After last year’s economic carnage, the spectre of runaway inflation is the last thing the region needs.
As prices for many vital goods and services surge across the globe, central bankers in most advanced economies refuse to take their foot off the gas, even as inflation gets stickier. But things are very different in emerging economies.
Last year many emerging economy central banks slashed rates to extreme lows as economic activity ground to a standstill and inflation crumbled. But now many of them are frantically hiking them again as inflation returns with a vengeance, largely on the back of forces that are global in scope. They include low inventories, supply chain shocks, soaring shipping costs, labour shortages, extreme weather events, surging demand for certain commodities and consumer goods, and the huge monetary and fiscal stimulus programs still under way in most advanced economies.
Latin America’s two largest economies, Brazil and Mexico, have respectively raised rates five times and three times so far this year. There’s likely to be more to come. Although rising commodity prices are largely welcome in the resource-rich region, most countries would rather avoid a return to runaway inflation, especially given the current weakness of their economies. In Brazil and Mexico anybody over the age of 35 can remember what life was like under high — or in Brazil’s case hyper- — inflation. They don’t want to go through it again.
In Brazil today inflation rates have tripled over the past year, from 3.1% in August 2020 to an anualized 9.7% in August 2021, its highest level since 2016. In September, the IPCA-15 consumer-price index — a mid-month predictor of the official inflation rate — surged by 1.14% over the month. If the indicator rings true, Brazil will soon report its highest reading for the month of September since 1994. That was when the country had just launched a new currency, the Brazilian Real, after being ravaged by its second bout of hyperinflation in seven years.
Currency Movements, Extreme Weather Events
There are a number of reasons why Brazil is suffering particularly high inflation right now, even among its peers. First, the Real has fallen around 10% against the dollar since July. As in Europe, the country’s energy market has been battered by unexpected weather events, including its worst drought in almost a century. Reservoirs in the Southeast and Midwest regions, which account for nearly 70% of the storage capacity, reached near-record lows of less than a quarter full over the summer. The drought has fuelled higher prices not only for food, as domestic production of staples has fallen, but also of energy, since Brazil depends on hydroelectric power for around two-thirds of the electricity it consumes.
By July marginal operating costs of the Brazilian power system had reached their highest levels since 2015. And energy prices, as IHS Markit warned in July, are a vital contributor to inflation since they have an impact at each stage of the production and distribution chain:
Both wholesale prices and retail tariffs are therefore likely to result in higher production costs for companies operating in the manufacturing sector such as the production of automobiles, chemicals, and metallic products. Low water levels will also affect the agribusiness sector, which will experience reduced water supply for irrigation and impaired movement of cargo through waterways.
By the end of August producer inflation had increased by 23.5% year-to-date. All activities monitored by the Brazilian Institute of Geography and Statistics (IBGE) registered price increases in August. The fact that prices are surging so fast at a time when the economy appears to be stagnating — it contracted by 0.1% in the second quarter — is of particular concern, raising the spectre of stagflation.
In Mexico, inflation is not quite as high as in Brazil, partly because Mexico’s central bank, Banco de Mexico (Banxico for short), didn’t cut rates as aggressively as most of its peers last year. AMLO’s leftist government also didn’t unleash nearly as much fiscal stimulus as its right-wing Brazilian counterpart. Nonetheless, the consumer price index (CPI) in Mexico still weighed in at 5.59% in August, almost double the central bank’s target rate of 3%.
Banxico raised its benchmark policy rate by 25 bps to 4.75% last week, saying that while it expects the shocks fuelling inflation to be transitory, they may still pose risks to the price formation process and to inflation expectations, due to their variety, magnitude and potential duration of their effects.
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