High inflation’s impact on LatAm sovereign ratings is currently contained
Appropriate monetary policy responses have contained the impact of high inflation on Latin American sovereign ratings although it is important to monitor potential spillover effects, Fitch Ratings says in a new report.
Besides the global factors of high commodity prices and supply-side disruptions, high inflation in 2021 also reflected excessive stimulus in some countries, weaker currencies and idiosyncratic shocks like drought. Our base case assumes inflationary pressures will decline during this year.
Central banks have tightened policy well ahead of expected US rate rises. Twelve-month inflation expectations are below current prints in the main inflation-targeting countries, but remain near or exceed the top of target ranges, suggesting inflation will only return to target levels in 2023.
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Fitch has not taken negative rating actions based purely on inflation dynamics in 2021-2022. Only 11% of Latin American sovereigns are now on Negative Outlook, down from the peak of nearly 60% in August 2020, following several downgrades.
Nevertheless, high inflation is part of 2022’s more challenging economic landscape, along with tighter external financing conditions, and slowdowns in China and the US. We forecast regional growth to slow to about 2%, although this will not stop further, more modest fiscal consolidation in several countries (Brazil is a notable exception).
Inflation can create risks to the public finances, such as demands for price controls, subsidies or reducing selective taxes. It may increase socio-political risks, hindering policy making and reforms.
We think such risks are currently contained, but this could change if inflation remains high for a prolonged period of time. Prolonged or higher-than-expected inflation prints could also hinder consumption and prompt more monetary tightening, curbing investment.
