Brazil Abandons Financial Transaction Tax

Brazil’s government has unexpectedly announced that it will scrap a tax on foreign investments in local debt, a move designed to stem a sharp depreciation in the real (BRL) that had threatened to fuel already high inflation in Latin America’s largest economy.

The country’s finance minister, Guido Mantega, said that a drop in foreign inflows prompted the removal of the financial transaction tax, known as the IOF, on foreign purchases of government bonds and other fixed-income investments. “We have observed a reduction in the international liquidity coming to Brazil,” he added. “We are removing the obstacles for the entry of capital.”

The abolition of the 6% tax, effective immediately, removes a key barrier that Brazil had raised to prevent the BRL from strengthening too much. The appreciation of the currency was hurting local industries and exporters. The IOF tax was introduced in late 2009, with the aim of limiting the surge of cheap money flowing into Brazil after developed nations loosened monetary policies to stimulate their economies.

More recently, indications that the US is considering a reduction to its monetary stimulus has dragged down the BRL and other emerging market currencies, prompting a reversal of the policy.

Mantega stressed that the move was unrelated to prices. “There is no intention on the part of the government to conduct anti-inflationary policies through the exchange rate,” he said, rather the IOF was withdrawn to reflect the regularisation of the market.

“Today, with the market returning to normal and the US Federal Reserve likely reducing its expansionist policy, we can remove this obstacle,” he added.

Nonetheless, the reduction of capital controls will likely help the BRL rally from near four-year lows and ease pressure on inflation, which has turned into a political liability for Brazil’s president, Dilma Rousseff, as she prepares for her re-election campaign in 2014.

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