Adriana Arreaza
Directora de Estudios Macroeconómicos de CAF
Latin America and the Caribbean ended the year with a mixed macroeconomic balance, marked by relatively solid growth rates, improved external and fiscal performance, albeit with high inflation rates.
We expect a final average growth of 3.5% in the region for 2022, higher than the more modest expectations of a 2.3% expansion we had at the beginning of the year.
There were several factors behind these improved results. First, the hike in commodity prices fueled by the war in Ukraine, which favored energy, metal, and food exporting countries in the region. Second, broad access to financing, particularly favored by the portfolio’s tactical moves in favor of the region vis-à-vis China and the conflict in Eastern Europe. The third factor is the carryover effect of the progressive reopening of activities such as tourism that underpinned recovery in many Caribbean economies.
Thanks to these results, most Latin American economies have reportedly bounced back to pre-pandemic GDP levels this year. The revival of economic activity have also apparently improved conditions in the labor markets. Employment and labor participation returned to pre-pandemic levels in most of the region.
Economic activity, however, is starting to show signs of weakness in recent months as we project growth of just 1.3% in 2023 for the region. This is the result of a less favorable context derived from the synchronized monetary tightening that is straining financial conditions and cooling global demand; weakening commodity prices; high uncertainty; and persistent inflationary pressures.
In sum, just as economic activity was—surprisingly—in a upward trend in 2022, so was inflation. In several Latin American countries, annual variation in prices exceeded double digits during the year, which had not occurred in decades. In recent months, however, inflation rates have begun to recede, as some of the factors that initially caused the rise in prices are beginning to dissipate.
For example, commodity prices, international freight costs, and problems in value chains have improved. The progressive lifting of some of the supply constraints, coupled with weaker demand, has closed the gap between supply and demand, thus mitigating the upward momentum in prices.
Inflation rates could therefore have peaked and continue to converge towards targets set by central banks in 2023. If they do converge, the cycle of interest rate hikes could be coming to an end. In this sense, some central banks in the region have already declared that interest rates have reached their desired levels, which would stop—or at least slow down—the process of hikes.
But core inflation—inflation that does not consider volatile supply components such as food and energy, and on which central banks may have a greater impact—is only beginning to recede in some countries. Thus, even if they have reached their peaks, interest rates are expected to remain in restrictive territory until inflation shows strong signs of convergence to targets.
How slow and stable inflation’s path of convergence to targets will be is difficult to predict, particularly in an uncertain environment where supply-side surprises may emerge. What is easier to predict is that the region’s central banks—which were ahead of the curve with the withdrawal of 2021 stimulus—will surely not let their guard down.
Lastly, on the fiscal front, improved performance continued to be observed. Fiscal deficits receded in most countries and, together with nominal output growth, this led to a reduction in debt in the region to 69% of GDP in 2022, after peaking at 77% in 2020. However, debt levels remain high and additional consolidation efforts will be required to restore fiscal room and stabilize debt.
Fiscal authorities have been facing the difficult task of striking a balance between continuing efforts to clean up fiscal accounts, protecting the most vulnerable groups, and moving forward with public investment plans. This relaxing of inflationary pressures poses an additional challenge, i.e. fiscal policy should not run counter monetary policy. This means that policymakers should avoid fostering an aggregate momentum to demand, which may accelerate inflation again.
Otherwise, monetary authorities will need to raise interest rates further to counteract the impact of the fiscal momentum on demand and prices. This would not only affect credit conditions, thus affecting consumption and investment decisions of private agents, but would also negatively impact the parameters for the sustainability of public debt.
Noteworthy is that inflation is a highly regressive tax. Precisely, containing it is imperative to protect the most vulnerable. Consequently, it should remain a public policy priority in the short term. This will require better targeted assistance policies, seeking a more efficient allocation of spending, which properly financed through more progressive taxes. The introduction of indexation mechanisms, regressive subsidies, or other measures that call into question medium-term fiscal stability may actually go in the opposite direction, hindering the process of reducing inflation.
The macroeconomic situation in Latin America, while complex, is not much worse than in other emerging—and even advanced—economies in terms of the need to curb inflation and restore fiscal room. Having strengthened institutions to implement more coherent monetary, financial, and fiscal policies in the region has allowed, among other things, keeping the scourge of inflation under control, greater financial stability, and less pro-cyclical management of economic cycles.
Macro-economic stability is of course no silver bullet to solve structural deficiencies that the region is carrying over, such as low growth or the marked social inequalities that pass on from one generation to the next. But it is a pre-requisite for sustained improvements in people’s well-being. In its absence, it is difficult to conceive that comprehensive public policy agendas needed to address the region’s structural problems may be successfully implemented. If there is one place where this should be clear, it is in Latin America.
