related previous work and other relevant issues. Chapter three contains the research methodology. The research’s sources of and method of data collection are stated, the econometric model specified. It also contains the various procedures for data analysis and interpretation.
Chapter four contains data presentation and analysis. The fifth chapter is concluding part of the work, which includes the summary of findings, policy recommendations and conclusion.
1.10 Definition Of Operational Terms
In order to properly understand this study, the following terms are defined contextually:
- All share index: Is a total market index, reflecting a total picture of the behaviour of the common shares quoted on the Nigeria stock exchange via its price movement.
- Exchange rate: This is the rate (units) of our domestic currency in exchange with other foreign currencies of the world.
- Interest rate: The amount charged, expressed as a percentage of principal by a lender to a borrower for the use of assets. It is typically noted on annual basis.
- Market index: It can be seen as an aggregate value produced by combining several stocks or other investment vehicles together and expressing their total values against a base value from a specific date.
- Monetary policy: This can be expressed as the process by which the monetary authority of a country controls the supply of money via contraction and expansion of credit.
- Money supply: The entire stock of currency and other liquid instruments in a country’s economy as of a particular time.
- Stationary: This is used to refer to data series whose means and auto co-variance do not depend on time.
8.Stock Market: This is a market where medium and long –term funds can be obtained via the selling of common stock in the capital markets.
- Total Market capitalization: This is a price weighted index of all the stock traded on the floor of the Nigerian Stock Exchanges within a particular trading period of time.
10.Total Value of security traded: This is sum of the total value of securities traded on the floor of the Nigeria Stock market at a particular period of time.
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