UPDATE 4-Brazil extends tax on foreign debt to curb currency

Mon Mar 12, 2012 12:21pm EDT

* IOF tax extended to foreign debt issues up to 5 years
    * Gov't battling dollar inflows to tame currency strength
    * Real weakens near 2 pct to two-month low on new measure
    * Economists still doubt long-term effectiveness of move


    By Brad Haynes	
    SAO PAULO, March 12 (Reuters) - Brazil extended the
reach of a financial tax on foreign debt on Monday in another
attempt to slow dollar inflows that have driven up its currency
and threatened a fragile economic recovery.	
    President Dilma Rousseff extended the scope of a 6 percent
tax known as the IOF on foreign borrowing, applying it to debt
maturing in up to five years, according to a decree in the
government's official daily gazette. 	
    The tax had previously been charged when companies in Brazil
took foreign loans and issued bonds abroad with a maturity under
two years. It was extended to three years on March 1.
    Rousseff has blamed loose monetary policy in developed
economies for foreign cash flows into Brazil's financial markets
 fueling the appreciation of the local currency, the
real. The stronger currency has unleashed a flood of cheap
imports and hurt the competitiveness of struggling Brazilian
industries. 	
    The tax increase is a preventive measure aimed at
slowing the tide of "speculative capital" flowing into Brazil,
the Finance Ministry said in a statement. 	
    The real weakened 1.8 percent on Monday to 1.817
 per dollar, its weakest level in two months. The tax
measures and more aggressive market interventions by the central
bank have weakened the real by more than 5 percent so
far this month, making it one of the world's worst performing
currencies.	
   
 	
    Still, economists questioned the long-term effectiveness of
the measure, noting that it would only affect a small portion of
Brazilian corporate debt. 	
    "Ultimately, they didn't have any impact on the real the
last time around in 2010 and the first half of 2011," said Neil
Shearing, senior economist with Capital Economics in London,
citing a rally that pushed the real to 1.55 per dollar.	
    "I suspect they're only really swimming against the tide
this time around too," he added.	
    Goldman Sachs Group economist Alberto Ramos told clients in
a note that the IOF measures would have a limited impact on the
exchange rate given the average maturity of Brazilian companies'
foreign bond issues is around 10 years. 	
    Most Brazilian companies are taking advantage of
inviting market conditions this year to issue debt of 10 to 15
years, according to Italo Lombardi, Latin America economist with
Standard Chartered in New York. 	
    	
    ALLURING INTEREST RATES	
    Brazil is struggling to reduce the allure of its interest
rates, the highest among major economies, to foreign investors
seeking bigger returns than those available in larger developed
economies.	
    Brazil's central bank slashed its Selic overnight rate by a
larger-than-expected 75 basis points last week to 9.75 percent.
Economists see more aggressive rate cuts on the way. That
would be welcome news for Rousseff who has made lowering
interest rates a main focus of her government. 	
    "The rate cuts by the central bank aren't just meant to
heat up the Brazilian economy. I applaud the bank because the
larger intent is to balance domestic and international rates,"
said Rousseff in an interview with a local news Web site on
Sunday. 	
    But relatively loose fiscal policy and a tight job market
are expected to fuel nagging inflationary pressures by the end
of the year, forcing interest rates higher again in 2013,
according to analysts in a weekly central bank survey published
on Monday. 	
    Easing fears about the European debt crisis have
 boosted investors risk appetite since the start
of the year, sending cash into higher-yielding assets like
Brazilian debt and fueling the real's nearly 9 percent
rally in January and February. 	
    The currency surged as Brazil's industry struggled through
its rockiest stretch in years, contracting three times more than
economists expected during January and piling pressure on
officials to act. 	
    Stagnating industry slowed economic growth to 2.7
percent last year, adding to concerns Brazil had become
complacent after the economy expanded 7.5 percent in 2010.
Critics say the government lacks the political will to address
the taxes and crumbling infrastructure that are choking
growth. 	
    Brazilian authorities have denounced what they call
 a "currency war" prompted by monetary stimulus and
subsidized lending in major world economies.
 	
    Finance Minister Guido Mantega on Friday said the
government will take further measures to ensure the currency is
not overvalued.  	
    "What's scary is how all of this could impact overall
appetite for investment in Brazil," said Lombardi, of Standard
Chartered. "Although they (Brazilian government) have reaffirmed
they are not going to tax foreign direct investment... you never
know, they are being very aggressive." 	
    Mantega has distinguished between restrictions on
shorter-term cash flows into domestic capital markets and the
foreign direct investment (FDI) crucial to sustained economic
growth. 	
    Some analysts have questioned how much of Brazil's FDI
flows are in fact a disguised play on fixed income assets, a
claim Mantega said he found unlikely but would investigate.
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