CHAPTER ONE

INTRODUCTION

1.1     Background to the study

          The Nigerian capital market is relatively new and has many factors influencing it. The capital market is for sourcing of long term loans, while the floating of government bonds will greatly stimulate the capital market in it’s size and activities. Also, most market started with bonds that are actually floated first.

          According to SEC, (2000), the bond market is preferred as the ideal mechanism for the exchange of claims among buyers. Government bonds has interest bearings securities in the capital market and also mutual relationship with itself, thus government stock as an instrument gives the capital market room to exist.

          The presence of government bonds in the Nigerian capital market can be traced to the early twentieth century (20th) and also floating of a bond in 1946 by the then colonial government. The Federal government development bonds which were formally introduced in 1959 was designed to provide long term finance for government projects and later most proceeds are leased on regular basis till 1986 when deregulation of the capital market started.         

          The recent challenges of the capital market in Nigeria was due to economic meltdown from 2009, according to CBN (Central Bank of Nigeria) annual report on it’s fair share on government bonds. The dismal performance of the banking sector was owing to reforms, administrative charges and others of the CBN and SEC and also counter policies within and outside the market are some factors that have inhibited the capital market as well and the impact of government bonds.

1.2            Statement of research problem

The secondary objective of floating government bond is to source for funds which would be loanable to state governments. Most authors on the Nigeria n capital market literature have recognized the significant impact the capital market has on the economic growth and development of Nigeria, but to some extent the capital market have under gone some challenges which include; Unstable macro-economic environment, poor system of supervision and regulation, limited range of securities, inhibited foreign capital inflow etc.

This research work attempts to ascertain if government bond has been able to influence capital market growth and economic development in Nigeria. In Nigeria, much work has not been done to empirically investigate the impact of government bonds on capital market growth in Nigeria. This is the gap in knowledge the researcher is attempting to fill.

1.2.1 Research questions

1.                                         The impact of government bond on capital market growth in Nigeria.

2.                                         The relationship government bonds have with economic growth and development in Nigeria

1.3     Objectives of the study

          The main objective of the study is to investigate;

1.                 The impact of the government bonds on capital market growth in Nigeria

2.                 To ascertain if government bond affect economic growth and development in Nigeria.

1.4     Research hypotheses

          The following research hypotheses will be tested in the course of this study:

(i)               Government bonds do not have effect on capital market growth in Nigeria.

(ii)            Government bonds does not significantly affect economic growth and development in Nigeria

1.5     Significance of study

                               i.            Government: The study will enable the government to understand when to float bonds and how to set up policies to achieve a stable macro-economic environment animal at fostering the growth of the capital market.

                            ii.            Investors: The study will enable investors to seek for better return on their investment in fixed income securities.

                         iii.            Students and fellow researchers: This study will enable students to understand the meaning of capital market growth and government bond. Researchers can build on this research work for further study by expanding the scope of for their academic purpose.

1.6     Scope of the study

          This study attempts to investigate the impact of government bonds on capital market growth in Nigeria. Data will be extracted from the entire stock market list in the Nigerian stock exchange annual reports and statement of accounts, Central Bank Statistical bulletin, stock exchange fact book over a period of time specifically 1990 to 2011 which is the scope of the study. This document will form the source of data collection.

1.7     Limitation of the study

          The major constraint is the heavy reliance on secondary data. It was difficult to obtain data directly from the capital market operators that capture government bond indicators. However, the present study relies on data extracted from Securities and Exchange Commission (SEC) report, Central Bank of Nigeria statistical Bulletin, Nigerian stock Exchange (NSE) annual reports and statements of accounts. Therefore a significant reduction in the problem of inadequacy and reliability in data of the present study.

CHAPTER TWO

LITERATURE REVIEW

2.1     Introduction

          Government bonds have been in existence since the 1970s. However, bonds issued then have been illiquid and redeemable only to the CBN upon maturity. In 2003, the federal government returned to the debt market to mobilize funds for long-term capital projects. In the process, they effectively championed the creation of over-the-counter (OTC) bond market by issuing short-term maturity notes.

          Today, the Nigerian government has issued about four billion naira worth of bonds that are supposed to be trading in OTC market of the stock market. The approved budget in 2010 authorized the CB to underwrite for the DMO to raise nearly eight hundred and sixty billion naira (N860.00 billion) worth of stocks for the market. However, These bonds rarely exchange hands and considered illiquid by most of the institutions that purchase them in the primary market at the primary dealer/ market maker (PDMM) actions.

          Recently, a few municipal governments such as Lagos, Ogun, Rivers, Imo (issued 2016, 18.56 naira @ 15.5%), Bayelsa and Abia states have either issued or received approval to issue bonds for long-term capital projects. The total amount of bonds or pending issues is less than five hundred billion naira (N500 billion) and there are no indication that these bonds will be marketable in OTC market.

          One of the important sources of mobilizing funds for development is by issuing bonds. Bonds are “I owe you generally called IOU’s (debts) that both FGN, Municipal governments, and corporation to mobilize funds to manage infrastructural development. Bonds are issued in tenors (maturities) of three, five, ten and twenty years long, and as a debt instrument that be paid back with interest at a future date based on the prevailing interest set by the CBN’s monetary policy rates.

          In the care of a municipal government, the rating of the municipality also factors in the interest rate pricing of the bond. The longer the tenor of the bond the higher price (interest) the lenders of money to the borrower expect to be paid and vice – versa for the shorter maturities. The borrower pays the lender periodic interest, usually every six months on the bond until maturity and at the end final interest and principal are paid back to the lender. Therefore Government bond trading becomes important in the capital market, since these bonds are very sensitive to interest rates (the main determinant for prices and yields on bonds) and other economic management factors such as inflation, unemployment and economic growth.

2.2     Government bonds

          A government bond is issued by the national government denominated in the country’s own currency bonds and are debt investments where by an investor loan a certain amount of money for a period of time with certain interest rate to accompany it (Osazee, 2001). Bonds issued by national government foreign currencies are refered to as sovereign bonds and the first ever government bond was issued first by the English government in the year 1613.

          According to Osaze (2001), Government bonds serves as fixed income securities traded in the capital market. Fixed income security is instruments that earn investors a fixed and almost certain return through out the period which they invest. Fixed income securities can either be short, medium, long dated (FRN 24th Development stock, 2001 with coupon rate of 12.5%). Government bonds is issued periodically on medium and long term basis to raise funds to finance government development projects, they are safe and secure instrument because government do not default in the repayment obligations.

          Also Osaze 2011 opines that the major subscribers to government bonds are the national social insurance trust Fund (NSITF) while others are; pension funds, insurance companies, commercial banks, savings institutions, public corporation and the CBN.

          According to National debt management Frame work 2008-2012, government bonds are risk free bonds, because they can raise taxes or create additional currency in order to redeem the bond at maturity. Example, in the U.S.A., treasury security are denominated in their dollar ($) equivalent; In this way the term risk-free means free of credit risk. However, some other risk still exists such that currency risk for foreign investors (example non – U.S. investors of their treasury securities would have lower returns due to value drop of dollar against other currencies). Again inflation risk in that principal repays at maturity will have less purchasing power than anticipated in the inflation – index bonds, which protect investors against the risk by increasing the interest rate given to the investors during economic increase.

2.3.    Varieties of government bond

          In general, government bonds are known as fixed income”: securities because the amount of income the bond wills general each year is “fixed” or set, when the bond is sold. No matter what happens or who holds the bond, it will generate exactly the same amount of money invested in it.

          There are four basic kinds of bonds, all defined by who is selling the debt.

1.       The federal government bonds

          U.S. government bonds are called treasuries because they are sold by the Treasury department. And Treasuries come in a variety of different “maturities” or lengths of time until maturity, ranging from three months to 30 years. Various types of treasuries include Treasury notes, Bills, bonds, and inflation – indexed notes. These all vary based on maturity and amount of interest paid. The treasury department also sells savings bonds as well as other types of debt through the bureau of the Public debt. Treasuries are guaranteed by the U.S. government and are free of state and local taxes on the interest they pay.

2.       Other government agencies bonds

          Some government agencies and quasi-government agencies like the federal National Mortgage Association (FNMA), the federal home loan mortgage corp (FHLMC) and the government National Mortgage association (GNMA) see bonds backed by the full faith and credit of the government for specific purposes, such as finding home ownership.

3.       Corporate bonds

          Companies sell debt through public securities markets just as they sell stock. A company has a lot of flexibility as to how much debt it can issue and what interest rate it will pay, although it must make the bond attractive enough to interest investors or no one will buy them. Corporate bonds normally carry higher interest rates than government bonds because there is a risk that the company could go bankrupt and default on the bond, unlike the government, which can just print more currency if it really needs it. High-yield bonds, also know a Junk bonds are corporate bonds issued by companies whose credit quality is below investment grade. Some corporate bonds are called convertible gonads because they can be converted into stock if certain provisions are met.

4.       State and local government bonds (music):

Unlike corporations, though, the only way that a state can get more income is to raise taxes on it’s citizens, always an unpopular more. As a way around this, the federal government permits state and local governments to sell bonds that are free of federal income tax on the interest paid. State and local government can also waive state and local income taxes on the bonds, so even though they pay lower rates of interest, for borrowers in high tax brackets the bonds can actually have a higher after – tax yield than other forms of fixed income investments.

2.4     Capital market growth/performance

          A review of the performance of the Nigerian stock market will obviously highlight its roles as a place were medium to long-term securities are traded and it comprises the primary market for the issue of new securities and the secondary market where existing shares are traded. The activities and trading in this market is managed by the Nigerian stock exchange (NSE) which  evolved in 1977 from the Lagos stock exchange, established on June 5, 1961. As at end 2007, there were ten trading floors of the NSE in Lagos. Other than these, there are institutions such as the Securities and Exchange Commission (SEC), which is the regulatory authority established in 1979, issuing houses, investment advisers, portfolio managers, investment and securities tribunal (IST), the stock broking firms, registrars and other operators. The interactions among these players influence and width and the depth of the market. The evolution, reforms/legislations, structure, transaction cost and efficiency are apthy covered in CBN (2007).

          Prior to this period, trading in the market was weak, attributable mainly to low level of information dissemination and awareness. However, with computerization and availability of corporate information, number of deals, market capitalization, total value of shares traded and turnover ratio have recorded significant growth. The improvement could be attributed to the second-tier security market (SSM), deregulation of interest rates, privatization progrmame of government-owned companies, enhancement in market infrastructure and requirements, innovations as well as the banking sector reform, and on the following which include.

New issues: The contribution of the new issues market to the National Economy may be accessed through a comparison of new issues with some economic indicators such as Gross Fixed Capital Formulation (GFCF) during a given period. Capital for nation is defined as investment in fixed assets which is financed with monies varied through the capital market. Thus, new issues contributes to the stock of capital in an economy and invariably to economic development. The size of the new issues market is a major sources of funds for the acquisition of fixed assets and utilization of the Nigerian capital market by many corporate entities and government in last 25years have boosted new issues activities. The reason for this development may not be farfetched one reasons. In the capital market in comparison to that of the money market (bankers). The cost of raising funds in the capital market is usually below 10%. While that of the money market, as well all known has been fluctuating and risen a high as 35% a few year ago.

According to SEC NSE and CBN, annual total new issues before 1989 was below £41 billion, from 1989-1996, it housed between Nlbllion and N10 billion, from 1997, it crossed the NI0billion mark. It is at 2003, the figure was over N180 billion.. It rose to N522.8 billion in 2005. With the recently concluded minimum of N25 billion recapitalization exercise for banks majority had to resort to the capital market for fresh capital. They include Zenith Bank, Guaranty Trust Bank, just to mention but a few. A total N804,400.82 billion fresh fund was raised by banks in 2005 out of which N419,268.20 billion was allotted as at December, 2005.

In comparing total issues with fixed capital formation (GFCF) total new issues in 1981 represent 2.5% of Gross Fixed Capital Formation (GFCF) rose to 4.1% and later rose again to 5.2% in 2001. It recorded its highest performance in 1990 and 2003 with performance of 24.8% and 30.6% respectively. The reasons for these exceptional performances may not be farfetched. The further deregulation of interest in the money market in 1989 may have acted as money market in 1989 may have acted as catalyst on bolstering activities in the new issues segment of the capital market. This may be responsible for high performance recorded in 1990. The federal governments floating of N430,600 million bonds in year 2003, also obviously contributed to the superlative performance of the year.

In 2009, there was a hill in the primary market as indicated by the decline in the number of applications received and issues offered for public subscription reflecting the liquidity crises and investors' warning confidence in the market. The Exchange approved 30 applications for both new issues and merger/acquisitions, valued at N392,070.00 million compared with 70 applications valued at N2.6 trillion in 2008. The non-bank corporate issues accounted for 71.5% of the total new issues approved with 25 applications valued at N520 million,, while the banking sub-sector accounted for 3.6 percent with one application valued at N45.52 millions. The state government bond issued amounted to N69.5 billion, representing 24.9 percent of the total of the non-bank applications, foreign listings and insurance sub-sectors accounted respectively for N27.5 billion (9.8 percent)

No new issues was raised through initial public offer (IPO), while N314.7 billion was raised through supplementary issues. The sum of N31.7 billion was raised through rights issues and N71.7 billion through bonds issue, including four state government bonds listing by introduction accounted for N131.0 billion, while share placement took N7.4 billion four (4) applications by unit trust for memorandum listing valued at N22.8 billion were also approved during the year 2009.

New issues, when compared with the preceding five years (average), the primary market was less active during 2010, in terms of number of applications received and issue offered for public subscription. This can be attributed to the liquidity crisis and the overriding pessimism of investors. The exchange considered and approved 31 applications for new issues valued at N2.44 trillion or 9.8% of GDP, as against 30 applications for new issues valued at N520.00 millions or 1.2% of GDP in 2009. Non-banks accounted for eighteen, seven for banks and four for state bonds.

Listing by introduction accounted for N17.7 billion, mergers for N2.091 billion, public offer for N5.2 billion, rights accounted for N46.6 billion, bonds for N173.7 billion, while share placing accounted for N928 billion.

New listing in 2010 on the exchange dropped to 264 from 266 in 2009.

1.     Market  Capitalization:  A  recorded  by  the  SEC  statistical bulletin, SEC capital Nigerian Stock Exchange All-share index (NSE ASI) closed at 24950.20 points, up 85 basis points on the year and down 1.7 percent.

2.     Trading Value: In analyzing the value of   transactions in the Nigerian Stock Exchange (NSE). It was observed that from 1961-1990, government stock dominated trading value with a percentage range of 55. 91-99-55. Thereafter industrial securities

began to dominate. In terms of the overall value, from 1961-1975, the   annual value of transacting on   the   exchange was between N100 million from N600 million from 1995, the value

crossed the Nl billion market. Trading value was N1470 million and N980 million as at 2003 and 2005 respectively

3.     Turnover Ratio: The turnover ratio of transactions on the Nigerian Stock Exchange (NSE) has not been impressive over the years. In 1990, it was 11.5%, where it experienced a little rise, it remain dismal up to 2003 at 8.9%. The turnover ratio however, rose to 11.6% in 2004 but dropped to 10.1% in 2005.

In 2009, despite the  downturn experienced in the   stock market, year 2008 foreign portfolio investments stood at about N150.14 billion, representing 6.3 percent of the total turnover of the Nigerian Stock Exchange (NSE), which stood at N2.4 trillion.

When compared with the N256 billion foreign portfolio investments recorded in 2007, it was a decline in volume and concurrently. Total sales during 2008 was excess of N556.93 billion culminating in a net outflow of about N406.8 billion. It shows that foreign investors are having confidence in Nigerian economy based on their belief in the resilience of the stock market due to high returns, liquidity and safety of investment.

In all, turnover in the Nigerian Stock Exchange closed the year at N2.4 trillion or 10.4 percent of Gross Domestic Product (GDP), up by 14.04 percent on the N21 trillion (9.1 percent of GDP) recorded in 2007.

Average daily activity rose from 570.6 million shares worth N8.62 billion in 2007 to 775.65 million shares valued at N9.55 billion in 2008.

Transactions in the industrial bond sector accounted for N3.53 billion or 0.15 percent compared to N12.87 billion or 0.14 percent in 2007, with preference stocks the most active.

The federal government bonds turnover stood at Nl million, while a turnover of N10.44 trillion was recorded in 78,248 deals in the over the counter (OTC) market for federal government bonds, as against N4.13 billion in 2007. Overall, the stock exchanges turnover ratio dropped from 28.21 percent in 2007 to 21.86 percent in 2008, attributable to decline in stock prices.

The secondary market segment of the NSE recorded poor performance as there was significant capital reversal owing to low investor's confidence, following the global economic and financial crisis. A turnover volume of 102.9 billion shares was recorded, indicating a decline of 46.9 percent from the 193.1 billion shares in 2008. Similarly, a market turnover of N685.7 billion was recorded, representing a decline of 71.4 percent from the level in 2008. The bulk of transactions remained in equities, which accounted for N685.3 billion or 99.9 percent of the turnover value. Transactions in the industrial loan sub sector accounted for n412.8 million, representing 0.1 percent of the total, while the preference stocks sub-sector remained inactive of the top twenty (20) listed companies by turnover volume, the banking and insurance sub-sectors accounted for eighteen (18), while information and communication technology and conglomerate had one (1) each. The share of banks in the twenty (20) most capitalizalised stocks in the NSE was 59.0 percent.

Towards the end of the year, however, the market rebounded, owning to market corrections. Consequently, foreign portfolio investments with N229.0 billion were recorded in the preceding year (CBN Annual report, 2009).

2.5 Indicator of capital market development

in the Nigerian stock exchange

2005

2006

2007

2008

2009

Number   of      listed security

288

288

309

299.0