The role of interest rate in the determination of investment and, hence economic growth, has been a matter of controversy over a long period of time. Yet, what constitutes an approoriate interest rate policy still remain to be a puzzling question. | Resource Mobilization Financial Liberalization and Investment The Case of Some African Countries Mohammed Nureldin Hussain Nadir Mohammed and Elwathig M. Kameir Introduction The role of interest rate in the determination of investment and hence economic growth has been a matter of controversy over a long period of time. Yet what constitutes an appropriate interest rate policy still remains to be a puzzling question. Until the early 1970s the main line of argument was that because the interest rate represents the cost of capital low interest rates will encourage the acquisition of physical capital investment and promotes economic growth. Thus during that era the policy of low real interest rate was adopted by many countries including the developing countries of Africa. This position was however challenged by what is now known as the orthodox financial liberalization theory. The orthodox approach to financial liberalization McKinnon-Kapur and the broader McKinnon-Shaw hypothesis suggests that high positive real interest rates will encourage saving. This will lead in turn to more investment and economic growth on the classical assumption that prior saving is necessary for investment. The orthodox approach brought into focus not only the relationship between investment and real interest rate but also the relationship between the real interest rate and saving. It is argued that financial repression which is often associated with negative real deposit rates leads to the withdrawal of funds from the banking sector. The reduction in credit availability it is argued would reduce actual investment and hinders growth. Because of this complementarity between saving and investment the basic teaching of the orthodox approach is to free deposit rates. Positive real interest rates will encourage saving and the increased liabilities of the banking system will oblige financial institutions to lend more resources for productive investment in a more efficient way. Higher loan rates .
