How Bolivia’s Government Kept Inflation Under Control

Step off a plane in Bolivia, and the walls of the jet bridge will be covered in ads about the country’s natural wonders, industrial projects, and—more unusually—its inflation rate, which it touts as the lowest in the region. While much of South America is ablaze with rising prices, Bolivia does appear to be an exception, with 3.17 percent interannual inflation as of November. It’s true that the governing Movimiento al Socialismo (MAS) party has managed to spare Bolivians much of the inflationary pain of the last year. But this has come with a cost—one that, on its current trajectory, cannot be sustained indefinitely.

The government’s political communication isn’t limited to jet bridges. It’s plastered on giant billboards all over Bolivian cities. On the radio, coverage of the World Cup was regularly interrupted to remind listeners that they are living in the country with the lowest inflation in the region. The fact—and the perception—that the MAS has kept inflation under control has great political importance. “In focus groups, people see the principal virtue of the current government as its management of the economy,” said Lourdes Montero, economist and country manager for Oxfam in Bolivia. “And what is the signal that these people are reading? It’s inflation.”

A variety of economic policies have played a key role in keeping Bolivia’s inflation low, and the most important of these are a fixed exchange rate and subsidies of essential products.

For more than a decade, Bolivia has had a de facto dollar peg, at 6.90 bolivianos to the U.S. dollar. People can buy and sell dollars freely, but the central bank holds the rate steady by injecting dollar reserves into the market when necessary. Having a fixed exchange rate helps anchor people’s expectations. This, in turn, stabilizes prices. All of this has contributed to Bolivia’s steady economic growth. “The fixed exchange rate created a sense of certainty—and any economy is fundamentally based on certainty and uncertainty,” Montero said.

The exchange rate has also kept inflation low by favoring imports—and contraband. Holding the boliviano strong against the dollar has the effect of making imports cheaper. And as a landlocked nation that shares long borders with several countries, Bolivia has a lot of tariff-dodging contraband too. Bolivia’s chamber of commerce estimates $3.6 billion of contraband enters Bolivia a year, which would be equivalent to 9 percent of its GDP. “Smugglers are watching closely for variations in prices between countries,” said Roberto Laserna, director of Ceres, a Bolivian think tank. “And it’s easy to buy relatively cheap dollars here and take them to places they’re scarce, like Argentina, where they can buy much more.”

Cheap imports are good news for consumers. The situation is more complicated for producers, who might find imported goods getting cheaper but whose exports are less competitive: the flip side of the strong boliviano. Economists who back export-oriented development are therefore critical of Bolivia’s fixed exchange rate. “But perhaps we should look at the dynamics of our neighbors, where part of their instability and inflationary logic is based on fluctuating dollar prices, and this creates insecurity and vulnerability in the economy,” Montero said.

Besides the fixed exchange rate, Bolivia’s subsidies have also helped keep inflation low. Inflation in many countries is largely being driven by rises in energy and food prices. Bolivia subsidizes both. Export controls and prices negotiated with Bolivian producers have helped supply the domestic market with food. Bolivia is a gas producer and sells it cheap at home. Meanwhile, the state has a monopoly on importing and distributing fuel—and it has kept the price fixed at 3.74 bolivianos (or $0.54) a liter since 2004. “That’s why the effects of the external shock of fuel and food prices at the global level have not been transmitted in their entirety to the Bolivian economy in contrast to what has happened in other neighboring countries,” said Gabriel Loza, former president of Bolivia’s central bank.

But both the fixed exchange rate and the subsidies have their cost—one that is becoming harder to bear the longer current global economic conditions prevail. “No economy will be immune, nor its defenses impenetrable, if the external problems extend beyond 2022, as is predicted,” Loza said. “The exchange rate, for example, will be sustained so long as international reserves are kept at adequate levels. And the subsidies depend on the sustainability of fiscal income—and especially the income from hydrocarbons.”

Almost every year since the MAS first came to power in 2006, natural gas has been Bolivia’s top export. The revenues helped the government build up international reserves to a peak of $15 billion in 2014. Then a combination of falling production and prices slashed that source of income. Bolivia’s reserves have fallen steadily since. The latest data showed reserves of $3.8 billion, of which the majority is gold and less than $800 million is foreign exchange that can be deployed rapidly. Foreign exchange is needed to maintain the dollar peg and to import fuel, among other things. The government also needs dollars to service its foreign debt, which stood at 31.2 percent of GDP in 2021. That is low for the region—but nonetheless a drain on foreign exchange. Bolivia’s reserves fell by almost $1 billion in the last year despite a trade surplus. “We’re in a very delicate situation,” said Gabriel Espinoza, former director of Bolivia’s central bank.

Bolivia’s fiscal situation is also less rosy than it was in 2014, when the value of gas exports began to fall. Since then, it has run a deficit every year. International debt relief programs helped bring Bolivia’s public debt down when the MAS first came to power. But now it stands at more than 80 percent of GDP, according to the International Monetary Fund (IMF). In its country report from September, the IMF assessed Bolivia’s public debt as “sustainable, but with high risks.” It will keep rising while the government maintains a deficit, and one of its biggest outlays right now is fuel subsidies. The IMF estimated Bolivia will have spent about $1.5 billion, equivalent to 3.7 percent of its GDP, subsiding fuel in 2022. That’s more than double what the year’s budget anticipated. “Subsidizing the price of hydrocarbons is what constitutes the biggest hole in this country’s fiscal balance,” Montero said.

The most immediate way to stem the loss of reserves and reduce the deficit would be to adjust the dollar peg or reduce fuel subsidies. But the government has made it clear that adjusting the dollar peg is not on the table. As for fuel subsidies, the MAS tried to reduce them once before in 2010—and massive protests forced a U-turn. Either move would jeopardize the economic stability of the country and the social advances that have been built on it. Levels of poverty, consistently lowered over the last two decades, could relapse. For a government that derives much of its support and legitimacy from those accomplishments, it could be fatal. “The political cost of changing the exchange rate or reducing fuel subsidies is impossible to confront in the short term,” Montero said. “Right now, we’re in a very delicate moment of recovery.”

Other ideas have been proposed by lawmakers and analysts, but all are politically tricky. With legislative approval, the central bank could monetize its reserves of gold, which would increase their liquidity—but such a measure might be read as desperate and, therefore, a bad signal for the sustainability of the fixed exchange rate. Access to external financing is limited and increasingly expensive, reflecting little appetite for Bolivian debt among foreign investors. Another approach would be to increase the tax take: Loza said the government should draw more fiscal income from gold miners, coca producers, and the big wholesalers of Bolivia’s informal economy, which accounts for roughly 62.3 percent of GDP. But these relatively untaxed sectors are key pillars of support for the MAS.

The most palatable option for the government would be to extract and export more of Bolivia’s natural resources—but this is not a short-term fix. Bolivia has huge lithium resources that the state has been trying to develop for more than a decade. YLB, the state lithium company, said industrial production of lithium carbonate will start next year. But the amount would be small, and given previous delays, it is uncertain. Trying to rejuvenate gas production is another option. But YPFB, the state gas company, has been unable to find and develop new gas fields. Foreign investment may be required to turn the industry around.

For now, Bolivia is—at least in terms of inflation—an oasis in the middle of the continent. The government is paying for this in growing debt and dwindling reserves, and it has few levers to pull that could stabilize or reverse these trends without a steep political cost. This means the key question is whether, and when, global economic conditions will change in Bolivia’s favor. “Reserves are there to be counted when your social or political problems could be worse than spending them,” Montero said. “The sustainability of such policies depends on the management of the fiscal space. And that’s a very fine calculation.”