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Brazil takes more steps to curb currency

Mar 12 2012 16:54 Reuters

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Sao Paulo - Brazil extended the reach of a financial tax on foreign debt on Monday in yet another attempt to slow an avalanche of dollar inflows that has driven up the value of its currency, threatening a fragile economic recovery.

President Dilma Rousseff extended the scope of a 6% tax known as the IOF on foreign borrowing, applying it to debt maturing in up to five years, according to a decree in the government’s official daily gazette on Monday.

The tax had previously been charged when companies in Brazil took foreign loans and issued bonds abroad with a maturity under two years, but was extended to three years on March 1.

Rousseff has blamed loose monetary policy in developed economies for foreign cash flows into Brazil’s financial markets that have fuelled the appreciation of the local currency, the real. The stronger currency has unleashed a flood of cheap imports and hurt the competitiveness of struggling Brazilian industries.

The real weakened more than 1% early on Monday to 1.8074 per dollar, its weakest level in two months. The tax measures and more aggressive market interventions by the central bank have weakened the real by more than 4% so far this month, making it one of the world’s worst-performing currencies.

Still, economists voiced doubt as to the long-term effectiveness of the measure, noting that it would only affect a small portion of Brazilian corporate debt.

“Ultimately, they didn’t have any impact on the real the last time around in 2010 and the first half of 2011,” said Neil Shearing, senior economist with Capital Economics in London, citing a rally that pushed the real to 1.55 per dollar.

“I suspect they’re only really swimming against the tide this time around too,” he said.

Goldman Sachs Group economist Alberto Ramos told clients in a note that the IOF measures would have a limited impact on the exchange rate, given that the average maturity of Brazilian companies’ foreign bond issues is around 10 years.

Brazil is also struggling reduce the allure of its interest rates, the highest among major economies, to foreign investors seeking bigger returns than those available in larger developed economies, where interest rates are near record lows.

Brazil’s central bank slashed its Selic overnight rate by a larger-than-expected 75 basis points last week to 9.75% and economists see more aggressive rate cuts on the way.

But relatively loose fiscal policy and a tight job market are expected to fuel nagging inflationary pressures by the end of the year, forcing interest rates higher again in 2013, according to analysts in a weekly central bank survey published on Monday.

Easing fears about the European debt crisis boosted investors risk appetite at the start of the year, sending cash into higher-yielding assets like Brazilian debt and fuelling a nearly 9% rally in the first two months of the year.

The hard-charging currency came as Brazil’s industry struggled through its rockiest stretch in years, contracting three times more than economists expected during January and piling pressure on officials to act.

Brazilian authorities have responded with denunciations of a “currency war” prompted by monetary stimulus and subsidised lending in major world economies. Finance Minister Guido Mantega on Friday said the government will take further measures to ensure the currency is not overvalued.

The IOF tax on financial transactions will apply to direct overseas loans as well as bonds issued in foreign capital markets, according to the official gazette.

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