Higher food, fuel costs grip Latin America

As a commodity-dependent region, Latin American economies and politics have long been beholden to events outside the hemisphere. The Russian invasion of Ukraine is no exception. While Latin America continues to grapple with the fallout from the Covid-19 pandemic, the war in Ukraine has intensified supply chain problems and boosted fuel and food prices. These conditions are contributing to already high inflation and rising costs of living which politicians and central banks are ill-equipped to correct. This could result in social unrest, a fact that augurs poorly for incumbents and short-term political stability.

The pandemic hit the region especially hard, causing the highest per capita death rate in the world, economic contraction and a rise in poverty. A combination of supply chain disruptions and demand-side pressures meant that, by the end of 2021, consumer price inflation in the region had jumped from an average of 4 percent between 2015 and 2019 to over 7 percent. According to the World Bank, the main contributors were food and energy, accounting for more than 90 percent of inflation in Costa Rica, 75 percent in Paraguay, 66 percent in Brazil and almost 60 percent in Colombia.

Rising commodity prices and additional disruptions to the supply chain following Russia’s invasion will make these inflationary pressures worse.

Food costs

High inflation is already hitting consumer food staples across the region. The Food Price Index of the Food and Agriculture Organization of the United Nations measures the monthly change in international prices of a basket of food commodities. In May, it was down just 0.8 percent from its all-time high in March. It is likely to remain elevated throughout the year and may rise further.

Economic sanctions on Russia and the damage to Ukraine’s agricultural sector will cause significant harm. Both countries are major global suppliers of barley, corn and sunflower oil. More importantly, they account for nearly 30 percent of all global wheat exports. An increase in wheat prices is already raising costs on basic food items such as flour, bread, pasta and packaged foods. Furthermore, any reduction in the wheat supply will push up demand and prices for wheat grown in other places – something that could benefit Argentina but is likely to hurt the rest of Latin America.

Within the region, countries dependent on imported food, such as Venezuela and the Caribbean states, will be the hardest hit and should see rapidly rising costs for consumers. Food and agricultural goods account for an average of 19 percent of the Caribbean Community and Common Market (CARICOM) members’ import bill, and some CARICOM members import up to 60 percent of their food requirements. Mexico and most of South America should fare slightly better in this regard.

Regardless of the country, the additional cost of living increases is an unwelcome and politically damaging development. Rising food insecurity is likely to worsen the poverty and economic vulnerability of many Latin Americans, especially the urban poor and migrants. This will exacerbate inequality in what is already the world’s most unequal region and contribute to voter dissatisfaction.

Fuel prices

A steep increase in fuel prices is adding to the discontent. The cost of gasoline rose steadily throughout 2021, impacting public transportation, government budgets and agriculture. The price of crude oil jumped even higher in late February in response to the Russian invasion and resulting Western sanctions, as well as the announcement that the United States and the United Kingdom would ban imports of Russian energy.

This is bad news for Latin American leaders. As with food, high gasoline prices lead to public anger and lower approval ratings for politicians. Prices directly hit citizens’ pocketbooks at the pumps while also contributing to welfare losses through higher public transport and shipping costs. Transportation unions, which must balance fuel and labor against what they pass onto consumers, can go on strike – something that has already happened in Brazil, Mexico, Peru, El Salvador and Panama, among others.

Higher energy prices also constrain government budgets, as politicians attempt to keep costs down by limiting price hikes (e.g., Jair Bolsonaro in Brazil), cutting taxes (e.g., Nayib Bukele in El Salvador), or increasing fuel subsidies (e.g., Andres Manuel Lopez Obrador in Mexico, among others). These policies present drawbacks, including diverting budgets from other social spending. Lastly, these changes provide further incentives for the theft and resale of gasoline. This is especially true in Mexico, where fuel theft was already common among drug trafficking organizations, organized criminal groups and so-called “huachicoleros,” or petroleum thieves.

Ultimately, rising fuel costs will be a net negative for Latin America. While some oil-exporting economies like Brazil, Colombia and even Venezuela may benefit from higher energy prices, the increased costs will still be a shock to consumers (and voters) much faster than benefits can accrue. Instead, the surge in food and energy costs will put significant pressure on households’ disposable incomes. They are also the most visible reminder of inflation for most people and thus present governments with acute policy challenges.

Policy responses

Governments have limited policy tools at their disposal to address the fallout from supply chain disruptions and the war in Ukraine. Central banks across the region have already pursued one, aggressively hiking interest rates to dampen demand and curb inflation. After unprecedented monetary policy easing during the early months of the pandemic in 2020, the Central Bank of Brazil first raised rates in March 2021, and others later followed suit, leading to cumulative rate hikes that are 1.75-9.75 percentage points higher than 2020 levels. This should help temper inflationary pressures but will also stifle already low growth rates.

Beyond that, Latin American governments across the ideological spectrum are considering adopting fuel subsidies to ease the burden on citizens. The problem is that many countries overspent their budgets to cope with the pandemic. With high debt payments and limited money to blunt the impact of cost-of-living increases, governments may struggle to find alternative policies. This is the case of El Salvador, for example, which approved a costly subsidy for gasoline distributors in April that will add to the country’s debt.

Other countries will be constrained to do so. Argentina’s new agreement with the International Monetary Fund, signed in March, calls for a reduction in energy subsidies by the end of June. In Brazil, strong public pressure to increase fuel subsidies faces the institutional resistance of state-owned oil company Petrobras, which sees a subsidy as cutting into its profitability.

Source: GIS Reports

To read the full original article, please go to: https://www.gisreportsonline.com/r/latin-america-inflation-ukraine/

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