ABSTRACT
Using Nigeria aggregate level data
for 26 years: 1986-2011, the study estimates the impact of financial
liberalization on stock market efficiency in Nigeria. The study used the
Generalised Least Square (GLS) to estimate the four hypotheses formulated for the
study. The ratio of stock market capitalization to gross domestic product,
ratio value of shares traded to gross domestic product, ratio of all share
index to gross domestic product, and ratio of value of shares traded to market
capitalization were adopted as the dependent variables, while the independent
variable was financial liberalization (percentage in foreign equity ownership).
The study also controlled for some macroeconomic variables such as exchange
rate, inflation rate and interest rate that might impact on the dependent
variables. The results showed that the regression coefficient for financial
liberalization was negative and non-significant in predicting or promoting four
proxies of stock market efficiency, which supports the preposition that financial
liberalization does not transform or promote stock market efficiency. Based on
the results, the study recommends inter alia: promotion of favourable
macroeconomic environment; formulation of policies that will reduce the impact
of speculative hot money, strengthening of the legal system, stronger
transparency in terms of information disclosure, the need for the establishment
of effective and efficient Dispute Resolution Mechanism, the urgent need to
rethink the tenure of the market; among others.
CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
The issue of market efficiency, as
espoused by Fama (1965, 1970), which posits that prices fully reflect available
information has remained at the heart of financial economics literature. Lim
and Brooks (2011), state that the efficient market hypothesis defines an
efficient market as one in which new information is quickly and correctly
reflected in its current security price. Generally, the argument is based on
the assumption that at any given time, prices of stocks fully reflect all the
available information related to them. This is the path toed by Marashdeh and
Shrestha (2008), Maghyereh (2003), Bashir, Ilyas and Furrukh (2011), among
others.
For the market to be efficient,
the prices of stock must reflect company fundamentals, state of the economy and
most importantly, the law of demand and supply, which can only come to fruition
through liberalising the stock market (Kawakatsu and Morey, 1999; Waliullah,
2010). Proponents of this theory have documented extensive evidence to show
that financial liberalization promotes stock market development (Ortiz, Cabello
and Jesus, 2007). Against this background, the effects of financial
liberalization on stock market efficiency has remained a core issue in finance
literature, more so, considering efforts by governments especially in the
developing countries to liberalize their financial markets in order to catch up
with the developed countries on one hand and to integrate their economies to
the global economy on the other. The impact of financial liberalization on the
stock returns and volatility is an important issue for researchers, regulators
and investors (Nazir, Khalid, Shakil and Ali, 2010).
An illustrative list of studies of
the effects of financial liberalization on stock market efficiency includes
those by Henry (2000) who found that stock market liberalization may reduce the
liberalizing country’s cost of equity capital by allowing for risk sharing
between domestic and foreign agents; Kim and Singal (2000) found that stock
returns increase immediately after market opening without a concomitant
increase in volatility; Bekaert, Harvey and Lundblad (2003) report that
integration affects the functioning of the equity market, the cost of capital,
the diversification ability of local participants, the level of prices, the
business focus of local companies, and foreign capital flows while the
empirical findings of Levine and Zervos (1998) show that stock markets tend to
become larger, more liquid, more volatile, and more integrated following
liberalization and Grabel (1995) states that financial liberalization induces
increased asset price volatility. On his part, Miles (2002) reports that
reforms has a statistically significant impact in almost three fifths of the
emerging markets surveyed, but more often than not, the effect is actually to
raise, rather than lower the volatility of stock returns. In this connection,
therefore, the highly articulated view of Levine (2001) which states that
international financial integration can promote economic development by
encouraging improvements in the domestic financial system is worth noting.
Specifically, Bekaert and Harvey
(1995) explain that markets are completely integrated if assets with the same
risk have identical expected returns irrespective of the market. A prominent
line of research suggests that financial development has a causal influence on
economic growth (Ujunwa and Salami, 2010). However, Stigliz (2004) in his
criticism of the International Monetary Fund (IMF) policy of pressuring
countries into liberalizing their capital markets, reports that economists,
particularly in developing countries, had long expressed doubts about the
virtues of capital market liberalization.
The foregoing effects especially
the aspects detailing the positive imparts of liberalization, may have formed
part of the reasons why liberalization became a matter of choice in Nigeria in
the 1980s. Financial liberalization which involves banking reforms, insurance
reforms and stock market development, without doubt, could have significant
effect on stock returns and volatility. Ojo and Adeusi (2012) state that in
Nigeria, financial sector reform was a component of the Structural Adjustment
Programme (SAP) which was introduced in 1986. They further state that some of
the reforms created for the money market indirectly affected the capital market
activities simultaneously. Quoting Nnanna, Englama and Odoko (2004), these
reforms according to Ojo and Adeusi (2012) include deregulation of interest
rates, exchange rate, entry/exit into the banking business, establishment of
the Nigeria Deposit Insurance Corporation (NDIC), strengthening the regulatory
and supervisory institutions, upward review of capital adequacy, sectorial
credit guidelines, capital market deregulation and introduction of direct
monetary policy instruments.
Opening of capital markets
represents an important opportunity to attract the necessary foreign capital
(Kim and Singal, 2000). Foreign capital in the nature of portfolio flows may
take a different
pattern when the market is made more open following liberalization. On the
issue of regaining access to foreign capital by developing countries, Bekaert
and Harvey (2003) argue that portfolio flows to developing countries (fixed
income and equity) and foreign direct investment replaced commercial bank debt
as the dominant sources of foreign capital. They argue further that portfolio
flows to developing countries could not have happened without these countries
embarking on a financial liberalization process, relaxing restrictions on
foreign ownership of assets, and taking other measures to develop their capital
markets, often in tandem with macroeconomic and trade reforms. Specifically,
Nigeria was in dire economic crisis in the period preceding liberalization.
Omotoye, Sharma, Ngassan, and Eseonu, (2006) are of the view that the oil glut
of the mid-1980s exposed the fundamental weakness of the Nigerian economy and
greatly intensified the country’s debt management problems. On their part,
Omoleke, Salawu, and Hassan, (2010) point out that it is a trite fact that,
deregulation and privatization in Nigeria are consequences of failure of the
state owned enterprises. Also, Adeyemo and Salami (2008) see privatization as a
strategy for reducing the size of government and transferring assets and
service functions from public to private ownership and control.
According to Alabi, Onimisi and
Enete (2010), the argument for economic reforms in Nigeria in the 1980/1990s
could be attributed to several reasons among which were: the need for more
money to fund imports, policy reactions towards combating the impending
economic collapse, external shocks of foreign loans; the enterprises in Nigeria
have found themselves in a state of perfidy, low performance and undoubted
inefficiency.
Probably as a result of the
foregoing, the Babangida government in 1986 applied for what was known as the
IMF loan. As part of requirements for the loan, the IMF insisted on certain
conditionalities which prescribed exchange rate depreciation, privatisation and
liberalization. This resulted in a package that later became known as
Structural Adjustment Programme (SAP). It could be argued that these conditionalities
were prescribed as part of qualifications for the facility and also due to the
need for greater integration of the Nigerian economy into the global economic
system. Anyanwu (1992) argues that the IMF-World Bank economic policy packages
embodied in President Babangida’s Structural Adjustment Programme (SAP)
provided overt encouragement to the fostering of an unregulated, dependent
capitalist development model, while allowing only a supportive role for the
government in a refurbished economic environment of highly reduced government ownership and control
of enterprises.
There is no doubt that these
conditionalities were universal in terms of prescriptions for the economic
ailments of developing and underdeveloped economies irrespective of
backgrounds, structure and individual level of development even when generally
classified as developing or underdeveloped. To this extent, Ekpo (1992) is of
the opinion that the countries of West Africa continue to experience
underdevelopment despite the economic growth of the early and late sixties. He
added that the sustained crisis, evidenced in low productivity, high rates of
inflation, high rates of unemployment, deterioration in standards of living,
huge external debts, social and political chaos, etc, prompted virtually all
the countries in the West African sub-region to implement, in one form or
another, the typical International Monetary Fund (IMF) and World Bank
adjustment programmes.
Proponents of these prescriptions
can argue that the choice is anchored on the belief that globalisation
increases economic integration of world economies which manifests in increased
trade and investment. In the view of Zekos (2005), globalization is
characterised by structural reforms such as trade and investment liberalization
and increased trade and international investment flows promoting growth,
altering the composition and geographical distribution of economic activities,
stimulating competition and facilitate the international diffusion of
technologies having significant effects, both positive and negative, for
sustainable development. But the level of economic development and the point in
the lifecycle of individual economies which could have formed the basis upon
which prescriptions were made appears to have been inadvertently omitted. In
the case of Nigeria, the economy was characterised by sustained fiscal
imbalance and exposure to external shocks which brought about both domestic and
external instability. In fact, economic deregulation in Nigeria was not a
policy option during the oil boom period of the 1970/1980s as no evidence
suggests that external influence on policy choices at that time was strong. The
need to transmute from a planned to market economy, although, arose through the
influence of the World Bank and IMF, impetus was added by thinking in the
international arena due to what was seen as benefits of the free market system.
Smith, Jefferis and Ryoos (2003) made a strong case for transition from planned
to market economy by stating inter alia: “we believe success requires a
psychological readjustment, a mind-shift from the failed assumptions of a
decadent, centrally planned economy to those of a competitive, vigorous and.....
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