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Will Treasury net more money from new beer tax where it failed with Keg?

FINANCIAL STANDARD
By Moses Michira | December 8th 2015

On Friday evening, a retiree strolled to his favourite bar in the Donholm neighbourhood of Nairobi, grabbed a seat at the counter and ordered the brandy he enjoys every so often.

The sequence of events that followed best captures how a piece of legislation that came into force earlier in the week will force a change in the lifestyles of ordinary Kenyans.

As he would learn from the barman, who also doubles as the waiter, the Sh500 he had taken out to pay for the brandy would not be enough to also cover the cost of his preferred mixer, as used to be the case.

After a brief chat about why prices for both the alcohol and soft drink had gone up so abruptly, the would-be patron walked out of the bar and headed to the nearby Sweet Valley Liquor Store for a bottle of his favourite drink, which cost Sh380, up from Sh330 the previous week.

He headed home, his hopes for a quiet drink at the bar dashed.

Flat rate

“I can tell my customers are not very happy,” said Mama Kate, the proprietor of the liquor store.

Several customers had come in over the weekend, learnt of the new prices and simply walked away. The few who returned after comparing prices at different outlets came back complaining about how expensive life’s little luxuries had become, and how it may be time to stop drinking, she added.

This is a situation that will play out many times over in the coming weeks in corner shops, bars and even smoking places, following the introduction of higher taxes on beverages and cigarettes, among other commodities.

Beer is now being taxed at a flat rate of Sh50 per half litre, the most common size the beverage is bottled in in Kenya, and there is a Sh2.50 levy on each cigarette stick.

The new schedule is contained in the Excise Duty Act, which came into effect on December 1.

It also raised the prices of cars and polythene bags, though the effect of this has yet to resonate with as many people, since they are not exactly everyday consumables.

It has now been a week since prices were adjusted, though supplies of some of the affected commodities had been interrupted for days before. Some retailers were hoarding products in anticipation of earning bigger profit margins come December 1.

Frustrations among smokers are palpable in the designated smoking sheds, as they discuss how a Sh5 coin can at most buy them a sweet now after the price of the best-selling cigarette, BAT’s Sportsman, rose to Sh7.

Everyday life just got costlier for them where it hurts the most — their addictions.

“I cannot comprehend how with Sh20, I can only buy two cigarettes,” Dennis Gituma, who has been smoking for more than a decade, said.

It is double trouble for him since he loves his gin and takes it regularly. Christmas will likely not be enjoyable, he fears.

Lower-end beers, with recommended retail prices of below Sh100, such as East African Breweries’ Balozi, have seen the biggest price hike, proportionately.

Taxes now take up nearly 60 per cent of selling price — more than the combined costs of production along the supply chain that starts from the fields, where barley and wheat are grown.

Similarly, the Government will take up more than half of the retail prices for regular cigarettes, and almost half for premium brands.

It is expected to lead to the biggest price increases since the hyperinflation era of the 1990s on beer and cigarettes, which are viewed as non-essential purchases. However, to their consumers, they easily rank as high as food on the list of priorities.

Black market

While it might be too early to determine if the higher prices will discourage consumption and lead to lower sales, evidence from past studies have shown that consumers of cheap products tend to be highly price sensitive.

A policy paper authored by former Central Bank of Kenya Governor Njuguna Ndung’u and two other scholars in 2001 on Kenya showed that such price-sensitive consumers will readily move to more affordable alcoholic beverages in times of price increases.

This has since played out, only with plenty of casualties. Within the last four years, for instance, the consumption of un-malted beer fell more than 75 per cent after the State introduced taxes on EABL’s Senator Keg Lager, which targets the bottom end of the market.

Keg had been touted as the perfect alternative to dangerous and unhealthy brews that were responsible for hundreds of deaths and cases of blindness around the country.

The price for a 300ml serving rose from Sh25 to Sh35 in 2013, with the Government hoping to raise more than Sh6 billion from sales of Keg.

However, consumers voted with their feet and went back to consuming dangerous brews.

While the Sh10 increase per serving might sound little to some, it makes all the difference to a consumer with Sh100 to spend in a sitting. Before the price rose, such a consumer would get four servings of Keg; this went down to two after the new tax rate was effected.

Consumer tastes shifted faster than the State could comprehend. It is in this period that hundreds of unlicensed spirits manufacturers sprang up all over the country, and provided a growing market for ethanol imported through the black market.

In any case, millions of thirsty people cut from the formal alcohol market were happy enough to consume any drink that promised to deliver a high for cheap.

Overnight, regular people became master brewers and distillers, but with devastating outcomes for both consumers and the taxes that the State had hoped to collect.

Predictably, hundreds of people died and the billion-shilling payout the taxman anticipated did not materialise. EABL nearly discontinued the production of Keg, the then managing director Charles Ireland said, after sales dropped 75 per cent. Earlier this year, however, the tax rate was revised downwards.

In a more recent commentary last month, Jane Karuku, who is the managing director of EABL’s largest subsidiary, Kenya Breweries Ltd, warned that higher tax rates on beer could yield even less taxes for the Government by discouraging consumption.

This would be a disastrous outcome for the Treasury, which crafted the revised laws to raise more than Sh28 billion between now and June 30, 2016.

A possible scenario of lower spending on beer and cigarettes, and a slowdown in the importation of used cars — whose prices rose by as much as Sh200,000 a unit — could hurt the Government’s already tenuous financial position.

A gaping hole at the Exchequer needs to be filled urgently. Unlike the previous financial year when the State borrowed over Sh250 billion through the now divisive Eurobond, which helped support public sector expenditure, this year, such money is harder to come by for both the Kenya Revenue Authority (KRA) and consumers.

Signs of distress were clear when the State borrowed at interest rates above 20 per cent on short-term debt in October, throwing the market into a spin and leading to an increase in the cost of ordinary loans.

Three international banks would become the saving grace for the State at the height of the financial chaos, granting it Sh60 billion in loans to ease domestic borrowing.

The average yield on the benchmark 91-day Treasury Bill has since dropped from October highs to 9.218 per cent at last Thursday’s auction.

Continue spending

Treasury Cabinet Secretary Henry Rotich is already preparing a supplementary budget to be presented before Parliament and detailing which planned projects must be shelved even before the country reaches the halfway mark in its financial year.

It will be the first time in Kenya’s history that the State has been forced to eat humble pie in a supplementary budget, which is usually a request to increase the spending ceiling on various items of an existing and approved Budget.

“It has never happened, but it is now necessary,” CBK Governor Patrick Njoroge said in an off-the-cuff comment.

The Government will be waiting anxiously to see if the higher taxation schedule will indeed lower consumption over these seven months. It will hope, however, that consumers find it within their hearts and budgets to maintain their spending on beer, bottled water, juices, cigarettes and imported cars to support the Treasury’s efforts to boost public coffers.

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