NEW YORK, June 5 (IFR) - The Brazilian government’s decision this week to cut a tax on fixed-income investments to zero spells trouble for the country’s global Real bond market and will deflate the bid among foreigners for infrastructure debentures.
The government cut its IOF tax, a federal tax on financial operations that levied 6% on fixed-income investments, in a move that had an immediate impact on the sovereign’s Global Real curve.
The Global 8.50% Real-denominated 2024s were quoted at 96.80 early Thursday, after bottoming at 95.00 a day earlier.
They were a good seven points lower than the 104.00 level they traded at before the IOF announcement, as investors saw little incentive in holding a lower-yielding instrument when they could now buy more liquid government Treasuries without the 6% tax burden.
In response, the fixed-rate NTN-F due 2023s and the inflation-linked NTN-B due 2022s tightened about 25bp and 15bp respectively to hit 10.20% and 4.45%.
“You don’t have the 6% offshore tax so there is a huge incentive [to buy local Treasuries],” said a Sao-Paulo based banker. “We had a lot of offshore accounts this morning and our sales desk was crazy buying these local instruments.”
While the elimination of the IOF tax may not put an end to Global Real issues entirely, it will certainly make a shallow market even shallower. Leads can no longer rely on buyers who had local accounts but bought the offshore Global Real bonds to avoid paying 6%.
Demand will now be narrowed to investors who don’t have a local presence in the form of a so-called 2689 account and simply require Euroclearable instruments for their portfolios.
There has always been limited momentum in the Global Real market as the relatively small investor base could only absorb so much supply, with each subsequent issuer seeing less and less demand. As the buyer base shrinks, so will the incentives for executing such trades, some bankers argue.
However, they are more ambivalent about IOF elimination and its impact on the tax-exempt, infrastructure bonds that they have just started touting to foreigners.
It was certainly unlucky timing for Brazilian tollroad operator Rodovias do Tiete, which is still on the road and is making its second attempt at placing this type of instrument into international hands that now have less incentive to participate.
This could in turn affect pricing dynamics, though it is debatable whether the international bid was that strong in the first place.
“On the margins it has a bit of an impact,” said a senior banker.
A reduction in foreign demand could be mitigated by a drop in rates locally and a continuing bid from local retail accounts who are exempt from both withholding and IOF taxes on such deals.
“The impact on infrastructure bonds could be both good and bad,” said a banker at a Brazilian financial institution.
“It is good if the government paper gets more bids locally and pushes yields down, but bad if investors prefer to invest new money in government paper that has more liquidity, pushing yields higher on future infrastructure transactions.”
More broadly the slashing of the IOF tax was welcomed as part of a dismantling of the unpopular capital controls imposed several years ago as the government sought to rein in the appreciation of the Real in the face of quantitative easing in the US.
Since then authorities have had to deal with higher inflation, slowing GDP growth, a weakening Real and a sharp reduction in capital, encouraging them to reverse earlier policies.
A total of 75bp in cuts over the last two Copom meetings has underscored the central bank’s seriousness about tackling inflation and the dropping of the IOF tax is seen as a return to more orthodox policies, say analysts at Ashmore.
As a result, Ashmore expects foreign participation in the local Treasury market to rise above the current 14.5% - a low level versus other emerging markets. In Peru and Mexico, for example, it is over 50%.
“Overall this is good for Brazil. The central bank’s 50bp increase last week and this measure shows a seriousness about the economy,” said a Sao Paulo-based banker said.
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