Identifier
Created
Classification
Origin
06NAIROBI1808
2006-04-26 14:08:00
UNCLASSIFIED
Embassy Nairobi
Cable title:  

Drought and Oil Prices Drive Kenya's Inflation

Tags:  ECON EFIN KE 
pdf how-to read a cable
VZCZCXYZ0010
PP RUEHWEB

DE RUEHNR #1808/01 1161408
ZNR UUUUU ZZH
P 261408Z APR 06
FM AMEMBASSY NAIROBI
TO RUEHC/SECSTATE WASHDC PRIORITY 1283
INFO RUEHXR/RWANDA COLLECTIVE PRIORITY
RUCPDOC/USDOC WASHDC PRIORITY 2787
RUEATRS/DEPT OF TREASURY WASHDC
UNCLAS NAIROBI 001808 

SIPDIS

DEPT FOR AF/E, AF/RSA
DEPT ALSO PASS TO USTR FOR BILL JACKSON
TREASURY FOR LUKAS KOHLER

SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN KE
SUBJECT: Drought and Oil Prices Drive Kenya's Inflation
Rate Up

REF: Nairobi 1614

Summary:
--------
UNCLAS NAIROBI 001808

SIPDIS

DEPT FOR AF/E, AF/RSA
DEPT ALSO PASS TO USTR FOR BILL JACKSON
TREASURY FOR LUKAS KOHLER

SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN KE
SUBJECT: Drought and Oil Prices Drive Kenya's Inflation
Rate Up

REF: Nairobi 1614

Summary:
--------------

1. Drought-induced food price increases and rising oil
prices caused Kenya's overall inflation rate in March 2006
to jump 19.4% compared to March 2005. This will exacerbate
poverty in Kenya, where over half the population is
unemployed and living on less than $1/day. However,
underlying inflation, which excludes volatile food and
energy, has been holding steady at about 5%. The Central
Bank of Kenya's (CBK) monetary policy appears to be
effective at keeping interest rates stable, and the
shilling has remained strong. Even if the impending rainy
season provides normal rainfall, energy and food prices
will likely continue to rise and feed inflation, and may
reduce 2006 GDP growth below the CBK's 5% forecast. End
summary

How the GOK Measures Inflation
--------------

2. The CBK and the Central Bureau of Statistics (CBS) use
several different statistics to measure inflation. The CBS
releases Consumer Price Indices (CPI) and inflation rates
on a monthly basis. The CPI is based on data collected from
selected retail outlets in 13 urban centers in the second
and third week of the month, and is believed to represent
the spending behavior of Kenyan urban households. The
Consumer Price Index is used to calculate two rates of
inflation; overall and underlying. The overall rate of
inflation includes prices for the following categories of
goods and services. The CBK calculates overall inflation
for Nairobi lower and middle/upper income groups and varies
the weighting for each category of goods and services by
income group. CBK also calculates overall inflation for
the other 12 urban centers in the survey.

Food and drink
Alcohol and tobacco
Clothing and footwear
Housing
Fuel and power (energy)
Household goods and services
Medical goods and services
Transportation and Communication
Recreation and Education
Personal Goods and services


3. The underlying rate of inflation excludes the volatile
categories of food, energy and transport/communication.
The CBK targets the underlying rate in its monetary policy
planning and implementation.


4. The CBS and CBK use changes in the CPI to calculate

several time-series measures of inflation. The titles they
use for these measures are misleading and inconsistent, and
media reports are even more so. Here are the translations.

Month-on-Month or 12-month: Actually year-on-year (YOY)
change in prices, since it compares the CPI in the current
month with the CPI in same month in the previous year.
Example: Feb 2006 month-on-month or 12-month inflation is
the change from Feb 2005 CPI to the Feb 2006 CPI. This
report will refer to this measure as YOY change.

Growth over one month: Change in CPI from the previous
month. Example: Feb 2006 growth over one month is the
change in CPI from January 2006. This report will refer to
this measure as MOM change.

Average Annual: Compares average CPI for the last 12 months
with the average CPI of the preceding 12 months. This
measure serves as the seasonally-adjusted inflation rate,
and is less volatile. Example: Average annual inflation in
Feb 2006 is the change from the average Feb 2005-Feb 2006
CPI and the average Feb 2004-Feb 2005 CPI. This report will
refer to this measure as average annual change.

Drought Pushes Overall Inflation to New Heights
-------------- --


5. Drought-induced increases in the price of food and
beverages pushed the March 2006 YOY overall inflation rate
to 19.4%, the highest YOY rate since September 2004. In
the 12 months since March 2005, food and beverage prices
have risen 29%, followed by energy at 12.6%, and alcohol

and tobacco at 10.2%. The overall inflation rate rose 1.7%
MOM in March, a smaller jump than the February 4% MOM or
January 8.7% increases. The average annual rate of
inflation, which is effectively seasonally adjusted, rose
11.36% in March. The average annual inflation rate has
been rising since December 2005, after declining in the
second half of 2005. Outside of Nairobi, March YOY
inflation was 14.5%, higher than the February increase of
11.2%.


6. Wages have not increased to match the inflation. Over
50% of Kenyans live on less than one dollar/day, and
unemployment is over 50%, so this high inflation is pushing
workers and consumers deeper into the hole, exacerbating
poverty.

Underlying Inflation Is Lower and Within CBK Target Range
-------------- --------------


7. Excluding increases in the volatile food, energy and
transportation/communication categories creates a different
picture. The average annual underlying inflation rate has
been declining since September 2005, and fell to 5.08% in
March 2006. This is within the CBK's target range for

monetary policy. Stable interest rates and the continued
strength of the shilling against the dollar indicate the
CBK monetary policy remains effective, despite the drought
and rising world oil prices.


8. In its annual monetary policy statement released in
March 2006, the CBK confirmed it would continue the policy
set in October 2005, but make the necessary adjustments to
compensate for the drought and financing of drought relief
operations by the government. CBK Governor Andrew Mullei
said the CBK maintained its 5% inflation target, would work
to ensure that the current high inflation does not
translate into inflation expectations. The target growth of
money - known as reserve money - will be at an average of 7
per cent for 2006 to keep interest rates stable and low
enough to support economic activity. The CBK controls
reserve money through sales and purchases of government
securities to commercial banks under repurchase agreements
(REPOs).


9. Making the task of controlling inflation more difficult,
electricity prices will rise 17% to 8.2/kwh shillings on
June 1. The increase is a one-year surcharge for diesel-
generated power needed to compensate for the drought-
induced shortage of hydro-electric power. Although the
supplemental generators are supposed to avoid the need for
power rationing, the increase in Kenya's already high power
costs will further degrade Kenya's international
competitiveness.

Impact on GDP Forecasts
--------------


10. The CBK's latest forecast was that overall inflation
increases would slow as the onset of the long rainy season
relieves the drought in many places and leads to increased
food production. However, Kenya Shell managing director
Patrick Obath said fuel prices were likely to increase this
year due to surging international prices. Nairobi Stock
Exchange (NSE) Chief Executive Chris Mwebesa also warned
the inflation rate was set to rise further as effects of
the drought continue to bite. Mwebesa predicted that GDP
growth rate would be reduced to 4.5-5.5% in 2006, after
growing at about 5.2% in 2005. The CBK has reduced its
2006 GDP growth estimate from 6% to 5.5% because of the
drought.

Comments
--------------


10. It is unfortunate that drought, rising food and energy
prices will make managing Kenya's economy more difficult at
a time when the GOK is struggling to deal with grand-scale
corruption scandals and politicians are increasingly
focused on the December 2007 general elections. Although
CBK Governor Mullei was recently suspended for allegedly
steering relatively small consulting contracts to his son's
firm, there is no indication yet of any change in the CBK's
management of monetary policy. (Ref A, classified.) The
long rains started on time, and have even caused flood
damage in some parts of the country. However, it is still
too soon to determine whether the rains will refill the

reservoirs behind the hydro-electric dams, will maintain
food production, and reduce the need for the GOK to provide
food assistance to the arid areas in the north and
northeast. End comment.

Table 1
Overall Inflation, 2005-2006, based on Central Bureau of
Statistics Consumer Price Index. All numbers are
percentages.

CPI MOM change YOY change Average
Annual
2005 -------------- -------------- -------------- --------------
--------------
Jan 174.4 1.28 14.87 12.1
Feb 176.1 0.97 13.94 12.43
Mar 178.6 1.42 14.15 12.91
Apr 183.4 2.69 16.02 13.62
May 184.5 0.60 14.78 14.48
Jun 182.5 -1.08 11.91 14.97
Jul 181.1 -0.75 11.77 15.21
Aug 182.1 0.53 6.96 14.41
Sept 179.4 -1.49 4.27 13.13
Oct 179.8 0.25 3.72 11.89
Nov 182.0 1.18 6.04 11.01
Dec 185.2 1.77 7.56 10.31
2006
Jan 201.3 8.68 15.39 10.41
Feb 209.3 4.01 18.87 10.88
Mar 212.8 1.66 19.14 11.36


Table 2
Underlying Inflation, 2005-2006, based on Central Bureau of
Statistics Consumer Price Index. All numbers are
percentages.

MOM change YOY change Average Annual
2005 -------------- -------------- --------------
Jan 1.32 4.93 3.64
Feb 0.32 5.21 3.86
Mar 0.28 5.31 4.09
Apr 0.48 5.9 4.41
May 0.47 6.42 4.78
Jun 0.61 5.79 5.01
Jul 0.24 5.95 5.22
Aug 0.17 5.48 5.35
Sept 0.23 5.39 5.43
Oct 0.13 4.79 5.42
Nov 0.12 4.69 5.39
Dec 2.17 4.94 5.4
2006
Jan 1.66 4.0 5.31
Feb 1.05 3.94 5.2
Mar -- 3.82 5.08

BELLAMY