Latin American companies, both large and small, face a challenging international context and rising inflation rates in the post-pandemic context. How can this situation conspire against a prosperous climate for investment and business?

The pandemic aggravated the structural problems of regional economies. Inflation in Latin American countries soared as a result of the stimulus measures taken by governments to deal with the health crisis. In this way, the inflationary process that was accentuated in 2020 by Covid-19 was consolidated in 2021, according to an analysis by experts from SURA Insurance Trends and Risks, shared to Make Sure You Live.

According to data provided by the Economic Commission for Latin America and the Caribbean (ECLAC)), a UN agency, the largest economies in the region - Brazil, Mexico, Chile and Colombia - closed 2021 with a higher-than-expected rise in inflation. 

Not counting countries with “chronic inflation”, such as Argentina, Haiti, Suriname and Venezuela, the Latin American and Caribbean region reported a general inflation of 7,2% in 2021. This is indicated by ECLAC in its report 'Preliminary Overview of the Economies of Latin America and the Caribbean'.

“Latin America was the region most affected by the pandemic,” ECLAC notes in the document, adding that “2022 is expected to be marked by asymmetries between countries and a slowdown motivated by uncertainty.”

About this, Alicia Bárcena, Executive Secretary of ECLAC, states that “the pandemic has inflicted lasting damage to the growth of economies in much of the region, which is aggravated by the structural problems that preceded the crisis, problems of low investment, low productivity and informality.”

Inflation and its consequences on the economy

In response to the inflationary crisis in the region, Latin American central banks have called for an increase in interest rates to prevent an even greater depreciation of their currencies. Argentina leads the ranking of countries with the highest interest rates in the region - with 40% - followed by Brazil with 9,25%. 

Julian Gonzalez, Director at GrupoSet Latam, a consultancy firm specialising in SMEs, explains to asegura de Vivir that “increasing interest rates is the monetary tool that central banks have most at hand to control inflation”. However, it adds, “one must be careful because this can push the economy into a recession that is worse than the problem they are trying to improve”.

“It should be noted that raising interest rates can cool down the economy,” the specialist points out. “Loans become more expensive and, obviously, people and companies try not to borrow. Over time, this translates into a decrease in consumption and less money circulating in the market,” he adds.

González adds that, by raising interest rates, they are not only trying to stop inflation. Central banks are also trying to stop an abrupt outflow of capital, which would further depreciate the local currency. “This would lead to more inflation,” concludes the Director at GrupoSet.

Andres Rave, Regional Director of Business Solutions at SURA Insurance, understands the increase in rates as an “initial handbrake” that, ultimately, “discourages demand and indebtedness, partly regulating the increase in prices but without resolving the underlying problem linked to the supply situation.”

The impact on companies

“This systemic effect affects the entire business park,” Rave stressed in an interview with asegura de Vivir, “both SMEs and large companies.” According to the expert, “the difference lies in the ability to negotiate inputs, suppliers, inventories, prices and the financial muscle of large companies, which have greater resilience to these changes.” 

For an SME, “working in an environment with so much inflation means the impossibility of having information or certainty to project and have a clear idea of ​​its profitability,” says Julián González, “and this is one of the greatest pains that an SME entrepreneur can have: uncertainty.”

“Prices are rising, there is less movement in the economy – which reduces consumption – and, consequently, business profit margins are reduced. Administrative costs are also increasing, as are most of the expenses that the business structure bears, not only inputs and materials but also logistics. All of this causes costs to increase and the company cannot always transfer them to prices. In this way, profitability is increasingly lower,” emphasizes the GrupoSet executive.

Another important point is the financing capacity of companies. González warns: “Companies need credit to finance their growth and this will become increasingly expensive. Therefore, they will not have anywhere to get this money. Investment will slow down because people will prefer these financial elements since loans are very expensive.”

Obstacles in 2022

Beyond the internal phenomena that arise in local economies, the International Monetary Fund (IMF) The Fed warns that emerging economies should prepare for U.S. interest rate hikes, and notes that “faster-than-expected cycles by the Federal Reserve could shake financial markets and trigger capital outflows and a depreciation of their currencies.”

In parallel, the American investment bank, Goldman Sachs, estimated in early February that the FED will increase the interest rate seven times throughout 2022.

Regarding this situation, the Director of GrupoSet warns that the tightening of the US FED's inflation rates will inevitably harm emerging economies "because it will act as a vacuum cleaner for dollars," and explains: "Today investors will prefer to put their money in US bonds rather than in emerging countries."

Thus, as interest rates rise in the US, the flow of capital to emerging economies is likely to slow, impacting economic growth in those countries and, of course, weakening their currencies.