Brazil removes tax on foreign loans; aims to limit FX fall

BRASILIA Wed Jun 4, 2014 10:48am EDT

BRASILIA (Reuters) - Brazil removed a 6 percent tax on some short-term foreign loans on Wednesday in a move that could help the central bank stem a recent depreciation of the local currency that has threatened to stoke inflation.

Authorities were caught off guard on Monday by a rapid drop in the value of the real, which slid 1.5 percent to its lowest in nearly two months on speculation that the central bank may reduce its intervention program in the foreign exchange market.

The bank was able to limit the depreciation by announcing it was doubling the rollover of currency swaps, derivatives that provide investors with hedge against currency losses.

The finance ministry removed the tax, called an IOF tax, on international loans with maturities of between six months and a year, saying it would help lower financing costs for local companies and banks.

"I think it serves both purposes; the government reduces the cost of foreign financing and at the same time opens the door for more dollars to limit the depreciation (of the real)," said Jankiel Santos, chief economist at Espirito Santo Investment Bank.

"It also signals that the central bank may reduce its forex program."

A weaker real raises the value of imports, adding inflationary pressure. Inflation has slowed recently, but remains very close to the 6.5 percent ceiling of the official range.

Finance Minister Guido Mantega later told reporters that the aim of the tax cut was not to tame prices but to normalize the currency market.

"This measure is not directed at inflation. We do not administer our currency to control inflation," said Mantega, adding that the biggest impact of the measure will be to help smaller banks to get cheap loans abroad.

Higher inflation hurt domestic consumption and dragged down the economy at the start of the year. Brazil's gross domestic product barely grew in the first quarter and could post even more sluggish growth ahead as investment and industrial output drop.

The economic slump threatens to further dent the popularity of President Dilma Rousseff. She remains the favorite to win the Oct. 5 general election, however, due to record-low unemployment and wide-ranging social programs.

Citi analyst Kenneth Lam said the tax cut will not have much impact on corporate credit flows, but will be marginally positive for the local exchange rate.

After initial gains on Wednesday, the real weakened 0.5 percent to trade at 2.2888 per dollar.

The central bank started to offer currency swaps in August to stem the depreciation of the real after expectations of tighter monetary conditions in the United States sparked an exodus of capital from emerging economies.

In December, the bank slowed the pace of its currency intervention as it extended the daily offer of swaps until at least June 30.

Central bank chief Alexandre Tombini has signaled the bank could again slow the pace of intervention after saying on May 22 that demand for the swaps had decreased slightly.

Loans of a year or more already avoid paying the IOF tax. Companies borrowing at a maturity of less than six months will continue to pay the 6 percent IOF tax, the finance ministry said. It added that the measure will cost the government 10.3 million reais ($3.8 million) in tax revenues in 2014.

(Reporting by Alonso Soto; Editing by Walter Brandimarte; and Peter Galloway)

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