Case Study: Brazil Considers Adjusting Taxes to Support Currency
September 28, 2010 (Bloomberg) -- Brazil’s government is considering higher taxes on short term capital inflows in a bid to stem the appreciation of the country’s currency, the real. Currently, Brazil has a 2% tax on foreign purchases of equities and fixed-income securities. According to Finance Minister Guido Mantega, the aim of these capital controls it to fend off “excess speculation” involving the country’s currency. These taxes are an example of indirect intervention, and specifically the use of capital controls. The intent is to reduce the expected return on investment in Brazil and discourage global investment into Brazil.
President Luiz Inacio Lula da Silva’s administration is trying to stem a four-month rally in the real (beginning in June of this year), which has extended its advance to 36% since the end of 2008, the second-best performance among emerging-market currencies tracked by Bloomberg after the South African rand.
Competitive Devaluation
Finance Minister Guido Mantega said yesterday that “We are experiencing a currency war.” The artificial devaluation of currencies by various countries “is a global strategy.” This is a strategy commonly known as competitive devaluation, whereby a country engages in policies to weaken its currency in order to encourage exports. Competitive devaluation was popular in during the Great Depression (i.e., 1930s) when countries around the world attempted to stimulate domestic growth and employment through exchange rate adjustments. However, today we are seeing evidence of some countries using this policy (perhaps Japan recently and China over time).
Direct Intervention
Finance Minister Guido Mantega said yesterday that the government will buy all “excess dollars” entering Brazil. According to Altamir Lopes, head of the central bank’s economic department “The central bank bought $5.9 billion in the first 12 days of September, the most in 11 months.” The central bank has purchased U.S. dollars every day since July 9, swelling its foreign reserves to a record $274 billion.
Offsetting Global Investment in Brazilian IPO
The central bank has also been boosting its intervention in the foreign exchange market to offset an inflow of dollars from global investors participating in Petroleo Brasileiro’ s recent common stock offering. On September 24, the Brazilian state controlled oil company, raised 120.4 billion reals (the equivalent to $70 billion USD) to develop offshore fields. As it turns out this was the world’s largest common stock offering. The PetrobeoBrasileirosale amounted to about 18% of the value of all equity offerings completed thus far in 2010 and exceeded by three times the record initial public offering of $22.1 billion by Agricultural Bank of China in July of this year, according to Bloomberg data.
USD/BRL Exchange Rate: January 2009 to the Present