Nearshore Americas

Is Inflation Undermining the Case for Nearshore?

Following a two-year battering by Covid-19, economies around the world are suffering from high inflation rates. In the US, 2021 saw inflation of 7.5%, the highest year-over-year growth in 40 years. The Nearshore, a region always susceptible to external economic shocks, is seeing inflation rise rapidly in some key markets too.

During the worst of the pandemic, global economic output fell drastically and caused a major slowdown in growth. Indeed, many of the world’s strongest economies actually shrank. Latin America was no different, with Mexico’s GDP shrinking by 8.3% in 2020, Colombia by 6.8% and Argentina – struggling with economic difficulties even prior to the pandemic – by 9.9% in the same year.

Many major economies saw a rebound from Covid-19 as activity reengaged. But supply chain problems and war in Europe are no exacerbating economic issues that will see a global slowdown in growth into this year and next that risks a “hard landing” for developing economies, according to the World Bank.

We spoke to economic and political experts to find out what this means to some key Nearshore markets in Latin America. 

Mexico

Ramón Peña-Franco

“The latest data we have on inflation is from the second week of February, and it shows that the annual rate was 7.22%, and continues to be above the Bank of Mexico’s 3% target,” Ramón Peña-Franco, an economic consultant. 

“The trajectory of core inflation is worrying, and shows no real response to the sixth consecutive increase in the interest rate by Banxico,” he added.

There has been much talk of Mexico’s economic slowdown in recent weeks. At the end of January, the country entered technical recession – when economies contract for two consecutive quarters. Deputy Finance Minister Gabriel Yorio blamed the results on “global supply bottlenecks, increased prices for raw materials, and higher costs for ground transportation and sea shipping,” according to Reuters.

While pent-up demand pushed the economy into 5.9% GDP growth in 2021, the bounce back is waning and this recovery is faltering badly. 

“The Mexican economy is not returning to its pre-pandemic levels and is showing signs of stagnation. This is resulting in a ‘stagflation’ scenario” said Peña-Franco.

For Mexicans, the price of staple food stuffs is rising, as are energy costs. Higher interest rates can squeeze businesses and nation Nearshore providers may struggle to expand.

Colombia

Colombian GDP expanded 10.8% in 2021 after 2020’s contraction, and the outsourcing industry, via the government’s so-called ‘Friendshoring’ efforts, played a significant part in that growth. 

According to Invest in Bogotá, the country’s BPO industry has grown at an average annual rate of 19% during the last seven years (as of July 2021) and generates 230,000 direct jobs. Job opportunities have grown by an average annual rate of 6% during the last six years, says the IPA.

“Colombia is very sensitive to external shocks” — Sergio Guzmán

The government increased the minimum wage by 10.7% (which now means the minimum wage sits at around US$250 per month), which should help those on the lowest rung to the formal economy, but will be unlikely to impact BPO agents who earn, on average, between US$3.91 to US$4.30 per hour according to sources.

Sergio Guzmán, director and co-founder of Colombia Risk Analysis

“If you look at the prices for all food stuffs, you’ll see that they’ve gone up significantly,” said Sergio Guzmán, director and co-founder of Colombia Risk Analysis. 

“Broad inflation is affecting the Colombian market, and the minimum wage increase will have an inflationary push considering 60% of the employees make minimum wage,” he added.

While inflation was also present last year, in 2022 the country has also seen a devaluation of the peso. “We’re very sensitive to external shocks,” said Guzmán. 

Presidential candidates for the election later this year are offering quick-fix solutions without any long-term potential, Guzmán added. 

But all of this taken into account, he does not see Nearshore investment stuttering. Country risk profiles are more important to investors, and risk here is low.

“There have been several recent instances of hostile takeovers of Colombia companies but foreign capital and that suggests that a devalued currency – as well as the sound fundamentals of Colombian corporates – are attractive to wise foreign investors,” said Guzmán. 

Central America

James Bosworth, founder of Hxagon

“Latin American currencies did particularly poorly during the pandemic and people who were being paid on local currencies versus dollars certainly saw a loss on the real value of their income” said James Bosworth, blogger on risk in Latin America and founder of risk assessment firm Hxagon. 

Due to low rates of export and high rates of import for commodity goods, Central American economies are affected strongly by a change in rates.

“Central America is always hit hard by commodity hikes much harder than South America because South American economies tend to be based heavily around commodity exports. Argentina, Brazil, Chile, Peru, Colombia are all net commodity exporters in either energy or food or both. They can then benefit from higher prices. But none of this is true for Central America, which is a food importing region,” said Bosworth, adding that high food prices are often at the root of social protest.

The region’s “anti-incumbent” moment is continuing and social protests have continued despite the pandemic. Added to this is the need for payment of the significant debt that the region’s governments took on to face the economic backlash during the pandemic, he added.

“Companies would do well to pay their employees better” — James Bosworth

This year Nicaragua’s inflation rate rose to its highest rate in eight years following a strong 2021. Meanwhile, in Guatemala, inflation actually dropped from December 2021 to January 2022. Costa Rican inflation rose by only 0.37% in January.

But the hardships that the region’s people are facing should be remembered by investors who’re looking to extract maximum value from labor arbitrage, Bosworth said,

“Nearshoring to Latin America is done in part because of the shared time zone, English speakers and cultural affinity. But the cheaper labor costs play a role in this too. One of the things that investors need to understand is that the percentage of Latin Americans’ income that goes on rent, food and transport is significantly higher than in the US. So with commodity inflation all of these costs have gone up. Companies would do well to pay their employees better […] Companies that want to get ahead of the curve should offer higher wages. It’s still cheaper to hire in Latin America,” he said.

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Other Nearshore Markets

Peru: Inflation for 2021 ended at 6.4%, the highest in 13 years. Depreciation of the Peruvian Sol, as well as climbing energy and food costs were the blame, the government said. 

Argentina: Another worrying fiscal year is in store for Argentina, after economists predicted that the country would end 2022 with a startling annual inflation rate of 55%. Argentina’s ongoing financial dilemma has given it the unwelcome status as the country with the fourth-highest inflation rate in the world. Currency woes and underlying problems will not let up soon. 

Ecuador: A 60-day state of emergency to combat crime at the end of 2021 did little to settle economic nerves in Ecuador. The dollarized economy enjoys certain benefits, but growth is forecast at just 2.8% for this year.

Peter Appleby

Peter is former Managing Editor of Nearshore Americas. Hailing from Liverpool, UK, he is now based in Mexico City. He has several years’ experience covering the business and energy markets in Mexico and the greater Latin American region. If you’d like to share any tips or story ideas, please reach out to him here.

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