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Brazil makes move to brake currency rally

Brazil 50 real notes. Vinicius Ramalho Tupinamba/iStockphoto

Vinicius Ramalho Tupinamba/iStockphoto

Brazil unveiled a potentially steep tax on foreign exchange derivatives Wednesday, knocking the real back from a 12-year high in its latest bid to curb a currency rally that is hampering local industry.

The measure imposes a 1-per-cent tax on trading in currency derivatives that result in a net bet the real will firm, allowing for an up to 25-per-cent levy in the future.

The Brazilian real weakened nearly 2 per cent on the news to 1.567 per dollar from Tuesday, when it closed at its strongest since January, 1999. The currency had surged more than 8 per cent this year, adding to a 4.6-per-cent gain in 2010.

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"We are going to make speculation less profitable with all these measures," Finance Minister Guido Mantega said at a news conference. "We are in the middle of a currency war. Imagine if no measures had been taken – the dollar would be even lower."

If the current tax did not have the desired effect, he added, the government would be willing to raise the levy.

Mr. Mantega was quick to stress that defensive currency hedging would not be hurt by the measure, and the head of the central bank said Brazil will still welcome foreign inflows.

"Brazil continues to be a country receptive to foreign investment," central bank head Alexandre Tombini said in Rio de Janeiro.

Analysts said the move, part of the Brazil's piecemeal approach to reeling in currency gains, will have little long-term impact while interest rates remain the highest among major world economies.

"The problem isn't going to go away with a little tax on derivatives. It might help at the margin, but it's not going to solve the problem," said David Rees, an emerging markets economist with Capital Economics in London.

"Over the medium- to longer-term, they need to get real interest rates down and that's going to take a lot longer to do and require structural reforms," he added.

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With acrimonious U.S. debt talks stalled and an ongoing sovereign debt crisis roiling the euro zone, Brazil looks even better to investors, analysts say.

Separately, Brazil has proposed that a meeting of World Trade Organization ministers in December discuss exchange rates in the context of world trade, a WTO spokesman said Wednesday.

There is a consensus that the international body should study the relationship between currencies and trade, but Brazil also wants to see how the WTO works with the World Bank and the International Monetary Fund for more policy-making coherence.

Brazil has seen foreign money flood into its economy this year – $10.87-billion (U.S.) this month through July 22, according to central bank data. Much of that has come as foreign direct investment, more reliable than speculative funds known as hot money.

Brazil has taken in a record $32.5-billion in FDI so far in 2011.

Many economists had believed the centre-left government of President Dilma Rousseff would not let the real slip through the psychologically significant 1.55-per-dollar level, a perceived floor for months.

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The new tax may be an effort by Brazil to defend that level, said Pedro Tuesta, a Latin America economist with 4Cast in Washington. "It was the floor just on Friday, not long ago," he said. "I am betting on that floor."

The new measures hit shares of exchange operator BM&FBovespa particularly hard, as it tumbled 4.4 per cent.

With the real trading at levels not seen since a currency crisis that brought Brazil to its knees in early 1999, the government has stepped up efforts to curb the rally.

Mr. Mantega warned markets Monday: "We're always ready to take measures that will stop excessive gains in the Brazilian currency."

But investors pushed the real higher Tuesday, shrugging off Mr. Mantega's latest attempt to talk the currency down.

Brazil has taken a flurry of steps over the past year to brake the real's rise – from selling reverse currency swaps to slapping reserve requirements on banks' foreign exchange positions.

Brazil is not alone. Many emerging market economies have seen currency gains as they have recovered ahead of still-struggling industrial nations.

In practical terms, that means many emerging economies have raised interest rates to battle the inflationary pressures that come with brisk growth. But in the United States, interest rates remain near zero to boost lacklustre economic expansion.

Brazil's central bank has raised interest rates five times this year to curb inflation. Analysts see at least one more hike this year from the current 12.50 per cent.

With Brazil's investment-grade ratings from all three major agencies and those high interest rates, foreign investors have borrowed money cheaply abroad to chase tempting returns in the country – pushing up the real in the process.

The strong real has hurt exporters and sparked furious complaints from industry leaders who say the continued firming in the currency threatens their capacity to create jobs.

But complicating Ms. Rousseff's currency woes is the inflation rate at 6.75 per cent in the 12 months through mid-July, above the official target range of 4.5 per cent, plus or minus 2 percentage points.

In a country still haunted by memories of runaway prices, taming inflation is high on Ms. Rousseff's list of priorities.

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