UPDATE 3-Kenya faces daily power cuts, inflation to worsen

* Business group calls shortfall, utility cuts "shocking"

* Drought, transmission breakdowns behind shortage

* Kenya relies on dams for lion's share of power (Adds Kenya Power MD, manufacturers' quotes, details)

By James Macharia

NAIROBI, July 25 (Reuters) - Kenya, east Africa's biggest economy, faces daily power cuts from Wednesday for an unspecified period, its sole electricity supplier said, and manufacturers warned the outages would drive production costs and inflation higher.

Kenya Power said on Monday the blackouts would last for about three hours each day. It blamed transmission breakdowns and a delay in installing generators after a drought in the farm-based economy lowered water levels at hydro dams.

The drought in east Africa has constrained electricity supplies in the region and has already forced neighbouring Tanzania to implement daily 12-hour power cuts for an indefinite period.

Analysts said the power cuts could lead to the use of more diesel or heavy fuel to produce power, which has happened in the past. They said this could push oil imports higher and raise electricity costs, worsening inflation that has accelerated this year to double digits.

"The outages mean an additional headache for industrialists already facing high production cost numbers ... It will frustrate attempts to cool off inflation," said Robert Shaw, an independent economic analyst.

Manufacturers in Kenya blame inadequate power supplies and regular outages for adding to their output costs, which has slowed production and expansion as well as overall economic growth and has forced some to consider moving to other countries.

"We expected the drought situation to pose a bit of challenge, but the magnitude of the shortfall in supplies and the resultant drastic action by Kenya Power is shocking," said Betty Maina, chief executive of the Kenya Association of Manufacturers. "We are not prepared."

"It is a blow to our operations because such outages mean taking to other more costly sources of power, which adds to our overhead costs at the end of the day," she said.

Kenya Power said planned maintenance as well as the unavailability of 26 megawatts (MW) contracted from the Mumias Sugar Company co-generation plant had also affected the national electricity reserve. Mumias, Kenya's largest sugar miller, is carrying out annual maintenance at its factory in western Kenya.

Kenya Power, which is 50 percent owned by the government, did not provide details of the reserve and consumption levels.

Joseph Njoroge, its managing director, told a news conference that the country, which produces about 1,300 MW, has a daily shortfall of 70-90 MW of power.

"There is therefore insufficient power generation reserve margin to meet the ever rising national power demand," he said.

Most of Kenya's power supply is sourced from KenGen , the biggest power producer in the country.

Njoroge said the western parts of the country were worst affected by the shortfall due to a low-capacity transmission network, which hampered the flow of supplies from the eastern part of the country to cover the deficit.

Kenya's energy regulator said the power shortage was caused partly by a breakdown at a hydro-power plant but was optimistic the situation could improve in about two months, when the hitches with these production units would be repaired. (Editing by David Clarke and Jane Baird)