Nigeria enters deflation

Nigeria has entered into deflation — but prices are still rising at 16%-per-year. Come again?

The west African country, an important oil producer which has the largest economy on the continent, gives us a perfect example to show the difference between deflation as traditionally thought of and deflation as it actually is. You see, deflation is properly defined as a contraction in the supply of money and credit in an economy — not declining prices as most people (virtually the entire world) believes.

Figures for July, show that money supply and private sector credit both declined on an annualized basis; down 1.5% for money and 1.1% for credit. As the chart below shows, money supply briefly deflated in 2013 and 2014; before that in 2004. Credit last went through a deflation in 2011.

Meanwhile, what most people think of in the context of deflation (or inflation), the Consumer Prices Index (CPI), is increasing on a year-on-year basis at 16%. Thus, an economy can be experiencing deflation and yet still have a rising CPI. This is because the level of consumer prices in an economy is driven by many factors and should, therefore, be thought of as what it is — an index of prices.

Is this just semantics or does the difference between monetary “flation” and the changes in an index of prices matter? Well, yes, it does matter, because, sometimes, examining how an economy is inflating or deflating in terms of money and credit can give us clues as to what the effect might be on other things, such as asset prices.

The chart below shows that on the previous two occasions where the Nigerian money supply rate-of-change has actually gone negative, it marked a top in the stock market.

In 2004, stocks slid by 32% in the nine months after the money supply YoY% went below zero. When the money supply YoY% went below zero in 2013, the stock market had a few months left to rally but would then see a decline of 45% in less than two years. It’s not highlighted on the chart, but when private sector credit growth registered its deflation at the start of 2011, the stock market fell 28% that year. Now, with the stock market having been on a tear since March this year, rising by 44%, and with both money supply and private sector credit registering deflation, a top in the market may be around the corner. And with the stock market being a lead indicator of the economy, that would mean some downside pressure on Gross Domestic Product (GDP).

Nigeria has just emerged from five straight quarters of GDP contraction, the worst slump in 25 years. The message from money and credit deflation, though, is that it may be a little early to celebrate.