CAPITAL MARKETS AND ECONOMIC GROWTH: THE NIGERIAN PERSPECTIVE
ABSTRACT
The objective of this study is to examine the determinants of capital market development in Nigeria. The study adopts a time -series research design with an extensive reliance on secondary data. The study covers the period 1985 -2010. The study utilizes regression analysis as the data analysis method. However, it incorporates multivariate co-integration and error correction in order to undertake a thorough examination of the characteristics of time series economic data. Four analytical procedures are involved in the co-integration and error correction model. First, the unit root test carried out for each of the variables so as to ascertain the time series properties of the data set and obtain the stationary status. This is to ensure that the variables are stationary and that shocks are only temporary and will dissipate and revert to their long-run means. Next, the test of Co-integration is performed in order to discover the long run rational properties of the data. The third step is to obtain the error correction representation for the model which helps to analyze the dynamic short run and long run behavior of the model.  The findings of the study revealed that Gross Domestic Product (GDP) is positively related to market capitalization used as a proxy for capital market development.  A positive relationship was also observed between foreign direct investment and capital market development in Nigeria.  Openness was also observed to exhibit an inverse relationship with market capitalization .The relationship between political stability (POLSTA) and capital market development was also observed to be negative. The analysis of the slope coefficients for the short run reveals that openness is observed to exhibit a positive relationship with capital market development.  FDI and POLSTA were also observed to exhibit a short–run positive relationship with capital market development. GDP was however observed to be inversely related to capital market development in the short run. The negative sign of the error correction coefficient conforms with theoretical expectations and indicates the presence of an adjustment mechanism to long-run elasticity. The recommendation is that policies should be put in place by the regulatory agencies and organs of the Government to ensure a sustainable capital market growth and development in Nigeria.
TABLE OF CONTENT
CHAPTER ONE: INTRODUCTION                            
1.1     Introduction                                 
1.2     Statement of the Research Problem.                    
1.3     Research Objectives.                                
1.4     Research Hypotheses                            
1.5     Scope of the Study                            
1.6.     Limitation of the Study                     
1.7     Significance of the Study                            
CHAPTER TWO: LITERATURE REVIEW                        
2.1     Introduction                             
2.2     Capital Market and Developing Economies                
2.3     Capital Market and Economic Growth: The Challenge for Developing
Economies                            
2.3.1    Macroeconomic Stability                    
2.3.2     Development of the Banking Sector                
2.3.3     Institutional Quality                        
2.3.4     Shareholder Protection                        
2.4.     The Nigerian Experience                        
2.4.1     The Nigerian Capital Market                        
2.4.2    Legal and Regulatory Environment                    
2.4.3     Market Overview                            
2.4.4     Performance of Key Market Indicators.                
2.5.     Evaluating the Impact of Capital Market on Economic Growth in Nigeria.
2.6     Challenges of the Nigerian Capital Market                    
2.7     Promoting Capital Market Growth in Developing Economies    
2.7.1     Automation                                
2.7.2     Demutualization                            
2.7.3     Regional Integration                        
2.7.4     Institutional Investors                            
2.7.5     Regulation and Supervision                        
2.7.6     Capital Flows and Encourage Foreign Participation            
CHAPTER THREE: METHODOLOGY AND MODEL SPECIFICATION      
3.1     Introduction                                
3.2     Research Design                        
3.3     Scope of the Study                            
3.4     Sources of Data                            
3.5     Data Analysis Method                            
3.6     Model Specification                                
CHAPTER FOUR: PRESENTATION AND ANALYSIS OF RESULT        
4.1 Introduction                            
4.2 Presentation of Result                            
4.3 Hypotheses Testing                        
CHAPTER FIVE:    SUMMARY AND DISCUSSION OF FINDINGS, RECOMMENDATION AND CONCLUSION            
5.1     Summary of Findings                        
5.2      Discussion of Findings                     
5.3     Conclusion                                 
5.4      Recommendations                             
5.5      Recommendation for Further Study                
Bibliography                                
Appendix 1                            
Appendix 2                            
Appendix 3                            
Appendix 4                                
Appendix 5                            
Appendix 6                            
CHAPTER ONE
INTRODUCTION
1.0 INTRODUCTION
In the last two decades, studies on the capital market have received considerable attention from contemporary finance and economics literature resulting from its auspicious role in the provision of long-term, non-debt financial capital which enables companies to avoid over-reliance on debt financing, thus improving corporate debt-to-equity ratio and also in the mobilization of resources for national growth. According to Ndako (2010),  the capital market is viewed as a complex institution imbued with inherent mechanism through which long-term funds of the major sectors of the economy comprising households, firms, and government are mobilized, harnessed and made available to various sectors of the economy. For sustainable economic growth, funds must be effectively mobilized and allocated to enable businesses and the economy harness their human, material, and management resources for optimal output. Hence, the capital market is an economic institution, which promotes efficiency in capital formation and allocation.  
The capital market contributes to economic growth through the specific services it performs either directly or indirectly. Notable among the functions of the capital market are mobilization of savings, creation of liquidity, risk diversification, improved dissemination and acquisition of information, and enhanced incentive for corporate control. Improving the efficiency and effectiveness of these functions, through prompt delivery of their services can augment the rate of economic growth (Okereke-Onyiuke, 2000; Levine and Servos 1996; Obadan, 1995; McKinnon, 1973).
In retrospect, the theoretical framework for the effects of capital market on economic growth   dates back to the work of Schumpeter (1911) which explained that a well developed financial system can facilitate technological innovation and economic growth through the provision of financial services and resources to investors. The above argument of Schumpeter (1911) was later advanced as the McKinnon-Shaw (1973) hypothesis, which is a policy analysis tool for developing countries with strong recommendation and high priority on the efficiency of financial systems in facilitating capital accumulation and financial intermediation.
The above hypothesis became formalized and popularized through the endogenous growth models of Fry (1988), Greenwood and Jovanovic (1990) and Pagano (1993) which specifies explicitly the modeling of the link between financial intermediation role of capital markets and growth indicators. These models have identified the capital market as an institution that contributes to the economic growth of emerging economies, they are also considered as a variable in explaining the economic growth in the most-developed ones.  
The Nigerian capital market started operations in mid-1961 with eight stocks and equities; there were also about seven United Kingdom (UK) firms quoted on the Nigerian Stock Exchange (NSE) which had, at the same time, dual quotations on the London Stock Exchange. At the commencement of operations, the market  started with 0.3 million shares worth N1.5 m in 334 deals and the value continued to grow steadily to N16.6m in 634 deals by 1970 (CBN 2004).  From the 1960s up to the late 1980s, trading was dominated by government securities and this was partly explained by the implementation of the Nigerian Enterprises Promotion Decree of 1972 and 1977 which allowed a high level of public participation in the capital market. Also prior to the deregulation of the Nigerian capital market in 1995, the pricing of new issues was controlled by the SEC as against firms’ preferences for a market determined pricing system (CBN 2004).
According to Nigerian Stock Exchange report (NSE, 2009), in 1995 the Federal Government liberalized the capital market with the abrogation of Laws that prevent foreign investors from participating in the domestic capital market. This includes: The Foreign Exchange (Monitoring and Miscellaneous Provision Decree No: 17, 1995; Nigerian Investment Promotion Commission Decree No: 16, 1995; Companies and Allied Matters Decree of 1990 and Securities and Investment Act (ISA) 45 of 1999. These legislations have accorded Nigerians and foreign investors the same right, privileges and opportunities for investment in securities in the Nigerian capital markets. Other key measures include: The Central Security Clearing System (CSCS) which commenced operations in April 1997. It is a central depository for all the share certificates of quoted securities including new issues.
With a market size of over 233 listed equities and gradual stability of the market resulting from the aftermath of the volatility induced by global economic crisis, there is a need to examine theoretical expectations with regard to the effects of Nigerian capital market on economic growth.  It suffices to note that with inference from evidence in extant literature across different countries, the arguments are quite inconclusive and with mixed results with regard to the effects. For example Grilli and Milesi-Ferretti, (1995), Kraay, (1998) and Rodrick, (1998) found that capital market does not affect growth, while others stood their ground that the effect is positive (Levine, 2001, Bekaert et al., 2003 and Bonfiglioli and Mendicino, 2004), yet others note that it is negative (Eichengreen and Leblang, 2003). Certain studies show the effects to be heterogeneous across countries at different stages of institutional and economic growth (Bekaert et al, 2003, and Edwards, 2001) and countries with different macroeconomic frameworks (Arteta, Eichengreen and Wyplosz, 2001). Rancière, Tornell and Westermann (2006) observed that we could expect the growth effect of capital markets   to be smaller in high-income than in middle-income countries. Consequently, this study is an attempt at evaluating the link between capital market and economic growth and thus providing empirical evidence from Nigeria.
1.2 THE RESEARCH PROBLEM
In recent times there has been a growing concern on the role of capital market in economic growth and thus the capital market has been the focus of economic policies and policy makers because of the perceived benefits it provides for the economy. The capital market provides the fulcrum for stock market activities and it is often cited as a barometer of business direction. An active capital market may be relied upon to measure changes in the general level of economic activities (Obadan, 1998).
Deducing from the extensive studies on the theoretical expectations on the role of capital markets on economic growth which have formed the core of normative economics,  the  capital market is expected to contribute to economic growth through the transmission mechanisms  of  savings mobilization, creation of liquidity, risk diversification, improved dissemination and acquisition of information, provision of long-term, non-debt financial capital which enables companies to avoid over-reliance on debt financing, and enhanced incentive for corporate control amongst others. However, an x-tray on the path of “positive economics” which is concerned with “what is” rather than “what should be” reveals that the argument in the literature on the growth effects of capital market has not been adequately resolved. The inconclusive nature of these theoretical and empirical studies provides the basis for a further empirical investigation on the role of capital market in economic growth. Hence, the need for this study.
Furthermore, a fundamental weakness of most studies providing evidence from developing economies is that past regression analyses were often run without a thorough examination of the characteristics of time series economic data. It is therefore not surprising that some of them are, in fact “spurious regressions” exhibiting an excellent fit between unrelated variables, especially when levels of the variables themselves are used in the regression. In general, when the regression includes non-stationary variables, the estimation of coefficients and inference from them becomes impossible (Iyoha and Ekanem, 2004).  Besides, recent empirical studies (Abu-Badr and Abu-Qarn, 2008; Wolde-Rafael, 2009; and Ndako 2010). have shown that major macro economic variables such as Gross Domestic Product often used as proxy for economic growth may be a non-stationary process rather than a trend-stationary process as was generally assumed. This implies that the conventional approach in regression has not always yielded reliable results. Consequently, this study addresses this gap by employing the Cointegration technique and Vector Error Correction Model (VECM) to determine the long and short run dynamics between capital market performance and economic growth in Nigeria.  
In the light of the above, the following research questions have been specified to guide the direction of the study. They are as follows;
Is there a positive relationship between market capitalization and economic growth in Nigeria?
Is there a positive relationship between number of listed securities in the capital market and economic growth?
 Is there a positive relationship between the volume of shares traded in the capital market and economic growth?
1.3 RESEARCH OBJECTIVES.
 To evaluate the relationship between market capitalization and economic growth in Nigeria.
To ascertain the relationship between the number of listed securities in the capital market and economic growth.
To examine the relationship between the volumes of shares traded in the capital market and economic growth.
1.4 RESEARCH HYPOTHESES
The following testable propositions were specified for the purpose of the study. They are as follows;
 There a positive relationship between market capitalization and economic growth in Nigeria.
There a positive relationship between number of listed securities in the capital market and economic growth.
 There a positive relationship between the volumes of shares traded in the capital market and economic growth.
1.5 SCOPE OF THE STUDY
This study attempts to examine the relationship between capital market and economic growth in Nigeria. The study adopts a time series design and will cover the period between 1985-2010.
1.6. LIMITATION OF THE STUDY
There is always a challenge of ascertaining the level of data accuracy especially with regard to time-series data. The study considers this a limitation.
1.7 SIGNIFICANCE OF THE STUDY
It is expected that this study would consolidate existing literature on the issues surrounding the relationship between capital markets and economic growth. The study would also facilitate the examination of the short run and long run effects of capital markets on economic growth and thus boosting   the empirical evidence from Nigeria.    Furthermore, given the empirical nature of the study, the outcome of this study would aid policy makers and regulatory bodies in economic modeling and policy simulation with respect to the selected variables examined in the study.
The result of the study would be of benefit to investment analysts, investors and corporations in examining the effectiveness of the capital market and thus evaluating the options available for accessing long-term, non-debt financial capital which enables companies to avoid over-reliance on debt financing, thus improving corporate debt-to-equity ratio prices.  It will also be useful in stimulating public discourse given the dearth of empirical researches in this area from emerging economies like Nigeria. Finally, it would also add to the available literature on the area of study while also providing a platform for other researchers who may want to further this study.