Anyone who follows Brazil closely should know by now that whenever the Brazilian real hits 1.70 to the dollar, alarm bells go off in the Finance Ministry.
It will only be a matter of time before the government intervenes to weaken the real. It’s not a 100% guarantee, though close enough.
But if external forces like excess liquidity leading to high commodity prices are in play, then the real will strengthen and the government will be on hair-trigger alert to do something about it.
Brazil is getting expensive, and the government does not want to be priced out of the export markets.
As expected, the Brazilian government followed through by extending the 6% financial operations tax, or IOF, on dollar loans from two to three years.
This follows from a torrid start to the year, where the Central Bank of Brazil’s data shows that up to February 24 overall inflows to Brazil equaled $12.5 billion this year.
The move also follows from last Tuesday’s presentation by Central Bank president Alexandre Tombini before the Senate, where a surprisingly large part of the discussion was dedicated to the possible negative effects of excessive capital inflows and the still very high interest rate spread between Brazil and other major economies.
Brazil’s interest rates are coming down, but in the local economy they are still over 10%. Local currency bonds pay nearly 12% depending on the maturity date.
That’s high, even as Brazil’s risk is coming off. For example, in the sovereign debt market (priced in dollars) Brazil’s government bonds yield just under 3.6%.
Investors like Brazil’s local government debt better because they get the high yield on investment grade credit coupled with a stable to strong currency that can add to the bonds capital gains.
The government has slapped taxes on foreign investors of Brazilian fixed income in efforts to slow the inflows into the bond market, and will likely do so again. Usually the tax ebbs the flow for a short period of time.
If global liquidity remains on its current course, then there might be no stopping the real from breaking 1.70 this year. Finance Minister Guido Mantega will do what he can to make sure that trend doesn’t last in Brazil. His tolerance level for a strong real above 1.70 is very thin.
The goal of curtailing excess appreciation goes in the same direction as the goal of easing monetary conditions to help boost economic growth.
This, says Tony Volpon, managing director of Nomura Securities in New York, raises the possibility of an accelerated pace of rate cuts.
“While we maintain our forecast of a 50 basis point cut in the benchmark Selic rate to 10% at next week’s rate-setting, we believe the possibility of a larger rate cut is not immaterial.
We also believe that the recent increase in capital inflows and general improvements in market and economic conditions make our R$1.80 forecast for the close of first quarter now unlikely to be met,” he said, adding that an average of R$1.75 in the first is likely.
Raising the IOF tax on domestic derivatives (mainly the popular dollar futures market on the BM&F Bovespa futures exchange) as well as on equity and bond inflows are part of the government’s arsenal to keep the real from getting too strong.
As a rule of thumb, when the real remains between 1.70 and 1.80, the Central Bank usually steps in to soak up dollars by acting as a large sum buyer in the dollar spot market. However, whenever the dollar weakens to the 1.60-1.70 range, Mantega gets antsy and will intervene.
Mantega has a large range of instruments at his disposal, from IOF tax hikes to gobbling up dollars in the spot market to add to their sovereign wealth fund. Investors should not rule out excess taxes, however.
“Marcelo Solomon, an economist of Barclays Capital, said Thursday, “We believe today’s announcement will add some noise to the forex markets, but should not reverse the (Brazilian real) appreciation trend – especially as the risks of new IOF tax increases motivates investors to anticipate their investment decisions and accelerate the inflows of hard currency into Brazil,” he said in a note to clients.
“There is a growing risk that the USD/BRL will once again test the 1.70 level on the way down and when successful move swiftly to the 1.65 level. So expect more measures to come.”
forbes.com
It will only be a matter of time before the government intervenes to weaken the real. It’s not a 100% guarantee, though close enough.
But if external forces like excess liquidity leading to high commodity prices are in play, then the real will strengthen and the government will be on hair-trigger alert to do something about it.
Brazil is getting expensive, and the government does not want to be priced out of the export markets.
As expected, the Brazilian government followed through by extending the 6% financial operations tax, or IOF, on dollar loans from two to three years.
This follows from a torrid start to the year, where the Central Bank of Brazil’s data shows that up to February 24 overall inflows to Brazil equaled $12.5 billion this year.
The move also follows from last Tuesday’s presentation by Central Bank president Alexandre Tombini before the Senate, where a surprisingly large part of the discussion was dedicated to the possible negative effects of excessive capital inflows and the still very high interest rate spread between Brazil and other major economies.
Brazil’s interest rates are coming down, but in the local economy they are still over 10%. Local currency bonds pay nearly 12% depending on the maturity date.
That’s high, even as Brazil’s risk is coming off. For example, in the sovereign debt market (priced in dollars) Brazil’s government bonds yield just under 3.6%.
Investors like Brazil’s local government debt better because they get the high yield on investment grade credit coupled with a stable to strong currency that can add to the bonds capital gains.
The government has slapped taxes on foreign investors of Brazilian fixed income in efforts to slow the inflows into the bond market, and will likely do so again. Usually the tax ebbs the flow for a short period of time.
If global liquidity remains on its current course, then there might be no stopping the real from breaking 1.70 this year. Finance Minister Guido Mantega will do what he can to make sure that trend doesn’t last in Brazil. His tolerance level for a strong real above 1.70 is very thin.
The goal of curtailing excess appreciation goes in the same direction as the goal of easing monetary conditions to help boost economic growth.
This, says Tony Volpon, managing director of Nomura Securities in New York, raises the possibility of an accelerated pace of rate cuts.
“While we maintain our forecast of a 50 basis point cut in the benchmark Selic rate to 10% at next week’s rate-setting, we believe the possibility of a larger rate cut is not immaterial.
We also believe that the recent increase in capital inflows and general improvements in market and economic conditions make our R$1.80 forecast for the close of first quarter now unlikely to be met,” he said, adding that an average of R$1.75 in the first is likely.
Raising the IOF tax on domestic derivatives (mainly the popular dollar futures market on the BM&F Bovespa futures exchange) as well as on equity and bond inflows are part of the government’s arsenal to keep the real from getting too strong.
As a rule of thumb, when the real remains between 1.70 and 1.80, the Central Bank usually steps in to soak up dollars by acting as a large sum buyer in the dollar spot market. However, whenever the dollar weakens to the 1.60-1.70 range, Mantega gets antsy and will intervene.
Mantega has a large range of instruments at his disposal, from IOF tax hikes to gobbling up dollars in the spot market to add to their sovereign wealth fund. Investors should not rule out excess taxes, however.
“Marcelo Solomon, an economist of Barclays Capital, said Thursday, “We believe today’s announcement will add some noise to the forex markets, but should not reverse the (Brazilian real) appreciation trend – especially as the risks of new IOF tax increases motivates investors to anticipate their investment decisions and accelerate the inflows of hard currency into Brazil,” he said in a note to clients.
“There is a growing risk that the USD/BRL will once again test the 1.70 level on the way down and when successful move swiftly to the 1.65 level. So expect more measures to come.”
forbes.com
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