The prospect of further policy easing in the developed world is stoking fears about asset price bubbles in Latin America. High commodity prices, good growth prospects and comparatively high returns, make the region attractive to investors. As a result, capital inflows have been strong and are likely to stay that way. That is not necessarily a problem, particularly given low domestic savings rates in the likes of Brazil. However, channelling inflows into productive capacity is difficult and the region is vulnerable to asset price bubbles and a pick-up of inflation. Equities, particularly in Colombia, are beginning to look expensive and inflation is starting to edge up (albeit due to food prices). Meanwhile, strong exchange rates throughout the region are squeezing the manufacturing sector, giving growth a rather unbalanced look. It is too soon to suggest that the influx of capital has created bubbles, but that’s not to suggest that they will not inflate in the future. In this context, policymakers are making sensible moves: they have stepped up FX purchases, tightened capital controls and interest rates are now on hold in much of the region. A fiscal tightening is the next step, but there is a risk that political barriers in the likes of Brazil could delay necessary action.
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