Rising inflation, rate hikes and defaults in Latin America

Mexico and Brazil, having seen the economic destruction that high inflation can cause, do not want to see it again.

By Nick Corbishley for WOLF STREET:

Latin America will soon be hit by a wave of bankruptcies and business failures, according to Jesús Urdangaray López, CEO of CESCE, Spain’s largest provider of export finance and insurance. CESCE insures companies, mainly Spanish, against the risk that their customers do not pay due to bankruptcy or insolvency. It also manages export credit insurance on behalf of the Spanish State.

The biggest clients of CESCE are large Spanish companies with large operations in Latin America. For many of these companies, including Spain’s two biggest banks, Grupo Santander and BBVA, Latin America is its biggest market. CESCE three biggest shareholders are the Spanish state and, yes, the two largest Spanish banks, Grupo Santander and BBVA.

BBVA, heavily invested in Argentina, warned on the worsening situation in the country. If Argentina’s economy continues its inflationary spiral, it could end up affecting BBVA’s overall performance and financial health, the Spanish bank said.

The Argentine government is once again trying to restructure its foreign currency debt with the IMF, having already defaulted on debt once since the start of the virus crisis.

Ecuador was the first to default on its foreign currency debt, followed by Argentina, then Suriname, Belize and Suriname twice more – six sovereign defaults so far in 13 months.

Latin America has been hit hard by the viral crisis. But the region’s cash-strapped governments, with weak currencies and rising inflation, cannot afford to provide the kind of financial support programs that are in place in more advanced economies. The budget response has added just 28 cents in additional deficit spending for every dollar lost in production. In contrast, governments in more advanced economies have increased their spending by one dollar for every dollar lost in production. A few, like those in the United States and Australia, were significantly higher.

Such fiscal largesse has never been an option in Latin America. The result was a massive collapse in economic production. The region’s GDP fell 7% last year – the worst contraction of any region tracked by the IMF. In some countries, especially those heavily dependent on tourism, it was much worse than that. Peru’s GDP, for example, contracted by 11% while that of Mexico, the region’s second-largest economy, fell 8.5%.

Brazil has shrunk by fair 4.1% last year, as public spending skyrocketed. But his debt exploded. By the end of the year, public debt had reached 89% of GDP, more than 30 percentage points above the regional average (55%). The decision of the Central Bank of Brazil at the start of the crisis to cut interest rates to 2%, their lowest level on record, helped support the economy.

But it also fueled inflation. In April, consumer prices rose at an annual rate of 6.8%, the highest since 2016 and well above the upper limit of 5.25% set by the central bank.

The central bank, in trying to curb inflation, implemented a surprise shock and fear rate hike of 0.75 percentage points in March, and in May again raised its policy rate by 0, 75 percentage point to 3.5%, and at the time indicated a similar rate hike would come in June. Rising rates will make it harder for businesses, consumers and the government to service their debts.

Inflation is rising more slowly in some Latin American countries (eg Peru, Chile, Bolivia) and more rapidly in others, particularly Argentina and Venezuela.

Mexico is also experiencing a spike in consumer prices, although the government has adopted a more moderate fiscal response to the virus crisis. The Bank of Mexico cut its key rate to 4% earlier this year, but it’s still relatively high. Inflation hit 6.1% in April, double the central bank’s target rate.

The price of food is rising sharply. Corn prices have more than doubled since August of last year. This fueled the rise in prices of corn tortillas – the quintessential staple of Mexican food and cuisine – which reached their highest average level since 2017. One of the last times that prices rose so rapidly, in 2006, this led to hunger riots.

Mexico, like Brazil, has seen the economic destruction that high inflation can cause and they don’t want to see it again. If consumer prices continue to rise, the Bank of Mexico may have to start raising rates, making it even more difficult for the economy to emerge from its deepest recession since 1932.

It will take time for the first round of rate hikes to have a significant effect on slowing consumer price inflation. And they may not even be enough to tame inflation, given that most of the pressures fueling consumer price hikes are largely global in scope. These include low inventories, supply chain shocks, rising shipping costs, growing demand for certain commodities and consumer goods in developed countries, especially states. United, and faced with these supply constraints, a massive fiscal and monetary stimulus in advanced economies.

Even as this stimulus threatens to fuel disruptive inflation in the world’s poorest economies, northern hemisphere central banks have shown little interest in shutting down gas. These price increases are transitory, they say, having adopted a wait-and-see strategy. And that means prices will likely continue to rise in Latin America even as the region’s economies remain in deep crisis. By Nick Corbishley, for WOLF STREET.

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