Nov. 20 (Bloomberg) -- Emerging-market governments from South Korea to Brazil will fail in their efforts to stem currency rallies by limiting foreign investment, according to Brown Brothers Harriman & Co. and RBC Capital Markets.

“Controls can certainly slow the moves but not reverse the gains,” Win Thin, a senior currency strategist at Brown Brothers in New York, said in an interview.

Brazil said Nov. 18 it would impose a tax to close a “distortion” caused by last month’s levy on foreign purchases of stocks and bonds aimed at curbing the real’s 34 percent gain this year against the dollar. South Korea, India, Indonesia and Kazakhstan also signaled this week they are considering measures to halt the appreciation of their currencies, which have slowed exports and threaten to undermine their economies. Taiwan’s financial regulator banned foreign investors on Nov. 10 from placing funds in time deposits to curb currency speculation.

“These measures have a short-term effect on reducing the pace of the currency appreciation,” Eduardo Suarez, an analyst at RBC in Toronto, said in an interview. “The strengthening of the currencies we’re seeing in many emerging markets is caused by very solid growth expectations, improvement of credit fundamentals and stock exchange gains. I don’t think they can totally stop the appreciation.”

South Korea said yesterday it will tell banks to hold more foreign-currency assets that are easily converted into cash to prevent a repeat of last year’s funding crunch. The Korean won has gained 8.2 percent this year. Only the Indonesian rupiah has appreciated more among the 10 most-active Asian currencies, with a 14 percent advance.

Carry Trades

The Indonesian central bank is “studying” the possibility of limiting foreign holdings of Bank Indonesia’s bills, central bank Senior Deputy Governor Darmin Nasution said yesterday.

Emerging markets are poised to extend their biggest rally in a decade as investors borrow dollars to buy stocks, bonds and currencies in the world’s fastest growing economies, Arnab Das, the London-based head of market research and strategy at Roubini Global Economics, said earlier this month.

The International Monetary Fund said Nov. 8 that traders are probably using the dollar to fund “carry trades” around the world and the currency may still be overvalued even after its slide this year. In a carry trade, investors borrow in countries with low interest rates to invest in higher-yielding assets elsewhere.

“Capital controls risk denting EM optimism,” Thin wrote in a note to clients yesterday. He cited the example of Chile, which imposed a so-called “encaje” from 1991 to 1998, which taxed short-term inflows of foreign capital in an attempt to avoid currency speculation.

Colombia Controls

“Our own experience of the 1990s shows how, despite imposing capital controls, the exchange rate strengthened significantly,” Chilean central bank President Jose De Gregorio told lawmakers March 18. The peso, up 8.3 percent in the past month against the dollar, fell the most in almost seven months yesterday after De Gregorio said the bank doesn’t rule out intervening in the currency market.

“Most research has shown that the encaje was not very effective in preventing peso strength,” Thin said.

Brazil’s imposition of a tax on foreign stock and bond investments last month to curb appreciation in the real sparked speculation similar measures would be implemented in Colombia, which last year abolished capital controls that were introduced in 2007.

Brazil’s real has rallied the most among emerging-market currencies. Finance Minister Guido Mantega said the gains threaten the country’s exports when he implemented the so-called IOF tax on Oct. 19. The currency has been little changed since then, slipping 0.5 percent.

‘Negative’ for Stocks

Colombia’s peso has gained 14 percent this year, the third- best performance against the dollar among major Latin American currencies tracked by Bloomberg. Finance Minister Oscar Ivan Zuluaga said Nov. 11 that the country isn’t considering capital controls to stem the currency’s rise.

Slowing foreign inflows could reverse the rally in emerging-market stocks this year, said Jeffrey Saut, chief investment strategist at Raymond James & Associates in St. Petersburg, Florida, which manages $214 billion. The MSCI emerging-markets index has climbed 71 percent in 2009, heading for the biggest annual gain in 16 years.

Measures to limit currency gains “could have a negative effect in their equity markets,” Saut said. “With per capita incomes rising and GDP growth much stronger in emerging and frontier markets than in the developed markets, I think it’d be very foolish for them to go down that road.”

BRIC Growth

The four biggest developing economies -- China, Brazil, Russia and India -- will expand 4.4 percent as a group in 2009, compared with a 3.6 percent contraction in advanced economies, RGE forecast in a research report last month.

Indian stocks are being driven higher by foreign fund inflows and investors need to be “cautious” at these levels, U.K. Sinha, chairman and managing director of UTI Asset Management Co., said yesterday.

India may take steps to slow capital inflows should foreign investments surge, Finance Secretary Ashok Chawla said in New Delhi yesterday. “As the situation evolves we’ll see what needs to be done,” he said.

The benchmark Bombay Stock Exchange Sensitive Index, or Sensex, has rallied 76 percent this year. The rupee has gained 3.2 percent this quarter, the best performance among Asia’s 10 most-traded currencies.

To contact the reporters on this story: Allen Wan in New York at awan3@bloomberg.net; Veronica Navarro Espinosa in New York at vespinosa@bloomberg.net

Last Updated: November 20, 2009 10:31 EST