Brazil’s currency and local bonds took a hit this week following the government’s imposition of a new tax on foreigners buying local debt, rattling fragile market sentiment in Latin America’s largest market.
The finance ministry announced an IOF (financial transactions) tax of 1.5% on fixed income investments, covering the purchase of public bonds, flows to investment funds and fixed income derivatives by international investors.
In January, the government abolished the 0.38% so-called CPMF tax, but now the tax has effectively been raised to 1.5%. This will apply upon the conversion of foreign currency into BRL when funds enter the country and will take effect from March 17.
This is an effort to stem the appreciation of the currency to protect export competitiveness and ward off unwelcome speculative capital from short-term investors.
“There is an excess of short-term international investments inside the country,” Brazil’s finance Minister Guido Mantega said.
While LatAm assets staged a modest rally buoyed by the Federal Reserve unlocking the global liquidity gates, Brazil bucked the trend following the announcement of the IOF tax.
The real closed at BRL1.6915 to the dollar yesterday (Thursday), compared with Wednesday’s close of BRL 1.6740 - before the announcement was made. This is still a 25% year-on-year gain, fuelled by furious capital flows to local debt and equities as well as the global commodity boom.
The government blamed international market turmoil for the cancellation of its weekly fixed-rate LTN and NTN-F bond auctions. Yields on the January’s benchmark zero-coupon note increased the most in three months by 0.14% to 12.21% yesterday, as local debt prospects were further hit by indications the central bank may hike interest rates to stem inflation.
“We believe one of the main consequences of the measure will be to reduce foreign investments in shorter-term fixed income bonds, since the costs of these operations in relation to the expected return will increase significantly versus the current situation without the charging of IOF tax,” said Credit Suisse.
Analysts suggest that the measures will have little impact on the inflow of dollars and the Real’s strength.Bullish investors have banked on the lucrative promise of currency appreciation in the region, stepping up allocations to local currency fixed-income assets.
But these measures have now sparked fears that political pressures to ward off the rally could induce short-term volatility in investment.
“This is not going to reduce currency appreciation and everyone knows that. But now we realize that currency strength is going to have significant political implications this year,” said one LatAm DCM banker in New York.
Further tax rises in Brazil could be on the cards since the tax rate can be hiked up to 25% without approval from Congress. Nevertheless, foreign investment in Brazilian equities is exempt from the IOF tax.
- Banco BMG managed to price a $250m 6.875% 2-year bond at 99.772 with a yield of 7%, last Friday (7 March). The small size and short tenor of the issue attracted $350m of demand, which upsized the deal from the $100m minimum. Investors were offered discounts for the bid offer according to the size of their orders. BCP Securities led the Ba1 rated offer.