Brazil Dismantles Capital Control as Real Drops to Four Year Low

Brazil dismantled capital controls for the second time in eight days as it seeks to arrest a decline in the real that threatens to further fan inflation.

After the currency weakened to a four-year low yesterday, the government removed the 1 percent tax charged on bets against the dollar in the futures market. The so-called IOF tax was implemented in July 2011 and its removal follows last week’s elimination of a tax on foreign purchases of bonds.

A weaker real increases import prices and threatens to derail Brazil’s efforts to tame inflation that is running at the top of its target range. A stronger currency would help a central bank that has increased the benchmark interest rate in its past two meetings rein in consumer prices, Jankiel Santos, chief economist at Banco Espirito Santo de Investimento, said.

The tax cuts are “meant to curb an even stronger weakening of the real that would put extra fuel on inflation dynamics,” Santos said by phone from Sao Paulo.

The real yesterday closed at a four-year low of 2.1564 per U.S. dollar. The currency had lost 5 percent over the last three weeks, making it the worst performer against the dollar of 16 major currencies tracked by Bloomberg after the South African rand.

“With the dollar strengthening, it doesn’t make sense to keep this obstacle in place,” Finance Minister Guido Mantega told reporters in Brasilia yesterday. “We are reducing the IOF so there will be greater supply of the dollar in the futures market.”

Currency War

Brazil is unwinding capital controls that it began putting in place in 2010 to defend itself from policies Mantega then characterized as a currency war. The dollar has strengthened worldwide amid speculation the U.S. Federal Reserve will dial back its bond-buying program, Mantega said yesterday.

He scrapped on June 5 a 6 percent tax on foreign investment in bonds purchased in the Brazilian market. Still the real continued to slide, and on June 10 and June 11 the government offered foreign exchange swap contracts worth $3.86 billion in four auctions.

The tax measure probably will have a limited impact on the exchange rate, Barclays Plc analysts Guilherme Loureiro and Marcelo Salomon wrote in a note e-mailed to investors yesterday.

“Negative global conditions and growing fiscal concerns locally should continue to dominate flows,” they wrote.

Annual inflation accelerated for nine straight months through March to 6.59 percent, above the top of the central bank’s target range of 2.5 percent to 6.5 percent. It eased back to 6.5 percent in May.

Policy Response

Policy makers responded by raising the benchmark interest rate to 8 percent, after keeping borrowing costs at a record-low 7.25 percent from October to March.

The key rate was lifted 50 basis points on May 29, surprising 38 of 57 analysts who expected policy makers would raise borrowing costs by 25 basis points for a second consecutive time.

“We increased rates in April and May, and we are in the process of fighting inflation without giving it any relief at the moment,” central bank President Alexandre Tombini said yesterday in an interview on Record television. “We will bring the inflation rate lower.”

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