Inflation in Latin America is growing at its fastest pace in over 20 years. Already in 2021, inflation had doubled to reach 6.6% – a level comparable to the financial crisis of 2008. In 2022, inflation projections are even higher and should come in at some 8 to 10%. So which countries have witnessed the largest price increases? What are some of their drivers? And what are monetary authorities doing to contain them?
1-Where do we observe the most significant price increases?
The countries of the region can be classified into 3 groups:
1) In a 1st group we have countries for which the rate of inflation is completely off the rail.
a. There, we encounter Venezuela, which had triple digit inflation at 117% in August;
b. We also have Argentina and Suriname – which were recently exposed to sovereign debt restructuring proceedings. In these countries, inflation is between 50 and 70%;
c. And then we also find Haiti and Cuba where the price increase is around 25% due in the case of Cuba to shortages linked to international sanctions or due, in the case of Haiti, to an economic and institutional crisis that has been ongoing now for several years;
2) In a 2nd group we find the main economies of the region with inflation between 8 and 14%.
a. First, we have economies with inflation levels comparable to those of the euro zone and the United States at around 8-9% where we encounter Mexico, Guatemala, Peru, Uruguay and lately, Brazil, which managed to bring down its inflation rate by reducing taxes on certain products.
b. At slightly higher levels -- in a range of 10 to 14% -- we find in this order Colombia, Nicaragua, Costa Rica, and Chile.
3) Finally, we have a 3rd group of countries which exhibit lower levels of inflation, very often below 5%.
a. Here we find officially dollarized economies such as Ecuador and Panama, but also countries such as Bolivia which has deployed significant subsidies and put in place sizable price controls.
Two points of attention:
• The first is that if we put aside the countries in the first group, inflation is on average 7 points above the targets set by central banks in the region.
• Second remark – even if many countries find themselves in an unprecedented situation, for some countries, they had experienced comparable levels of inflation before the pandemic. This is the case of Brazil, Colombia and Uruguay, who in 2016 had inflation rates that approached 10%.
2-So what is driving inflation in the region?
a. It is first explained by global factors:
• The Covid shock, the re-confinements in China and more recently the War in Ukraine have weighed unfavorably on the availability and prices of inputs in industry, but have also brought up the cost of transportation, food and energy. As such, countries like Brazil or Mexico, which have fairly large manufacturing sectors, were greatly impacted by the effects of these external supply shocks and have as a result experienced sharp rises in production prices.
• More recently, the inflationary shock has been amplified by the disruptions to the supply of fertilizers associated to the embargoes on Russia and Bielorussia. It should be recalled that Latin America is the 2nd most dependent region when it comes to fertilizer imports as 80% of its local needs have to be met by external markets.
b. Then there are country-specific factors that help to explain the current price dynamics and where often inflation can help to shine a spotlight on some of these economies’ underlying structural weaknesses.
1. For example, several countries experienced significant currency depreciation movements in 2021 (often linked to concerns about their fiscal position or rising political risks). This phenomenon aggravated the effect of external shocks by accentuating imported inflation. We encountered this situation in countries like Argentina, Colombia, Chile Peru, but also Brazil;
2. Some countries have experienced severe constraints on their production apparatus in the wake of Covid, especially in countries that have rolled out major stimulus programs (such as in Brazil). While this is certainly a global phenomenon, Latin America has been disproportionately affected by the fact that the levels of investment relative to GDP are structurally low, often about half as high as in emerging Asia. This situation tends to make the productive fabric of many economies in the region more prone to bottlenecks;
3. Another aggravating factor includes the impact of exceptional climate events. For example, we had a hydroelectric crisis in Brazil due to a severe drought, which weighed heavily on the price of electricity;
4. The structure of economies also plays a role: in particular, the degree of dependence of economies on food imports. This, in particular, explains the dynamics of inflation in the Caribbean in countries such as the Bahamas, Barbados, Haiti or Cuba, where the proportion of food imports in total imports can in some cases approach 40%;
5. The profile of consumer spending is also another important factor, especially in a context of sharp rises in commodity prices. For example, in Latin America food captures on average 25% of households’ budgets. By way of comparison, in Western Europe this proportion varies between 8% (for example in the United Kingdom) to some 13-14% in France and Italy;
6. In some countries the origin of inflation is not exclusively driven by supply constraints but reflects also an overheating demand that has often been fueled by fiscal stimulus measures. This is particularly the case for Colombia and Chile.
So far in the region, we haven’t yet witnessed a spiral between prices and wages in the same way as we have seen in emerging Europe where the labor market is very tight. In Latin America, unemployment levels remain relatively high and even if there is a recovery in employment, between 50 and 80% of the jobs being created have been in the informal sector – a situation that is unfavorable to having collective negotiations around wages.
That said there are mechanisms at work that make inflation more persistent:
• For example, some countries have wage indexation mechanisms for formal work or rents (such as Chile and Brazil). These mechanisms are strongly linked to episodes of hyperinflation in the 1980s and 1990s, and by weighing on the collective memory have also tended to influence household consumption and savings behaviors
• These indexation practices and other psychological factors can make it easier for inflation to spread to other sectors of the economy.
3-So what are monetary authorities doing to try to contain this situation?
Overall, rate hikes in the region have been faster and more pronounced compared to other regions of the globe but also compared to previous tightening cycles. If we remove outlier countries, rate have on average been hiked by around 700 to 800 basis points since March 2021.
However, while central banks have been on the whole relatively proactive we must remember 2 points
1. First is that despite strong rate hikes, several countries still have monetary policies that are not yet in restrictive territory (this is the case of Peru or Colombia);
2. Another important point is that the rise in rates in Latin America has limits in terms of its ability to fight off inflation:
a. First, because the actions of central banks influence aggregate demand not supply (and most economies in the region mainly face supply shocks which central banks have no control over);
b. Second, because the credit channel in Latin America is much weaker than in Asia, for example. With the exception of Chile, the levels of credit intermediation are quite low due to high informality and this tends to affect the impact that rate changes can have on the economy;
c. Third, because monetary policy often remains strongly constrained by fiscal policy, especially in a context where we are witnessing an increase in social risk due to rising food insecurity and energy costs.
i. In fact several countries have experienced over the past year some form of social unrest (Peru, Ecuador, Panama, Guatemala).
ii. But even if almost all the states in the region have put in place measures to preserve the purchasing power of their citizens, when these measures are not sufficiently targeted and are not of a temporary nature, they can have an adverse impact on inflation either through the demand channel or through the exchange rate channel via the weakening of currencies, which is often the case for countries that exhibit important fragilities on the fiscal front.
