Inflation and Interest Rates in Latin Countries

Except for Venezuela and Argentina, Latin American countries are much better prepared to face external shocks than before. Inflation, is no longer a constraint to prevent economic growth. Indeed, Brazil and Mexico, the two largest economies in South America, have achieved single digit inflation that are similar to developed economies. Indeed, both countries will post headline inflation between 4 to 5% in 2010. Chile, however, is experiencing deflation on a month to month basis whereas Peru is also showing inflation rates similar to Brazil and Mexico.

In this context, Venezuela and Argentina are the exception to the rule. In Venezuela, headline inflation reached almost 30% year over year in April whereas in Argentina inflation reached 15% in the same period. The market is fully convinced that Kirchner is underreporting inflation data. Since the government issues bonds attached to the inflation, the yield is smaller with a ‘lower’ inflation. It is also known that the growth data is also being manipulated. These are negative aspects for Argentina especially considering that without restoring the credibility in official data, Argentina will not be able to attract the necessary capital (from both resident and non-resident investors) to recover from an economic contraction (estimated to be 2-3% in 2009).

There is no compelling evidence of systemic cracks in the banking sectors of the largest countries in South America. While the pace of local lending growth has decelerated and credit-adjudication standards have tightened, official intervention in defense of local financial sectors has been relatively moderate, when compared with the crises in both the United States and the United Kingdom. All the Central Banks in the region are pursuing an expansionist monetary policy. The Chilean central bank has lowered its monetary policy rate by 700 basis points to the current level of 1.25%. Similarly, the Peruvian reference rate was cut by 100 bps to 4% in early May. Also, Banco de Mexico, lowered its rates by 75 basis point to 5.25% in May. A recent flu outbreak that has further undercut the economy, and pushed some brokerages to bet on a cut of 100 basis points this month, or another 75 basis point cut in June. In Brazil it is possible to see the Central Bank lowering its Selic in June by 100 basis point to 9.25%, the lowest interest rate Brazil has ever had.