Tough times ahead for Kenya as VAT on basics, oil prices bite

Saturday September 07 2013

Protesters in Nairobi demonstrate against the new VAT Bill on essential commodities. File

Kenyan consumers are headed for a rough patch with an expected surge in inflation following a new tax on basic commodities and a Middle East crisis that threatens to push up oil prices.

Global crude oil prices have risen six per cent over the past one month, raising fears over their impact on inflation and exchange rate instability.

Business executives, while expressing optimism over higher growth in 2013, see inflation rising further in the coming months.

In the Central Bank of Kenya’s Market Perceptions Survey released on Friday, banking and non-banking executives polled say the impact of the current inflationary pressures on growth is expected to be only short-term. The survey cites slow uptake of government expenditure, insecurity, instability in Middle East and North African (MENA) region, and slow recovery of the global economy as the main risks to growth.

Bank and non-bank executives polled by the CBK expect the economy to grow by 5.67 per cent and 5.63 per cent respectively this year. The majority of them expect inflation to rise to around seven per cent in the remaining part of the year.

Last month, inflation hit 6.67 per cent from 6.02 per cent.


International oil prices have been edging upwards since June, due to instability in Syria that could worsen as the US prepares to make limited military strikes on the war-torn country, which is being accused of using chemical weapons in the suburbs of Damascus, killing more than 1,000 individuals.

“While Syria is not a major oil producer, if the conflict deepens, it could impact supply channels for oil in the Middle East. Already, these fears have set oil prices rising,” said Sumayya Hassan-Athmani, chief executive officer at the National Oil Corporation, the state-backed oil marketer.

“Prices could rise to $125 per barrel if air strikes are launched and $150 per barrel if the conflict were to spread to the region, disrupting production,” she said.

Murban crude

Murban crude in the international markets was averaging $103 in June, compared with Friday’s $111 per barrel, data from the Organisation of Petroleum Exporting Countries shows.

The one-off price increases following the implementation of a new value added tax (VAT) law that came into effect from September 2, are currently filtering through the economy and are expected to push up the cost of living this month, with the poor feeling the pinch the most. Further price increases are expected as a result of rising global oil prices and poor rains predicted by the Kenya Meteorological Service.

VAT increases to 16 per cent up from 12 per cent on electricity and an additional five cents per kilowatt hour Water Resources Management Authority levy, are expected to be felt from the end of this month, further eating into the purchasing power of already struggling households.

An analysis by the CBK shows that the products that have now been roped into the 16 per cent VAT regime will carry a combined weight of 11.7 per cent of the Consumer Price Index. These goods include newspapers, textbooks, electricity, mobile phones and charcoal.

“Although we expect headline inflation to continue to rise, it should do so within a fairly narrow six to eight per cent range” said Razia Khan, Standard Chartered’s regional head of research for Africa.

“...Unless we see an escalation of spending pressures, related perhaps to devolution, eventual Eurobond issuance may lead to a reduced domestic financing requirement. More fine-tuning through liquidity operations may then be needed to keep market interest rates and the policy rate aligned. Either way, the CBR itself is seen on hold at least until the end of the year,” said Ms Khan.

According to the survey, large banks are expecting the inflation rate to average 7.6 per cent, medium banks 6.88 per cent, small banks 6.91 per cent and non-bank private firms 6.71 per cent.

The CBK survey reveals that private firms are expecting inflation to benefit from stability of the exchange rate, expectations of lower pressure on commodity prices due to slowdown in economic activity in emerging economies and the monetary policy measures in place.

On Tuesday, the Monetary Policy Committee — the CBK’s policy making organ — kept the Central Bank Rate unchanged at 8.5 per cent. Central Bank Governor Njuguna Ndung’u said the decision was informed by the fact that there were no demand-driven inflationary pressures that would require a revision of its monetary policy stance.

(Read: Uganda raises key rate as Kenya keeps it on hold)


“Inflation remained within the allowable margin of 2.5 per cent on either side of the government’s medium-term target of five per cent, while exchange rate stability was sustained,” said Prof Ndung’u.

“Following the instability in the MENA region, international oil prices rose between June and August 2013, which contributed to the increase in domestic fuel prices. Foreign exchange inflows from tea exports to the region, which account for about a third of Kenya’s tea exports, could be affected. These developments coupled with the high current account deficit remain a threat to macroeconomic stability,” said Prof Ndungu.

Business executives, the CBK survey shows, expect lending rates to remain stable or decline slightly in the remainder of 2013 due to improved liquidity. But short-term inflationary pressure and a pick-up in economic activity could exert some pressure on the interest rates, which have averaged 16-17 per cent over the past two months.

“Both supply of and demand for credit are expected to increase in the remainder of 2013 with the expected pick-up in economic activity” says the survey. “Banks expect exchange rates to remain stable, but with a tendency to weaken slightly mainly reflecting increased demand for imports with the pick-up in economic activity, slow recovery of the global economy and high current account deficit,” the survey says, adding that ongoing government initiatives to attract foreign investors and expand trade markets and resilient diaspora remittance inflows are expected to support exchange rate.

High inflation — which ordinarily erodes consumers’ spending power —has been affecting the performance of companies in the region leading to flat revenue growth.

Uchumi Supermarkets, which released it full year results for the period ended June 2013 last week, said that though there was a general decline in inflation in the East African economies, the rate was still high and this translated into lower unit consumption. The supermarkets chain posted a 30.31 per cent increase in profit after tax to Ksh357.01 million ($4.1 million) as at June 2013 compared with Ksh273.97 million ($3.2 million) as at June 2012.

Rainfall distribution

The meteorological department, in its latest assessment, said that poor distribution of rainfall may impact negatively on agricultural activities in most areas between October and December and that food security is expected to deteriorate, especially in the eastern sector of Kenya during and after the short rains.
The escalation of the crisis in Syria comes at a time when Egypt, which is the third single largest importer of Kenyan goods in Africa, is going through political turmoil. “All these things have a negative impact on the economy. They will definitely impact on economic growth, which will either slow down or remain stagnant,” said Paul Gachanja, an economics lecturer at Kenyatta University.

The CBK survey polled executives from 43 banks, eight deposit taking microfinance institutions, 58 non-bank private sector firms from Nairobi, 36 from Mombasa, Kisumu and Eldoret and 19 from Nakuru, Nyeri and Meru.