With South America’s COVID-19 cases appearing to have peaked, economic activity looks to have returned to pre-pandemic levels as restrictions are lifted. Strong commodity prices should support GDP growth into 2022 but there is a risk that high inflation across the region becomes entrenched; central banks are already raising interest rates.

Rising commodity prices increase producing countries’ wealth, fuelling consumption, though driving imports. They should also increase investment, but that is being deterred by political and economic uncertainty.

High inflation will take time to moderate. It was fuelled by currency depreciation, easing pandemic restrictions, and the higher commodity prices themselves. But more recently, there are demand pressures as consumption has surged and now workers’ wage demands are also rising.

We now expect Brazil’s inflation to rise from 4.5 per cent last year to 8.6 per cent in 2021 before sliding to 3.4 per cent in 2023 while Uruguay’s rate falls from 7.2 per cent this year to 6.3 per cent in 2023, and Peru’s inflation retreats from 5.7 per cent to 3 per cent over the two years. Even Argentina’s rate of nearly 50 per cent is forecast to fall to 35 per cent in 2023.

For much of 2022, we think South American economies will see a combination of above-target inflation and slowing GDP, which while exceeding pre-pandemic levels has not recovered lost ground.

The most significant re-opening left is national borders – though while Uruguay stands to gain from an influx of visitors, outward tourism could damage Argentina’s finances.

All the inflation-targeting countries – Brazil, Chile, Colombia, Peru and Uruguay – have started raising interest rates. Our base scenario sees tightening cycles lasting until mid-2022, but monetary authorities could pause as they see inflation falling to target levels, even easing back to neutral levels at some point in 2023.

However, there is a significant risk of inflation de-anchoring in the mid-term: deterioration of fiscal positions or stalled structural reform could raise inflation expectations, forcing central banks to hike rates even higher.

We expect fiscal deficits to be reduced. But the improvement will come from the economic recovery and high commodity prices, with governments spending most of the windfall but reluctant to cut expenditure or phase out what were introduced as emergency measures. Indeed, Peru’s new administration was elected with an agenda to increase spending.

We have increased our GDP growth forecasts for 2021 as economies recover from last year’s falls. We now expect 11.5 per cent growth for Peru this year, then 5.1 per cent next year and 3.0 per cent in 2023, with Chile at 9.6 per cent this year, followed by 3.2 per cent and 2.2 per cent, and Brazil’s growth falling from 5 per cent to 1.3 per cent then improving to 1.5 per cent. Uruguay’s growth is forecast to be steady at just over 3 per cent over the three years.

However, risks for potential growth are skewed to the downside. Investment has declined significantly, recoveries were mostly consumption-driven, and employment is still below pre-pandemic levels. South America appears to be emerging from the pandemic with lower labour and capital stock while it is uncertain whether productivity gains will remain.

First published 12th October 2021.

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