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Brazil will impose a tax on foreign investment in an attempt to stem the rise of the Real (via Bloomberg):
The government announced yesterday it will impose a 2 percent tax on foreign purchases of fixed-income securities and stocks starting today. The levy is higher than a previous 1.5 percent tax scrapped a year ago amid the worldwide credit crunch and one that didn't cover equities.
Finance Minister Guido Mantega said yesterday the measure seeks to curb gains in the real, which has strengthened the most of any major currency this year on the back of higher commodity prices, a credit rating upgrade from Moody's Investors Service and forecasts for faster economic growth. A stronger currency makes the country's exports more expensive in dollar terms, hurting companies that rely on making sales abroad.
The Brazilian currency is indeed up against the dollar this year by roughly 35%, but I’m not sure it makes sense to make capital control decisions based on how your currency is performing against the currency everyone loves to hate. Huge fiscal deficits and an accomodative central bank make the US dollar pretty unattractive and not just in comparison with the Real. Brazil’s economic performance is, in many ways, much better than the US and they should be happy the Real is not the basket case it once was and that the dollar has become.
The Brazilians have done an excellent job of conducting monetary policy. Take a look at the price of Gold in reals over the last two years:
Considering the economic turmoil of those two years the value of the real has been remarkably stable when compared to gold. Monetary policy would seem to be pretty damn effective. The US economy would be in a lot better shape if we had done as good a job.
What the Brazilians are concerned about is the potential for the hot money flows to reverse. Their answer is to limit the inflows but maybe a better approach would be to find ways to ensure the inflows are more permanent. That could be accomplished by making Brazil a more attractive place to invest. The effective corporate tax rate in Brazil is around 34% and could easily be cut. It might initially cause the Real to appreciate even more, but inflows would more likely be direct investment which is more stable and long term.
Another approach would be to further reduce the tariff structure. Brazil has done a great job of reducing tariffs that were very high in the 80s, but the average tariff is still around 11.5%. If these tariffs were reduced, presumably imports would rise and relieve some of the upward pressure on the Real.
Finally, Brazil makes it very difficult for her citizens to take capital out of the country. I suspect there aren’t many Brazilians looking to move capital out right now, but certainly restricting capital outflows while complaining about a rising currency makes no sense.
The Mundell-Fleming model argues that a country can’t fix the exchange rate, allow free capital movement and have an independent monetary policy all at once. If the Brazilians want to cap the rise in the Real, they either have to restrict capital flows or increase the money supply. Considering Brazil’s level of development, enacting tough capital controls makes no sense; they can use all the capital they can get. A better policy would be for the central bank to expand the money supply and meet the demand for reals. If corporate taxes and tariffs were cut at the same time, the capital would be deployed productively and import prices would fall, offsetting any inflationary impact.
I’m not sure why Lula chose to impose a tax that has been tried in the past and failed. Brazil needs to take advantage of this situation to raise the standard of living for all Brazilians. That can be accomplished with sound money, low taxes and free trade. The central bank is doing its job and producing sound money. Lula has the credibility to accomplish the rest.
[...] Brazil Taxes Foreign Investment | Contrarian Musings [...]
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