UPDATE 2-Brazil narrows reach of foreign loan tax, helping real

Wed Dec 5, 2012 10:04am EST

* Tax will now apply only to foreign loans of up to 1 year

* Decision is latest in series of measures to support real

* Real gains modestly for third day

By Natalia Cacioli

SAO PAULO, Dec 5 (Reuters) - Brazil on Wednesday took another step that will likely support its currency, the real, as it reduced the scope of a financial transaction tax (IOF) on foreign borrowing by domestic companies -- a move that often facilitates dollar inflows to the country.

Only foreign corporate loans of up to one year will keep paying the IOF tax, which remains unchanged at 6 percent, according to a presidential decree published in the official gazette. Previously, the tax was levied on loans of up to two years.

In Brasilia, Finance Minister Guido Mantega said the measure was intended at allowing local companies to raise more funds for working capital and investment in order to boost production.

But he acknowledged the government was able to adopt the measure because, with large cuts in Brazil's benchmark interest rate, the country became less attractive to "speculative capital" seeking arbitrage opportunities.

The announcement followed a decision on Tuesday, exclusively for exporters, to lift the same IOF tax from advance payments of up to five years and a series of auctions of dollars and currency swaps on Monday.

"The government had closed the tap for dollar inflows. It started opening it yesterday and today it keeps doing that," said Reginaldo Siaca, a manager at the foreign exchange desk at Advanced brokerage in Sao Paulo.

On Wednesday, the real gained modestly for the third consecutive day after the latest IOF policy announcement. It had slumped to a 3-1/2-year low on Friday after data showed the country's economy grew at half the rate economists expected in the third quarter.

It last traded 0.5 percent stronger at 2.1053 per dollar.

An IOF tax on foreign loans maturing in up to five years was initially imposed in March, when the real was stronger than 1.8 per dollar and Brazil was fighting a barrage of dollar inflows that the government considered part of a "currency war".

As the real has weakened since then, the government in June narrowed the reach of the IOF tax, charging it only on foreign loans maturing in up to two years.

Other measures to provide liquidity to Brazil's foreign exchange market could still be in the pipeline.

"The market still needs dollars -- we had a trade deficit and it's the end of the year, when demand for dollars grows," said Siaca, from Advanced.

While traders discussed whether the government was defending a new floor for the real around 2.1 per dollar, most economists agree policymakers aim to smooth out end-of-year currency fluctuations.

During that period, dollars can be in short supply as Brazilians vacation abroad and subsidiaries of multinational corporations may increasingly send profits to their headquarters to help their overall bottom line for the year.