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Implications of Brazil’s removal of tax of foreign capital inflows

Brazilian Real vs USD (BRLUSD) 2013-06-10Enlarge GraphThe Brazilian government removed the IOF tax from 2009, which was aimed at limited inflows of cheap money from post-crisis stimulus.

In 2009, Brazil had instituted a 6% tax on foreign capital flows (IOF tax) to prevent a flood of cheap money coming from the U.S. and Europe after their governments started stimulus programs that provided abundant cheap money. It was aimed at reducing short-term speculation that could distort the market as well as avoid an appreciation of the Brazilian Real which could hurt exports.

Fast forward four years, and now Brazil has seen a steep reduction of foreign inflows and the Brazilian Real has depreciated close to 8% in just three months. Additionally, uncertainty in international markets due to slower than expected economic recovery and speculation about the Federal Reserve’s phasing out of monetary stimulus has caused a sell-off of emerging markets and long duration assets, including sovereign bonds.

Brazil’s Finance Minister Guido Mantega commented on the action:

“We have observed a reduction in the international liquidity coming to Brazil… We are removing the obstacles for the entry of capital. [...] Today, with the market returning to normal and the (U.S. Federal Reserve) likely reducing its expansionist policy, we can remove this obstacle.” The removal of the IOF tax may have the following effects in the short-to-medium-term:

  • Boost Brazilian equities market
  • Cause an appreciation of the Brazilian Real
  • Stop inflation rise
  • Hurt exports slightly

The last two are by-products and not the direct intentions of the policy change. Mantega specifically said the tax removal was not aimed at fighting inflation, and given the Selic rate hike to 8%[see Brazil surprises with unanimous 50bps interest rate hike], inflation should be more than taken care of.