After hiking interest rates seven times in eleven months, Brazil now faces the most dreaded of economic scenarios: stagflation.
Inflation in Latin America’s two largest economies, Brazil and Mexico, keeps rising despite repeated interest rate hikes by their respective central banks. In Brazil, interest rates have risen faster than in any other major economy this year, yet with little apparent impact on consumer price inflation or producer prices.
On Wednesday (Dec. 8), the Central Bank of Brazil raised the Selic rate by a whopping 150 basis points to 9.25%. It was the second 150-basis point rise since Octoberand the seventh consecutive interest rate hike in 2021. Since March borrowing costs in Brazil have surged by a whopping 725 basis points, the most among major economies. But consumer price inflation and producer prices keep rising. The central bank has pledged that the tightening cycle won’t end until rising inflation estimates return to the central bank target (3.75%).
“It is appropriate to advance the process of monetary tightening significantly into the restrictive territory,” the central bank wrote in a statement accompanying its decision. “The committee will persist in its strategy until the disinflation process and the expectation anchoring around its targets consolidate.”
Brazil now faces the most dreaded of economic scenarios: stagflation. A portmanteau of “stagnation” and “inflation”, stagflation is a situation in which prices don’t stop rising in a sluggish, shrinking economy. As shown in the graph below (courtesy of Trading Economics) inflation has been on a constant upward trajectory since December 2020. In October it hit an almost six-year high of 10.67%, nearly triple the central bank’s target.
The economy is also in recession, having contracted by 0.4% in the second quarter of 2021 and 0.1% in the third.
Despite slowing economic activity, the central bank has slammed on the monetary policy brakes in an attempt to tame inflation. But it also risks squeezing yet more life out of the economy by making it even harder for heavily indebted businesses and consumers to service their debts. As prices and borrowing costs rise simultaneously, hurting consumers and businesses even more than before. The National Confederation of Commerce’s family consumption intention index dropped in November, as higher inflation and interest rates choked household spending, as The Brazilian Report reports:
The findings corroborate results from a survey by consumer protection service Procon, which highlighted that 70 percent of consumers in São Paulo claim to have lost revenue during the pandemic. Over 90 percent say that essential goods such as food, electricity and fuel have eaten up a massive chunk of their household budgets.
Interest rate hikes appear to be having a muted impact on inflation in Brazil in any case. This should hardly comes as a surprise given that today’s inflationary pressures are a result of myriad factors, many of them global in nature and as such beyond the control of Brazil’s central bank. They include extreme weather events such as the once-in-a-century drought Brazil suffered this summer (Brazil’s winter), which fuelled rising prices not only of food but also energy, as Brazil depends on hydroelectric power for around two-thirds of the electricity it consumes. Given the highly interconnected nature of the global economy, extreme weather events in other parts of world could also end up feeding into higher prices in Brazil.
Another key factor driving prices higher is the global supply chain crisis, which shows little sign of letting up any time soon. The monetary stimulus programs in more advanced economies are also likely to be exacerbating global price rises, though it’s impossible to tell just how much. It is probably the confluence of these two factors — a sharply limited global supply of many vital products at a time of surging money supply (although this trend now appears to be slowing) — that is truly damaging.
In Mexico, conditions are somewhat better than in Brazil. The economy is still growing, albeit not nearly enough to make up for last year’s 8.5% contraction. By the end of this year annual economic growth is forecast to weigh in at around 6.5%, according to Bank of Mexico estimates.
But as in Brazil, inflation is roaring. The country’s consumer price index surged to 7.37% at the end of November, from 6.24% in October. As Trading Economics notes, it was the highest increase in CPI since January of 2001, as costs ballooned for food and non-alcoholic beverages (10.8% vs 8.4% in October), transportation (9.5% vs 7.3%), furniture and household maintenance (7% percent vs 6.2%) and restaurants and hotels (7.1% vs 6.7%).
Staple foods have experienced some of the steepest price rises. So far in 2021 green tomatoes have surged a whopping 148% in price; fresh chilli, 137%; avocado, 46%; onions, 45%; tomatoes, 36%; and corn tortilla, 16%. As El País reports, the surging prices have been a sobering experience for young Mexican adults belonging to Generation Z — the so-called centennials, born between 1996 and 2012 — who had never witnessed an inflationary surge as dramatic as this one.
For most people in older generations, the rising prices no doubt evoke painful memories of the sharp devaluations of the 1980s and 1990s, which sparked brutal bouts of inflation. During the lost decade of the ’80s inflation reached a vertiginous peak of 179% in February of 1988. A few years later, as the Tequila Crisis raged, it briefly surged above 50% once again. In both crises people with US dollar accounts did quite nicely while most people in the middle and lower classes could only stand by and watch as their savings and purchasing power disintegrated.
But it’s not just consumers who feel the pain of inflation; so too do many businesses, particularly small ones. Today, many of those businesses are still trying to recover from the economic fallout of last year’s lockdowns. Now, as a result of rising inflation an estimated six out of ten small businesses in Mexico have suffered a fall in sales in recent months, according to the National Small Business Alliance (ANPEC). “If inflation continues to head higher, more people will struggle,” says Cuauhtémoc Rivera, president of ANPEC.
As I noted in my previous article on inflation in Latin America (posted Oct. 5), prices are also rising fast along the Andes. That trend has intensified sharply in the last two months.
Chile’s inflation rate has done nothing but rise since February this year, reaching 6.7% in November, its highest level since 2008. Peru’s CPI was at 5.7% during the same month while Colombia’s reached a four-year high of 5.26%. Consumer price inflation rose to 8% in Uruguay while on the other side of the Rio Plata, in Argentina, the official rate of inflation is firmly above 50% once again.
It’s the speed at which this trend is happening that is perhaps most worrisome. In the first year of the pandemic, inflation in the five largest and most financially integrated Latin American countries, Brazil, Mexico, Chile, Peru and Colombia — the so-called “LA5” — was below average for emerging market economies. Now it’s higher, as depicted in this following graphic from an IMF blog post.
As the graph shows, one of the main forces driving this surge in inflation is soaring food prices, which is hitting the poorest particularly hard. As the IMF blog notes, food prices “started increasing even before the pandemic and have risen more than 18 percent on average in LA5 countries since January 2020:
In Latin America, food prices make up about a quarter of the average consumption basket. For households still reeling from the coronavirus crisis, higher food bills leave less to spend on other goods. In a region with the highest levels of income inequality, the burden is highest for low-income households who spend a larger share of their income on food.
Even core inflation, which excludes food and energy prices, has exceeded the pre-pandemic trend this year, reaching an average of 5.9 percent year-on-year in October.
As central banks in Latin America try to dampen the inflationary pressures by hiking rates, they risk plunging their economies into a stagflationary spiral, as already appears to be happening in Brazil. One of the reasons the central banks are doing this is to defend their currencies against a strengthening dollar. They know that if financial conditions in the U.S. and other advanced economies were to suddenly tighten, as the Fed and other major central banks begin hiking rates to stifle inflation (which isn’t beyond the realms of possibility), it could spark sharp asset sell offs and capital outflows in their own economies. And that is how many financial crises in Latin American have begun.