The Looming Inflation Disaster on Smaller Economies in the South America Region

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Photo by Kelly Sikkema on Unsplash

South America — We always talk about how grim the “inflation problem” is in the US and Europe, how both Americans and Europeans are losing confidence in their government in the face of growing commodities prices and tightening monetary policies by the US Federal Reserve (Fed) and the European Central Bank (ECB). However, although these western events warrant a valid concern, the region that sits behind the limelight on the world stage is perhaps the most vulnerable region in the face of a worsening global economic landscape.

The region seems so near geographically yet far in terms of its coping mechanisms with the current sour economic environment. Moreover, the region that has relatively vast lands and natural resources has little actual economic productivity and conversion. Lastly, the region that sits on the southern part of the globe has, unfortunately and ironically, gone south with its monetary and fiscal policies.

Inspired by the recently published paper on the matter in the International Monetary Fund (IMF) authored by Emine Boz, Ilan Goldfajn, Jaime Guajardo, and Metodij Hadzi-Vaskov. In this piece, we’ll tackle the looming inflation disaster that South America (SA) may face, according to the UN’s international financial institution body.

The Harsher Economic Reality

The authors opened with a straightforward take on the region, saying, “Our work shows that high inflation is a bigger challenge in smaller economies because they are less diversified, rely more on imports, and have more limited policy levers at their disposal.”

Hence, unlike large economies such as the US, China, and Europe, smaller economies in the SA are more concentrated in their wealth sources. As a result, they rely more on imports to meet their total domestic needs and, worst, have few monetary and fiscal policies available to combat the rising economic pressure effectively.

“Many of these countries have pegged exchange rates and do not have an independent monetary policy. Thus, they had to rely on temporary fiscal measures, of which about half were targeted to the most vulnerable,” the authors added.

In addition, since the “real effects” of inflation trickle down and are more apparent on the most basic goods, primarily necessary food items (such as bread and wheat), which many SA economies have been importing to fulfill their demand — prices have gone up significantly, and the most vulnerable during these price increases are the bottom section of the population. “The poorest households have been hit the hardest, and food insecurity is on the rise,” the authors emphasized.

Furthermore, the authors also revealed the widening impact of microeconomic discrepancy on the region. “The ongoing inflation wave is hurting the poor more given the rapid increase in food prices. Inflation estimates across income quintiles in CAPDR show that over the past few months, the poorest quintiles have faced considerably higher inflation rates than the richest quintiles.”

Region’s Sovereign Debt Aggravates the Effects

“Many of the small countries have high public debt and elevated sovereign spreads, partly a legacy of the COVID-19 pandemic. Facing higher public debt levels, smaller economies have more limited fiscal space and policy options at their disposal,” the authors exclaimed.

To top everything, the government or sovereign debts of various SA economies have been steadily growing as they borrow more and also since the spread between their currencies and the US dollar continues to increase. This inadvertently makes them even more susceptible to borrowing even more to fulfill the growing spread. Hence, creating a vicious cycle or loop that could have a long-term or worse, permanent detrimental effect on the region.