New Initiative from Brazil?

Media reports are playing up local press stories that Brazil officials are evaluating additional measures to slow capital inflows which are driving the Brazilian real higher. The 2% tax may have led to some greater volatility in the currency, but net-net the currency remains firm. Other ideas being considered include the government selling a BRL denominated bond issue overseas. Perhaps most important for foreign investors though is the talk that officials may change the rules and allow investors to deposit guarantees overseas.

That said, it is not clear the significance of the local press report which is said not to cite sources. Moreover, just yesterday Finance Minister Mantega was quoted indicating that the government was not looking at additional measures to curb the real's strength.

The BRL is up about 34% against the US dollar this year. The Bovespa is up 70% in local terms. Officials are wrestling with a significant challenge--absorbing the capital inflows. Figures from the central bank indicate there was a net $14.6 bln foreign exchange inflow in the month of October, the bulk of which was net investment inflows (~$13.1 bln) and a bit from net trade flows (~$1.5 bln).

Two points to make about the net investment inflows. First the net reflects incoming investment of almost $40 bln and about $26.6 bln in outflows. This suggests another way Brazil and other countries experiencing strong inflows can mitigate the impact--encourage capital outflows.

Second, year-to-date Brazil reports a net foreign exchange inflow of almost $23 bln. The same year ago period saw a net inflow of $12.5 bln. The October inflow was flattered by a Spanish bank's IPO that raised more than $6 bln and overseas debt sales by Brazilian companies (who then apparently repatriated the proceeds).

One consequence of Brazil's 2% tax and some of the other measures that it is reportedly considering could be a slowing of the development of local capital market capacity. This is to say its tactical measures may undermine its strategic goals. And even if it slows the development of its local capital markets, neither its daily intervention nor the tax is seeming to deter upward pressure on the currency.

Brazil is not alone in wrestling with this problem. The challenge is East Asia is also acute. Hong Kong Monetary Authority is defending its peg buy buying US dollars. This has seen its money supply (M1) rise 55% above year ago levels (Sept). In South Korea, to cite another example, foreign currency reserves have grown among the fastest in the world, rising roughly $63 bln this year so far.

Lastly, the challenge countries like Brazil face in absorbing capital inflows may put greater pressure on recycling some of those funds and that in turn may point to a source of demand for US Treasuries.
New Initiative from Brazil? New Initiative from Brazil? Reviewed by magonomics on November 05, 2009 Rating: 5
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