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Some in the media have recently uttered the word deflation as a possibility for some Latin American economies. Rather than deflation or a decline in prices, Moody’s says it sees a certain deceleration of inflation or a slowdown in annual price increases as more likely, and that this would be a positive development for Latin American countries.

Moody’s believes the Latin American deflationary fears are due to a misinterpretation of the month-on-month contraction seen in May’s inflation data for several countries in Latin America as a sign of imminent deflation. Such a conclusion is both premature and unrealistic because the month-on-month data contain wide fluctuations and are subject to seasonal variations, claims Moody’. Inflation is more accurately tracked on a year-on-year basis in the Consumer Price Index (CPI). Those more reliable numbers show very high inflation for most countries in Latin America relative to the rest of the world.

 

For example, Argentina, Brazil, Costa Rica, Uruguay, and Venezuela still faced double-digit inflation in May. Other countries such as Mexico, Colombia, and Ecuador also had a relatively high inflation in May at 4.7%, 8.6%, 7.7%, respectively. This compares to the average rate of inflation of 4% in developing countries in 2002-03, according to the International Monetary Fund.

The ratings agency does not see a significant risk of deflation in Latin America, because the output gap remains well below its cyclical peak in 2000 and inflation rates remain high. However, Moody’s does see a slower rate of inflation as more likely because global oil prices are declining. The prospect of lower global input and output prices could also help dampen inflationary pressure in many Latin American countries that are experiencing high inflation rates.

The anticipation of lower inflation rates would benefit Latin America in several ways. First, it would lower the risk premia, and potentially drive down borrowing costs, particularly for countries that have historically high inflation rates. This would enable governments to spend more money on economic development and social programmes than on debt service. Second, countries under the IMF programme are more likely to meet the programme’s inflation target, thus sending a positive signal to the markets. And, lastly, a slower rate of inflation would help build more credibility for the governments and monetary authorities, and help facilitate the transition into inflation targeting for a number of countries.