As a region with a history of high inflation, Latin America’s reaction to the current inflationary environment is particularly interesting, says Joaquin Thul, economist at EFG asset management.
Latin America is experiencing, in common with the global trend, a surge in inflation. But in contrast to the rest of the world, this comes when very high inflation – indeed, hyperinflation – is still widely remembered in the region.
Brazil and Peru had inflation rates above 1,000% p.a. in the late 1980s/early 1990s. Action was taken to curb this perennial weakness in the 1990s, with all countries in Latin America, except Brazil, giving their central banks independence and a price stability mandate.
Dealing with surging prices
The rise in Latin American inflation this time around started in 2021 and has been the first major challenge facing the region’s independent central banks. Inflation rates in the five major economies were between 2% and 4% in the early stages of the pandemic and rose to above 10% in Chile, Colombia and Brazil more recently.
The IMF forecasts rates will return to around 6% at the end of 2022 and 3-4% at the end of 2023. The one reason for being reasonably confident in that view is that Latin American central banks have reacted quickly and forcefully.
Latin America CPI inflation rates
Source: Refinitiv, data as at 1 July
There have been 13 rate hikes in Peru, 11 in Brazil; 10 in Mexico; 9 in Chile and 8 in Colombia. As inflation and interest rates have risen so have local currency bond yields. With the exception of Chile these are now in the 8-13% region.
What this means for LatAm debt
If inflation does fall back quickly and then remains in a 2-4% range, such yields represent an interesting opportunity. Wary that currency depreciation can eat away from the returns when expressed in a hard currency, some will be cautious about holding such debt.
However, according to one influential study they need not be too concerned. A database of foreign-currency denominated government bonds traded in London and New York between 1815 (the battle of Waterloo) and 2016 shows the returns have been sufficiently high to compensate for risk.
Real ex-post returns have averaged more than 6% annually across two centuries, including default episodes, major wars, and global crises. Even so, many will prefer exposure to the region’s hard currency debt (issued predominantly in US dollars). Interestingly, governments in the region look set to be among the first issuers of sustainability-linked sovereign hard currency bonds. If that is the case, the attitude towards Latin American debt may well change permanently in the not too distant future.
