New VAT measures drive inflation to a 15-month high

Consumer good prices rose at the highest rate in 15 months driven by introduction of value added tax (VAT) on previously exempt and zero-rated goods, according to official figures released on Monday.

Inflation, the rate at which the price of a select basket of goods rises, hit the 8.29 per cent mark in September from 6.67 per cent the previous month mainly driven by the near three per cent rise in the prices of food and non-alcoholic beverages that account for 36 per cent of the basket of goods used to measure the price changes or the Consumer Price Index (CPI).

The Kenya National Bureau of Statistics (KNBS) said imposition of VAT on a large number of consumer goods and seasonal factors affecting supply of common food crops were the main causes of the rise in the cost of living.

Prices of food and non-alcoholic beverages rose at the rate of 2.87 per cent followed by a 2.29 per cent rise in the prices of alcoholic beverages and tobacco.

Consumers also had to contend with significant price escalation in key household expenditure areas such as housing, electricity and gas. 

The government picked September 2 as the effective date for the new law that imposed VAT on a wide range of items, including bread, milk, books, newspapers, transport, petroleum and paraffin, setting off a wave of consumer price increases.

(READ: Tough time for consumers as Treasury rolls out VAT law)

The price of milk rose by the largest margin of Sh10 for a 500ml packet to an average of Sh57.43 last month or 22.1 per cent higher than the retail price of Sh47 in August. Newspapers came in second with a 20 per cent rise to Sh60 in the same period.

KNBS said 50 units of electricity rose 6.6 per cent to Sh603.7 from Sh566.5 the previous month.

Economists expect the wave of consumer price increases to have double impact of hurting aggregate demand for goods and services as well as spark demand for higher wages, saddling businesses with the twin challenges of slow revenues and higher operating costs.

Businesses have traditionally responded to similar challenges by cutting back their workforce or freezing new hiring.

Economic growth is also expected to suffer from the persistent high interest rate regime that discourages new borrowing for investment and consumption.

Interest on government debt — which acts as a reference for commercial bank loans — is expected to rise in tandem with higher cost of living as investors demand inflation-beating yields.

Banks are currently charging an average base lending rate of 17 per cent, down from 20 per cent last year but still significantly higher than lows of 13 per cent in early 2011.

High interest rates have the effect of raising costs for existing borrowers and delaying new investments as businesses wait for more favourable credit terms.

“The government has a delicate job of balancing the objectives of economic growth and price stability,” said Gerrishon Ikiara, an economics lecturer at University of Nairobi.

Mr Ikiara said he expects the Central Bank of Kenya to raise its signal lending rate to tame prices if VAT continues to be a major driver of inflation in the coming months.

He however argues that higher taxation is a necessary short term pain that will be compensated for by long-term economic growth as the state invests in infrastructure projects.

The new tax measures are expected to boost government’s revenue by more than Sh10 billion in the current financial year and help fund a record Sh1.6 trillion budget that came with a Sh356.9 billion deficit.

Total government receipts in the three months to September stood at Sh148.4 billion or 11.6 per cent of the target for the full year ending June 2014. More than 400 items were last month removed from the list of tax exempt goods.

The tax is charged on a product whenever value is added at any stage of the production chain.

Analysts expect demand for both essential and non-essential goods to slow down as consumers seek to balance their budgets in the wake of the all-round price increases.

Kenya Dairy Board was the first to sound alarm over high milk prices that went up ostensibly on account of the new VAT law.

The statutory body said it expected demand for packaged milk to fall substantially in favour of unprocessed milk sold through informal channels.

Kenya Revenue Authority (KRA) has since clarified that pasteurized milk remains exempt from VAT, a move that has seen the price of a 500ml packet revert to Sh45.

Connoisseurs of non-essential goods are now paying more under the new law, with consumption of such items expected to be dominated by the relatively small number of households with large discretionary spending power.