EAC Inflation Outlook: Nudging up Again?
Monday, 01 November 2010
Headline inflation rates in EAC countries have been on a consistently downward trajectory for the past six quarters. Like most emerging economies, the EAC were heavily exposed to the commodity price spike of 2007/2008, during which prices of food and fuel rose sharply and drove inflation up into the double digits.

When considering that the consumer price inflation (CPI) baskets of EAC countries are loaded with food items - they contribute more than 50% of CPI weightings in Tanzania, Rwanda and Burundi -, it is easy to see why rising food global food prices would have caused such problems in East Africa. In 2009, the lowest inflation rate in the region was in Rwanda at 10.4% (IMF). Prolonged drought across the region exacerbated the problem as the supply of food contracted.

Since then, the trend has been downwards for a number of reasons. Firstly and most obviously, this has been a natural correction after the shocks to commodity prices; prices cannot rise so quickly for long, and economies adjust to new price levels. Although food prices have continued to rise steadily since the start of 2009, oil prices have remained stable. Inflationary pressure was also somewhat absorbed by the balance of payments: more expensive imports were financed by higher export earnings - EAC countries produce a lot of food.

Decent rains and hence harvests across the region, but also the return to business as usual in Kenya after the post-election violence have boosted supply and helped bring down prices. Some creative accounting has also been at work here: the EAC countries have all either changed or are in the process of changing their inflation computation methodologies. The old format tended to overstate the inflation rate, whereas the new geometric approach is likely to give lower rates in the future.

Finally, the continued stagnation of developed economies has meant that exports from EAC countries remain subdued. This has helped keep prices stable. As of September 2010, inflation rates in Kenya, Tanzania, Uganda and Rwanda were below 5% (Burundi is yet to publish its September rate). In Uganda, September’s published inflation rate was just 0.3%.

Monetary authorities can rightly claim some credit in managing inflation down to its current level. High interest rates and tight monetary policy also had a role to play in bringing inflation down. There is now some evidence that central banks are relaxing monetary policy in an attempt to stimulate demand. This will bring with it inflationary pressure. Central banks have an incentive to keep inflation low: 5% inflation is the benchmark set for entry into the proposed East African Monetary Union.

Inflation is unlikely to stay so low for long. As the global economy bounces back, demand for East African goods, particularly for cash crops such as coffee and flowers is likely to increase. Global food prices have risen for seven consecutive quarters and it is possible that producers have yet to pass on price increases to consumers. Inflation could be forced up at any time by freak weather events disrupting supply. Disruption at Mombasa port has already caused price increases as supplies fail to reach their intended destinations. General elections in Uganda (2011) and Kenya (2012) also pose threats to stability - and hence the supply of food, and food prices - across the region.



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