Beginning today (Tuesday), Brazil will impose a 2% tax on foreign investment in the country's stocks and bonds. Analysts have called the move a "desperate" bid to reign in the skyrocketing value of its currency, which has gained more than 30% against the dollar this year.
The tax will make it more difficult for companies to obtain financing and drive government bond yields higher, but Brazilian Finance Minister Guido Mantega said it will not affect foreign direct investment (FDI) into the country.
"We will continue to encourage foreign investment," said Mantega. "Our concern is with excessive speculative investments, short-term capital that would cause a bubble."
Brazil's benchmark stock index, the Bovespa, has surged 79% this year and yesterday closed at its highest level in 16 months. About 17 billion reais of net inflows from international investors had poured into the Brazilian stock market through September.
Meanwhile, commodities prices, a credit upgrade by Moody's Investor Service, and a rebound in gross domestic product (GDP) have made the Brazilian currency the best performing major currency this year - up as much as 36% against the dollar.
However, the strengthening real has also made Brazilian exports less competitive. By stemming the flow of dollars into Brazil, the government hopes to contain the currency's rise. But many analysts believe the real's long-term potential will eventually overwhelm any short-term effect wrought by the tax.
Nick Chamie, head of emerging markets research at RBC Capital Markets Corp., told Bloomberg News that he remains "bullish" on the real in the "medium term" even after cutting the currency to "underweight" from "overweight."
"There are very good prospects for growth in Brazil, it is going to be a major destination for foreign direct investment," Chamie said. "We downgraded it tactically. On a short-term basis, it will underperform emerging-market currencies."
Brazil's economy expanded by 1.9% in the second quarter and is expected to log growth of 5% or more in 2010.
At the same time, the dollar is expected to languish as the United States fights its way out of a devastating recession. Underscoring its weakness was a recent report that showed the greenback was all but abandoned by the world's central banks in the second quarter.
Central banks around the world increased their foreign currency holdings by $413 billion in the three months ended in June, the most since at least 2003, according to data compiled by Bloomberg. But 63% of that new cash was put into currencies other than the dollar. That's a record-high percentage for any quarter with more than an $80 billion increase in holdings.
The dollar's 37% share of new reserves is down from about a 63% average a decade ago.
"Global central banks are getting more serious about diversification, whereas in the past they used to just talk about it," Steven Englander, a former Federal Reserve researcher who is now the chief U.S. currency strategist at Barclays PLC (NYSE ADR: BCS), told Bloomberg. "It looks like they are really backing away from the dollar."
Englander predicts the U.S. dollar will drop another 3.3% over the next three months.
Developing countries have sold about $30 billion for euros, yen and other currencies each month since March, according to strategists at Bank of America-Merrill Lynch.
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