Citigroup predicts high inflation rates for three EAC neighbours in 2012

Embattled
Currency fluctuations in the region have been helped by the eurozone crisis, as euro denominated businesses sell out in favour of dollars.

Rapid rise of inflation rates across the three countries has also seen the units weaken significantly, on the back of soaring food and fuel prices.

As monetary tightening takes effect, lending rates shot up in the past year and affected domestic borrowing.

2012 is expected to bring some relief in the way of appreciation of the Uganda and Tanzania shilling especially thanks to foreign direct investments and donor funds respectively, but the Kenyan unit is likely to remain subdued due to upcoming general elections which pose a security threat, causing investors to shy off.

Even though most analysts are divided on whether the Central Bank of Kenya should cap the key policy lending rates, they seem to agree that inflation and exchange rate volatility may be here to stay and that Kenya may yet witness the highest cost of living in the region.

Those supporting retention of current rates cite the need for the market to consolidate the full impact of the rate surges without hurting borrowing even as some say high costs will scuttle economic growth.

Citi Bank in its latest report titled East Africa Macro View argues that whether the Monetary and Fiscal Policy Committee (MPC) decides to change the current interest rates or not, the problem of inflation could be here for the better part of this year.

The bank in its latest regional macroeconomic outlook says the relative currency stability that has been achieved due to sharp monetary policy tightening is not sustainable in the medium to long since it has not been matched by a significant drop in inflation.

The report predicts that the three countries Kenya Uganda and Tanzania are headed into a period of persistently high inflation this year, with Kenyans set to experience the highest cost of living which will only drop slightly after the first quarter of 2012.

Mr David Cowan , the bank’s head of research for Sub-Saharan Africa, adds that Inflation is expected to remain high for the better part of the year and start to significantly drop in the last quarter of 2012 with Kenya’s overall inflation remaining the highest of the three countries.

Kenya’s inflation is expected to be higher due to insufficient food production compared to her neighbours.

Despite the drastic measures taken by all the central banks in the region, the rate of inflation has remained stubbornly in the double digit region due to high cost of energy, a phenomenon that could persist for the better of the year depending on political climate in oil producing countries.

The bank says that due to the recent experience of rapidly weakening shillings and rising inflation in 2011, all three central banks will be cautious to loosen monetary policy too quickly in 2012 even if inflation falls back more quickly than expected.

“The challenge for East Africa central banks in 2012 is to understand the speed with which inflation will fall back in 2012 and how to respond to it,” said the Citigroup Global Markets report.

Uganda’s headline inflation dropped from 29 per cent in November to 27 per cent in December despite improved food production, but Tanzania’s hopes of lower inflation were dashed last week after fuel prices increased.

The new prices could add pressure to inflation which rose to 19.2 per cent in November from 17.9 per cent previously and dropped marginally to 18.9 per cent at the close of the year.

In effect, monetary policy in the first quarter of 2012 can perhaps be characterised as being “too tight”, or in some ways paying the price for the delayed tightening that occurred in early 2011.

Prospects of the euro zone debt crisis worsening are deepening the woes of the euro in what could add more pressure on the East African currencies as investors sell euro denominated assets in favour of the dollar.

But, for currency stability to be maintained in the medium to long term, the key is to ensure that fiscal policy is also tightened in the post election period and that funding for the currency account deficits – which will remain substantial in 2012 – is found.