ABSTRACT
The study examined specifically
the impact of inflation on stock market performance at the Nigerian Stock
Exchange. The study used time series data for 21 year period; 1986-2006, to
fill this important research gap. The least square regression approach was used
to estimate the necessary models. The regression results showed that
coefficient of inflation rate does not have significant negative impact in
explaining the long run performance of the stock market performance indicators
tested. The result as well showed that the coefficient of inflation rate was
negative, implying that, though theoretically inflation did not have
significant negative impact on stock market performance indicators on the
surface, but intrinsically considering the time value of money, inflation
actually depreciated the real worth of the market indicators. In view of the
above the following recommendations were made towards measures that can be used
by the government for achievement of low and predictable inflation in Nigeria.
The measures are as follows: Adoption of balanced budget by the government;
Import substitution and encouragement of domestic production; Enhancement of
food production through extension of credit facilities to agricultural sector
as well as construction of silos for storage of excess produce in order to
avoid hoarding or scarcity of food items; Prevention of sharp practices through
sound management of the exchange rate of the naira; Implementation of measures
to mope up excess liquidity in the system that result from upward review of
workers salary; Earnest pursuance of stable macro-economic environment devoid
of political turbulence and instability; Granting of total autonomy to the
Central Bank in the formulation and implementation of monetary policies; and
encouragement of massive industrialization for improved industrial output in
order to facilitate appreciation of the naira in the international market.
CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND TO THE STUDY
Inflation
as a concept is intrinsically linked to money as captured by the often heard
maxim '' inflation is too much money chasing after few goods''. Inflation also
has been widely described as an economic situation where the increase in money
supply is "faster" than the new production of goods and services in
the same economy [Hamilton 2001]. Usually economists try to distinquish
inflation from an economic phenomenon of a one time increase in prices or when
there are price increases in a narrow group of economic goods or services
[Piana 2001]. Thus the term inflation describes a general and persistent
increase in the prices of goods and services in an economy [Ojo 2000, Melberg
1992].
High rate of inflation is a problem that has faced
the Nigerian economy for over a long period. The country registered low rates
of inflation in the years immediately after independence. Available information
indicates that the country experienced a double digit rate of inflation in
1970; this was attributed to the outcome of the civil war. Other periods of
high inflation were 1974-1979, when the wage freeze was discontinued, as was
recommended by the Udoji salary review commission of 1974. The rate of
inflation rose to 20.9% in 1981; 23.2% in 1983; 39.6% in 1984; 10.2% in 1987;
38.3% in 1988 and 40.9% in 1989. In 1990, inflation rate reduced to a
at January-May 2013 were 12.75%, 12.44%, 11.70%,
11.00%, and 10.70% respectively (National Bureau of Statistical News May 2013).
The above data still placed Nigeria in the category of high inflated region as
her inflation rate still recorded above 5%. Normal inflation is between 1-5%.
Any rate below zero % amounts to deflation (Vegh, 1992 and Piana, 2001).
There are three dominant schools of thought on the
causes of inflation in recent times; the neo-classical/monetarist,
neo-keynesian and structuralist. The neo-classical/monetarist is of the view,
that inflation is driven mainly by growth in the quantum of money supply.
However, practical experiences of the Federal Reserve in the United State [US]
have shown that this may not be entirely correct. For instance the US money
supply growth rates increases faster than prices itself [Hamilton 2001,
Colander 1995]. This has been traced to the increased demand for the US dollar
as a global trade currency.
The neo-Keynesians attributes inflation to
diminishing returns of production. This occurs when there is an increase in the
velocity of money and an excess of current consumption over investment. The
structuralist attributes the cause of inflation to structural factors and
underlying characteristics of an economy [Adamson 2000]. For instance in
developing countries, particularly those with a strong underground economy,
prevalent with hoarding or hedging, individuals expect future prices to
increase above current prices, hence demand for goods and services are not only
transactionary, but also precautionary. This creates artificial shortages of
goods and reinforces inflationary pressures.
Factors that affect the level of inflation can be
grouped into institutional, fiscal, monetary and balance of payments. Several
studies [Melberg 1992; Cukierman,Webb and Neyapti 1992; Grilli, Masciandaro and
Tabellini 1991; Alesina and summers 1993; Posen 1993; Polland 1993; and Debelle
and Fischer,1995] have shown that the level of independence [legal
administrative instrument] of monetary authority is an important institutional
factor that affects inflation, especially in industrialised countries, while
the rates of turnover of central bank governors in developing countries was seen as an important factor
influencing inflation. However, caution should be exercised in the
interpretation of these findings, giving the difficulty in measuring the actual
level of independence of the central bank.
The fiscal factors relates to the financing of
budget deficits, largely through money creation process. Under this view,
inflation is said to be caused by large fiscal in-balances, arising from
inefficient revenue collection procedures and limited development of the
financial markets, which tends to increase the reliance on seigniorage as a
source of deficit financing [Agenor and Hoffmaster 1997; Essien 2005]. The
monetary factors or demand side determinants include inncreases in the level of
domestic demand, monetization of oil receipts, interest rates, real income and
exchange rate [Moser 1995]. Prudent monetary management was also found to aid
the reduction in the level and variability in inflation [Alesina and Summers
1993].
The balance of payments or supply side factors
relate to the effects of exchange rate movements on the price level. For
instance, exchange rate devaluation or depreciation induces higher import
prices, external shocks and accentuates inflationary expectations [Melberg
1992; Odusola and Akinlo 2001; Essien 2005].
Amongst the various debates in economics has been
the relationship between inflation and the performance of the stock market. A
stock market is where equities and bonds are issued and traded, either through
exchange or over the counter market. The trading of securities such as stocks
and bonds are conducted in stock exchanges, which are grouped under the general
term stock market. The stock market is a collection of financial institutions
set up for the mobilization and allocation of long –term funds for developing
the-long-term end of the financial system [Ologunge, Elumilade and Asaolu
2006]. In this market, lenders [investors] provide long-term funds in exchange
for long term financial assets offered by borrowers. The market is an important
institution for capitalist countries because it encourages investment in
corporate securities, providing capital for new business and income for
investors.
It is one of the most vital areas
of the economy as it provides company access to capital and investors with a slice
of ownership in the company and the potential of gains based on the company’s
future performance [Finance and Investment Dictionary 2000]. Okafor [1983]
categorized the market in three ways; on the basis of securities exchanged
[bond and equity stock market]; on basis of market organisation [securites
exchange and over-the counter market]. On the
basis of age: [primary and secondary market]. He further sub-divided the market
into corprate bond market, the muncipal bond market for government bonds. The
market is generally classified into two main sections, the primary and
secondary market. The primary market is where new issues are first offered,
with any subsequent trading going on in the secondary markets. The instruments
tradeable in the stock market are bonds, government development stocks,
industrial loans, preference stocks and equities [Nigeria Stock Exchange Fact
Book 2005]. The stock market is unique in a country’s financial system because
of its role in the economy. Levine [1991] defined these roles as raising
capital for business, mobilizing savings for investment, facilitating company’s
growth, redistribution of wealth, corporate governance, creating investment
opportunities for small investors, government capital raising avenue for
development projects and barometer of the economy.
The relationship between inflation
and stock market performance indicators has received a great deal of attention
throughout the modern history of economics[ see Summers,1981a; Feldstein,
1980b,1982; Fama,1981; Gultekin,1983; Pindyck, 1984; Benderly and Zwick, 1985;
Kaul, 1987; Chen and Jordan,1993; Boudoukh and Richardson,1993; Chen and
Jordan,1993, Omran and Pointon,2001; Saryal, 2007; Eromosele, 2009 et cetera].
Theoretically, it is expected that, since inflation means an increase in
general level of prices, and as common stocks can be considered as capital
goods, then the stock prices should move with the general level of prices. So
when there is a general increase in inflation, cost of common stock should also
rise to compensate investors for the decrease in the value of money. In this
framework, it is expected that there is a positive relationship between
inflation and stock prices [Omran and Pointon, 2001]. However, early empirical
studies demonstrated a negative relationship between the inflation and stock
returns [see Lintner 1975, Zvie Bodie 1976, Charles Nelson 1976, Eugene Fama
and William Schwart 1977, Jaffe and Mandelker 1976, Bulent Gultekin 1983,
Gautam Kaul 1987]. The inverse relationship between a higher inflation rate and
a lower common stock prices according to Feildstein [1980a], results from basic
features of the United States of American (US) tax laws, particularly historic
cost depreciation and taxation of nominal capital gains. This, is also
reinforced by other studies [see Feildstein and Summers 1979, Fieldstein 1980b,
1982; Summers 1981a, b; Pindyck 1984, Fama 1981]. Dokko and Edelstein [1987]
examined this relationship in the US market by using the mundel [1963]
wealth-effect hypothesis, and the Darby [1975] tax-effect hypothesis. The
results of their study indicated negative
relationship exist between the level of expected inflation and the expected
real stock market returns.
Chen, N., R. Roll and S.A. Ross [1986]
used monthly data for the period 1958-1984 to test the impact of inflation rate
on stock prices. They defined three variables related to the inflation rate;
expected inflation; the change in expected inflation; and unanticipated
inflation and found a significantly negative relationship between the inflation
variables and stock prices. Similarly, Chen and Jordan [1993] found the same
result for same variables.
Benderly and Zwick [1989],
however, suggested that there exist a structural relationship between the
inflation rate and stock returns arising from the real balance effect
pertaining only to a period of adjustment rather than to a long-run
equilibrium......
================================================================
Item Type: Postgraduate Material | Attribute: 162 pages | Chapters: 1-5
Format: MS Word | Price: N3,000 | Delivery: Within 30Mins.
================================================================
No comments:
Post a Comment