Brazil Reduces IOF on Financial Derivatives » More Liquidity in the Market

Brazil has reduced a financial transactions tax on currency derivatives to zero after its currency, the real, hit four-year lows against the dollar on Wednesday.

The measure was the second such move in a week to dismantle currency controls as the government sounds a rapid retreat from its earlier “currency war” against foreign capital inflows.

The 1 per cent tax, which applied to short dollar positions in the futures market that were essentially a bet on a stronger real, was considered one of the most onerous of Brazil’s currency controls when it was introduced in July 2011.


“This was the measure that created all kinds of distortions in the market, generated big losses in people’s portfolios, reduced liquidity and really caused inflows to suddenly stop,” said Tony Volpon, Nomura economist.

The government’s removal of the tax reflects increased concern that expectations that the US Federal Reserve will begin tapering off liquidity, combined with weakness in the Brazilian economy, are driving the country’s once mighty currency to new lows.

The real was trading at R$2.1564 against the dollar on Wednesday, a depreciation of 1.1 per cent compared with the previous day’s close.

The continued weakness in the currency has come despite a move by the government last week to remove another key currency control dating from 2010 by lowering to zero from 6 per cent a financial transactions tax on foreign buying of domestic bonds.

The currency controls were designed to prevent the real appreciating so much that domestic industry would be rendered uncompetitive.

But the removal of the controls has yet to result in a stronger currency, with the central bank forced to intervene in swap markets in recent days to smooth out the volatility in the exchange rate and keep the real from depreciating too quickly.

“It doesn’t make sense to maintain this obstacle,” said finance minister Guido Mantega on Wednesday of the removal of the derivatives tax. “With this there will be a greater offer of dollars in the futures market and a reduction in the depreciation of the real.”

The reduction to zero “is very good news but it is unfortunate that there is still the possibility that they will bring it back at some point”, said Nomura’s Mr Volpon.

While the tax reduction will probably have an impact on the market, its effect on the real’s depreciation may be limited, he said.

“We live in a very different moment in terms of global liquidity so there is no one measure that is going to turn this thing round,” he said.

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