Latin America Staring at Stagflation?

Inflation is running hot, statistically and topically, in some advanced economies.  Central banks in those countries are considering action to address it. But in Latin America (LATAM), monetary authorities have already been forced to quell inflation, even though their economies continue to struggle. Stagflation may be setting in at difficult time for the region.

Latin America has been underperforming for several years vis-à-vis other emerging markets. Even its best years, from 2003 to 2013, saw growth fueled by a China-led commodity boom. While the recent rise in commodity prices has helped the region, those prices remain well below the levels needed to secure economic prosperity for Latin producers.

Latin America has been among the areas most deeply affected by COVID-19 economically and socially. Global gross domestic product contracted by 3% in 2020 compared to a 6.8% decline in the region’s output. Jobs in LATAM are heavily concentrated in contact-intensive sectors like restaurants, shops or public transport, which account for 43% of total employment.  With the pandemic wreaking havoc on these sectors, Latin Americans worked 16% fewer hours in 2020, almost twice the global loss.

Latin monetary authorities eased policy considerably last year to deal with the initial disinflationary risk from the COVID-19 shock.   But a combination of economic recovery, supply chain disruptions, and weaker currencies has led to a sharp rise in inflation across the region. Against this backdrop, the Central Bank of Brazil raised rates in March and will likely continue to tighten through the remainder of the year.  Mexico’s Banxico surprised with an early rate lift-off in June. Colombian and Chilean central banks are likely to follow suit.

Recovery is far from complete across the region. COVID-19 infections remain relatively high; a slow start to vaccinations and reliance on the less effective vaccines has allowed the virus to sustain itself.

With the exception of Brazil, the scale and design of government support during the pandemic has been insufficient to offset the economic pain. Fiscal responses in LATAM have been more generous this time than in the past, but they still parsimonious relative to other emerging markets.  Large amounts of resources were deployed to boost healthcare systems, with little room left for income support measures.

Many governments around the world have, for every dollar of lost output, boosted their spending by at least a dollar. The median LATAM country added only 28 cents of extra deficit spending for every dollar of lost output.

Lower tax receipts, currency depreciation and economic relief measures have all led to higher public deficits and indebtedness. In all, more than $80 billion of Latin American bonds have been restructured since the pandemic began. As a result, the region’s governments are under pressure to improve or least stabilize deteriorated fiscal positions through tax increases or spending cuts.  

With pandemic still raging and social conditions fragile, either of these options will be hard to implement.  The politics surrounding them are perilous; voters will go to the polls in Argentina this year, and Brazil next year. Incumbents will not want to run on platforms of austerity. Nonetheless, the balance between fiscal sustainability and a fiscal cliff of spending reduction will define the long-term trajectory of LATAM economies.

The pandemic and the related disruptions might fade over the coming quarters, but the scarring the virus will leave on Latin Americans will take a long time to heal.

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