WisdomTree: Brazil Repeals Financial Transaction Tax — What Could it Mean for Bond Investors?

ETF Trends

• On June 5, the Brazilian government removed the 6% Financial Transaction Tax (IOF 1 ) on foreign exchange conversions of the Brazilian real for government bond investments.
• On June 13, the government removed the 1% tax on currency derivatives.
• We view the reduction of these barriers to entry as a positive development for the local bond market.
• More attractive accessibility could lead to lower bond yields and more efficient markets, should the clouds leading up to Standard & Poor’s negative outlook announcement 2 dissipate.

After a disappointing May and June that saw many emerging market currencies depreciate against the U.S. dollar, Brazilian finance minister Guido Mantega removed the 6% Financial Transaction Tax linked to the purchase of local market fixed income securities. On June 13, the government also removed its 1% tax on currency derivatives. We view these as positive developments for Brazilian assets, given that it removes impediments to fixed income investment flows. However, the timing of such announcements has raised some red flags. Foreign participation in the local markets had stagnated at around 15%, compared to other Latin American markets such as Peru and Mexico, which have benefitted from much higher participation. 3

The IOF tax was raised to 6% in September of 2010 as a primary weapon in the government’s fight against hot money flows. During his announcement about removing the tax, Mantega commented that flows had normalized and the value of the currency was not being used to combat inflation. But the change is underscored by concerns over the recent weakness in the currency (May’s 6% decline was the steepest decline since September 2011) combined with disappointing growth in the face of burgeoning inflation pressures. The central bank’s repeated intervention in currency markets and the recent move by the government on the tax side can be viewed as defensive actions sought to cap the real’s weakness. Interestingly, during the announcement, Mantega was quick to point out that the tax could be reinstated in the face of prolonged currency strength. [Brazil ETFs Lower on Protests]

Next page: Investors re-evaluate Brazil

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