## Latin America Faces a Third Shock as Global Financial Conditions Tighten

_IMF Blog, October 13, 2022_

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## Bibliographic details
- Authors: Santiago-Acosta-Ormaechea, Gustavo Adler, Ilan-Goldfajn, Anna Ivanova
- Published: October 13, 2022

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### Third shock and macro backdrop
- Latin American countries face a third shock: the tightening of global financial conditions, following the pandemic and Russia’s invasion of Ukraine.
- Current positive growth momentum reflects:
  - Return of service sectors and employment to pre-pandemic levels.
  - Favorable external conditions: high commodity prices, strong external demand and remittances, and rebounding tourism.
- Financing conditions are becoming scarcer and costlier as major central banks raise interest rates to tame inflation.
  - Capital inflows to emerging markets are slowing and external borrowing costs are increasing.
  - Domestic interest rates in emerging markets are rising as central banks hike rates and investors reduce appetite for risker assets.
- These factors are expected to decelerate activity by weighing on domestic credit, private consumption, and investment.
- Higher interest rates are pushing commodity prices down as the global economy decelerates, reducing their cushioning effect on the region.
- The transition to higher global interest rates may be bumpy, with possible spikes in volatility and investor risk aversion if a soft landing is uncertain.

### Growth: current strength and outlook
- The IMF upgraded its growth projection for Latin America and the Caribbean this year to 3.5 percent from 3 percent in July.
- Growth next year is projected to slow to 1.7 percent.
- Regional heterogeneity:
  - Commodity exporters (South American countries, Mexico and some Caribbean economies) are likely to see growth rates halved next year due to lower commodity prices and rising interest rates.
  - Economies of Central America, Panama and the Dominican Republic will slow as trade with the United States and incoming remittances weaken, though they benefit from lower commodity prices.
  - Tourism-dependent Caribbean economies will continue recovering, but slower-than-anticipated amid weaker tourism prospects.

### Inflation dynamics and forecasts
- Despite slowing growth, high inflation will persist for some time.
- Major central banks in the region hiked interest rates early, which will help bring down inflation, but the process will take time as monetary policy must tame domestic demand.
- Price pressures have broadened beyond food and energy in Brazil, Chile, Colombia, Mexico and Peru.
  - Inflation recently reached a two-decade high of 10 percent in these countries.
- IMF inflation forecast for the five countries:
  - Price increases will reach around 7.8 percent by year-end.
  - Inflation will remain elevated at about 4.9 percent by the end of next year (still above central banks’ tolerance bands in most cases).

### Financial sector resilience and debt vulnerabilities
- The region’s generally healthy banking systems mitigate the risk of financial distress; regulation and supervision have improved in many countries.
- Pockets of vulnerability remain:
  - Corporate debt has grown considerably over the last decade, especially outside the banking system.
  - Monitoring these vulnerabilities is key to identify potential sources of stress and take early action.
- High levels of international reserves and strong central bank credibility will help mitigate the impact of tighter financial conditions.
- Rising borrowing costs will test public finances through higher interest payments, as public debt and financing needs remain elevated.

### Policy priorities and the balancing act
- Monetary policy:
  - Central banks in the region have acted fast and kept long-term inflation expectations anchored.
  - Monetary policy should stay the course and not ease prematurely to avoid the high cost of restoring price stability later if inflation becomes entrenched.
- Fiscal policy:
  - Should focus on rebuilding policy space where needed by reining in public spending, improving tax system design, and strengthening fiscal frameworks for sustained discipline.
  - Fiscal consolidation must be inclusive and protect the poor to be effective and durable.
  - Where fiscal space exists, fiscal policy should be coordinated with monetary policy to support vulnerable groups while high inflation persists and growth weakens, but without fueling domestic demand.
  - Careful calibration is required to offset spending measures aimed at protecting the poor.
- Getting this balancing act right is presented as key to achieving inclusive and sustainable growth and building resilience against future shocks.

*Authors: Santiago Acosta-Ormaechea, Gustavo Adler, Ilan Goldfajn, Anna Ivanova — October 13, 2022.*

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## References

- [remittances](https://www.imf.org/en/News/Articles/2022/09/19/cf-the-unexpected-rise-in-remittances)
- [July](https://www.imf.org/en/Blogs/Articles/2022/07/27/blog-shifting-global-winds-pose-challenges-to-latin-america)
- [Central America, Panama and the Dominican Republic](https://www.imf.org/en/News/Articles/2022/09/16/CF-Smaller-Economies-in-Latin-America-and-Caribbean-Face-a-Bigger-Inflation-Challenge)

_Source: https://www.imf.org/en/blogs/articles/2022/10/13/latin-america-faces-a-third-shock-as-global-financial-conditions-tighten_