Ideas & Debate

Kenya should do more to tackle high inflation

A trader at his grocery store at the Top Market in Nakuru. FILE PHOTO | NMG
A trader at his grocery store at the Top Market in Nakuru. FILE PHOTO | NMG 

Kenya’s current macroeconomic conditions have left policymakers in a dilemma. Stewards of macro-economic outcomes are caught between slowing growth and persistently high inflation.

That no one single policy tool can simultaneously address both concerns is obvious. To be sure, if interest rates were increased to contain inflation, economic prospects would weaken further.

If lowered, interest rates could boost growth with the risk of fuelling inflationary pressures. Inflation, which measures the overall change in commodity prices, has been on an upward trajectory for the last five months.

In May, food prices hit a record high propelling inflation to 11.7 per cent. The fact that current economic production is unable to catch up with demand could be a result of several factors, including the prevailing harsh weather conditions.

This may be augmented by the lack of policies that allow for adequate and timely response to these adversities.

According to the Meteorological Department, May marked the cessation of the depressed and poorly distributed long rains over most parts of the country.

Already expectations for this year’s harvest have significantly deteriorated due to the combination of poor weather and the armyworm infestation. The fragile outlook could potentially fuel speculation on future food prices sustaining the high cost. On a brighter note, supply-driven inflation has historically proven to be temporary. However, the ability of these transitory pressures to persist cannot be gainsaid.

For instance, higher wages aimed at cushioning consumers could potentially revive demand for some goods sustaining the upward push on prices. Moreover, it has also been verified that inflation expectations are major determinants of inflation. When insufficiently anchored, restoring confidence in the institutional ability to manage future inflation may be difficult, occasionally triggering runaway inflation.

Yield curve

Expectations have been fairly elevated since late last year when the drought was confirmed.

In a normal market, inflation expectations could be deduced from the shape and characteristics of the yield curve.

This is because the curve incorporates expectations of future events, particularly developments around inflation.

The change in slope is a fairly good predictor of the adjustment in inflation expectations over a given period of time.

Over the last four months, yields have been fairly sticky across the curve suggesting that the slope of the curve and by extension overall expectations remain somewhat unchanged.

Even so, the current curve may not provide a perfect measure of inflation expectations given the effect of interest rate controls on yields.

Meanwhile, the mandate to contain inflation rests primarily with the central bank. That said, its emphasis on recent inflation developments has been unsatisfactory perhaps justified by the transitory nature of the current supply side constraints.

Yet, the central bank’s rhetoric has been proven effective in managing inflation expectations. When left purely to the markets, potential speculation is adequate to keep pressure mounting.

Certainly, the recent deflationary measures announced by the government are welcome. Maize meal subsidies have become popular. But how much is maize flour as a percentage of the inflation basket?

Elevated expectations

Just about 3.4 per cent. If you include milk and sugar this adds up to 9.5 per cent. Ideally, for inflation to considerably come down, it’s imperative that focus widens to other commodities which may already be inflated by elevated expectations.

That said, subsidies are costly and especially for an economy running a nine per cent fiscal deficit, and therefore not sustainable. The government is spending and at the same time foregoing tax revenues on subsidised commodities including maize flour, bread and electricity for the low end consumers.

The radical changes in global climate conditions suggest that food security will remain vulnerable, not only in Kenya but across the region.

Indeed, the drought has affected the entire region but the food situation has been better managed in Uganda and Tanzania where inflation has remained fairly tame at about 6.5 per cent.

Undoubtedly, there is need to strengthen the national capacity to deal with food insecurity through deliberate, appropriate and effective policies. This may require stronger food reserves, more investment in research and development as well as agricultural innovations.