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Inflationary spiral hits economy

Creeping inflation is threatening to scuttle the much-anticipated economic recovery in Kenya.
18 October 2004 - Deremo Maiko

Almost two years since the new government took the reins from the Kenya African National Union [KANU] regime, Kenyans are experiencing the highest inflation rate ever since the days of Goldenberg money-printing scandal of the early ‘90s.

The month-on-month inflation has hit a worrying 16 per cent, sending alarms in business circles and the donor community. This overall inflation measure includes the impact on food and oil prices. For a country where some 56 per cent of the rural population lives under the poverty line, this certainly worries the economic planners especially for its stability implication.

There are obvious reasons why inflation should assume an upward trend. One is the global oil prices, which have in recent weeks threatened to breach through the $50 to the barrel. Localised though is the food factor: In what looks like a cyclical affair (covering for years) Kenya has been heavily affected by a drought-inspired famine that has resulted in heavy imports of food commodities from the region and beyond.

The impact of both has been the depreciation of the Kenya shilling against the hard currencies.
Add to this scenario the fact that the government has consciously opted to bring down the general interest rates. This needs more explanation. When the new rulers came to power in 2003, the interest rates were high as the KANU government withstood a donor boycott by borrowing in the domestic market to cover for the resulting deficit.

The new National Rainbow Coalition [NARC] administration, acting on promises of over $4.1 billion in donor funding covering four years, decided to bring down the rates—a double-edged sword also meant to bring down the rate of private borrowing and the government’s cost of borrowing.

The donors never came in the force they had promised as allegations of corruption quickly surfaced. The NARC government last month agreed with the International Monetary Fund, in exchange of fresh funding, that they had to resort to the domestic markets for funding as the pledges fell way above what is forthcoming. This practically means that over and above the Sh22 billion ($255 million) targeted for lifting from the domestic market, another Sh10 billion ($125 million) would be fetched there.

Understandably, this measure is also meant to reduce liquidity in the domestic market and pressure up the rate of interest. According to local analysts, the low rate of interest and high liquidity in the banking system (spawned by low effective demand rate for credit in the money markets) has been one cause of the currency depreciation and inflation.

IMF said that the apparently expansionary monetary regime had resulted in 13 per cent increase in the total money quantity—called aggregate monetary supply by central bankers. Despite the said concern by the Bretton Woods institution, the critical underlying inflation—driven by changes in money supply—has remained below the target of 3.5 per cent. An interesting argument by Washington has been that the low rates of interest have tended to represent a distortion of the macro-economy.

How successful the new measures will be in controlling the general price surge remains to be seen. For one, it is clear that inflation pressure is imported through oil, a fact that has made the economy grow at a sluggish 2 per cent. But with the drought set to end with the short rains in November, it is certain that some of the inflationary pressure will ebb. Whether this will quickly affect the borrowing rates is another matter altogether.

Kenyans who have rushed to take the bank personal loan and consumer lending loans are quite worried about monetary squeeze as advised by the donors. The banks in the country normally reserve the right to increase lending rates on already advanced loans.

Inflation is not a new phenomenon to Kenyans. In 1993, it is estimated to have hit 105 per cent as the KANU government engaged in various monetary indiscretions to fund the 1992 multiparty elections. However, a new Central Bank governor Micah Cheserem under the tutelage of the Bretton Woods engaged in a mop up operation that left the market dry. Tight monetary policy was the operating word until last year. In that way inflation was contained through high rates. The flipside is that liquidity in the bank industry built up as no one was borrowing—what with huge default rates haunting the banking industry.

At the end of the day, stabilisation of oil supply from the Gulf, Nigeria and Russia will be the major determinant of Kenya’s growth and macro-economic price levels. In the meanwhile, the money markets pricing benchmark, the 91-day Treasury bill continued surging above 3 per cent with local media reports indicating the Bretton Woods were in favour of 5 per cent. Whatever the rate, it is certain that the East African country is in for a tough time.

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