Inflation is easing but is Kenya out of the woods?

Inflation is always a concern for everyone, given its impact on purchasing power when driven by the most essential goods, such as food and fuel.

Kenya experienced a deceleration in food inflation for the past two consecutive months, leading overall inflation to slow to more than a year low.

According to the figures reported by the Kenya National Bureau of Statistics (KNBS) for August, overall annual inflation fell to 6.7 per cent compared to 7.3 per cent in July and 7.9 per cent in June.

The drop in inflation was attributed to improved rain levels, which positively impacted Kenya's agricultural harvests. It played a significant role in mitigating the impact of rising fuel prices.

Inflation in Kenya has been driven primarily by rising food prices - due mainly to the poor performance of the agricultural sector caused by inadequate rainfall. Additionally, the removal of fuel subsidies contributed to the rise in fuel prices and a weaker shilling, increasing overall inflation.

The slower inflation reading in August meant that inflation fell within the Central Bank of Kenya's (CBK) target of 7.5 per cent for the second time in a year. Our base case is for inflation to remain sticky around the 8.0 per cent mark, in light of a weakening Kenya Shilling and recent fiscal measures that included doubling VAT from eight per cent to 16 per cent on petroleum, kerosene, aviation and jet fuel.

According to our estimates, the shilling should trade from 150 to 155 to the dollar by the end of 2023. Currently, according to CBK figures, the exchange rate is 144 per dollar. We think further weakening is needed to regain economic competitiveness and stabilise the external sector.

Despite its continued depreciation over the past four years, the shilling remains overvalued, according to our estimates. A further decline in its value is necessary, as Kenya's foreign exchange reserves remain under pressure, partly due to upcoming debt obligations.

Specifically, Kenya faces a Eurobond repayment of $2 billion (Sh290 billion) due in mid-2024. The country's external funding conditions remain constrained amidst global elevated interest rates and limited access to funding for emerging and frontier economies. (Continues Pg8)

The weakening shilling is part of the inflation equation. It weakened over the past four years and lost approximately 30 per cent of its value. Relative to other frontier and emerging market currencies, the shilling has been stable for a few years while other currencies have weakened.

Most recently, the sharp rise in commodity prices (the price of sugar, for instance, has doubled) in 2021-22 in a post-pandemic recovery resulted in the current account deficit widening (Kenya had to pay more to import commodities such sugar, rice, oil and wheat), leading to increased pressure on foreign exchange (FX) reserves.

The burden intensified when the US Federal Reserve tightened its monetary policy, leading emerging and frontier economies, including Kenya, to borrow from global markets at higher interest rates. The shilling had to weaken (the same goes for other emerging and frontier currencies) due to limited foreign financing, wider trade deficits, and eroding FX reserves.

So, how should the public protect themselves against the rising inflation? People need to hold assets, including equities and real estate, whose value will rise and protect them from rising inflation.

Given the positive real yields they offer; government treasuries are attractive investments. In other words, these treasury yields are much higher than inflation, protecting your savings.

Holding some foreign currency within your portfolio is also essential since interest rates on the USD are at their highest level in decades.

The writer is head of Macro-Economic Analysis at EFG Hermes Research