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Smaller Economies in Latin America and Caribbean Face a Greater Inflation Problem

  • ECONOMY

Smaller Economies in Latin America and Caribbean Face a Greater Inflation Problem

By Emine Boz, Ilan Goldfajn, Jaime Guajardo, and
Metodij Hadzi-Vaskov

September 19, 2022

Much less diversified economies, better reliance on imports, and better public debt make preventing inflation tougher

As inflation continues to be elevated throughout Latin America and the Caribbean (LAC), the impression on actual incomes and buying energy stays a key problem, particularly for probably the most susceptible. We seemed into this problem from the attitude of smaller economies in LAC by analyzing latest inflation dynamics for 3 sub-groups of small economies: Central America, Panama, and the Dominican Republic (CAPDR); theCaribbean; and the smaller economies in South America—Bolivia, Ecuador, Paraguay, and Uruguay.

Our work reveals that prime inflation is an even bigger problem in smaller economies as a result of they’re much less diversified, rely extra on imports, and have extra restricted coverage levers at their disposal. The poorest households have been hit the toughest and meals insecurity is on the rise. Many of those international locations have pegged alternate charges and would not have an impartial financial coverage. Thus, they needed to depend on momentary fiscal measures, of which about half have been focused to probably the most susceptible. Nations with bigger pre-existing subsidies tended to introduce smaller measures.

Inflation on the rise

In the course of the first half of 2022, inflation reached multi-decade highs in lots of of those international locations. The most recent out there inflation information for August reveals that yearly headline inflation exceeded 9 p.c in CAPDR and 6 p.c within the smaller economies of South America. Within the Caribbean, it reached virtually 6 p.c in March. Core inflation confirmed related tendencies, staying at decrease ranges than headline inflation because it strips out meals and power costs.

Smaller economies are sometimes much less diversified and rely extra on imports, making them extra vulnerable to inflationary pressures arising from increased import costs. Additionally, meals and gas—each of which have skilled massive value will increase because the starting of the conflict in Ukraine—account for a bigger share within the consumption basket in these economies.

Smaller economies even have extra restricted coverage levers at their disposal. They sometimes have much less versatile alternate fee preparations, and therefore, rely much less on alternate fee changes. Lots of the small international locations have excessive public debt and elevated sovereign spreads, partly a legacy of the COVID-19 pandemic. Dealing with increased public debt ranges, smaller economies have extra restricted fiscal area and coverage choices at their disposal.

Poorest hit hardest

The continued inflation wave is hurting the poor extra given the fast improve in meals costs. Inflation estimates throughout earnings quintiles in CAPDR present that over the previous few months, the poorest quintiles have confronted significantly increased inflation charges than the richest quintiles. The principle driver of this discrepancy has been the rise in meals costs. These developments could worsen meals insecurity additional, which had already elevated throughout the pandemic.

Responding to international shocks amid home constraints

Many international locations worldwide have carried out measures to mitigate the impression of upper international power and meals costs within the home financial system, significantly after the beginning of the conflict in Ukraine. To gauge the magnitude of those measures, we estimate the response of home gas costs to a one p.c change within the worldwide gas value—the go via from worldwide to home gas costs. We discover that the pass-through from worldwide to home gas costs has declined from about 1 earlier than the conflict (ie home costs have been transferring virtually one-to-one with worldwide costs on common throughout 2015-2021) to about 0.8 after the beginning of the conflict. An analogous decline has been noticed within the pass-through from worldwide to home gas costs within the smaller international locations in LAC.

A number of constraints have formed the coverage responses. Many small LAC economies have foreign money pegs and thus much less coverage flexibility to deal with the impression of the worth shock. Just a few of those economies have elevated coverage charges to include second-round results and maintain inflation expectations anchored. To mitigate the impression of upper international power and meals costs, they’ve carried out discretionary fiscal coverage measures, most of which have been introduced as momentary and about half have been focused to probably the most susceptible.

The scale of the fiscal measures has diverse throughout economies—they’ve been bigger for economies with bigger weights of meals and transportation of their shopper value index (CPI) basket, weaker social security nets, or decrease earnings per capita.

Wanting on the new measures and their prices gives a partial image as a result of some international locations already had in place intensive subsidies on meals and gas. When evaluating present power or meals subsidies with the price of new measures, we observe that international locations with bigger pre-existing subsidies tended to introduce smaller measures.

Making ready for a probably extra persistent inflationary shock

Policymakers ought to be ready for a doable long-lasting inflationary shock. Given the uncertainty across the depth and length of the shock, the next common rules will help policymakers navigate via these turbulent instances: (i) home costs ought to modify to worldwide costs, whereas offering focused and momentary assist to probably the most susceptible; (ii) if focused measures usually are not possible, value smoothing mechanisms with clear exit methods may assist whereas social security nets are strengthened; and (iii) think about offsetting income or spending measures to restrict general fiscal impression.

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Emine Boz is Assistant to the Director within the Western Hemisphere Division.
Ilan Goldfajn is Director of the Western Hemisphere Division.
Jaime Guajardo is Deputy Division Chief within the Western Hemisphere Division.
Metodij Hadzi-Vaskov is the Regional Resident Consultant for Central America, Panama and the Dominican Republic.

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