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While inflation is expected to ease in Latin America because of the COVID-19 crisis, major Latin American currencies, such as the Brazilian real and the Mexican peso, have suffered more than 20 percent declines since the start of the year. (Photo: Mexican Government)
Wednesday, April 15, 2020

COVID-19 & Latin America: The Inflation Impact

Can Latin America expect big swings in consumer prices?

Inter-American Dialogue

Central banks across Latin America, including in Brazil, Mexico and Chile, have slashed interest rates and boosted stimulus spending in efforts to fight the economic downturn caused by the Covid-19 pandemic. At the same time, demand has collapsed for some goods and services, such as restaurant meals, fuels, transportation and tourism, as customers stay home under quarantine orders. How is the global pandemic changing the outlook for inflation in Latin America’s largest economies? To what extent could deflation become a problem as consumer spending evaporates in some sectors? How are the actions of external actors such as the U.S. Federal Reserve and China shaping consumer prices in Latin America and the Caribbean?

Claudio M. Loser, visiting senior fellow at the Inter-American Dialogue, president of Centennial Group Latin America and former head of the Western Hemisphere Department of the International Monetary Fund: The outlook for prices in Latin America is unlikely to be deflationary. It is important to understand that the pandemic is a two-pronged phenomenon: On one side there is a collapse of demand, but on the other there is a supply shock, at least in internal markets. If the focus is on commodities, prices have declined for oil, metals and industrials, but no significant decline has been observed regarding food and other necessities. This will depress exports, and thus has already led to currency depreciations. As for manufacturing, both demand and supply have effectively collapsed, and beyond some issue of accumulated inventories (cars, appliances, clothing), there is no reason to expect a decline in prices yet, although conditions will change when there is a slow recovery. As far as most services are concerned, the current lockdown that prevails in most of the region precludes the use of prices to increase demand, while there is strong demand for basic items. In addition, demand is being sustained by the stimulus/income-support policies that the various regional governments have put in place. Also, the policies of key world players—the United States, China, the European Union, Japan and the United Kingdom—will help demand, with a spillover to the rest of the world. In this regard, the worldwide expansionary fiscal and monetary policies should not be expected to have a major inflationary impact under current circumstances. However, if they extend beyond the pandemic in Latin America, the continued expansion will most likely have an inflationary effect. 

Nelson Altamirano, professor of economics at the School of Business and Management at National University: Economic growth predictions for Latin America for this year are negative—between -1.9 percent and -3.8 percent. These numbers are based on a contraction of exports, reduction of domestic markets and reduction of fiscal spending as compared to 2019. Contrary to the boom economic context before the financial crisis of 2008-2009, the coronavirus-fueled economic recession strikes when Latin America has very low economic growth, increasing social discontent and shrinking investment levels. So, even if this recession is shorter, it could affect demand harder than the one 12 years ago. This time, consumers will reduce spending even after the quarantine is over due to the uncertainties created by unemployment and the realization that the new normal requires less consumption. Firms, in turn, are postponing investment or looking for safe alternatives outside the region. Most governments are implementing fiscal and monetary policies to counter this trend with their limited resources. To continue doing it, and given the low prices for commodities, we expect these governments to renegotiate their debt obligations with the IMF and World Bank soon to allow them to support fiscal policies without inflationary risks. However, we expect some inflation to occur because of the devaluations of local currencies against the U.S. dollar, as it happens in Argentina, Brazil and Chile. The only country we expect to have two-digit inflation rates is Argentina, which already suffered a 53.8 percent inflation rate last year. It may suffer an inflation rate of between 40 percent and 50 percent this year. Brazil, Chile and Colombia may be suffering inflation rates of around 4 percent. Overall, inflation rates will not become the major issue for Latin America in 2020. Unemployment, informality, extreme poverty and low investment will be the major issues.

Desmond Lachman, resident fellow at the American Enterprise Institute: By now, there can be little doubt that the coronavirus pandemic will plunge the world economy into a significantly deeper economic recession than that of 2008-2009. There is also reason to fear that the world economy will be very slow to recover as global asset price bubbles burst, as bankruptcies become pervasive and as credit conditions tighten. In the context of the likely sustained rise in world unemployment and very depressed international commodity prices, deflation rather than inflation is likely to be the main economic challenge. This view is shared by global bond markets where long-dated government bond yields are negative in Europe and at all-time lows in the United States. The Latin American economy now appears to be facing a perfect storm, which is likely to cause a deeper regional recession than that experienced in the industrialized countries. Not only is Latin America’s economy being hit by the pandemic, it is also being seriously challenged by an international commodity price bust, a record pace of capital repatriation and unusually weak external demand for its products. Very weak demand and very high unemployment rates at home should exert considerable downward pressure on inflation in most Latin American countries. However, that downward pressure could be offset to a large degree by considerable exchange rate weakness. In that context, it must be of some concern that since the start of the year we have seen more than 20 percent declines in major Latin American currencies, such as the Brazilian real and the Mexican peso.

Daniel Artana, chief economist at FIEL in Buenos Aires: In a deep recession, monetary printing is unlikely to produce a sizable increase in inflation. But as the recession is reduced, central banks need to come back to the initial ‘flow’ situation and at the same time mop up all the excess liquidity they issued in the meantime. This is not an easy task. Therefore, some above-the-norm inflation is likely both in developed and in developing nations after the pandemic is over. In the meantime, we will add problems to estimate inflation properly, not only because the quarantines make the life of statistics offices more difficult, but also because there will be some activities with no effective transactions.


Republished with permission from the Inter-American Dialogue's daily Latin America Advisor



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