(Bloomberg) -- Fiscal imbalances could threaten Latin America’s success in taming inflation, as governments across the region boost growth through more public spending, according to the World Bank.
Latin America is “having a hard time” defending macroeconomic discipline as governments miss or loosen their fiscal rules, William Maloney, chief economist for Latin America and the Caribbean at the bank, said during an interview. As countries across the region increase minimum wages to boost consumption, they are jeopardizing gains in taming historically elevated inflation rates.
“There’s been a lot of pressure on governments to stimulate the economy by any means,” Maloney said. In its latest report, the bank estimates Latin America will grow 1.9% this year and 2.6% next, slightly exceeding previous forecasts but still among the lowest regional rates in the world. It’s “absolutely a cautionary tale,” the economist added.
With unemployment at historic lows but wages still catching up to their pre-pandemic levels, households depend on government transfers to make up their monthly income. On the political front, Maloney also sees resistance toward fiscal or tax reforms that could generate more revenue. And while high interest rates managed to “vanquish” inflation, they have also put the heat on central bankers who have been publicly blamed for sluggish growth.
“The region did well in managing inflation, but we have to defend those gains, and that means getting fiscal policy under control,” he said.
The bank expects major central banks to hit their inflation targets this year or next, as many continue to ease monetary policy. Colombia and Peru both lowered borrowing costs to a two-year low last month, while Chile is seen delivering another quarter-point reduction next week. Still, major economies like Mexico are easing policy only very gradually while Brazil just kicked off a hiking cycle as tight labor markets reignite inflation fears.
“Implicitly, Brazil is saying they lowered interest rates too fast,” Maloney said. The bank estimates real interest rates are likely to remain above pre-pandemic levels across the region. “Monetary authorities need to proceed with caution, because we want interest rates to come down as fast as possible, but we don’t want to jeopardize the gains against inflation in the process.”
Presidents across the region are still counting on higher government spending to improve living standards, even as money transfers implemented during the pandemic recede. Mexico, Bolivia, Costa Rica, Ecuador and Dominican Republic have “significantly” lifted their minimum wages with a positive impact on key social indicators. Yet, labor markets are not infinitely resilient, the bank warns, and further rises can deter job creation and increase informality and unemployment rates.
With debt at 62.8% of gross domestic product, progress in reducing liabilities is “limited” and the region needs more fiscal space through gains in efficiency, spending reductions and increased tax revenues, the bank warns. Proposals like taxing the super rich, as Brazil has pushed during G-20 meetings, are “unlikely” to address the region’s fiscal challenges. Instead, a properly administered wealth tax on property could generate as much revenue as 3% of GDP, the bank estimates.
Investment remains weak in countries like Argentina, Chile, Colombia and Peru. Growth has “largely” been propelled by consumption and progress on reducing poverty and inequality remains “slow” in what Maloney calls a “middle-class squeeze” with rising costs of private education and pension systems.
“None of our countries are growing especially well going forward,” said Maloney. “We need to be moving at rates closer to 5% and that means we have to take really seriously the kinds of structural measures” needed to obtain that growth.
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