Brazil sets 2% tax on capital inflows

Brazil has imposed a 2 per cent tax effective from Tuesday on money entering the country to invest in equities and fixed income instruments. Direct investment in the productive economy will not be affected.

The move, announced shortly before local markets closed on Monday evening, is designed to slow the appreciation of Brazil’s currency, the real, which has gained 36 per cent against the US dollar this year.

The dollar closed at R$1.71 in São Paulo, slightly weaker than its intra-day high of R$1.70.

The government had denied repeatedly over the past few months that it would impose capital controls. President Luiz Inácio Lula da Silva said as recently as Friday that no such plans were in preparation.

But the idea of taxing foreign portfolio flows has been floated in recent days, apparently to gauge market reaction.

Alvise Marino, emerging markets analyst at IDEAglobal, a New York research firm, said in a note to clients the move could undermine the government’s credibility.

“This policy decision is in contrast with the government’s official stance throughout [the real’s] recent appreciation period, and could represent a threat to the solid reputation of predictability and accountability earned by public institutions over the past few years,” he wrote.

However, he said the measure could also boost the administration’s political clout less than a year before general elections in October 2010.

Pressure has grown in recent months for the government to take measures to counter the real’s appreciation, especially from some business and trades union leaders, as the strength of the real has put a steady drain on the competitiveness of Brazilian exports.

Portfolio inflows have been particularly strong since Brazil emerged from a short recession in the second quarter, apparently shrugging off the impact of the global crisis. Economic growth is expected to be slightly positive this year and to reach 5 per cent or more in 2010.

Mr Marino noted that the three-month moving average for foreign direct investment in Brazil was $1.55bn in August, a fall of 56 per cent from a year earlier, while the same figure for portfolio flows was $5.19bn, an increase of 159 per cent.

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