Latin America

Multiple factors explain this alarming upsurge in global inflation following the outbreak of the virus. First, the rapid economic recovery, especially of the world’s two largest economies—China and the United States—led to a strong rebound in global demand, particularly for raw materials, pushing up their prices. As of September 2021, commodity prices have increased 65%⁷ from their lowest level in April 2020 (figure 2). Prices for oil and natural gas, in particular, have soared. In the same period, the West Texas Intermediate crude oil price grew 850%,⁸ while the price for natural gas (Henry Hub Spot) was up 272%.⁹ This uptick in energy prices is exacerbating the concerns around global inflation as excessive demand and supply shortages are expected to continue at least throughout 2022. Higher inflation expectations are also feeding the process, by triggering current price hikes. Nevertheless, higher commodity prices will have a positive impact on Latin American economies as they boost exports and public revenues (via export taxes and/or state-owned enterprise profits). For example, the United Nations Conference on Trade and Development (UNCTAD) defines a nation as commodity export–dependent if it derives more than 60% of its export revenue from commodities. In the latest UNCTAD report, all South American countries were classified as commodity export–dependent. For Chile, Ecuador, Peru, Bolivia, Paraguay, and Venezuela, this percentage exceeds 80%.¹⁰

Second, COVID-19 outbreaks in regions that serve as critical links in global supply chains have resulted in longer-than-expected supply disruptions (mostly in Asia), causing delayed supply response to rapid demand recovery. Some relevant costs, such as transportation, have soared, causing higher selling prices for consumers. Moreover, the distribution of shipping containers throughout the world became highly distorted during the pandemic, as a series of events, for example, the closure of the Suez Canal and restrictions and congestions in several ports, exacerbated delays in delivery times. As a result, from March 2020 to September 2021, freight costs shot up by 674% globally.¹¹

Finally, depreciation in the exchange rate may also push inflation up in Latin America, through the rise in imported goods prices. The majority of countries in the region have faced a currency depreciation in 2021. This is a concern that may well persist in the next year, when advanced countries will likely increase interest rates, which may put pressure on exchange rates in Latin America and, consequently, increase inflation.

The reaction of monetary policy: The beginning of normalization

Given that supply chain disruptions and the cost-driven inflation will last much longer than expected, inflationary pressures will persist in the short term. In a move to ensure that higher inflation expectations do not become entrenched, the major central banks may respond by tightening monetary policy. The central banks in Latin America have shown themselves to be extremely sensitive to the effects of inflation, even when the sources of inflation lie outside the region (for example, the inflationary effects of supply chain disruptions and high energy prices). The central banks have thus made keeping inflation in check their priority. Hence, they are acting firmly and aggressively, led by Brazil, which started raising rates earlier than their EM peers (figure 3).

The rise in interest rates will not come without costs, since it would negatively affect the ongoing recovery and simultaneously increase debt-servicing costs for the region’s increasingly indebted public sector, placing even more pressure on governments to tighten their fiscal policy. Things may get much more complicated in 2022 if developed economies too begin to normalize their monetary policies.

However, the change in the current monetary policy might not lead to significantly divergent outcomes seen after the subprime crisis. In 2010—a time of economic recovery and inflationary acceleration—several Latin American economies undertook an upward cycle of rates. Back then, the bull cycle lasted for about a year, when inflation rates returned to hover around the targets set by the central banks. As expected, the contractionary monetary policy implemented in 2010 can be associated, among other factors, with lower regional growth in 2011,¹² despite commodity prices reaching all-time highs at that moment.

Latin American central banks will be keeping a close watch on the evolution of domestic prices in developed economies, particularly in the United States. This is because the persistence of high levels of inflation in the United States will define the timing and aggressiveness with which the Federal Reserve (Fed) decides to normalize its monetary policy. As seen in figure 4, interest rates in developed countries are still at the bottom of the cycle.

Why is monetary normalization in the United States so important to emerging economies? Going back to 2013, when the post subprime crisis ended, the tightening cycle in the United States resulted in a greater financial volatility, generating capital outflows from EMs to the bond markets of developed countries (“flight to quality”), which led to depreciations of local currencies against the dollar. Additionally, higher risk-free rates translated into larger financial costs, making it difficult for EMs to manage external debt. In response, central banks of emerging economies, in an attempt to limit capital outflows and control currency depreciation, were forced to imitate the rises in interest rates.

Currently, the Fed is seeking to communicate its policy clearly and is preparing the ground for a reasonably, orderly exit from an extremely accommodative US monetary policy stance. Therefore, the impact on emerging economies would be more limited.

Latin America should also learn from the volatility witnessed during the post subprime crisis. This experience taught governments that macroprudential regulations play a key role in limiting the impact of financial volatility on local economies. In particular, sustaining healthy finances (seeking fiscal balance and low levels of public debt, particularly external), floating exchange rate schemes, and accumulating reserves appear to be key factors in this regard.

Economic expectations for 2022

With the reopening of economic activities and progresses made in vaccination, we expect the reactivation of global demand to persist in 2022. However, the pace of recovery will likely remain moderate as the economic stimuli and positive base effects subside. Against this backdrop, global inflation should ease gradually as world inventories are adjusted, global supply chains are restored, and the prices of commodities and intermediate goods fall.

In the case of Latin America, after a contraction of 6.8% in 2020 and a likely rebound of 6.3% this year (figure 5), we expect a 3% GDP expansion in 2022. Increases in interest rates will continue, while the fiscal policy will likely be focused on reducing fiscal deficits and public debts, which will prove challenging in a context of rising social demands.

These growth rates will mean that in 2021 less than half of the region’s economies will surpass their prepandemic GDP, but most economies should do so in 2022 with the exception of Venezuela, Ecuador, Bolivia, and Panama. This is nonetheless a promising scenario as growth forecasts for most economies in the region have been revised upwards during 2021. At the beginning of the year, forecasters had Guatemala and Paraguay as the only countries to outgrow their 2019 GDP, with some countries only expected to do so by 2024.

Despite these forecasts, risks loom over the region’s economic growth. The normalization of monetary policies in developed economies could generate episodes of financial stress, affecting economic recovery, especially of highly indebted economies such as Argentina and Brazil.¹³ On the domestic front, two main factors could potentially have a negative impact on the region’s economic prospects in 2022 and beyond. First, several countries such as Brazil, Chile, Colombia, and Costa Rica are set to hold presidential elections next year—a factor that has proven in the past to be a source of instability in Latin American economies. Second, a deeper, more holistic transformation of the region’s economy, to realize productivity gains and a higher long-term growth, is still pending. This process will be critical during the following years, considering the region is moving toward a more complex economic environment.

Argentina

Executive summary

Argentina’s economic recovery, although sustained, is expected to be uneven. An improved vaccination program and a welcome drop in the number of COVID-19 cases in recent months have allowed the government to relax pandemic-related restrictions. Rise in inflation (despite price and foreign exchange (FX) controls) and political and economic uncertainty in light of the mid-term legislative elections due in November, however, pose downside risks to the country’s economic outlook.

Recent developments

After a quarterly increase of 2.8% (of the seasonally adjusted series) in Q1 2021, Argentina’s GDP contracted by 1.4% in Q2,¹⁴ a reflection of the onset of the second wave of COVID-19 in April/May.¹⁵ The economy, however, picked up strength in June/August: The rate of expansion, in fact, outpaced that seen in Q1 2021, with an average monthly advance of 1.4% (versus 0.8% in Q1¹⁶).

The reach and scale of Argentina’s vaccination campaign witnessed a significant improvement early this year: As of mid-November, 79% of the population has received at least one dose, while 60% has been fully vaccinated.¹⁷ A direct consequence of this has been a sharp decline in the number of daily positive cases—the first half of November, for example, saw a daily average of 1,186 (compared with a 30,000 average in the second wave’s peak, on May 21). This, in turn, allowed the government to lift various restrictions that were imposed to contain the virus.¹⁸

The ruling party suffered a defeat in the November legislative elections. The opposition, Juntos por el Cambio or JxC (led by former president Mauricio Macri), won with 42.0% of the votes at the national level, whereas the current ruling political alliance, the Frente de Todos (or FdT, led by the current president Alberto Fernández), received 33.6% of the votes. JxC prevailed in 13 districts, even in the Province of Buenos Aires (which accounts for more than a third of the country’s electorate and has historically supported Peronist governments) and Santa Cruz (home of vice and former president Cristina Fernández de Kirchner¹⁹). As a result, the Peronists lost control of the Senate, which had not happened since the return of democracy in 1983.

Growing volatility in the context of high political and economic uncertainty has resulted in increased pressures on the parallel FX markets. However, the authorities continued to use the official FX as a nominal anchor for inflation—sustaining a pace of devaluation well below the rate of inflation—while applying increasing controls to operate in the parallel markets.

Despite using the official exchange rate as an anchor and the presence of growing price controls, inflation has soared. The Consumer Price Index (CPI) rose by 3.5% in October, bringing annual inflation to 52.1%.²⁰ Although it is possible that this surge in inflation may be a result of the recent economic recovery and international pressures, it can also be attributed, in a large measure, to the increased printing of currency notes during 2020 (when the central bank’s assistance to the Treasury with money emission accounted for 7.4% of GDP) to make up for the fiscal deficit, in the absence of access to international financial markets.

In mid-September 2021, Argentina made a payment of US$1.9 billion to the International Monetary Fund (IMF), in a bid to reach a new deal over its remaining debt of US$44 billion. Meanwhile, the government continues its negotiation with the IMF, given the bulky maturities it has to face next year (of almost US$18 billion only in capital). Although some breakthroughs have been achieved in the negotiation process, an agreement is not likely to occur before Q1 2022, as the IMF would likely ask for a higher fiscal consolidation and other improvements in the economic policy, while the government may refuse making a significant adjustment.

Economic outlook

Recovery from a protracted recession during 2018–2020 will be slow and the 2021 economic growth largely reflects base effects. The ongoing reopening of the economy should support GDP growth forecasts of 2% in Q3 and 0.5% in Q4, completing an overall expansion of 8% in 2021, out of which 5 percentage points can be explained by the positive base effect of 2020 (as the economy started recovering in H2 2020). Economic growth in 2022 is expected to be moderate, around 2.7%. This scenario suggests that the recovery in the employment rate in the private sector will be timid, given the ban on firing employees and double redundancy payments.

We expect the Argentinian government to implement an economic program in 2022 that may usher in substantial fiscal improvements, with more credible stabilization and macroeconomic recovery policies, which might facilitate a reduction in inflationary risks, partially restoring business confidence and driving economic recovery after the pandemic. We assign a 60% probability of this scenario becoming the reality; however, economic growth in 2022 will not be free of downside risks.

Uruguay

Executive summary

Borders have started to reopen gradually, marking a much-needed progress for the tourism sector. The outbreak remains contained, aided by a substantial percentage of fully vaccinated population, which is helping to normalize the economy. Demand-side price pressures, however, are on the rise. Consequently, the central bank has started removing stimulus through a gradual rate adjustment. In the coming months, further interest rate hikes are expected.

Recent developments

GDP, adjusted for seasonality, grew by 0.9% in Q2 2021.²¹ The financial outturn was higher than expected, indicating that the economy fared better at adapting to pandemic-induced mobility restrictions (imposed in late March 2021) than anticipated. Growth in Q2 2021 rebounded from a 0.6% contraction in Q1, with the output virtually back to its prepandemic level (Q4 2019). On a year-on-year basis, the economy grew by 11.3% in April/June 2021, reflecting a low base of comparison, while it accumulated an expansion of 3.8% during H1 2021.

Health indicators, meanwhile, have improved in response to a successful vaccine campaign, with 76% of the population fully inoculated.²² Aiming to capitalize on this promising development, authorities have announced a range of new measures to boost the economy from Q4 2021 onward, that include the complete reopening of borders from November,²³ elimination of the value-added tax (VAT)²⁴ for tourists, and loans targeted to boost the tourism sector.²⁵

In addition to supply-side constraints and high commodity prices, demand-side price pressures are on a rise as the economy recovers from the COVID-19 crisis. In October, annual inflation dropped slightly to 7.9% from 7.4% in August, remaining well above the target range (3–7%²⁶). Prices for food and energy remain high. There are signs of price pressures building up in the services sector, which may become more pronounced as the country reopens its borders to tourists in November.

In a bid to lower inflation expectations, the Central Bank of Uruguay (BCU) raised rates by 50 basis points (bps) in August to 5% and by an additional 25 bps in October to 5.25%.²⁷

To strengthen Uruguay’s position at a global level and reduce its dependence on Argentina and Brazil, the government announced a prefeasibility study to evaluate a free trade agreement outside Mercosur with China, Uruguay’s main trading partner.²⁸ As a result, relations with Argentina are strained, casting risks on bilateral cooperation.²⁹

Economic outlook

The economic recovery will speed up in H2 2021, as the country approaches herd immunity and mobility restrictions are eased, which should lead to improved consumer sentiment, and therefore boost private consumption (although just moderately, owing to higher unemployment and low real wages³⁰). On the supply side, external demand will support growth in agriculture, although this sector remains vulnerable to adverse weather conditions.³¹ Services will recover partially, as mobility restrictions and border closures are eased, enabling an increase in consumer-facing activities.

The government is expected to continue to strengthen inflation controls by deindexing wages during collective bargaining, reducing dollarization in the economy, slowing public spending growth, and using interest rates to guide monetary policy.

A relatively stable currency and a slow recovery in private consumption will keep inflationary pressures in check in 2021 (7.2% by year-end). However, there are upside risks to the outlook. After the economy recovers in 2022, wage settlements with unions would increase indexation, posing a challenge in controlling inflation. In the medium term, inflation expectations will continue to converge to the inflation target set by the central bank but will still remain outside the range (6.3% for a 24-month monetary policy horizon; the target range will be 3–6% from September 2022 onward³²).

The BCU is expected to raise interest rates by another 75 or 100 bps, to 6.00% or 6.25% by the end of 2021, as the economic recovery strengthens, and the monetary policy rate is expected to reach 7.4% by the end of 2022. A growing concern is that the BCU may raise rates faster if the US Fed tightens policy earlier than anticipated, as this would likely cause peso depreciation and higher inflation.

Although the COVID-19 crisis temporarily suspended the government’s efforts to shore up the public finances, we forecast that the fiscal deficit will narrow slightly, to 4.7% of GDP, in 2021, from 5.3% in 2020, owing to higher tax collection as the economy begins to recover. However, there are risks that spending will rise, owing to pressure from public sector unions, in view of the lost purchasing power of salaries.

One of the main risks that Uruguay’s authorities should tackle is its high external debt, estimated at around 87% of GDP in 2020, 14 percentage points higher compared with 2019. If monetary tightening in advanced economies ends up triggering a disorderly increase in interest rates, Uruguay’s borrowing costs could increase considerably..  

Colombia

Executive summary

Colombia’s economy rebounded strongly in 2021, fueled by a robust domestic and foreign demand. Solid economic foundations, mainly strong consumer spending and high commodity prices, will likely spur growth in the short run. High inflation is expected to remain in check through tightening of monetary policy. Risks to growth include political uncertainty ahead of the 2022 presidential election and weak public finances.

Recent developments

The economy rebounded soundly in 2021, a relief after the largest contraction in the country’s history (–6.8%).³³ GDP grew at yearly rates of 1.1% and 17.6% in the Q1 and Q2, respectively,³⁴ and by July, the economy had already surpassed its prepandemic (February 2020) size.³⁵The recovery was driven by the bouncing back of the domestic demand following the easing of COVID-19–related restrictions and a sharp decline in cases and deaths.³⁶ Notably, retail sales have been steady despite a nationwide wave of protests and blockades between April and May 2021.³⁷ Other sectors, such as manufacturing and entertainment, have also performed well.³⁸ In fact, the seasonally adjusted Purchasing Managers’ Index (PMI) marked its second-best performance on record in September.³⁹ On the global front, Colombia has benefited from a surge in commodity prices, particularly oil and coal, its two main exports.⁴⁰

Interannual inflation reached 4.58% in October, a four-and-a-half-year high, and above the central bank’s upper bound of 4%.⁴¹ As in other economies of the region, the higher inflation in Colombia stems from disruptions to the global supply chain, higher transportation costs, and more expensive raw materials. Nonetheless, two further factors are idiosyncratic to the Colombian economy. First, the low base effect was strong, considering that inflation throughout 2020 (1.61%) was at its lowest in 66 years.⁴² This was mostly the consequence of prolonged and strict lockdowns. Second, the protests and blockades affected supply and distribution logistics within the country and led to shortages in several cities. On October 1, the central bank increased its monetary policy rate by 25 bps, from 1.75% (an all-time low) to 2%⁴³—a decision that marked the beginning of monetary policy normalization. Another increase of 50 bps followed on October 29, leaving the bank´s rate at 2.5%.⁴⁴

Economic outlook

Colombia has recorded one of the strongest economic recoveries in the region. We have upgraded our growth forecast for 2021 to 8.5%, from 5.8% that we projected in January. Our expectation for 2022 remains at 3.8%. The positive dynamics of consumer spending should carry over to the remainder of the year. Meanwhile, the Consumer Confidence Index is at the highest mark since January 2020,⁴⁵ and unemployment declined in August to 12.3%, down 2.7 percentage points from its peak in May.⁴⁶

The stimulus withdrawal and the normalization of the monetary policy should not negatively impact the ongoing economic recovery. However, it does send a clear signal that the Central Bank of Colombia is committed to keeping the surging inflation in check. In fact, we expect the central bank to further increase its monetary policy rate. We forecast the rate to be at 3% by the end of the year. Rate increases make sense in the current tapering process that is starting, like the one in 2013. Furthermore, the central bank argued that short-run inflation expectations were not as firmly anchored around the target and was concerned about a potential wage and price spiral.⁴⁷ It is likely that economic agents will buy into the central bank’s commitment and that inflationary pressures will subside. Consequently, we forecast that inflation will reach 4.9% in 2021 and 3.6% in 2022.

Nevertheless, risks to the Colombian economy still remain. In May, Standard and Poor’s downgraded Colombia’s credit rating below the investment grade from BBB– to BB+.⁴⁸ In June, Fitch followed suit,⁴⁹ officially stripping the country of its investment grade badge. Both agencies cited the withdrawal of a tax reform bill aimed at improving public finances by raising tax collection by 2% of GDP. Since then, the government has passed a far-less ambitious bill set to raise tax collection by half of what the original bill intended. The bill approval, however, prompted a third agency, Moody’s, to maintain the country’s grade—Baa2, above investment grade—and upgrade the country’s outlook from negative to stable.⁵⁰

The loss of investment grade status will make Colombia’s large deficit (8.6% of GDP) more expensive to finance. Moreover, public debt hovers around 62% of GDP.⁵¹ It is, however, expected that the rise in commodity prices will alleviate the burden somewhat as the government enjoys an increase in revenue from abroad, which also lessens the pressure on the exchange rate. In fact, the Colombian peso has recovered against the US dollar throughout October, and we expect it to end the year below COP 3,700 per US dollar (it reached COP 4,046 in late April). 

Another risk is political in nature: The country is set to elect a new president in 2022. Whoever is elected will likely need to cut government spending and raise taxes. However, Colombian Congress is assumed to be highly fragmented, with no party holding a majority. Reaching a consensus, specially about unpopular reforms, may prove to be a daunting task.

Finally, there still remains some pandemic-related uncertainty. Although vaccine dissemination has substantially reduced the number of cases and deaths from COVID-19, the speed of the vaccination rollout has stalled.⁵²  Another peak is set to occur later in the year⁵³ and it remains to be seen how it will evolve, considering the new variants of the virus that are already circulating.

Peru

Executive summary

After a tough 2020, Peru is enjoying one of the highest growth rates in Latin America. This is the result of a low base effect, combined with solid macroeconomic fundamentals. Two monetary challenges lay ahead: high inflation and currency depreciation. While the former is expected to come down with the adjustment of supply chains and lower pressures from oil prices, the latter will depend on how quickly Peru addresses its growing political uncertainty.

Recent developments

The Peruvian economy contracted 11.1% in 2020, a better result than expected, but it still remains the biggest annual drop since 1989. Price gains in industrial metal markets and a strong domestic demand have laid the foundation for a solid recovery in 2021. Available data has confirmed an outstanding economic performance. As per the figures for Q2, GDP grew 41.9% at an annualized rate.⁵⁴ Meanwhile, national output has recorded double-digit expansions for six straight months at a yearly average of 27.5%. Peru’s growth has been one of the highest in the region⁵⁵ and output has already recovered from the last year’s slump.⁵⁶

Interannual inflation hit 5.83% in October, a 12-year high.⁵⁷ As in other EMs, the central bank stepped in decisively to curb not only inflation but also future inflation expectations. Starting in August, Peru’s central bank raised its monetary policy rate at three consecutive meetings by 25, 50, and 50 bps, respectively. Ultimately, these decisions pushed the interest rate from 0.25% (an all-time low) to 1.5%.⁵⁸

Though a relatively stable currency, the Peruvian sol (PEN) has experienced a phase of volatility recently. By mid-April, the exchange rate against the US dollar was PEN 3.63, roughly the same as at the start of the year. Then, mounting political uncertainty from an extremely close presidential election affected business and consumer confidence. In just eight trading days, the currency lost 6% against the US dollar. The PEN appreciated afterward—but since mid-May, it has steadily depreciated and, on September 30, it hit an all-time low of PEN 4.14.⁵⁹

Economic outlook

Although GDP growth in 2021 has benefited from a favorable base effect, the Peruvian economy enjoys firm macroeconomic foundations. An exporter of copper and zinc, Peru has cashed in on the reopening of the world economy with both metals’ prices responding to the spike in demand. Domestically, private consumption improved with the easing of COVID-19–related restrictions and grew at a yearly rate of 30.7% in Q2.⁶⁰ We base our forecast upon these fundamentals and expect GDP to expand by 11.5% in 2021 and by 4% in 2022.

Inflation is expected to come down in the following months with the subsiding of supply chain restrictions. Nonetheless, we expect the central bank to increase its policy rate again and end the year at 1.75%. Future decisions on policy rate will depend on how inflation evolves in coming months, but further rate hikes are not out of the question. Moreover, interest rate increases are very likely in a tapering scenario like the one in 2013. With that in mind, we expect inflation to reach 5.1% at the end of the year and 3.0% in 2022.

Exports, an important source of national income, have surged recently.⁶¹ This should lessen the pressure on the local currency, which several analysts deem to be undervalued. We agree with those opinions and expect the exchange rate to fall to PEN 3.75 per US dollar by the end of the year.

The biggest risk to Peruvian economic recovery is the fragile political situation characterized by contentious relations between its executive and legislative branches. In October, Fitch Ratings downgraded Peru’s credit rating from BBB+ to BBB, citing the increasing political volatility as well as a deterioration of fiscal metrics.⁶² It seems unlikely for a tax reform aimed at improving debt ratios to be passed in the current climate of deep partisanship and political divide. This is a concern that should be tackled as a more harmonious political climate could set the foundation for long-term growth.

Furthermore, there is talk about the government holding a constituent assembly to write a new constitution, but this seems unlikely as the ruling party lacks a majority in the Peruvian congress.⁶³ The current president has replaced seven ministers of his cabinet with more consensual choices. More importantly, he reappointed the president of the central bank for a fourth five-year term.⁶⁴

In the past, the Peruvian economy has shown resiliency amidst political turmoil. Its country risk is the third lowest in Latin America according to Emerging Markets Bond Index (EMBI). Last November, Peru successfully sold bonds worth US$4 billion in the middle of a political crisis that saw two presidents resign in a week. A quarter of those bonds, set to mature in a 100 years, had the lowest rate ever sold by an EM government.⁶⁵