(c) 2021, Bloomberg – Patrick Gillespie
The US Federal Reserve, like many central banks, considers that the inflation that has arisen due to the reopening of the economies that were interrupted by the pandemic is of a “transitory” nature, and is not expected to increase interest rates until at least next year. In Latin America, by contrast, economic authorities are in a rush to reverse extremely low borrowing costs.
Since the end of June, the central banks of Mexico, Peru, Chile, Uruguay and even Paraguay have followed Brazil’s initial decision to raise interest rates, and many expect Colombia to do so as well. Latin America was perhaps the region in the world hardest hit by COVID-19 and is experiencing a rapid economic rebound that puts pressure on prices. Other reasons for the difference, however, may have to do with the high levels of inequality, informality and political instability on the continent – coupled with a history of inflationary explosions rooted in collective economic memory.
- What has been driving inflation?
Around the world, prices have risen faster than usual as pandemic-related restrictions culminate and previously held consumer demand that supply chains have been unable to meet is released. Some factors have affected Latin America in particular. For example, the global increase in food and energy prices has had a disproportionately large impact on the world’s most unequal region: food prices make up a larger share of inflation rates in Latin America compared to those in Latin America. advanced economies like the US. That means that high food costs – meat has risen 43% in Brazil – have played an important role in overall inflation.
2. Are there other factors specific to Latin America?
Yes. Many countries in the region are also net energy importers, and have seen gasoline prices rise as rising demand has led to congestion in global oil markets. Recent social upheavals have also triggered high volatility in some currencies. There is a strong relationship between prices and currencies in Latin America, and devaluations immediately manifest themselves in inflation. Meanwhile, governments face continued pressure to increase social spending to cope with the increase in poverty caused by the pandemic. The likelihood of larger deficits has worried investors about the outlook for currencies and raised their inflationary expectations, often leading local businesses to raise prices and workers demanding short-term wage increases. to open up to future inflation. All this coupled with the fact that the region has a long inflationary history: an average of 100% per year in the late 1980s and early 1990s, according to the International Monetary Fund.
3. How bad is inflation and what have central banks done?
Consumer prices for the month of July were as follows:
– Brazil: 9% year-over-year (YoY) – the highest since 2016. Central Bank: four interest rate increases since March for a total of 325 basis points to reach 5.25%.
– Mexico: 5.8% (close to the highest since the end of 2017). Central Bank: two increases of ¼ point to 4.5%.
– Chile: 4.5% (the highest since 2016). Central Bank: two increases, including the highest in two decades, for a total of 100 basis points up to 1.50%.
– Peru: 5% (the highest since 2009). Central Bank: first increase in five years to 0.5%.
– Uruguay: 7.3% (from 10% a year ago). Central Bank: 50 basis points up to 5%.
– Paraguay: 5.6% (the highest since 2014). Central Bank: Increase of ¼ point to 1%, the first increase in more than five years.
– Colombia: 4% (the highest since the end of 2017). The Central Bank indicated that it could soon increase interest rates.
4. Why are central banks acting now?
They are trying to escape the kind of deterioration in exchange rates that commonly occurs in emerging economies when inflation expectations rise. Latin America already hosts four of the worst six currencies among emerging markets this year. They are also reacting to an economic recovery that has been faster than expected – the region’s economy is now expected to grow this year at the fastest pace since 2009. Then there is a still-undefined political context, with violent protests in Colombia , a new left-wing government in Peru, and fears that Brazilian President Jair Bolsonaro is trying to undermine next year’s elections.
5. What is the benefit of these rate increases?
In some countries, inflation is increasing above the ranges established by the monetary authority, so controlling prices is also related to political credibility in a region of fragile institutions. Some analysts say that raising interest rates will preserve the economic recovery by anchoring inflation expectations, building credibility and counteracting what some investors perceive as excessive stimulus. And Wall Street sentiments are critical for Latin America, where sovereign bonds and currencies can plummet in just one night at the slightest sign of a political crisis or drastic changes in economic policies. In countries with political risks, rising inflation and growing economies, “it is time we started the slowdown,” said Alberto Ramos, head of Latin American analysis at Goldman Sachs.
6. What are the risks of increasing interest rates in the region?
Higher interest rates create higher debt obligations and larger fiscal deficits, which in turn can pose a threat to long-term recovery. Increases in interest rates are making domestic debt more expensive at a time when the region’s debt burden has risen to its highest levels in 30 years and countries are trying to cut Covid-related expenses. This is one of the risks involved in central bank decisions: authorities have been divided in Mexico, Colombia and Uruguay on whether or not to increase interest rates. A third wave of Delta variant Covid cases, now circulating in the region, could derail the economic recovery. “There is a certain reluctance in the region to toughen economic policies very hard,” says Alejandro Cuadrado, head of strategy for Latin American currencies at BBVA in New York. “In most cases the effect generated by monetary policy is slow.”
7. Why don’t interest rate increases have an immediate impact in Latin America?
Latin American economies are known for their high levels of labor informality – cash payments, low wages in companies that typically do not qualify for loans. This portion of the workforce – as well as that of employers – is expected to grow further during the post-pandemic recovery, putting more of the economy outside of the formal financial system. And more than half of the region’s adult population did not have a bank account before the pandemic. With so much activity off the books, the increase in interest rates does not have as immediate an impact in Latin America as it does in the US or Europe.
8. What are the banks projecting for the future?
That more increases are expected soon. The Central Bank of Brazil has already forecast another 100 basis point increase for September, while Colombia is due to do so soon after. For Cuadrado, from BBVA, the majority of central banks in Latin America will continue to increase interest rates this year. The notable exception is Argentina, which does not follow an inflation anchor system, and is not planning to raise interest rates in the near future despite 52% inflation. The economic authorities in Buenos Aires fear that an increase in interest rates could rather cause an acceleration of inflation because the increase in interest payments would increase the circulating money supply.
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