Brazil Hikes IOF to Stem BRL Rally

In its attempt to contain BRL appreciation, Brazil’s finance ministry increased the IOF financial transaction tax on foreign investor inflows into domestic fixed income securities to 4% from 2%. Market consensus points to only a short-term effect on the BRL. Luis Cezario, an economist with Goldman Sachs, believes the BRL could weaken slightly to BRL1.70-BRL1.80 per USD within the next 1-2 months from a current range of BRL1.65-BRL1.75. RBC agrees, saying that the tax hike will induce some short-term weakness in BRL initially. “However we expect this effect to be transitory and that appreciation pressures should remain fairly strong given the pace of capital inflows are unlikely to be altered materially by this tax change in the current context of G4 currency weakness, quantitative easing and significant excess global liquidity in the world’s financial markets,” the shop says. Domestic bond yields could spike 20bp-40bp along the curve with foreigners’ large holdings of issues in the long-end likely having a larger impact there, encouraging a steepening of the yield curve in the immediate future, RBC adds. On Tuesday, BRL closed 2.4% stronger at BRL1.66 per USD. This is not the first time the ministry has hiked the IOF tax to contain BRL appreciation. Credit Suisse, which also agrees that the effect will be temporary, says that in March 2008 the IOF rate was increased to 1.5% from 0.0%, reduced back to zero in October 2008 and then raised to 2.0% in October 2009. The new change, which took effect yesterday, will not affect equity investments, for which the IOF tax remains at 2%.