Inflation, shilling depreciation big threat to economy

Written by on 30 May 2022

Kenya’s economy has been facing a worsening case of inflation over several months now. Central Bank of Kenya (CBK) statistics show that inflation accelerated from 5.39 per cent in January 2022 to 6.47 per cent in April 2022.

All indicators are that the situation is getting worse, with the International Monetary Fund (IMF) forecasting that Kenya’s inflation rate for the year 2022 will be 7.2 per cent.

Inflation has combined with a rapidly depreciating shilling, which has lost ground from Sh113 to the dollar in January, to the current Sh116…and dropping. In June 2021, the shilling was trading at Sh109 to the dollar.

These two have combined to become a lethal cocktail that is capable of putting the economy into a spin that can derail the ongoing economic recovery. Runaway inflation can turn an economy into a basket case very quickly, with a country’s currency becoming worthless, and basic goods out of reach of the ordinary mwananchi. This has happened to several countries in Africa. Zimbabwe and Somalia come to mind.

Inflation is defined as a persistent rise in costs of goods and services in an economy in a given period. The current inflation has been attributed to several factors.

Prices of food have been on an upward trajectory. With the current unpredictable weather pattern, there is no guarantee of a bumper harvest that would bring prices down.

Prices of fuel have also been on an upward trajectory. The war in the Ukraine where Russia launched a military invasion have caused supply jitters, leading to a spike in global fuel prices.

Kenya has tried to temper the impact of rising prices through a subsidy on local pump prices, but the impact remains muted. It is questionable whether the fuel subsidy can be maintained for long.

The depreciation of the shilling is causing a cost push. As the shilling depreciates, imports  cost more since it now takes more shillings to buy the same quantity of goods or services from abroad. This reflects locally in increased prices of goods.

The government has also announced a raft of taxation measures on basic commodities. This includes imposition of tax on maize and wheat flour suppliers, as well as cassava, all inputs used to produce Kenya’s staple foods.

If these proposals are passed by Parliament, the manufacturers of these foods will have little alternative but pass on the extra cost to the consumer. This can easily lead to a spiral effect.

There is already a standoff between LPG importers and the government. The prices of LPG started on an upward trajectory when the government slapped 16 per cent VAT on the commodity. The price of 13kg cylinder has risen from Sh2,000 in January 2021 to Sh3,500 in some outlets in May 2022, a 75 per cent increase.

Suppliers say another tax on imported LPG has been imposed at the border, and they have no choice but to pass it onto the customer. Suppliers have parked their trucks at border points in protest at the new taxes.

The worst thing about inflation and its impact on economic recovery is that the CBK fights inflation by controlling money supply. It, therefore, tightens monetary policy, making it more difficult for banks to lend, as well as mopping up “excess liquidity,’ which leaves the economy gasping for air.

There is a very delicate balance which, if not well managed, can throw the economy into a recession.

Worse, as life becomes harder due to both high cost of living and the measures imposed to control it, there is a real risk of social instability. Governments, and central banks, are therefore, very wary about inflation. This is one of the most critically watched economic indicators.

Kenya has a tightrope to walk. Too stringent anti-inflation measures and the economy goes into recession; and failure to take adequately robust measures to control it will result in the economy going into a tailspin. It is times like this when the CBK governor and the Cabinet Secretary for the Treasury earn their money.

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