June 7, 2013 / 4:57 PM / in 5 years

Outflows of foreign funds from Brazil's Bovespa spike on tax change

* Removal of tax on bonds led to outflows from stocks

* Higher interest rates make bonds more attractive

* Net foreign outflows hit high for the year on June 5

By Asher Levine and Danielle Assalve

SAO PAULO, June 7 (Reuters) - Net outflows of foreign funds from Brazil’s Bovespa stock exchange totaled 1.33 billion reais on Wednesday, the highest figure recorded this year, according to data released by exchange operator BM&F Bovespa SA on Friday.

The exit of foreign investors came on the day Brazil’s government removed a 6 percent tax on foreign investment in local bonds, which led to a 2.26 percent one-day decline in the benchmark Bovespa index.

Analysts cited a number of reasons for the departure of foreign funds, including the unwinding of positions meant to get around the tax, known as IOF.

Previously, many foreign investors effectively avoided the tax by buying a stock and then building up an opposite short position in the futures market, allowing the investor to profit from the interest rate priced into the difference between the stock price in the spot and the future markets.

“Without the IOF on fixed income, those who traded off the difference between rates in the spot market and the futures market - the so-called ‘cash and carry’ operations - can now go straight to fixed income,” said Luiz Roberto Monteiro, an analyst with brokerage Renascenca in Sao Paulo.

Brazil’s central bank raised its benchmark interest rate by a half percentage point last week, a move that increased the attractiveness of Brazilian bonds compared with equities, analysts said.

“The movement (in stock flows) we’re seeing now also has to do with the expectation for a reduction of bond purchases (by the Federal Reserve) in the United States and the resulting fall in liquidity, which emerging markets are going to feel more than others,” said Alvaro Bandeira, a partner with Orama Investimentos in Rio de Janeiro, Brazil.

With the sharp decline on June 5, net foreign positions in the Bovespa fell to 6.56 billion reais. Foreign-held short contracts for the Bovespa index totaled 132,400, equivalent to nearly 7 billion reais.

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