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Latin America and the Caribbean: Dealing with Another Food Price Shock

World food prices are on the rise again owing mainly to global weather-related shocks. This has led to concern that the rise could result in higher inflation and hurt the most vulnerable.

Two points to note are that the recent increase in food prices has been less acute than the two previous episodes (in mid-2008 and early 2011), and features important differences across commodities. For example, while the price of soybeans, corn and wheat are up sharply, coffee and sugar prices are down. Market projections suggest that corn, soy, and wheat prices will stay high through end-2012, but then decline gradually as supply conditions normalize.

Watching out for inflation

The impact on domestic inflation in Latin America and the Caribbean of the latest food price shock is beginning to be felt, although the pass-through to core (or underlying) inflation has been relatively limited thus far.

Monetary authorities need to remain vigilant, however, as the impact of global food price shocks on inflation and inflation expectations can be significant, and often operate with a lag.

Countries with weaker monetary policy frameworks should be particularly alert and be ready to act decisively in view of their historically high pass-through from global to domestic food prices, and from domestic food prices to core inflation (for more detail, see our previous research).

Wage restraint will be required in countries with pegged exchange rate regimes or dollarized economies.

Uneven impact

The impact on the balance of payments of the higher food prices is also likely to differ across the region. While Southern Cone countries (which export soybeans, corn, and wheat) stand to benefit the most from the recent spike in food prices, the Caribbean, a large food importer, stands the most to lose.

Central America also will be adversely affected even though it is a net food exporter, because it imports corn and wheat (whose prices have risen) and exports coffee and sugar (whose prices have declined). These food price trends are adding to the external imbalances in the Caribbean and Central America, which have been affected by high energy prices for several years.

Protecting the poor

Policies to protect the poor, which tend to spend a larger share of their income on food, will need to be accommodated within tight budgets.

Countries that need to reduce public debt (the Caribbean) or regain policy space (Central America) will have to adopt those policies while keeping overall spending at a sustainable level.

Countries operating near potential (South America’s commodity exporters) would have to reallocate spending from other areas to income support for the poor to keep fiscal positions in check.

Countries could scale up well-targeted social safety net programs (while avoiding generalized price subsidies), and reduce taxes/tariffs on food items temporarily (while avoiding export taxes/restrictions as they generally distort production incentives and are difficult to unwind). Supply-side policies could be also considered to encourage food production (for example, subsidies on fertilizers and seeds), although these should be limited to clear cases of market failure in the agricultural sector.