IMPACT OF THE CAPITAL MARKET ON REAL SECTOR OF THE NIGERIAN ECONOMY (1987-2010)

ABSTRACT

The issue of whether capital market development has any direct impact on economic growth has/is still been debated in academic literature. Earlier research in this area of finance had emphasized the role of the banking sector in economic growth; however, the recent surge in capital markets activities with emerging markets like Nigeria accounting for a large amount of this boom has led to focus on the linkage between capital markets development and economic growth especially on its impact on the real sectors of these economies. The real sector of an economy is where goods and services are produced through the combined utilization of raw materials and other productive factors such as labour, land and capital and it comprises the agricultural, industrial, building and construction, and services sector of an economy. In Nigeria, despite the opportunities which the capital market provides through the provision of surplus funds, the growth of the real sector of the Nigerian economy has remained stunted. Problems such as the inaccessibility of funds by real sector firms from the capital market due to stringent listing requirements and conditionalities, lack of depth and breadth of the capital market to cater for the need of real sector firms among other challenges, have been attributed as major factors inhibiting the growth of the real sector of the Nigerian economy. It is against this background therefore, that this study sought to appraise and analyze the impact of the new issues market, market capitalization, turnover ratio and value of share traded ratio of the Nigerian capital market on real sector of the Nigerian economy. The study adopted the ex-post facto research design and annualized cross-sectional data for a 24-year period, 1987-2010, were collated from the Nigerian Stock Exchange Fact Books for the period. Four hypotheses were proposed and tested and descriptive statistics and graphs were also used to complement the regression results. The results from this study found that the new issues market of the Nigerian capital market has a positive and significant impact on agricultural output (coefficient of NIR = 0.04, t-value = 5.13; p = 0.00 < 0.05) but negative and significant on industrial output (coefficient of NIR = -0.05, t- value = -5.03; p = 0.00 < 0.05). Market capitalization has positive and significant impact on agricultural output (coefficient of Mcap = 0.01, t-value = 3.96; p = 0.00 < 0.05) but had negative and significant impact on industrial output (coefficient of Mcap = -0.01, t-value = -6.98; p = 0.00 < 0.05). Turnover ratio of the Nigerian capital market had positive and significant impact on agricultural output (coefficient of TVR = 0.68, t-value = 7.07; p = 0.00 < 0.05) but negative and significant impact on industrial output (coefficient of TVR = -0.59, t-value = -4.47; p = 0.00 < 0.05). And value of share traded ratio of the Nigerian capital market had positive and significant impact on agricultural output (coefficient of VSTR = 0.058, t-value = 5.55; p = 0.00 < 0.05) but negative and significant impact on industrial output (coefficient of VSTR = -0.0619, t-value = – 5.77; p = 0.00 < 0.05). The study, therefore, amongst others recommends that policies that will impact positively on the real sector, especially the agricultural and manufacturing subsectors of the Nigerian economy where it concerns funding, should be pursued with all the seriousness it deserves if Nigeria is to achieve her desire to be one of the top twenty economies in the world by the year 2020. Therefore, this study contributed, empirically to provide evidence on the impact of the capital market on the real sector of the Nigerian economy.

CHAPTER ONE INTRODUCTION

1.1       BACKGROUND OF THE STUDY

The issue of whether capital market development has any direct impact on economic growth has been debated in the academic literature. The early proponents of finance-led economic growth include Bagehort (1873), Schumpeter (1911) and Hicks (1969). Bagehort (1873) and Schumpeter (1911) argue strongly for the important role capital market development plays in promoting economic growth. They support their claim by arguing that the industrial revolution in England was the result of a functioning capital market that was instrumental in mobilizing and allocating long-term capital to the productive enterprises of the country. Their position was buttressed by Hick  (1969),  who  argued  that  a  well  functioning  banking  system  provides  intermediation services  to  productive  entrepreneurial  activities  that  spur  technological,  innovative,  and productive activities that increase real sector growth.

On the other hand, Robinson (1952) indicates that demand-pull initiatives from the private sector growth have the propensity to spur the financial sector to respond to financial or capital needs of the private sector. In her view, real sector developments (growth) and financial needs create the demand for a certain financial structure (equity versus debt) to cater to the needs of the private sector. Lucas (1988), in support of Robinson’s position, argues that the proponents of finance led growth exaggerate the impact of capital market development on real sector growth

However, ever since the pioneering contributions of Gurley and Shaw  (1955, 1960, 1967), McKinnon (1973) and Shaw (1973), the relationship between financial development and economic growth led to the recent debates on the issue. Thus, numerous studies sprang up to deal with the different aspects of this relationship both on theoretical as well as on empirical levels. The broadest division of such works is between financial intermediaries (banks, insurance companies, and pension funds) and markets (bond and stock markets). It is said that a large part

of an economy’s savings are intermediated towards productive investments through financial intermediaries and markets thus, since the rate of capital accumulation is a fundamental determinant of long-term growth, an efficient financial system is essential for an economy (see Garcia and Liu, 1999).

Earlier research in this area of finance emphasized the role of the banking sector in economic growth, however, since in the past decade when the world stock markets surged with emerging markets accounting for a large amount of this boom (Demirguc-Kunt and Levine (1996a),  recent research, therefore, begun to focus on the linkages between the stock markets and economic development as new theoretical work began to show how stock market development might boost long-run economic growth with new empirical evidence supporting this view that stock market development plays an important role in predicting future economic growth (see, Demirguc-Kunt and Levine, 1996a; Singh, 1997; Levine and Zervos, 1998).

Beginning from the 1990s, these empirical literatures illustrated the importance of financial sector development for economic growth, however, despite this growing consensus, it could be seen that the link between finance and growth in cross-country panel data has weakened considerably over time. At the very time that financial sector liberalization spread around the world, the influence of financial sector development on economic growth has diminished (see, Rousseau and Wachtel, 2007). Thus, the strongest elements of the modern economists’ canon are that financial sector development has a significant impact on economic growth. No wonder, a generation ago, economists like Goldsmith (1969) saw the relationship and gave attention to the benefits of financial structure development and financial liberalization and McKinnon (1991) contributed by agreeing that the widespread flows of saving and investment should be voluntary and significantly decentralized in an open capital market close to equilibrium interest rates.

However,  the seminal  empirical  work  that  established  the growth-finance link  is  King and Levine (1993), which extended the cross-country framework introduced in Barro (1991) by adding financial variables such as the ratios of liquid liabilities or claims on the private sector to gross domestic product (GDP) to the standard growth regression. They found a robust, positive, and  statistically  significant  relationship  between  initial  financial  conditions  and  subsequent growth in real per capita incomes for a cross-section of about 80 countries. In the subsequent

decade numerous empirical studies expanded upon this, using both cross-country and panel data sets for the post-1960 period (see Levine, 1997; Levine, 2005; Temple, 1999).

Most existing literature on relationship between the capital market and the economy has focused on the contributions of the financial intermediaries to economic growth (World Bank (1989), in fact, Levine (1997) and Liu (1998) and numerous empirical tests have shown that financial variables have important impact on economic growth. However, recently the emphasis increasingly shifted to stock market indicators due to the increasing role of financial markets in different economies.

For example, Atje and Jovanovic (1993) tested the hypothesis that the stock markets have a positive impact on growth performance. They find significant correlations between economic growth and the value of stock market trading divided by GDP for 40 countries over the period

1980-88 similarly, Levine and Zervos (1996, 1998) and Singh (1997) show that stock market development is positively and robustly associated with long-run economic growth.

In addition, using cross-country data for 47 countries from 1976-93, Levine and Zervos (1998) find that stock market liquidity is positively and significantly correlated with current and future rates of economic growth, even after controlling for economic and political factors. They also find that measures of both stock market liquidity and banking development significantly predict future rates  of  growth.  They,  therefore,  conclude that  stock  markets  provide important  but different financial services from banks.

Furthermore, using data from 44 industrial and developing countries from 1976 to 1993, Demirguc-Kunt and Levine (1996a) investigate the relationships between stock market development and financial intermediary development. They find that countries with better- developed  stock  markets  also  have  better-developed  financial  intermediaries.  Thus,  they conclude that stock market development goes hand-in-hand with financial intermediary development.

Existing models suggest that stock market development is a multifaceted concept, involving issues of market size, liquidity, volatility, concentration, integration with world capital markets, and institutional development. Using data on 44 developed and emerging markets from 1976 to

1993, Demirguc-Kunt and Levine (1996a) find that large stock markets are more liquid, less

volatile, and more internationally integrated than smaller markets. Furthermore, institutionally developed markets with strong information disclosure laws, international accounting standards, and unrestricted capital flows are larger with more liquid markets.

Theory also points out a rich array of channels through which the stock markets such as market size, liquidity, integration with world capital markets, and volatility may be linked to economic growth. For example, Pagano (1993) shows the increased risk-sharing benefits from larger stock market size through market externalities, while Levine (1991) and Bencivenga, Smith, and Starr (1996) show that stock markets may affect economic activity through the creation of liquidity. Similarly, Devereux and Smith (1994) and Obstfeld (1994) show that risk diversification through internationally integrated stock markets is another vehicle through which the stock markets can affect economic growth.

Besides stock market size, liquidity, and integration with world capital markets, theorists have examined stock return volatility. For example DeLong et al (1989) argues that excess volatility in the stock market can hinder investment, and therefore growth. Thus, though, it is now well recognized that financial development is crucial for economic growth, however, the relationship can go the other direction. In other words, economic growth can also promote financial development. Recent literature on growth deals with this causal relationship along three lines: financial deepening stimulates economic growth; economic growth promotes the development of the financial sector; and a circular relationship that financial development and economic growth simultaneously affect each other (see Garcia and Liu, 1999).

From the above therefore, the school of thought that says financial development causes economic growth argue that financial development has a causal influence on economic growth. That is, deliberate creation of financial institutions and markets increases the supply of financial services. The  financial  sector  increases  savings,  and  allocates  them  to  more  productive  investments, thereby financial development can stimulate economic growth (see, McKinnon, 1973; Shaw,

1973; King and Levine (1993)

A second school of thought says economic growth causes financial development. They postulate a causal relationship from economic growth to financial development. This hypothesis stresses the  passive  role  of  the  financial  system.  In  this  view,  financial  development  appears  as  a

consequence of the overall economic development. Continual economic expansion requires more financial services and new instruments. The financial system adapts itself to the financing needs of the real sector and fits in with its autonomous development. Therefore, this type of financial development plays a rather passive role in the growth process (see, Gurley and Shaw, 1967; Goldsmith, 1969)

A third school postulates the reciprocal relationships. This third view stresses the reciprocal relationship between financial development and economic growth. Economic growth makes the development of financial intermediation system profitable, and the establishment of an efficient financial system permits faster economic growth. By specializing in fund pooling, risk diversification, liquidity management, project evaluation and monitoring, the financial system improves the efficiency of capital allocation and increases the productive capacity of the real sector. At the same time, the technological efficiency of the financial sector increases with its size, because economies of scale and learning-by-doing effects are present in financial intermediation activities (see, Garcia and Liu, 1999).

As a result, the real sector can exert a positive externality on the financial sector through the volume of savings. Therefore, financial development and economic growth positively influence each other in the process of development. In reality, the financial and real sectors interact during all stages of development. In other words, there is, at no stage, only a one-way relationship between  financial  development  and  economic growth.  Thus,  more and  more authors  prefer describing the relationship as a two-way causation now. So far, many empirical studies have demonstrated  the  existence  of  a  positive  correlation  between  financial  development  and economic growth. However, these studies do not always establish the direction of the causality between these two variables, and those that do seek to identify the direction of the causality often lead to ambiguous conclusions (Liu, 1998).

It  could  be  observed  from  the  foregoing  that  most  of  the  literatures  on  the  impact  and relationship between the capital market (stock market) and economic growth are foreign literatures. African and Nigerian scholars as well have contributed to the debate between capital market and economic growth. For instance, Ziorklui, (2001) studied the development of capital markets and growth in Sub-Saharan Africa; a case of Ghana, and concludes  that the most severe constraint on private sector development and growth in Sub-Sahara Africa is the scarcity of

capital  or  credit  allocation  to  the  private  sector.  In  the  1980s,  as  part  of  their  structural adjustment programs, many Sub-Sahara African countries embarked on comprehensive structural and financial sector reforms in order to enhance savings mobilization and credit allocation to the private sector for growth and poverty alleviation, however in Ghana, the establishment of the Ghana Stock Exchange has provided an avenue for corporations to raise long-term capital and given opportunities for investor diversification thus enhancing the economy.

In Nigeria Donwa and Odia (2010) are of the view that the capital market is an institution that contributes  to  the  socio-economic  growth  and  development  of  emerging  and  developed economies as this is made possible through some of the vital roles played such as channeling resources,  promoting  reforms  to  modernize  the  financial  sectors,  financial  intermediation capacity to link deficit to the surplus sector of the economy, and a veritable tool in the mobilization and allocation of savings among competitive uses which are critical to the growth and efficiency of the economy (Alile, 1984). Donwa and Odia (2010) thus investigated the impact of the Nigerian capital market on her socio-economic development from 1981 to 2008. The socio-economic development was proxied by the gross domestic product (GDP) while the capital market variables considered included market capitalization, total new issues, volume of transaction and total listed equities and Government stock. Using the ordinary least square it was found that the capital market indices have not impacted significantly on the GDP. They therefore advised the government to put up measures to steer up investors’ confidence and activities in the market so that it could contribute significantly to the Nigerian socio-economic development.

Other Nigerian works that have dealt with the impact of capital market on economic growth includes Alile (1984), Anyanwu (1998), Ekundayo (2002), Osaze (2000) amongst others. However, none of these works have looked at the impact of the capital market on the real sector of the economy except Ziorklui, (2001), who has it as one of the objectives in his study.  Though it could be argued that the economy which these others works had discussed implies the real sector, however as defined by Sanusi (2011), that the real sector is where goods and services are produced through the combined utilization of raw materials and other production factors such as labour, land and capital and comprises agriculture, industry, building and construction, and services sector of an economy, there is a need to explore the impact of the capital market on the real sector of the Nigerian economy. Therefore, the lacuna which this work seeks to fill is to

examine the impact of the capital market not on the economy as whole but on the growth of the real sector with bias in the Agricultural and Manufacturing sector of the Nigerian economy using existing  proxies   for  capital   market   development   such   as   the  new   issues,   size-market capitalization (see, Donwa and Odia, 2010) and liquidity-turnover ratio and value of share traded ratio (see, Mohtadi and Agarwal, 2008) while the real sector output will be proxied by real sector contribution to gross domestic product growth rate (see, Ziorklui, 2001).

1.2       STATEMENT OF THE PROBLEM

The growth of the real sector in Nigeria has remained a major problem in spite of policies put in place by government to provide the sector with varying windows of investible funds, a major one of which is the capital market. Access to surplus funds by real sector firms from the capital market has been constrained due to stringent listing requirements and conditionalities, lack of depth and breadth of the market to cater for the need of real sector firms among other problems (Okafor, 1984).

Listing refers to an admission into the official list of the capital market. To be listed is synonymous with to be quoted and this entitles firms to raise funds as well as trade their shares in the market. The listing requirement as contained in the green book of the Nigerian Stock Exchange is documents setting out in detail the terms and conditions to be fulfilled by firms before listing. The conditionality for listings both for the first-tier as well as the second-tier such as; provision of trading record of the applicants; submission of last audited figures not more than nine months; not less than 25% of the issued share capital (first-tier) and 10% (second tier) available to the public; payment of annual quotation fees; amount to be raised depending on the borrowing power of the  firms;  regular submission  of annual  statements  and  accounts    and limitations of number of shareholders among other conditionalites restrict firms’ ability to raise funds through the capital market mechanism. In addition to the above, firms make a general undertaking to be signed and constantly fulfilled by the applying firms consenting to provide the exchange on a regular basis all pertinent information about its performances and expectations. These requirements are perceived by firms as too stringent thus most firms opt not to be listed and had remained private firms. Hence, the advantages which the capital market provides in

terms of fund raising and capital formation are not passed on to these firms. This has limited the growth of these firms.

Depth  of  the  market  refers  to  size  of  issues.  The  size  of  the  market  determines  cost  of transactions and constitutes an inducement to investors in the capital market. When a firm listed on the exchange raises fund through the new issues market, the money paid by investors for the newly issued shares goes directly to the company in contrast to a later trade of shares on the exchange, where the money passes between investors. A new issues market, therefore, allows a company to tap a wide pool of investors to provide it with capital for future growth, repayment of debt or working capital. A company selling common shares is never required to repay the capital to investors. Once a company is listed, it is able to issue additional common shares via a primary offering, thereby again providing itself with capital for expansion without incurring any debt. This ability to quickly raise large amounts of capital from the market is a key reason many companies seek to go public. There are several benefits to being a public company, however, significant legal, accounting and marketing costs; requirement for disclosure of financial and business information; time, effort and attention required of senior management to attend to the Stock Exchange rules and regulations; risk in obtaining required funding; public dissemination of information  which  may be useful  to  competitors,  suppliers  and  customers  are some of the problems faced by real sector firms hence their inability to raise funds from the market.

Breath of the market refers to the diversity of issues, either domestic or international securities. Firms can raise funds from the capital market through issuance of ordinary shares; preferences shares, debentures, warrants, convertible debentures, cumulative convertible preference shares, derivatives securities. The ability of the capital market to provide real sector firms opportunities to exploit these options enhances growth of the sector. However, the capital market in Nigeria has not been able to provide facilities for this options as there are limited instruments which are traded on the exchange and this have hindered the growth of the real sector in Nigeria. The derivatives market is still yet to be exploited in Nigeria by firms when compared to other developed capital markets. Even when some of these instruments are available, the technicalities and modalities for using them are not made available to these firms. This also has contributed to the problems encountered by real sector in exploiting the potentials of the capital market in enhancing growth of that sector.

It is against the forgoing that this work seeks to examine the impact of the capital market on the real sector of the Nigeria economy with bias in the Agriculture and Manufacturing sector of the Nigerian economy.

1.3       OBJECTIVES OF THE STUDY

This  study  examines  the  impact  of  the  capital  market  on  the  real  sector  (Agriculture  and

Manufacturing) of the Nigerian economy. Specifically, it is set out to appraise and analyze:

1.   The impact of new issue market of the Nigerian capital market on the real sector of the

Nigerian economy.

2.   The impact of market capitalization ratio of the Nigerian capital market on the real sector of the Nigerian economy.

3.   The impact of turnover ratio of the Nigerian capital market on the real sector of the

Nigerian economy.

4.   The impact of value of share traded ratio of the Nigerian capital market on the real sector of the Nigerian economy.

1.4       RESEARCH QUESTIONS

As a follow-up to the objectives of this study, below are the research questions which will guide this research, they are;

1.       How  far  does  the  new  issue  market  of  the  Nigerian  capital  market  have  positive significant impact on the real sector of the Nigerian economy?

2.       How far does the market capitalization of the Nigerian capital market have positive significant impact on the real sector of the Nigerian economy?

3.       To what extent does the turnover ratio of the Nigerian capital market have positive significant impact on the real sector of the Nigerian economy?

4.       How far does the value of share traded ratio of the Nigerian capital market have positive significant impact on the real sector of the Nigerian economy?

1.5         RESEARCH HYPOTHESES

The research hypotheses for this study are as follows:

1.      The new issue market of the Nigerian capital market does not have a positive and significant impact on the real sector of the Nigerian economy.

2.      The market capitalization of the Nigerian capital market does not have a positive and significant impact on the real sector of the Nigerian economy.

3.      The turnover ratio of the Nigerian capital market does not have a positive and significant impact on the real sector of the Nigerian economy.

4.      The value of share traded ratio of the Nigerian capital market does not have a positive and significant impact on the real sector of the Nigerian economy.

1.6       SCOPE OF THE RESEARCH

The research covers the period, 1987-2010. Liberalization involves easing restrictions on capital inflows or reducing impediments to repatriating dividends or capital. In either case, reducing barriers to cross border capital flows can affect the functioning of emerging stock markets by enhancing the integration of emerging markets into world capital markets, thereby bringing the prices of domestic securities into line with those elsewhere and secondly by forcing domestic firms seeking foreign investment to upgrade their information disclosure policies and accounting systems. Moreover, the entry of more foreign investors into emerging markets lead to putting pressure to upgrade trading systems and modify legal systems to support more trading and the introduction of a greater variety of financial instruments (see, Levine, 1996), thus this research looked at the impact of the Nigerian capital market on the real sector of the Nigerian Economy beginning from the liberalization era of 1987 to 2010 with bias in the Agricultural and Manufacturing sector of the Nigeria economy. Liberalization of the Nigeria economy was part of the policy framework of the Structural Adjustment programme (SAP) of Nigeria which was

introduced in 1986. Financial liberalization of the economy did not however take real effect until 1987.

1.7       SIGNIFICANCE OF THE STUDY

Given the important role a well-functioning capital markets seem to play in economic growth as the efficiency of trading systems determines the ease and confidence with which investors can buy and sell their shares which often translate to better welfare. This research will be significant to:

1.   Policy  markers/  Regulators:  Regulation  is  seen  as  a  way  of  buoying  investor’s confidence in brokers and other capital intermediaries and stakeholders. It ensures fair play and transparency in the market operations. This in turn encourages investment and trading in the stock market. Nigerian capital market had from the onset ensured that a strong institutional framework was in place through the establishment of Capital Issue Commission (though it had no legal status), which later metamorphosed, to Nigeria Securities and Exchange Commission in 1979 and serves as the apex regulatory body of Nigerian capital market. Of added importance is that the Nigerian Stock Exchange itself is  a  self-regulatory  institution.  Thus  this  research  will  contribute  to  the  volume  of materials required by policy markers/ regulators on how to improve investors’ confidence in the capital market. The findings from this study will raise some policy issues and give recommendations, which will reinforce the link between the capital market and real sector  growth in Nigeria

2. Academic Purpose: A lot of attention has been drawn to the question of the interdependence between stock market activity and economic growth. Numerous scholars have tried to assess the nature of this connection. As a result of those endeavors to understand finance-growth relationship there has been several numbers of research and working papers. All these results could be subdivided into classical cases such as stock market spurs economic growth; stock market indicates economic growth; economic growth promotes financial activity; there is no connection between the two fields. However none of these works have studied the impact of capital market on the real sector of  an  economy.  Thus  this  research  will  add  to  literature  by  introducing  a  sectoral dimension on the relationship between capital market and economic growth with special emphasis on the real sector of the economy.

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