VZCZCXYZ0000
PP RUEHWEB

DE RUEHNR #0468/01 0260930
ZNR UUUUU ZZH
P 260930Z JAN 07
FM AMEMBASSY NAIROBI
TO RUEHC/SECSTATE WASHDC PRIORITY 7029
INFO RUEHXR/RWANDA COLLECTIVE PRIORITY
RUCPDOC/USDOC WASHDC PRIORITY 2905
RUEATRS/DEPT OF TREASURY WASHDC

UNCLAS NAIROBI 000468 
 
SIPDIS 
 
DEPT FOR AF/E, AF/RSA 
DEPT ALSO PASS TO USTR FOR BILL JACKSON 
TREASURY FOR VIRGINIA BRANDON 
 
SIPDIS 
 
E.O. 12958:  N/A 
TAGS: ECON EFIN EAGR KE
SUBJECT: KENYA: HIGH INFLATION HITS POOR URBAN RESIDENTS HARDEST 
 
REF: 2006 NAIROBI 4378 
 
¶1. Summary: Driven mainly by food and fuel prices, overall inflation 
in Kenya rose sharply in the last quarter of 2006, most heavily 
impacting poor residents of Nairobi and other urban centers.  The 
Central Bank of Kenya (CBK) expects overall inflation to stabilize 
in 2007, but similar expectations did not pan out in 2006. 
Underlying inflation, which excludes food, energy and 
transportation, remained well below the CBK's 5% target for money 
supply management.  However, the CBK planned to decelerate growth of 
reserve money and money supply to further dampen underlying 
inflation pressures and perhaps reduce overall inflation. Based on 
leading indicators, the CBK raised its 2006 growth forecast from 
5.8% to 6%, and predicts similar growth in 2007.  Overall, the GOK's 
macro-economic management in 2006 has been successful, but rising 
food prices for the urban poor could become a destabilizing 
socio-political factor in an election year.  End summary. 
 
How the GOK Measures Inflation 
------------------------------ 
¶2. On a monthly basis, the Central Bureau of Statistics (CBS) 
releases Consumer Price Indices (CPI) and inflation rates for 
Nairobi and 12 other urban centers, and for lower and upper income 
groups in Nairobi.  The "overall" (headline) inflation rate is based 
on prices for 10 categories of goods and services.  The CBS measures 
"underlying" (core) inflation by removing the volatile categories of 
food and energy, but the Central Bank of Kenya (CBK) also removes 
transportation, since it relies so heavily on energy prices.  The 
CBK uses its underlying rate in its monetary policy planning and 
implementation. 
 
¶3. The labels the CBS, CBK, and media use for time series inflation 
measures are thus misleading and inconsistent.  Here are the 
translations. 
 
Month-on-Month or 12-month: Actually year-on-year (YOY) change in 
prices, since it compares the CPI in the current month with the CPI 
in same month in the previous year. 
 
Average Annual: Compares average CPI for the last 12 months with the 
average CPI of the preceding 12 months.  This measure serves as the 
seasonally-adjusted inflation rate, and is less volatile. 
 
Overall Inflation Measures Peak in December 2006 
--------------------------------------------- ---- 
¶4. Starting in August, food and fuel price increases accelerated, 
driving the CPI and overall inflation up.  YOY overall inflation 
rose from 11.5% in August to 15.6% in December.  Average annual 
inflation jumped from 11.4% in August to 14.5% in December.  The CBS 
noted that food prices in December 2006 rose 22.6% YOY, followed by 
energy prices at 13.5%, alcohol and tobacco at 7%, transportation 
and communication at 6.5%, and housing at 6%.  Prices in the other 
five categories rose 2%-5%.  The CBK expects overall inflation to 
stabilize at about 12% in 2007 if the next rainy season is good, 
international oil prices do not increase, and the shilling continues 
to strengthen against the dollar.  However, the press reports that 
the main two political parties have lined up Ksh7 billion (about 
US$100 million) for this year's general election campaigns. 
Campaign spending, plus the usual political patronage projects, will 
increase the inflationary pressures the CBK is trying to contain. 
 
¶5. The price increases hit low income consumers in Nairobi hardest, 
since CBS weights food expenditure at 56% of their expenditure.  In 
December, overall inflation for the Nairobi low income group was 
19.2% YOY, while middle and upper income group inflation was only 
6.4%.  In the other urban centers, overall inflation in December was 
14.7% YOY.  CBS does not yet survey prices in the rural areas, where 
the majority of the population resides, but staple food prices 
probably did not rise as much as in Nairobi, since rainy season 
flood damage to the roads may have boosted local supply by hindering 
shipments to urban centers. 
 
¶6. In trying to manage the money supply to control inflation, the 
CBK continues to face the challenge of a high level of remittances, 
many through informal channels, from expatriate Kenyans.  One source 
claimed the absence of banking services in South Sudan also caused 
large dollar inflows, but it was not clear whether these were 
converted to shillings or used for offshore transactions.  The CBK 
maintained the Central Bank Rate (CBR) at 10% and planned to 
decelerate growth of reserve money and money supply to dampen 
underlying inflation pressures.  Interest rates remained largely 
stable in the last quarter of 2006. 
 
Underlying Inflation Falling Slowly 
-------------------------------------- 
¶7. The CBK's underlying inflation rate, which excludes food, energy, 
and transport and communications because of their volatility, fell 
slightly in December to 4.3% YOY.  Average annual underlying 
inflation (seasonally adjusted) declined steadily in 2006, falling 
to 3.9% YOY in December.  The CBK therefore feels it has inflation 
largely under control. 
 
CBK Raises Growth Estimate for 2006 
------------------------------------ 
¶8. Based on leading indicators, the CBK raised its 2006 growth 
forecast from 5.8% to 6%.  It attributed the strong growth to 
macroeconomic stability and improved performance in tourism, 
telecommunications, energy, construction and manufacturing.  The CBK 
predicted similar growth in 2007.  However, instability in Somalia 
could deter some investment, particularly in the tourism sector on 
the coast north of Mombasa.  AIG Global Investment Group has come in 
on the low side of prognosticators, predicting just slightly over 5% 
growth rate in 2007, and cautioning that additional investment is 
needed to maintain the pace of economic recovery. 
 
¶9. Kenya's economy, in which agriculture represents over 24% of GDP 
and the transportation infrastructure is fragile and inadequate, 
remains vulnerable to weather fluctuations.  To reduce inflation and 
boost economic growth, the GOK needs to invest in infrastructure, 
especially in repairing the roads that were damaged by the floods of 
November and December.  Investments in water capture would reduce 
the economic damage caused by both drought and heavy rains. 
 
Comment 
------- 
¶10. Overall, the GOK's macro-economic management in 2006 has been 
successful in maintaining stability and growth.  Kenya may achieve 
6% growth in 2007, but investors normally hold off investments until 
after the election results are in.  Although politicians have not 
yet seized on rising food prices for the urban poor as an issue in 
the general election campaign, it may be hard to ignore a 19% 
increase over the last year, and it will be difficult for the CBK to 
keep overall inflation down to 12% in an election year.  If the high 
inflation continues, as seems quite possible, it will make life even 
harder for 19 million poor Kenyans, and may become another 
destabilizing factor in Nairobi's already-volatile slums. 
 
Ranneberger