How Latin American banks and investors can navigate inflation

Latin America is no stranger to inflation, but this current period of high inflation deviates from the norm and threatens to disrupt post-pandemic economic recovery. Here’s what you need to know.

High inflation levels have struck the Latin American economy before, but never like this. The recent spike of inflation is sweeping through Latin America, the United States, and Europe simultaneously when in the past, the impact of Latin American inflation was more localized and typically the result of domestic factors such as excessive money-printing.

However, a mix of international factors is driving this current inflation wave. Global supply-chain bottlenecks, input shortages, and high commodity prices fuel rising inflation levels across the globe. Latin American banks and investors may need to rethink their approach to navigating this unprecedented inflation period and its effects on the local economy.

Here’s what you need to know.

Latin American Inflation — A Country-specific Survey 

Latin America isn’t a monolith, and it’s essential to examine how high inflation has affected the economies of the continent's constituent countries to understand the current landscape. While some countries hold steady, others appear to be declining from their inflation high point.

Argentina: According to AXA IM’s internal research, Argentina will see some of the highest inflation levels across the LatAm region. Inflation in Argentina is expected to surpass 60 percent in 2022 alone. Given Argentina’s inflation levels have remained above 24 percent since 2014, reversing this long-standing trend will be an uphill battle.

Brazil: Although Brazil has a steadier macroeconomic framework than Argentina, Brazilian banks and investors face the most arduous road ahead. Last month, annual inflation in Brazil hit 12.1 percent  — a 19-year high — meaning Brazil’s inflation rate is now the highest of any major Latin American country, aside from Argentina. Since Brazil’s Central Bank has already increased interest rates by 925 bps to fight inflation, any new monetary policies will have to operate with little margin for error. If Brazil tightens monetary policy any further, it could soon hit a tipping point and risk stunting its still-recovering economy.

Mexico: Mexico, in contrast, may have already endured the worst of its inflationary cycle. Our research indicates that Mexico’s inflation rate has reached its apex and should end the year at around 7.0 percent. Mexico’s current annual inflation rate comes in at 7.7 percent, one of the lowest rates across the LatAm region.

Mexico’s ongoing rate hikes have proven far more effective at curbing inflation than Brazil’s. Mexico’s success in fighting inflation can also be attributed to decades-long macroeconomic stability, which significantly anchors long-run inflation expectations.

How Will Inflation Affect Latin American Economies?

High inflation across LatAm raises borrowing costs and threatens to slow down the economy significantly or, worse yet, trigger a recession. Many businesses took advantage of the low-interest rates and growth-friendly climate that have defined the last decade, but now they’re left with outstanding loans that will become more expensive as interest rates rise.

Higher inflation means companies now have to carry debt over a longer period at a greater cost. Also, inflated borrowing costs make capital less available and accessible, which presents challenges for businesses looking to expand.

At the same time, higher living costs threaten to significantly diminish consumer spending and companies’ sales, potentially chasing away foreign investors seeking economic stability. In this context, it’s worth noting that private consumption remains one of the most critical growth driver across most Latin American countries.

Next Steps for Navigating Inflation

Central banks have several tools at their disposal to combat these macro forces. They can adjust reserve requirements to expand or contract their money supply through monetary policy. Reserve requirements, which central banks set as a countermeasure against unexpected withdrawals, mandate the minimum amount of liquid assets commercial banks must hold to meet liabilities at any one time. A higher reserve ratio leaves banks sidelining more money. As a result, less money in circulation in the economy should drive down aggregate demand and inflation.

Central banks have long used increased interest rates to combat inflation, but the power of monetary policy is by no means a cure-all. LatAm countries are left between a rock and a hard place when balancing economic recovery initiatives against the challenges of rising inflation.

Meanwhile, if over-relied on, interest rate hikes threaten to destabilize the post-pandemic economic recovery across much of Latin America. If central banks tap into rate hikes too much, investors might start to believe this will become a supply shock that causes permanent inflation. The more skittish investors become, the greater their flight to safe havens and risk-off assets.

What’s more, the influence of central bankers remains limited — central banks have no control over global energy prices. At the very least, higher domestic interest rates cannot drive down global prices. At best, even the most effective monetary policies can only affect core inflation.

Staying Ahead of the Surge

Latin America was the first to commence its hiking cycle among the world's emerging market regions. Luckily, most central banks throughout LatAm have already performed most of the heavy lifting and have a slight edge in navigating inflation.

Chile and Mexico are approaching the ends of their tightening cycles, while Colombia, Peru, and other LatAm countries are taking a more gradual approach to rate hikes. We could potentially see central banks raise interest rates another two to three times this year.

However, it’s still too early to determine the effectiveness LatAm banks’ interest rate increases. If global energy and food prices continue to skyrocket, even the most hawkish central banks might be powerless to stop subsequent surges in inflation from spreading worldwide.

To learn more about AXA IM’s outlook on rising inflation levels across LatAm, get in touch with our expert team today.