Brazil’s currency and stocks fell sharply on Tuesday after the government imposed a 2% tax on foreign portfolio investment to stem a rapid rise in its exchange rate.
The move, announced shortly before local markets closed on Monday, follows steady gains in Brazil’s currency, the real, which has risen 36% against the U.S. dollar this year, reducing the competitiveness of Brazilian exports.
Foreign direct investment is not affected by the tax. Imposing taxes on international financial flows has symbolic significance for investors in emerging markets. Malaysia, blaming foreign speculation for destabilizing its economy, imposed capital controls to prevent a run on its currency in 1998 during the Asian financial crisis. Chile, one of Latin America’s most successful economies, maintained controls on capital inflows for many years but has now suspended them.
The possibility of a permanent “Tobin tax” on foreign currency or other financial transactions attracted more attention after the Group of 20 major nations asked the International Monetary Fund to consider the idea.
Analysts had expected the tax on foreign flows into equities and fixed income instruments to have little lasting impact on the Brazilian currency. “If it’s aimed at the exchange rate, they’re going to have a very tough time,” said Alvise Marino of IDEAglobal, a New York-based research firm. “They are fighting against the whole market. Everyone wants to be in Brazil now.
The real fell to R$1.71 against the US dollar on Monday after its intraday high of R$1.70 and fell below R$1.74 on Tuesday in morning trading before recovering slightly. The main stock index fell 4.1%.
Brazil emerged from a short recession in the second quarter. It is expected to show marginal economic growth this year and 5% or more in 2010.
Edemir Pinto, managing director of BM&FBovespa, the Brazilian futures and stock exchange, said foreign investors may now prefer to buy American Depositary Receipts from Brazilian companies listed in the United States, which would not be affected by the tax. .
“A third of our volume comes from foreign investors and they quickly redo their calculations. Several Brazilian blue chips have American Depository Receipts [traded in New York] where they will pay nothing and where the rules are clear and durable.
“The Brazilian market was one of the first to recover this year and was on a fantastic growth trajectory,” he said.
“About 70% of IPO shares are bought by foreigners. We therefore did not expect the government to take this drastic measure.
The country was protected from the crisis by its relatively closed economy. Exports represent less than 15% of gross domestic product and little credit comes from abroad.
Years of low inflation, economic stability and cheap but effective income transfer programs have brought millions of dollars to the consumer market for the first time. “Brazil has stronger fundamentals than anywhere else except China,” Marino said.
Mr Marino said that rather than trying to reverse the real’s appreciation, the government’s main objective could be to reduce volatility. Restricting flows would prevent a sudden appreciation in case the central bank raises interest rates in the first half of next year.