Brazil Cuts Dollar Loan Tax as Weak Real Threat to Inflation

Brazil further reduced taxes originally implemented to stem dollar inflows as the government tries to support the real in an effort to fight above-target inflation.

The 6 percent IOF tax, which previously was applied to foreign loans with maturities of up to one year, will now only be charged on loans and bonds with durations of up to six months, according to a presidential decree published today in the official gazette. The last time the government changed rules for such operations was December 2012.

The decision to stimulate dollar loans follows a drop in the real in the past month that was the worst among all major currencies after the New Zealand Dollar. A weaker real could further stoke inflation that the central bank says has a 40 percent chance of accelerating beyond the 6.5 percent upper limit of the target range this year.

“The exchange rate in the short term is the available tool to prevent consumer price gains from breaching the upper limit of the target,” Roberto Padovani, chief economist at Votorantim Ctvm Ltda, said in a phone interview from Sao Paulo. “The currency devaluation can affect both confidence in the economy and inflation.”

The real weakened 0.2 percent to 2.2861 per U.S. dollar at 2:30 p.m. local time, extending its monthly decline to 2.8 percent.

End of Cycle

The central bank last week halted the world’s longest tightening cycle as President Dilma Rousseff’s administration struggles to tame consumer prices without further jeopardizing growth. Policy makers kept the benchmark interest rate unchanged at 11 percent, after raising it nine consecutive times from a record-low 7.25 percent.

Inflation will quicken to 6.47 percent by year end from 6.31 percent in the 12 months through mid-May, according to the median estimate in a central bank survey of about 100 economists published this week.

The increase in the cost of living has reduced confidence in the economy and eroded growth. Latin America’s biggest economy will expand 1.5 percent this year, down from 2.5 percent in 2013, the central bank survey shows.

Speculation the central bank will scale back or eliminate a program of daily swap auctions prompted traders to sell off the real. The program that helped support the currency this year is scheduled to expire by the end of the month.

Real Gain

The real gained 3.3 percent since the start of the year, the best performance after the Australian dollar among the 16 most traded currencies tracked by Bloomberg.

The dollar loan tax cut will prompt an increase in foreign currency inflows to the country, Camila Abdelmalack, economist at CM Capital Markets, said by telephone from Sao Paulo.

“The measure is an incentive to raise funds,” Luis Otavio de Souza Leal, chief economist at Banco ABC Brasil, said by telephone from Sao Paulo. “With high rates in Brazil, it creates an alternative for companies to get funds abroad.”

Central bank President Alexandre Tombini signaled last month that policy makers could reduce the amount of swaps the bank uses to intervene in the currency market, saying that demand for hedging had eased.

Finance Minister Guido Mantega said the government is eliminating measures taken in the past four years amid what he called the currency war to protect Brazilian manufacturers from cheaper imports

“The currency market is functioning normally,” Mantega told reporters following the publication of the measure. “There’s no need for these instruments.”

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