KENYA CRISIS AFTERMATH: INFLATION SOARS, CONSUMERS AND

UNCLAS NAIROBI 000970

SIPDIS

SENSITIVE

DEPT FOR AF/E, AF/EPS, EEB/IFD/OMA,
DEPT ALSO PASS TO USTR FOR BILL JACKSON
TREASURY FOR VIRGINIA BRANDON
COMMERCE FOR BECKY ERKUL

SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN EAGR ENRG KE
SUBJECT: KENYA CRISIS AFTERMATH: INFLATION SOARS, CONSUMERS AND
PRODUCERS SUFFER

REF: A. NAIROBI 762, B. NAIROBI 414

SENSITIVE BUT UNCLASSIFIED. FOR USG USE ONLY.


1. (U) Summary: Driven mainly by food prices, seasonally adjusted
overall annual inflation in Kenya rose to a record 12% in March, and
underlying inflation continued to rise well above the target ceiling
rate of 5%. Food prices rose 4.3% from February to March alone, as
the aftermath of the crisis boosted the costs of fuel, farm inputs
and transportation. Meanwhile, the displacement of farmers from the
northern Rift Valley has led to forecasts of lower food production,
boosting prices further. Low-income consumers are most impacted,
but big increases in transportation and fuel prices hit all
consumers and producers. Western areas of Kenya that experienced
the worst violence face greater shortages and higher inflation.
Local analysts warn that rising global oil and food prices are
likely to keep inflation high throughout 2008. On the plus side,
interest rates have not yet risen significantly and wage increases
continue to lag well behind prices. Senior Government of Kenya
officials have finally reduced their 2008 growth forecasts to
4.5%-6%. However, investors continue to seek Safaricom shares and
buy long-term government bonds. High inflation is helping to fuel
protests against the costs of an expanded coalition cabinet. End
summary.

March Inflation Hits Record Levels
--------------

2. (U) Overall inflation rose 21.8% year-on-year (YOY) in March
2008, the highest rate since 1994, while seasonally adjusted
(average annual) inflation rose to a record 12%. The underlying
inflation rate, which excludes volatile food, energy and
transportation prices, rose 7% YOY and a seasonally adjusted 5.5%,
continuing to climb above the Central Bank of Kenya's (CBK) 5%
target ceiling for money supply management. The 28.8% YOY increase
and the 4.3% increase in food prices from February to March (MOM)
were stunning demonstrations of the impact of the post-election
violence and global markets on Kenya. Transport and communications
and fuel and power prices rose 19.1% and 15.6% YOY in March
respectively, but were only slightly changed from February levels --
see tables 1 and 2 below. The CBK's normally understated weekly
bulletin took a more ominous tone on April 4: "Increasing food
prices and high and rising prices of fuel and power continue to be
the major threat to price stability and the cost of living."

Table 1: March 2008 Overall Month on Month (MOM) and YOY Inflation,
not seasonally adjusted:

Item Group MOM change YOY Change
-------------- --------------
Food & Non-alcoholic drinks . . 4.3% . . 28.8%
Transport & Communication . . -0.1% . . . 19.1%
Fuel & Power . . . . . . 0.7% . . . 15.6%
Alcohol & Tobacco . . . . 0.7% . . . 14.2%
Medical Goods and Services . . 0.3% . . . 8.0%
Household Goods & Services . . 1.1% . . . 7.6%
Recreation & Education . . . 0.1% . . . 6.7%
Housing Costs . . . . . . 0.7% . . . 6.2%
Personal Goods . . . . . . 0.8% . . . 5.7%
Clothing & Footwear . . . . 0.9% . . . 4.8%
Average all Groups . . . . 3.1 . . . 21.8%


1st Quarter Inflation Also Very High
--------------

3. (U) March inflation reflects a rapidly rising trend through the
whole first quarter for all item groups, but food, fuel and power,
transport and communication continue to lead the way, followed by
alcohol and tobacco and housing. The consumer price index (CPI) has
risen 14.5% since the end of December, the biggest quarterly jump
since the severe drought of 2006.

Table 2 Q1 2008 overall inflation YOY % Changes:
Item Group Jan Feb Mar Q1 average
-------------- --------------
Food and Non-
Alcoholic Drink.. 24.6% . 24.9% . 28.2% . 25.9%
Fuel & Power .... 10.6% . 14.1% . 15.6% . 13.4%
Transport &
Communication ... 17.8% . 18.5% . 19.1% . 18.5%
Housing .......... 5.2% .. 5.9% .. 6.2% .. 5.8%
Medical goods
& Services ....... 3.6% .. 7.7% .. 8.0% .. 6.4%

Alcohol & Tobacco 12.8% . 14.1% 14.2% .. 13.7%
Source: Kenya National Bureau of Statistics


4. (U) Inflation across income groups and geographic areas also rose
sharply. The Nairobi lower income group continues to face the
highest inflation rate, reaching 23.2% YOY in March. However, the
other Kenyan towns in the survey are catching up: their prices rose
22% YOY in March. Please see Table 3. After rising about 12% YOY
in 2007, overall inflation in the first quarter of 2008 for the
Nairobi lower income averaged 20.5%. Inflation in Kenya's other
urban centers similarly jumped from a 2007 average of about 11.5% to
20.2% in the first quarter of 2008. However, prices for the Nairobi
upper income group, for whom food represents a much smaller share of
income, rose from a 2007 average of about 9% to only 10.8% in the
first quarter.


Q1 2008 overall inflation YOY % Changes
Item Group Jan Feb Mar Q1 average
-------------- --------------
Nairobi Lower
Income ...........19.9% . 18.3% .. 23.2% .. 20.5%
Nairobi upper
Income ........... 9.6% . 10.1% .. 12.5% .. 10.8%
Rest of Urban
Centers ......... 18.2% . 20.6% .. 22.0% .. 20.2%
Source: Central Bank of Kenya.


Food, Oil Prices Will Continue to Rise and Raise Others
-------------- --------------

5. (U) Food inflation is expected to persist through 2008 because of
production shortfalls, even if the rains are good. The
post-election violence drove thousands of farmers from their Rift
Valley homes, and prevented most from planting the next crop. The
destruction of many farm supply outlets and the expulsion of
middlemen has reduced the availability of seed, fuel and fertilizer
and restricted the amount of land the remaining farmers can afford
to plant. Fuel costs for land preparation have risen 92% to Sh2,300
($37) per acre. Fertilizer prices have risen 122% to over
Sh4,000/50kg bag ($64),reflecting global price increases.
Transportation costs have risen up to 25%, and will likely continue
to rise due to high global fuel prices.


6. (U) The Agriculture and Rural Development Group (ARDG) predicts
agricultural production in 2008 will fall as much as 40% below
average. An estimated 207,000 tons of grain in the fertile Rift
Valley were destroyed during the violence. The National Cereals and
Produce Board's (NCPB) maize stocks fell to 2.07 million tons by the
end of March. Kenya requires about 3 million tons of grain per
year, and production is expected to fall short by about 930,000
tons, requiring either increased imports, or drawing down stocks
well below the preferred level.


7. (U) The average retail price for unleaded fuel in Nairobi rose
from Sh84/liter in December to Sh95 by the end of March. In Nyanza,
Western and Rift Valley provinces, where the violence and road
attacks were worst, unleaded fuel prices are Sh150 to Sh200/liter
($2.42-$3.22). Kenya Shell Managing Director Patrick Obath said,
"Don't expect fuel prices to come down due to the volatile crude
prices." Kenyans fear they will soon see Sh100/liter prices
($6.50/gallon),which would also be reflected in higher prices for
other goods and services. Tabitha Runyora, a market analyst with
the Kenya Horticultural Development Program said, "Kenyans should
brace for higher prices throughout this year. Charles Ocholla, the
Investment Banking Manager at Suntra Investment Bank, warned "I
foresee inflation rates hitting 25% by the second half of this
year."


8. (U) Power prices rose in March, as the cost of consuming 50 kwh
went up by 10.7% to KSh. 315.38 due to increases in fuel costs and
foreign exchange adjustments, and more increases are likely in 2008.
The Kenya Electricity Generating Company (KenGen) and the Kenya
Power and Lighting Company (KPLC) have applied to the Electricity
Regulatory Commission (ERC) for tariff increases in July to cover
rising costs of generating, purchasing, and distributing power, and
to fund investments in new power plants. The two firms proposed
tariff increases of 60-171% for individual consumers, and zero to
40% for commercial and industrial consumers.

CBK Governor Sees Supply Problem, Not Monetary Issue
-------------- --------------


9. (U) CBK Governor Njuguna Ndung'u told the press that the high
inflation was a seasonal supply problem driven by fundamentals and
exacerbated by political shocks, rather than a monetary problem.
Although the underlying inflation rate crossed the CBK's 5% target
ceiling in October and has continued climbing steadily, he did not
offer any change in the CBK's policies of trying to mop up excess
liquidity, or caution the government about increased spending on the
Cabinet or recovery assistance. Ndung'u simply warned savings
account depositors earning 4% annually that their savings would
decline against the 5-7% underlying inflation rate. He encouraged
Kenyans to consider using unit trusts to invest in the Nairobi Stock
Exchange (NSE) to increase their returns and safeguard their initial
investments.

Interest Rates Rise Slightly
--------------

10. (U) Interest rates have not yet responded much to the high
inflation rates. The March 30 and April 7 T-Bill auctions were
undersubscribed, as investors focused on the Safaricom IPO (ref A).
The average 91-day T-bill rate rose from 6.89% on March 30 to 6.98%
on April 7, while the average 182-day T-bill rate increased from
7.81% to 7.94%. Average interbank rates increased from 6.37% to
6.43% during the week ending April 3, 2008, but the repo rate
remained stable at 6.45% during the week. Investors showed strong
interest in longer-term government paper, overbidding the offer of
Sh7 billion (about $113 million) of 15-year Government bonds by 31%
despite a three basis point decline in its yield to 13.1% from
November last year. Suntra Investment Bank, Manager Charles Ocholla
attributed the demand to insurance companies and fund managers
seeking long term assets to match their long term liabilities.

GOK Officials Finally Cut Growth Forecasts
--------------

11. (U) Finance Minister Amos Kimunya and CBK Governor Njuguna
Ndung'u recently tempered their previous rosy claims that the
economy would still grow 6% in 2008. They both publicly
acknowledged the crisis would cut growth economic growth to the 4.5%
- 6% range. The GOK has not yet published tax revenue figures for
February or March, making it difficult to determine what resources
it is likely to have to fund reconstruction and government expenses.


Comment
--------------

12. (U) The increased price of staples, including food, transport,
soap, and kerosene put great stress on households, many of which are
facing reduced income or unemployment, forcing hard choices between
eating, rent, and their childrens' education. Wages for the
majority of workers have not kept pace, and it is uncertain whether
the government will announce an increase in the minimum wage on May

1. This trend could greatly undermine the GOK's poverty reduction
efforts. However, investors lined up to buy Safaricom shares or
15-year Treasury bonds have not lost confidence in Kenya's future.


13. (SBU) Almost half of Kenyans lived in poverty before the crisis
destroyed many small businesses, drove away tourists, and put
hundreds of thousands out of work. Volatile western Kenya, where
support for the opposition ODM party and PM-designate Raila Odinga
is greatest, is facing both a higher incidence of poverty and higher
inflation. These conditions are helping to fuel civil society's
opposition to the costs of proposals for an expanded coalition
cabinet. While this puts pressure on the two sides to reach an
agreement before the economy gets worse, it would be more difficult
to reach agreement on a smaller cabinet with fewer patronage
positions.

RANNEBERGER