CHAPTER ONE

INTRODUCTION

1.1 Background Information

Economists have long stressed that the effective mobilisation of resources is a catalyst for national development. This depends on how well funds are raised and allocated across the sectors of an economy, so that each sector can manage its human and material resources to produce optimal output and sustain growth. One important area of underdevelopment in financial management in developing countries is the domestic capital market. In most developed countries the domestic capital market is a major source of funding for the state and has many advantages over foreign debt financing. Around the world, capital markets have contributed to financial development and, through it, to economic growth. The stock exchange is the intermediary that serves as the rallying point for overall market activity, and without a functioning stock market the capital market may be illiquid and unable to attract investment. Recent Nigerian evidence confirms the link between the stock market and the wider economy: Olarinre et al. (2023) found that stock market capitalisation and the total value of transactions are positively related to Nigeria’s economic growth, and Jayeola et al. (2023) report that market capitalisation, value of trade and interest rate contribute to sustainable economic growth. In essence, the stock market provides liquidity, contributes to capital formation and reduces investment risk by offering opportunities for portfolio diversification.

The capital market is vital to the growth, development and strength of any country because it supports government and corporate initiatives, finances the exploitation of new ideas and facilitates the management of financial risk. The pace of financial development is closely tied to the sophistication and efficiency of the capital market. The market channels funds into productive uses and ensures that they are applied to socio-economic growth and development rather than lying idle. Its relationship with the rest of the financial system is two-sided: Asemota et al. (2023) found that financial market activities are significant determinants of banking sector performance in Nigeria and recommended making the capital market and other non-bank institutions more attractive to investors.

Since 1960, market operators, regulators and governments have made efforts to strengthen the Nigerian capital market, and several reforms have been introduced to boost the sector. The Securities and Exchange Decree was promulgated on 1 April 1978 to replace the Capital Issues Commission and widen the scope of its activities, and the Second-Tier Securities Market (SSM) of the Nigerian Stock Exchange was established on 5 April 1985. The Companies and Allied Matters Act was enacted in 1990 to regulate the incorporation and activities of all corporate bodies in Nigeria. The Central Bank of Nigeria Decree of 1991 expanded the functions of the Central Bank and gave it greater autonomy in monetary policy. In 1995 the Nigerian Investment Promotion Commission Act No. 16 was enacted, together with the Foreign Exchange (Monitoring and Miscellaneous Provisions) Decree, which opened the capital market to foreign participation and eased the transfer of funds through authorised dealers (Ololade & Ekperiware, 2015). The 1995 Act was intended to ease such transfers and so improve the performance of the capital market. How far the market has come today depends on the strength and effectiveness of the regulatory framework on which it rides. Fagbemi et al. (2022) found that regulatory quality has a positive and significant influence on stock market performance in Nigeria over 1996 to 2019, which supports the view that sound governance and regulation strengthen the market. As the Nigerian economy integrates rapidly into the global marketplace, and in parallel with ongoing public sector reforms, the country will need to raise significant funding and develop deep, efficient and highly liquid capital markets in order to move to its next phase of growth.

Since the boom years, however, the capital market has recorded a steep decline in trading volumes and market capitalisation. The value index fell from 33,358.3 points in 2006 to 20,730.6 points in 2011, and the value of approved new issues dropped sharply to N2.03 billion in 2011 from about N1.41 trillion in 2006. With 201 listed equities, 48 listed bonds (including one exchange-traded fund) and an average daily turnover of about US$17 million, the market capitalisation of equities on the Nigerian Stock Exchange (NSE) stands at N6.54 trillion, while that of bonds is somewhat lower at N3.74 trillion.

Domestic output growth between 1981 and 2010 was mixed. Real GDP (at 1990 constant basic prices) declined in five years, namely 1982, 1983, 1984, 1987 and 1991, with falls ranging from 7.1 percent in 1983 to 0.6 percent in 1987, and annual real growth was positive in the remaining years. High growth rates of 10.2 and 10.5 percent were recorded in 2003 and 2004, before growth slowed to 6.0 percent in 2008 and recovered mildly to 6.7 percent in 2009. A key factor behind the negative growth of 1982 to 1984 was the weak performance of the oil sector in 1981 to 1983, owing to a glut in the international oil market.

Before the capital market was deregulated in 1991, analysts and researchers regarded it as underdeveloped. In international comparisons from that period, the world’s most developed stock markets were in Japan, the United States and the United Kingdom, while the least developed included Colombia, Venezuela, Nigeria and Zimbabwe. Between 1986 and 1993, the ratio of market capitalisation to GDP in Nigeria stood at 0.04 percent, 127 companies were listed on the exchange, and the turnover ratio (total value of shares traded divided by market capitalisation) was 0.01. Recent evidence suggests that depth and liquidity remain constraints. Tiamiyu et al. (2022) found that the Nigerian financial sector remains shallow and lacks the liquidity needed for stock market development, and that domestic savings relative to GDP is a consistent driver of stock market development.

1.2 Statement of the Problem

The Nigerian Stock Exchange is widely regarded as a platform that can transform several sectors of the economy, including agriculture, by supplying long-term capital for their growth and expansion. The central role of a financial system is to mobilise savings and intermediate efficiently, so as to create liquidity, reduce information costs and widen asset diversification. A well-developed domestic securities market stabilises the financial sector, strengthens competition within it and complements the banking sector, and the capital market is an instrument for wealth accumulation through investment.

The economic problem, however, is that the multiplier effect of the Nigerian capital market on investment, and through investment on the financial sector, has been limited. It is generally accepted that a functioning capital market should move resources from surplus spending units to deficit spending units, so that inequality and poverty fall and welfare improves. Nigeria nevertheless continues to record high inequality and poverty despite reported output growth. National statistics summarised in the literature show the poverty rate rising from about 54 percent in 2004 to about 69 percent in 2010 (Ajayi et al., 2016), and inequality worsened from 0.43 to 0.49 between 2004 and 2009. This suggests that a large proportion of deficit spenders have not been able to exploit the savings of surplus spenders efficiently for investment. It reiterates the rationale of this study, which is to identify the factors that affect the capital market in Nigeria and the extent to which capital market performance influences investment and, through it, financial sector development.

Part of the difficulty in drawing investment into the sectors of the economy lies in the diverse risks for which investors demand a premium on expected returns. The most immediate of these is inflation, which despite the best efforts of the monetary authorities has remained in the lower double-digit range for some time. With inflation averaging 11 percent in the ten years to the end of 2011, the real return on investment is considerably lower than the headline growth rate of about 6.0 percent suggests. Evidence on the macroeconomic sensitivity of the market is consistent with this concern: Okoro (2023) found that the exchange rate, interest rate and money supply are significantly related to market capitalisation in Nigeria.

There is also a strong case against the public sector’s growing borrowing requirement. As the Federal Government has borrowed more, the yields on its instruments have risen. These higher rates raise the attraction of government debt, push the private sector out of bond issuance and divert domestic savings from the capital market to the money market. Consistent with this concern, Omodero (2019) found that the interest rate exerts a substantial negative influence on private sector credit in Nigeria, and she recommended that government domestic borrowing be conducted with the interests of private businesses in mind.

If a soft or absent capital market leaves productive projects across the economy unfunded, there is a strong case for reviving the Nigerian capital market in the interest of sustainable financial sector development, which should in turn translate into growth. This forms the motivation for the study.

Several reforms have been designed to affect the capital market directly and indirectly. The most important was the 1995 Nigerian Investment Promotion Act, enacted to ease the transfer of funds through authorised dealers. This study therefore also seeks to establish the extent to which the 1995 reform affected the Nigerian capital market. Most recent studies of the Nigerian capital market have concentrated on its role in aggregate economic growth and development, or on its links to particular sectors, such as industrial output (Ezeanyeji & Usifoh, 2023) and the banking sector (Asemota et al., 2023). The effect of the capital market on financial sector development, and the determinants of capital market development, have seldom been investigated together in Nigeria, and this creates a research gap that the present study addresses. The evidence on the financial sector link is itself mixed: Jacob et al. (2023) found that deposit money bank and insurance industry development significantly affect financial deepening in Nigeria, whereas stock market development has an insignificant effect.

1.3 Research Questions

1. How is the trend of the capital market of Nigeria?
2. What are the determinants of capital market development in Nigeria?
3. To what extent did the 1995 Nigerian Investment Promotion Act affect capital market development in Nigeria?
4. Does the capital market impact on financial sector development in Nigeria?

1.4 Objectives of the Study

The broad objective of this study is to examine the performance of the Nigerian capital market. The specific objectives are:

1. To examine the trend of the capital market of Nigeria.
2. To ascertain the determinants of Nigerian capital market development.
3. To determine the extent to which the 1995 Nigerian Investment Promotion Act affected capital market development in Nigeria.
4. To evaluate the extent to which the Nigerian capital market impacts on financial sector development.

1.5 Hypotheses of the Study

The hypotheses are stated in null form, and the alternatives are inferred. They are:

• H₀₁: There exist no significant determinants of capital market development in Nigeria.
• H₀₂: The 1995 Nigerian Investment Promotion Act does not significantly impact on capital market development in Nigeria.
• H₀₃: There exists no significant impact of capital market operations on financial sector development in Nigeria.

1.6 Policy Relevance of the Study

The study examines the impact of capital market instruments on the sectors of the Nigerian economy. Although its scope is limited to the capital market, it is hoped that exploring this market will give a broad view of how the capital market operates. It will add to the existing literature by investigating empirically the determinants of the capital market and the role that the capital market plays in the financial development of Nigeria.

The study will therefore be relevant to researchers and academics, since it contributes to the stock of knowledge, stimulates the current debate in this area and suggests areas for further research. It is equally relevant to administrators and policymakers, as it will offer policy recommendations on how to improve the operations and activities of the capital market and strengthen its influence on the financial sector.

1.7 Scope of the Study

The study is country-specific and focuses on the Nigerian economy. It examines the capital market and how it relates to the financial sector, using time series data covering 1981 to 2013.

REFERENCES

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Asemota, G. O., Asemota, O. I., & Omoregie, C. L. (2023). An analysis of financial system development and banking sector performance in Nigeria. International Journal of Research and Innovation in Social Science, 7(5), 1459–1472.

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