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Lula’s Tax Fuels Rally in Overseas Real Bonds: Brazil Credit

Luiz Inacio Lula da Silva, Brazil's president
Luiz Inacio Lula da Silva, Brazil's president. Photographer: Chris Ratcliffe/Bloomberg

Brazil may sell real-linked bonds in the international market for the first time in three years as a tax increase on foreigners’ purchases in the local debt market shifts demand overseas.

The government’s international real-linked bonds due in 2016 are rising faster than its local bonds with similar maturity since the tariff change on Oct. 4, driving the yield difference to a seven-month high of 372 basis points, or 3.72 percentage points. The gap was 214 points on July 13, according to data compiled by Bloomberg.

President Luiz Inacio Lula da Silva today boosted the tax on foreigners’ fixed-income investments to 6 percent, two weeks after doubling it to 4 percent, to stem a currency rally that pushed the real up 34 percent in the past two years. Colombia, Chile and the Philippines are selling such debt abroad as record-low interest rates in the U.S., Europe and Japan fuel interest in higher-yielding securities. Emerging-market bonds denominated in local currencies have rallied 20 percent this year after a 22 percent gain in 2009, according to JPMorgan Chase & Co.’s GBI-EM Global Diversified Index.

“It’s a good opportunity for the government to sell debt,” Diego Donadio, a Latin America strategist at BNP Paribas in Sao Paulo, said in a telephone interview. “It’s expensive to invest locally because you have to pay more taxes. Brazilian assets are seen as a good opportunity for foreigners.”

‘Great’ Demand

Latin America’s biggest country may offer real-denominated overseas bonds before the end of the year, Treasury Secretary Arno Augustin told reporters in Brasilia Oct. 14. Augustin was traveling and unavailable for further comment on Oct. 15, according to the Finance Ministry’s press department. Paulo Valle, an undersecretary at the Treasury, declined to comment.

Developing countries have raised $2.8 billion by selling local-currency debt abroad, the most since 2007, according to data compiled by Bloomberg. Russia is also planning to issue ruble securities to international investors this year, Deputy Finance Minister Dmitry Pankin told reporters in Moscow on Sept. 8.

“Demand from investors has been great for global bonds,” Ram Bala Chandran, a Latin American currency and rates analyst at Citigroup Inc., said in telephone interview from New York. “If Brazil wants to issue, the market has appetite for it.”

Brazil raised the levy on foreigners’ fixed-income purchases, known as the IOF tax, to 4 percent on Oct. 4 from 2 percent after the real reached the strongest level in more than two years.

The tax on foreign investors’ margin deposits for futures markets will climb to 6 percent from 0.38 percent, Finance Minister Guido Mantega told reporters today in Sao Paulo. The government left the IOF rate at 2 percent on equity investments.

‘One More Obstacle’

Brazilian interest rates are too high and are luring capital as the U.S. lets its currency weaken and takes the Chinese yuan with it, Finance Minister Guido Mantega told reporters in Brasilia on Oct. 4. Brazil’s 10.75 percent overnight interbank rate compares with a benchmark rate target of between zero and 0.25 percent in the U.S. The tax increase will slow speculative investment into Brazil and protect exporters and domestic producers, Mantega said.

The tax has so far failed to curb the currency’s advance. The real gained 1.4 percent since Oct. 4 to 1.674 per dollar, extending its advance this year to 4.2 percent.

The IOF increase may have created the unintended consequence of driving investors to seek out international real bonds, said Marcela Meirelles, an emerging-market analyst with TCW Group Inc. in Los Angeles, which manages about $110 billion.

“The fact that the tax creates one more obstacle to go local could be a stronger argument to buy the global ones,” Meirelles said in a telephone interview. “The tax, on the margin, improves the demand for the global bonds versus the local counterparts.”

International Bonds

The yield on Brazil’s 12.5 percent international bonds due in 2016 fell 62 basis points since Oct. 4 to 8.1 percent, compared with a 23 basis-point drop to 11.57 percent on the local bonds due in 2017, according to data compiled by Bloomberg. Yields on the government’s international dollar bonds due in 2017 declined 25 basis points over that time to 2.84 percent.

The yield gap between the foreign and local real- denominated securities may narrow, said Daniel Tenengauzer, head of emerging-markets foreign-exchange and rates strategy at Bank of America Corp. in New York. In March, he predicted the difference would narrow to about 200 basis points.

“The 4 percent one-off tax is important, but in the grand scheme of things, Brazil is a very important market and investors have to be involved,” Tenengauzer said. “The tax has a marginal impact, but the big trend will not change.”

Credit Default Swaps

The extra yield investors demand to own Brazilian government dollar bonds instead of U.S. Treasuries rose nine basis points today to 181, according to JPMorgan’s EMBI+ index. The spread on emerging-market government dollar debt widened six basis points to 253.

The cost of protecting Brazilian bonds against default for five years climbed three basis points today to 100, according to CMA DataVision. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements.

The yield on the overnight interest-rate futures contract due in January 2012 rose six basis points to 11.28 percent.

Augustin said in an interview with Bloomberg Television in Brasilia in July 2009 that he planned an offering of real-linked debt overseas. Valle said in a Sept. 1 telephone interview that the government was considering a sale before year-end.

Colombia, Chile

“They’ve been saying that for quite some time but they haven’t done anything yet,” said Bala Chandran. “I’m not sure they want to sell.”

Brazil last sold real-linked bonds overseas in 2007, when it issued $1.9 billion of 10.25 percent notes due in 2028, Bloomberg data show.

Colombia sold the equivalent of $1.3 billion of 7.75 percent peso bonds due in 2021 in international markets in July, according to Bloomberg data. Chile issued $520 million of peso notes in July. Philippines raised $1 billion in its first sale of local-currency notes to overseas investors in September.

Brazil may offer as much as $1 billion of the bonds abroad, according to Donadio of BNP Paribas.

The tax “can cause a migration to the secondary offering for offshore bonds,” he said.

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