INTEREST RATE MACROSTRUCTURE, CORPORATE BOND MARKET DEVELOPMENT AND INDUSTRIAL OUTPUT IN SELECTED AFRICAN ECONOMIES


INTEREST RATE MACROSTRUCTURE, CORPORATE BOND MARKET DEVELOPMENT AND INDUSTRIAL OUTPUT IN SELECTED AFRICAN ECONOMIES

ABSTRACT:               

This study examines the effect of interest rate macrostructure and corporate bond market development on industrial output growth in some selected African economies from 1995-2014, namely Botswana, Cameroon, Cote d’ Ivoire, Egypt, Ghana, Kenya, Mauritius, Morocco, Namibia, Nigeria, South Africa, Tanzania, and Tunisia. In the World industrial output statistics, African economies have consistently ranked least and its pace of industrial output growth has been the least. The lapse in industrial output and the growth rate appear related to the underdeveloped corporate bond market, as their financial system over-relies on short term funds to finance industrial output growth. The study also deduces that the oligopolistic structure of the economies’ bank dominated intermediation system is linked to the drawback, as African commercial banks have been profiting from the perverted interest rate structure. The study introduces short run innovations to Toda-Yamamoto and Autoregressive Distributive lag methodologies, in an unbalanced panel data, sourced from World Bank Development and Worldwide governance indicators, Bank for International Settlements and the African Securities Exchanges from 1995-2014. The short run dynamic coefficients satisfy a priori expectations, which indicate joint influence flows and co- integration among industrial output, corporate bond issue, interest rate spread, technological development, and real per capita income. The long run results suggest that interest rate spread negatively influences industrial output. Corporate bond issue negatively influences interest rate spread, which suggests potency of the bond market to manage the spread. Corporate bond issue does not significantly impact industrial output; sovereign bond issue positively correlates with corporate bond issue. Corporate bond turnover does not link industrial output, while its nexus with corporate bond issue does not produce significant positive linkage, which suggests lack of signaling impact. Inflation expectation does not significantly influence interest rate spread, rather it is the spread that positively influence inflation, which suggests that inflation may be more of structural and institutional lapses than monetary phenomenon. Public debt positively links inflation expectation, but negatively influences bank competitiveness; and technological development negatively influences industrial output, which suggests poor human capital-industry linkage. The study recommends market-based economies; private investments in bond market Exchanges and investment banking institutions, full financial liberalization, with prudential regulation, and fiscal support for non-finance corporations to encourage bond issuing; tax and regulatory incentives for bank competitiveness towards interest rate reduction; review budgetary system on education for technological development; should encourage college-industry reorientation and interface. Overall, the study did not affirm the finance-led growth hypothesis of economic development in the selected economies.

CHAPTER ONE 

INTRODUCTION

Background of the Study

The African economy occupies a vantage position in the global economic community due to her diverse natural resources, the high population and other growth potentials. The World Bank Development Report (2015) indicates that Africa, occupied by about 1.17 billion people (16.4% of World Population of 7.3 bn.) in 54 countries, grew (in terms of output) by 4.1 per cent, third after South-Asia of 7.1 per cent, and East-Asia and Pacific region of 6.7 per cent in global ranking (World Bank, 2015a). African population is projected to rise by 2.6% (from 2014) to about 1.510 billion by 2025 (World Bank, 2014). With these advantages, it would be a greater force in development, for Africa to match these demographic and growth features with high level industrialisation like the developed economies and the High Performing Asia Economies (HPAE).

The United Nations Industrial Development Organization (UNIDO, 2013) reports that in terms of average regional contribution to World Manufacturing Value Added (MVA) from 2007-2011, East-Asia and Pacific contributed 16 per cent, South and Central-Asia gave 3 per cent, while except South Africa’s 1 per cent contribution, the rest of Africa contributed virtually nothing. Moreover, Africa managed to achieve 0.13 per cent increase to Global MVA growth from1990- 2011, rated as the lowest among global developing countries. In 2014, the region accounted for 1.6% of Global MVA (UNIDO, 2016), while among global developing and emerging industrial economies, the region’s MVA has consistently declined from 9% in 1990 to 7% in 2000, and to 4% in 2014 (UNIDO, 2015).

Economic growth and development by industrialisation is the desire of every country. In particular, though African governments may have been making industrial growth a priority, however the ability to mobilize the right financial resources necessary to build the requisite industrial and infrastructural technologies to transform the continent’s natural resources have been of great challenge to governments, financial development theorists and technocrats in Africa. Despite the resource potentials highlighted above, the low industrial output growth status and somewhat de-industrialisation policies of sub-Sahara Africa may have consistently made the African economies to produce worst statistics in human living index, unemployment, per capita income; and ever increasing cost of living index relative to other regions (Bhorat, Naidoo and Pillay, 2016).

This research study focuses on interest rate macrostructure and corporate bond market for industrial production in Africa. Due to the obvious roles of industrialisation in human development, it is probable that the sharp distinction between developed, emerging and frontier economies is largely attributed to the level of their industrialisation. An economy’s relative strength in the manufacturing / industrial sector defines its immunization from global economic shocks and advancement from economic backwardness (UNCTAD and UNIDO, 2011), while the deeper its financial system the higher it is insulated from macrofluctuations (World Bank, 2001).

In recent times, African economies may have been touted as world leading growth centers, with average of five per cent growth rate from 2003 to 2007 (Dahou, Omar, Pfister, 2009), perhaps due to increased returns from sale of primary / natural resources, but it appears to be the most impoverised region on earth (Deaton, 2015). The disappointments of the region’s financial system for enhanced operational, allocational efficiency and sustainable industrial financing and its positive implication on the economic system may be the bases of the perverse state of the peoples poverty, such that Rousseau and D′Onofrio (2013)’s research outcome dismisses the post 2007 global economic crises’s finance-led growth claim in sub-Sahara African economies; rather, the study otherwise suggests that it was monetization of primary commodity earnings rather than financial intermediation that was responsible for the real observed growth.

Modern development theorists advice that developing economies should be better concerned with the structure that bring forth growth, rather than the growth of the system. Rodrik (2015) regards contemporary developing economies as economies with no productive transformation base, hence no “coherent growth story”. This taught appear to suggest employing right financial structure that would be more efficient to spur industrial led growth, rather than the contemporary service sector led growth common in many African and emerging economies. The continent’s economic potential is unfortunately being tied to the growing young labour force and large consumer market base, devoid of the much required high value added activities such as industrial growth that should improve employment and income of the growing population (World Bank, OECD, WEF, and AfDB, 2015). Relative differences in sizes and institutions are obvious among the individual countries, however, it is clear that the entire region’s financial development performs less than other regions in the global financial system (Otchere, Senbet and Simbanegavi, 2017; Honohan and Beck, 2007).

It is also worth evaluating the reason why Africa seems yet to experience higher industrial output growth despite the ample industrial policies, because most of the very prosperous nations and regions today started from the brick of poverty, but soon identified their competencies, strengths and weaknesses, chose the part of technology through agricultural-industrial renaissance to development (UNIDO, 2014). The new United Nations Industrial Development Organization’s Inclusive and Sustainable Industrial Development (ISID) (UNIDO, 2014) initiative reminds developing countries that in all newly developed countries like the High Performing Asian economies (HPAE) it is usually industrial development and trade that shapes their successes. Where and how is Africa getting it wrong?

The World Economic Forum (WEF, 2015) underscores the need to develop the corporate bond market to accelerate a stable industrial finance in African markets, as UNIDO (2013) opines that bank financing is not resource efficient for manufacturing. Most African bond markets, except for South Africa, are underdeveloped. The capital markets, due to weak operating laws substantially lack public confidence, and are relatively more volatile, and hence they are treated as frontier market by international investors (World Bank, 2015b). Significantly, the African corporate bond markets remain underdeveloped relative to the economies’ current size and future potentials (WEF, 2015). It follows that African economies and markets largely operate poor finance-economic development nexus (poor linkage of the primary market to growth, and higher secondary market volatility), thereby spurring abysmal industrial growth. An appraisal of the structure and viability of African economies reveal that it is indeed skewed to primary produce development and export rather than diversified industrial / manufacturing sectors that would have added considerable employment opportunities. Weiss (2011) while counseling the global low income economies, particularly the sub-Sahara Africa on ‘paths to industrialisation’ says development is about structural change, the only antidote to sustainable growth.

Till date, the literature on growth-led finance versus finance-led growth debate in developing countries’ economic development trajectory is unsettled (Adegbite, 2016; Somoye, 2011; Shan and Jianhong, 2006). Aside from the World Bank concern for African industrial challenge, African governments since the 1970s have adopted several strategies to drive manufacturing and industrialisation, however, limited successes have been achieved (UNCTAD and UNIDO, 2011). Some of such policies include: the indigenization of multinationals; import substitution industrialisation (ISI) strategy of the structuralist school in the 1970s to the 1980s; Lagos Plan for Action of the 1980s, African Growth Opportunity Act (AGOA) of the 1990s, the New Partnership for Africa Development (NEPAD) in the 2000s, the Everything But Arm (EBM), the Import Restriction and Foreign Exchange Exclusion policies, and so on. A review of these programs and polices suggest, aside from structural and policy default issues, the existence of substantial industrial funding gap, as lack of industrialisation is largely a problem of development funding gap, not commercial funding gap. Ukwu (2004) reviews the “loopholes in NEPAD”, and reveals various discordant tunes beyond implementations, claiming that contrary to its label the initiative is not “home-grown”. Indeed, following the inaccessibilty of the traditional capital market institutions by indigenous enterprises for industrial finance in many African economies, the relevance of the much exaggerated formal capital market facilities has been subject of discussion, such that scholars claim that the institutions may have been ill- adapted and irrelevant, as it lacks provisions for much needed start-up and venture capital needs (Ojo, 2010).

The financial liberalization policies which succeeded in promoting bank intermediation-based finance for industrial output growth, may not have produced appreciable success at advancing the finance-led industrial growth thesis for African economies (Ousmanou, 2017; Ojo, 2010; Asogwa, 2005; Adebiyi, 2005; Emenuga, 1998). Consequently, the economies have long been encountering wide differentials in their saving-lending rates, with high profit takings by the banks (Ojo, 2010). Given the high prevalence of imperfect competitive market structure, and since the optimal level of reserve requirement often grows proportionately less than the deposit- taking rate, the larger monopoly banks may continue to dominate by earning “monopoly rent” being strengthened by the inherent advantage of their ‘market power’ (Ojo, 2010). It is revealed in the literature that contemporaneously, foreign banks with subsidiaries in Africa earn more returns than subsidiaries in other regions (Honohan and Beck, 2007) on the advantage of the wide margin.

The Mckinnon-Shaw (1973) liberalization theorem built on the financial development foundation of Gurley and Shaw (1955, 1960), and Goldsmith (1969)’s financial structure system development theory for countries’ industrial financing process, might have been wrongly applied in Africa. Nevertheless, it is the belief in the investment world that liberalisation of financial markets encourage greater investment efficiency and better process of resource mobilization for financing investments (Odoko, Okafor, and Kama, 2004). Goldsmith (1969) opines that a country’s financial interrelationship ratio would develop faster in favour of financial assets on the strength of liberalization.

The contentious debate of the market-based versus bank-based economies took a new turn recently at the instance of global want of an antidote for financial stability following the global stock market crash and subsequent wide spread economic depression. Despite the enormous impact of the crises on the United States (US), the persistent pre-eminence of the market-based system suggests that the US has “a strong bias that markets work”, while to the rest of the world, this position may be a narrow view. Adelegan and Razewicz-Bak (2009) found that the sub- Saharan domestic debt finance is weak relative to the bank finance, and attribute the lapse in African finance deepening to savings constraint. Asogwa (2005) however appraises both bank and market-based financial systems in Nigeria and concludes that for long term industrial financing, the bank-market template seems unsuitable, claiming that if adequate strategies are in place among the borrowers, mediators and investors, the advantages of market-based finance and growth could be enormous even in information poor countries. Bank-based finance chiefly advances availability doctrine, increasing default credit risk levels, and exacerbates financial instability. On financial instability, literature argues that if finance is fragile, banking is the most fragile part of it (World Bank, 2001).

Contemporary finance theory suggests that firms actually decide their financing choices and capital structure policies on the basis of prevailing macroeconomic variables, such as extent of market imperfections, taxes, interest rate (Harris and Raviv, 1991). For instance, Demirquc-Kunt and Maksimovic (1996) examine the hypothesis that financial market developments influence the corporate financing decision of firms, with the empirical results suggesting that in thirty (30) industrially developed and developing economies, the debt-equity ratio of firms actually depend on the initial level of stock market development. Put more succinctly, Megginson, Smart, and Gitman (2007) contend that corporations do care about the sources of capital formation, as though intermediate fund and direct market money are perfect commodity substitute, their sources do influence post financing ownership structure, financial flexibility, and repayment burden.

The Bond market is a time varying investment channel (Grishchenko, Zhaogang, and Hao, 2015). Its development depends on many factors, particularly the viability of the primary (new issue) market whose values transmit to liquidity of the secondary market (FMW, 2013; Andriansyah and Messani, 2014). The primary bond market helps in the performance of dual functions of improving savings culture and simultaneously investment. The secondary market in reverse provides foundation for price discovery for subsequent capital issues (Sorensen and Whitta-Jacobsen, 2010). Be that as it may, the primary bond market is a crucial variable for capital formation and industrial (investment) development.

In general, corporate bond finance option offers multiple benefits to the issuer, the investor, and serves the public interest, including mutual gains to global investors (Tendulkar, 2015). The development of an economy’s new issue (bond) market however depends on available institutions and their efficiency such as regulators and the judiciary systems (Adegbite, 2015). The need to curtail the deterrents of ‘information asymmetry’, towards boosting the direct finance culture for industrial growth cannot be over emphasized. A clear advantage in favour of the direct financing is that no transaction cost affects the investor unlike in the indirect market where higher intermediation fee has to be paid.

The World Bank contends that finance spurs investment to growth, however in many developing economies, the financial sectors are in urgent need of reforms (Ojo, 2010; World Bank, 1989). The mode of mobilizing and extent of availability of finance determines an economy’s growth path and can influence its economic development. Ojo (2010) also argues that the financial system, inclusive of its financing modes, constitute the architecture for the industrialisation process of most already advanced economies. Towards easing industrial financing, Chant (1992) argues that a financial system is expected to constantly explore new paradigms of transformation of financial resources, altering their risk and return towards the needs for long term industrial development. Potently, this research reasons that, this financial system that facilitates the platform for saving and lending, borrowing and investing, and being put-up for urgent reform in Africa is all tied together significantly by the rate of interest (Rose, 2003).

In the modern economy, interest rate, although has microeconomic foundation, is a national parameter with profound economic and financial effects, hence conceptually a macrostructure- a price of multiple interconnected influences. Importantly, interest rate has future value, a potency to regulate the price system of the future. Moreover, it has its global perspective, in the international financial system, through the world interest rate (wir) structure, providing sensitive signals to borrowers, lenders, savers, and investors. Dillen (1995) opines that nominal interest rate’s formation comprises world real interst rate, real exchange rate and domestic inflation. In the global context, trend in global real interest rate connotes the dynamics in international business cycle, which largely, is a function of global required return and investment opportunity (Dillen, 1995). In contemporary time, the mechanics of interest rate term structure is of major implications for the performance of the macroeconomy, and it has ‘complete’ forcasting influence (Salachas, Laopodis, and Kouretas, 2015). The mechanics of interest rate and its multiple layer of functionality stand it out as ‘special’ instrument in the financial service industry, with instant trigger reactions on other national parameters and aggregates (Okigbo, 1993). In specifics, its mechanics influences industrial outlook and financial service variables in the global markets, such as the US Fed rate does. When policies treat it in isolation its velocity effects on production, employment and prices have often resulted in egregious mistakes (Okigbo, 1993).

The increasing global linkages of economies and capital flows may impact more on domestic interest rate dynamics, as high real interest rate makes debt servicing more expensive. With respect to macroeconomic management, interest rate functions to restore equilibrium as a countercyclical business and policy instrument at firm and country levels respectively. Following studies on increasing integrated capital market economies, real interest rates are more externally determined, and hence are more than what the domestic economies can factor out (Bosworth, 2014). Though implanted through the economy’s monetary policy (MP), the impact of real interest rates could be moderated by subsisting fiscal policies with the purpose of influencing macroeconomic outcomes. It is suggestive that the prevalence of high interest spread in many African economies perhaps provide more indication that tax instrument for macroeconomic management is being underutilized (Spratt, 2009). Theory and literature suggest that nominal interest rate has multiple transmission channels such as the exchange rates, wealth and balance sheets, and inflation expectations, as the structure of yield curves conveys diverse set of information about the economy and its future directions (CBN, 2010).

From the preceeding discussion, it has been established that the macrostructure of interest rate and its links to bond market issuing can impact industrial output growth in the selected African economies.

Statement of the Research Problem

The African economy, except South Africa, is often described as a trading economy in basic commodities, due to the economy’s weak industrial base (United Nations, 2010; UNIDO, 2013). As stated in the preceeding discussion, the macroeconomic impacts of industrialised economy are obvious; various policies to stimulate industrial output growth and its sustainability in African economies seem inadequate, as the problem of right funding gap is persistent. For instance, the Nigerian Economic Society (2005) reviewed Nigeria’s industrial policy and suggested that Nigeria would become ‘highly industrialized’ by 2015; evidence however revealed that by 2015, the sector remained yet to significantly improve on its low capacity utilization, relative declining output growth rate, low employment generation, sub-optimal inter- sectoral linkages, etc (Chete, Adeoti, Adeyinka and Ogundele, 2016; WEF, 2016). Probably, the unrealized ‘dream’ may not be unrelated to the issue of financial ‘underdevelopment’, particularly of the corporate bond market.

The reason for this study is further deepened by the seemingly weak industrial output growth policy thoughts of African countries, evidenced in the continuous structural deficient pattern of her imports and exports. The doctrine of extroversion is evident in an economy that does not largely consume what it produces, and does not produce what it consumes. Ojo (2010) is consistent that the Nigerian banks seem to promote the deficiency, by financing foreign countries’ growth, as the banks are deficient in the production of ‘expected’ industrial development finance; preferring to financing less productive commerce and final consumption imports. Recent literature on dependency and African renaissances suggest that the doctrine of extroversion is not abating (see Table 2.6, Figure 2.5), as this seeming structural deficiency gap is on the rise, having attendant consequences on exchange rate volatility, unemployment, poverty, adverse terms of trade, etc, (Matunhu, 2011; Conway and Heymen, 2008; Ferraro, 2008). The prevalence of extroversion practice may be the non-addressing of long term capital deficiency of cross-sections of African economies.

Recently, numerous challenges of industrial competiveness of African economies were reviewed (WEF, 2013). The World economic forum found that the top three most important hindrances to doing business in the continent are in the order of access to finance, inefficient government bureaucracy, and corruption. In other words, dearth of long term capital is a potent factor that limits African transformation, for which Oni (2004) opines that Africa’s financial markets are shallow, and cannot withstand international markets shocks. The risk associated with short term capital for long term industrial need is often beyond what the bank-based financial system can cope with, as inability to rollover results in operational losses, even to sudden default of larger corporations (World Bank, 2015d). Long term bond finance links investment to growth more, improves the peoples’ welfare with shared prosperity.

In theory, the most appropriate form of industrial financing between bank-based and market- based finance led system is still in context (ICSA, 2015; Levine, 2004; Rajan and Zingales, 2003b). This study conjectures that to a large extent, African countries’ economic policies and initiatives have over-promoted the bank-based financing option for long term industrial financing which however seems inappropriate and inefficient. WEF (2015) is uncomfortable with the relative slow growth of corporate bond market among emerging and frontier economies, citing that the current credit crunch environment calls for acceleration of the corporate bond financing as it will produce significant long term benefits, than bank financing. For instance, Asogwa (2005) appraises various Nigerian government long term industrialisation projects sponsored via bank-based funding schemes from 1971 to 2002, and concludes that the outcomes have been unsuccessful. The dominance of bank-based financing of industrial growth in the economies may be unconnected with their monopoly of deposit taking and controller of the payment system, coupled with the information asymentry problem more pronounced with the market based finance.

This study notes that though by precepts of liberalization, banks in selected African economies are strategically favoured in resource mobilization for financial intermediation, however the uncompetitiveness of the saving/deposit rate suggests that depositors seem to be less favoured, unlike experience of the highly performing Asian economies (HPAE). The liberalisation policy though promotes bank-based model economy; however, overtime perversions are rife in interest rate structure, loan and deposit maturity structure, and inclusivity structure at expense of the long term industrial finance needs. Unfortunately, wide interest (lending and deposit) rate gap now pervades African economies- a model which financial economists claim is perpetuating ‘financial failings’ and furthers repression. Consequently, efforts at advancing credits over the years have been short-termist in nature (Asogwa, 2005), and at higher interest cost.

Moreover, this research study observes that banks as providers of intermediated funds assume to be ‘owners’ of the fund, as these deposits are largely of short term. This risk ‘ownership’ is, by default, being exploited by the banks to producing industrial loans, thus, inadvertently sponsoring business and market failures; at the detriment of the long term capital market, which hitherto is most appropriate for industrial financing. This financing behavior by the banks may have however made the long term capital market become seemingly unattractive. The long tenure financing by the bank is argued by the group interest theory of financial development; that it is undertaken to consolidate the banking sector dominance of financial intermediation process, and thus make the intermediation industry less competitive through oligopolistic behavior (Rajan and Zingales, 2003). The capital market funding of industrial output and growth however, has the benefit of matching assets and liabilities of firms, broader diversification of the intermediation industry, a better mechanism of deepening the intermediation process, which may help to augment financial stabilization, unlike the bank sourcing that is narrow, debt prone, that may push the economy towards financial fragility. Limited use of long term finance indicates market failure and policy distortions (World Bank, 2015d). The belief-based theories of asset bubbles perhaps have the bank assets in mind as potential source of asset bubble, often leads to banking crises by its loan production behavior, revenue recognition, over-valued assets, and asset-liability mismatch. This is a critical financial failings feature of many emerging and advanced bank-based economies that has significantly been responsible for these countries financial and economic development drawbacks (Knoop, 2013).

The IMF (2015) posits that systemic banking crises are related to the choice of bank assets, and that their choice of assets must be effectively regulated. Irrespective of intention to finance, since their major funds are of short term, the banks should only assume ownership for the short term. Timing is a strategic variable in finance and money management. Long term fund sourcing needs long term planning. If a firm is non-strategic in timing its finance needs, it may operate a financial time (maturity) mismatch, at high production cost. This is the bane of many African industrial outfits as they fall prey to bank financing mode which is uneconomical.   For instance, a seeming observation of finance sourcing characteristics among manufacturing outfits is that a 5-year time need of fund would not be sought till after the third year rather than today- a decision making model that Keynes regards as the animal spirit syndrome (World Bank, 2015c).

The World Bank has been worried about Africa’s financial system being able to make its touted growth and development inclusiveness, wondering if Africa can claim the 21st century (World Bank, 2000; Ayogu, 2006). On this, the literature insists that the financing ‘mode’ is the most significant in any industrialisation process, particularly in African economies (WEF, 2013a); while urging that the banking credit system is poorly oriented and ill-adapted to the industrial needs of most African economies, particularly the preponderant Small and Medium Enterprises (SMEs) (Ojo, 2010). Adebiyi (2005) argues that though Nigerian banks are highly liquid, they hardly want to produce credit for manufacturers due to risks and cost. Despite the banking sector high state of liquidity, the lending rate is on average over 20 per cent for prime borrowers and above 30 per cent to other fund users. Though, their lending capacity is a function of savings/deposits, which on its part is a function of real interest rate (Doyle, 2005), the saving/deposit rate is however not dynamic. Real savings rate have been negative in many African economies, hence retail deposit is discouraging, and given low supply, demand for bank credit attracts higher price (Mathews and Thomson, 2014).

Following the group interest theory of financial development, this study therefore deduces that the challenge that may limit industrial output growth of African economies may be associated with the interest rate gap between bank lending and deposit rates. Despite complementary antidotes to stimulate financial liberalization’s impactfulness on the bank interest spread, through concurrent encouragement of trade liberalization and product market liberalisation (Rajan and Zingales, 2003; Bircan, Hauner and Prati, 2012) the status quo of increasing interest gap remains in many African economies. The gap would have been stimulating oligopolistic incentive for the banks to raise bond at high coupon rate for onward credit to the industrial sector, at the high interest cost. The banks’ oligopolistic behavior limits the non-finance corporate (NFC) credit access, and may not help to stimulate growth of the corporate bonds market, and moderate investors’ risk perception towards the consumption of industrial debt stocks. Despite that the capital market provides many noble roles (Ojo, 2010), among others, opportunity for corporate security’s price discovery and the marketability of issued securities (secondary market window), bond and equity issuance are relatively poor in African economies compared to other regions.

In summary, the main motivation for this research study is the weak state of the corporate bond market for industrial finance, that may have made African economies to score least in global manufacturing output and annual growth rate, which this study associates with the perversed structure of interest rate. Indicative that, high interest rate spread, seemingly perpetuated by the bank-based industrial financing model and the bank lending behavior may limit the corporate bond market’s capacity to blossom for industrial financing, partly by banks offering bond at high coupon cost. That is, the extent to which the corporate bond market can stimulate industrial output growth depends on the interest rate macrostructure, proxied by the magnitude of the banks’ lending and deposit rate differential. A deduction from the group interest theory is that, increasing interest rate differential may stifle the corporate bonds market off the non-finance corporations (NFC), sufficiently de-motivate the economy’s financial competitiveness, and therefore slack the speed of financial development. The continent’s economies may not optimize industrial growth due to the ‘perverted’ interest rate structure. Lack of focus on this lapse would adversely and continuously affect long term capital formation potency of the primary bond market, and limit the industrial growth rate, with impulses transmitting to increasing unemployment, accentuating extroversion, stagflation, short term business cycles, and so on. The purpose of this research work is to investigate whether the proposition holds.

Research Questions

Following the above discussed problems, the research questions for this study are presented as follows:

1. Why would interest rate structure influence the primary corporate bond market development in the selected African economies?

2. To what extent does interest rate spread affect long-term industrial output growth in the selected African economies?

3. Why is there low primary corporate bond market issuing for industrial investments in the selected African economies?

4. To what extent is the secondary bond market active in the capital transmission process for industrial output growth in the selected African economies?

5. Why is there high interest rate spread in the selected African economies?

Objectives of the Study

The broad objective of this research it to examine the relative effects of interest rate structure and corporate bond market development on industrial output in some selected African economies from 1995-2014. The specific research objectives are as follows:

1. Investigate why interest rate structure would influence the primary corporate bond market in the selected African economies.

2. Assess the extent to which interest rate spread affects long-term industrial output growth.

3. To determine the underlying causes of low primary corporate bond market development for industrial output growth in the selected African economies.

4. Examine the extent to which the secondary bond market is active in the capital transmission process of industrial output growth in the selected African economies.

5. To establish a relationship that would aid in explaining the interest rate spread distortion in the selected Africa economies.

Research Hypotheses

The hypotheses, all stated in the null are as follows:

1. Ho. Interest rate structure does not significantly influence primary corporate bond market development.

2. Ho. There is no significant relationship between interest rate spread and long-run industrial output growth.

3. Ho. There are no significant causes of low primary corporate bond market issuing for industrial output growth in the selected African economies.

4. Ho. There is no significant relationship between the secondary corporate bond market and industrial output growth.

5. Ho. There is no significant relationship between inflation expectation and interest rate spread in the selected African economies.

Scope of Study

The study provides insight to the problems of high interest rate diffential that may have constrained corporate bond finance to improve industrial output growth in the thirteen African economies (Botswana, Cameroon, Cote d’ Ivoire, Egypt, Ghana, Kenya, Mauritius, Morocco, Namibia, Nigeria, South Africa, Tanzania, and Tunisia), that are major African capital market economies as at 2014. Owing to the infant state and slow growth rate of corporate bond market in the region, only countries that are members of the African Stock Exchange Association (ASEA) and whose bonds were traded as at 2014 are included in the sample of study, as listed on the appendix page. The study period covers 1995-2014 (20 years panel data analysis). The sample procedure and size are detailed in chapter three.

Significance of the study

The purpose of this study is to provide more understanding to the probable economic and financial effects of corporate bond market on industrial output growth in particular and the entire real economy in general, in the selected African economics. First, the observed challenges posed by the relatively high banking interest rate spread, needs reawakening more awareness, which can be effectively managed by a deepened corporate bond market. Reliance on corporate bond market as main source of manufacturing and industrial growth finance could promote the economies’ rapid industrialization, financial and macroeconomic stability, assist in arresting the growing incidence of dependency on foreign industrial production, promote financial development, and help to arrest incidence of stagflation, just as the High Performing Asian Economies (HPAE) had their breakthrough post 1997 crises upon embracing corporate bond market for industrial finance.

A country’s primary capital market should be the stronghold of the economy’s capital formation for industrial financing. The conundrum of inactivity of bond markets in Africa particularly, reveals how organized ‘economic corruption’ of inappropriate financing models may have

operated against the financial system, and against Africa’s development, particulary in the non- finance corporates (NFCs) in the real sector. Lack of striving bond market may have put monetary policies on interest rate on false path, which more or less have retarded Africa’s industrial output growth, and exacerbated her level of economic backwardness.

Stakeholders in the financial system that would benefit from a striving corporate bond market in the selected economies are the governments, foreign and local investors, the start-ups and existing entrepreneurs, industrialists, financial market regulators and operators (institutions) who are somewhat connected with the development of African economies; and the academic community in relations to deepening financial literature, in the long term saving-investment- output development nexus. Supporting institutions on global bond market development are the multilateral and bilateral development partners and institutions- UNIDO, UNCTAD, IFC, ADB, IOSCO, ASEA, and others, who may find the study useful for global financial deepening and inter-regional development initiatives.

For the government, a more developed corporate bond market can reduce the rate at which public bond issue crowds out the private sector. Besides, monetary and fiscal policies would find better accommodation in corporate bond market to regulate the economy, fighting inflation and unemployment, to soothe the peoples’ vicious cycle of poverty, than through banking credit. Policy forcast on future interest rates would be better achieved via the bond market mechanism. Governments in developing countries strive for the existence of efficient economic and financial system, which the bond market can help to accomplish; so a robust domestic corporate bond market would reduce problems often regarded as “original sin” and currency and maturity mis- match. Governments are protected more under conditions of macroeconomic stability, which sustainable industrial output growth helps to guarantee, by a more stable financing system (Spratt, 2009).

For firms that source external finance through bank credit for industrial growth substantial negative consequences may have resulted, due to mis-matching characteristics of bank credit finance. Corporate bond provides better substitute in stable finance for working capital, research and development, and actual expansion. The outcome would lead to increased businesses, expansion of operations, generate more employment space, and make the firms more socially responsible.

The study has the potency to assist the bond market in the selected economies to improve long term investment mechanism and outlook by facilitating better economic functioning, through stable saving instruments, and hence encourages stable saving culture, which has been lacking in many of these economies. Investors in the instruments can be sure of income stability, particularly in inflation indexed bond instruments. Despite the increasing awareness of the bond market, in terms of size relative to the economy, it is still not comparable with the banking system. This study helps to create awareness of the natural role of the corporate bond market to finance industrial growth and the real sector economy, with a view to reversing the financial inter-relationship ratio in favour of market based finance.

The interest rate structure is a weighty variable in contemporary development economics, which the lack of robust bond market may have enabled to high bank interest rate spread, and hence confounded many African economies. International evidence suggests that advanced economies are more economically stable due to low discount rate structure, relative high industrial outputs, and inventions for sustenance. This study is significant for low interest margin, enroot the long term industrial transformations of African economies.

Furthermore, this research study is significant, as efforts at corporate bond market development produce mechanism for financial stability. Unless former efforts are made to increase industrial output growth, by improving the market driven financial structure, reducing investment cost processes, and attractive business environment to lowering transaction costs and obstacles to doing business, the pervasive import dependencies, poverty, and instability may continually be magnified in African economies.

In summary, this study has facilitated corporate bond market development mechanism as most appropriate for capital formation and investments in industrial output growth in the sampled countries, and may transmit the positive spillover effects to sub-regional and continental peers. The HPAE are currently speading their positive experience of corporate bond development after the 1990s financial crises to the rest of developing world.

Limitations of the study

The study is restricted to bond market development. Its findings and implications do not generalise other capital market instruments. The corporate bond market is a recent development in African economies; hence the domestic capital market institutions’ are largely of government ownership and control discouraging rapid structural development. The study is limited to some selected African economies listed in the subsection on scope of studies above.

Structure of the Study

This thesis is structured as follows: Chapter one presents the broad introduction of the study- comprising the background of the study, statement of the research problem, the research questions, and the research hypotheses; then, the scope of study, the significance, the limitation, and definition of operational terms. Chapter two presents the theoretical literature made up of the conceptual reviews and their relationships, theoretical reviews, empirical reviews, the stylised facts, and a brief of the research gap. Next, is chapter three, the methodology, which comprises the research design, model specifications and techniques of estimations, and pre and post- estimation tests. Chapter four is on data presentation and analysis of the results. Chapter five presents the conclusion and recommendations.

Operational Definition of Terms

Asymmetric information: Economic and financial transactions in which parties do not operate on the bases of same information source.

Bond market: Markets for sale and purchase of long term fixed coupon debt.

Bond relative value analysis: A process of ranking individual bonds with respect to their expected return potentials

Capacity Utilization: This is the rate at which physical capital, such as industrial machines or plants operates in the production of goods and services relative to optimum installed capacity.

Capital market: A market where long term capital funds (Industrial debts, mortgage loans, equities, fixed income securities, and other alternative asset classes) are issued and traded.

Capital risks: It describes the losses incurred by an investor, of either all or part of the principal invested.

Capital formation: Mechanism by which the society directs part of current resources from desires of immediate consumption to the production of capital goods, of both human and material capital. Economic development depends largely on the rate of capital formation and accumulation.

Corporate Bond: A financial obligation of an entity that promises to pay a specified sum of money, first periodically called coupons and the principal at maturity.

Credit Rating Agency: An independent information source on the credit standing of debt security

Currency mismatch: Incidence arising from international bond issues that are serviced in foreign currency, such that the service cost varies with exchange rate

Economic corruption: In the context of this research, it is a state where acts are carried out against or that deviates from rational economic precepts; like inappropriate resource sourcing and allocation e.g. financing long term investments or projects from the short end (maturity) market, rather than the long term debt market; a hotbed of financial instability; time loss in public budget processing resulting in poor budget impact.

Effective rate of interest: This is the amount that one unit ($1) invested at beginning of a period will earn during the period of use of the capital, where interest is paid at the end of the period.

Emerging financial market: Market of developing countries, which is getting freed from government domination; the private sector is being encouraged to allocate capital resources.

Eurobond market: A market that offers bond outside the issuer’s country of location and denominated in a different currency in which the security is established.

Financial deepening: Increased provision of financial services and its macro effects in terms of depth and breadth of financial opportunities on the larger economy. The more liquid money is available in an economy, the more opportunities exist for continued growth.

Financial development: Mechanisms by which short and long term capital are mobilised and employed in the growth and development process, which in reverse order would enhance the development of financial capital.

Financial Innovation: This is development of financial service to meet customer demand or when technology enables the creation of innovative financial products.

Financial liberalisation: This is a market which eliminates various forms of government intervention in financial markets, thereby allowing supply and demand forces to determine prices, i.e. interest rates, exchange rate.

Financial intermediation: A contractual process of transformation of the issued liabilities of surplus saving units (SSUs) to acquire the liabilities of deficit spending units (DSUs), that suits the preferences of both parties.

Financial Market: Where participants or operators gather and analyse information to make informed purchase and sales of financial claims. Financial market performs functions such as: providing information on past and present prices and trading volume; reducing search cost; providing for standardization of contracts; reducing (transferring) credit risks for buyers and sellers; reducing informational asymmetry; and trading financial and non-financial risks.

Financial Repression: An indiscriminate distortion of financial prices (i.e. interest rate and exchange rate), which reduces the economy’s real rate of growth and the real size of the financial system (financial deepening) relative to non-financial magnitudes. It is measured as annual real interest rate lower than negative 5 per cent.

Financial Inter-relationship ratio: This is a quotient of the market value of a country’s aggregate financial instruments in existence relative to the value of the tangible net national wealth. It defines the rate of growth of a country’s financial superstructure.

Foreign Bond Market: A market in which bond is issued and denominated in a currency other than the issuer’s local currency. It enhances international diversification in the sourcing of foreign capital.

Frontier Market economy: An economy that is characterized by low capital market activity in the primary market and highly volatile in the secondary market. Government intervention and dominance in prices and resources allocation and is relatively high.

Inflation rate: This is continous increase in general price levels overtime

Industrial sector: The sector of a nation’s economy that comprises manufacturing, mining and construction.

Interest rate spread: The spread (gap) between the bank lending (interest) rate and deposit (savings) rate.

Macrostructure: The architectural formation of a subject matter or an economic instrument and applications. Macrostructure of interest rate means its formation, connections and the transmission effects on macroeconomic variables.

Manufacturing: This is the capacity to produce goods with labour, material and other inputs produced by others.

Natural rate of interest: Called the neutral rate, it is the real interest rate consistent with maintaining real GDP to equal its potential level, in the absence of transitory shocks in demand.

Nominal rate of interest: This is the price of credit agreed by a borrower and payable to the lender on an amount of a scarcely loanable fund for an agreed period relative to the amount actually borrowed, often expressed in annual per centage.

“Original Sin”: In the context of financial development, the inability to raise credit in foreign markets in domestic currency.

Risk management: Proactive, anticipated and reactive process of an entity to risks, given clear understanding of the entity’s objectives and constraints.

Term structure of interest rate: Relationship between interest rates and their maturities.

Wicksell Process or Cumulative Process: Wicksellian theory of cumulative process relates the interest rate gap between the natural rate and market (loanable) rate as responsible for investment, output, and income gaps and price level changes (inflation) in the economy.

Yield Curves: A graphical representation of yields across different maturity periods in the financial market. Additionally, it represents yield spreads across differences in maturities of different categories of fixed income securities.

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INTEREST RATE MACROSTRUCTURE, CORPORATE BOND MARKET DEVELOPMENT AND INDUSTRIAL OUTPUT IN SELECTED AFRICAN ECONOMIES



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