ECONOMICS MADE SIMPLE:Can the 3.4 per cent June inflation rate be tamed?

What you need to know:

Shortage and instability of electricity is inflationary. It drives high production costs that have to be covered through hiking prices of goods and services.

Tanzania is faced with a number of challenges including economic ones. Among the key macro-economic challenges has been inflation. Challenges have included taming it at single digits. The policy target has been taming it at five percent. It has been a struggle to attain this mark. Of late however, inflation has gone below this policy goal to as low as 3.4 per cent in June 2018. This is an improvement from a 3.6 per cent rate posted in May 2018 and 3.8 per cent in April 2018. This is an inflation rate that needs to be celebrated so long as the key macro-economic fundamentals of inflation are correct. Among other things, the 2018/19 national budget policy objectives include maintaining single digit inflation.

Available data suggest that inflation rate in Tanzania averaged 7.26 percent from 1999 until 2017. An all time high rate of 19.80 per cent was reached in December of 2011 and a record low of 3.4 per cent in January of 2003.

Among the key discussion issues is on whether the 3.4 per cent rate can be maintained. Inflation in Tanzania is basically due to structural than monetary factors. There are several main structural drivers of inflation in Tanzania that need to be addressed if the 3.4 per cent rate is to be tamed or even lowered. Some of these drivers are outlined in what follows.

Electricity

Shortage and instability of electricity is inflationary. It drives high production costs that have to be covered through hiking prices of goods and services. High electricity cost is known to have made captains and titans of the industry to reduce production or stop production. The other option available to the captains of the industry is to use alternative sources of power especially fuel-dependent generators. All of the above trigger inflation. The first two cause extra scarcity in the supply side of the economy thereby causing an increase in the general price level.

The last results into increased cost of production which has to be reflected in price level. Taming inflation at 4.4 per cent or near that mark will, therefore, call for stable, quality and adequate electricity.

Food supply

Food is another major driver of inflation in Tanzania. This is because this expenditure item has a weight of about 47.8 per cent in the Mainland Consumer Price Index (CPI) and 57.4 per cent in Zanzibar’s. In case of food shortage, whatever the cause, prices will go up thereby hiking inflation above the 4.4 per cent. In case of drought for example, one is likely to miss bumper harvests which will translate into higher food prices across the board.

This can also be the same in case of other variables that lead to less food in the market.

These include but are not limited to severe floods, pests, post-harvest looses and inability of food items to move from surplus to scarcity areas for any reason. The impact of these is reduced food supply which may lead to the rise in general price level and therefore inability to tame inflation at 3.4 per cent. Addressing the food supply side issues therefore is very important in taming low inflation rates.

Strength of the Shilling

Strength of a country’s currency has close relationship with inflation rate. If the currency is weak and declining, it can contribute in high inflation rate.

This will be via the route of goods and services imports which (import and export) is normal for an open economy that transacts with the rest of the world. This is because one has to pay more in terms of shillings for every good and service denominated in the appreciating foreign currencies. Partly that is why dollarisation of the economy is inflationary.

Addressing this kind of inflation requires measures to strengthen the shilling. These include increasing the quantity and quality of exported goods and services and/or prices of the same, increasing incoming tourists, increasing remittances from Tanzanian sons and daughters in the Diaspora and increasing aid and investments inflows. Equally important in strengthening the shilling is the need to reduce import volumes and prices paid for the same. An artificial and therefore very short term and unsustainable option of strengthening the shilling would be Central Bank intervention by way of supplying foreign currency in the money market. This may, however, put the foreign reserves into uncomfortable levels. Maintaining the 3.4 percent inflation therefore calls for inter alia strengthening the shilling.

Imported inflation

Part of the inflation in Tanzania is due to imports from inflation-ridden trade partners.

These are trade partners that are experiencing high inflation rates. Necessarily when goods and services are imported from such countries, they will be sold at higher than buying prices to cater for involved transaction costs and profit margins. Imported inflation can also be attributed to general global commodity prices including food prices. This too is an exogenous variable that Tanzania cannot control directly. Indirectly, this can be controlled by diversifying away from importing from inflation-ridden countries. But such alternative trade partners must exist.