Brazil sets 2% tax on capital inflows

Brazil has imposed a 2 per cent tax effective from October 20 on money entering the country to invest in equities and fixed income instruments. Direct investment in the productive economy will not be affected.

The move, announced shortly before local markets closed on Monday evening, is designed to slow the appreciation of Brazil’s currency, the real, which has gained 36 per cent against the US dollar this year.

Before that, the government had denied repeatedly over the past few months that it would impose capital controls, but the idea of taxing foreign portfolio flows has been floated in recent days, apparently to gauge market reaction.

This policy decision is in contrast with the government’s official stance throughout the real’s recent appreciation period, and could represent a threat to the solid reputation of predictability and accountability earned by public institutions over the past few years, in other words, the move could undermine the government’s credibility.

Portfolio inflows have been particularly strong since Brazil emerged from a short recession in the second quarter, apparently shrugging off the impact of the global crisis. Economic growth is expected to be slightly positive this year and to reach 5 per cent or more in 2010.

Pressure has grown in recent months for the government to take measures to counter the real’s appreciation, especially from some business and trades union leaders, as the strength of the real has put a steady drain on the competitiveness of Brazilian exports. Thus, on the other hand, the measure could also boost the administration’s political clout.

As the same situation happens in China, it is a new example that how the government could cool the entrance of “hot money”.