New 2% Brazilian Tax Inspiring Creative Investment Strategies

Brazil's 2% IOF tax comes as a wave of profit-taking weighs emerging markets in general. The MSCI EM index is off nearly 8% since October 20, while the Brazilian Bovespa entered "correction" territory Wednesday with a cumulative decline of a little more than 11% in the same period. In the last five days, net-net the Brazil real has slipped about 2.4% against the dollar. From its low on Monday near BRL1.70, through Wednesday's high, the dollar appreciated almost 4.7%. This underscores the point we initially made that the volatility of the Brazilian real is sufficiently high as to quickly offset the cost of the 2% tax.

Investors continue to seek ways to avoid the tax. Some investors are looking at some structured product whose return is tied to BRL's performance without having to buy the BRL itself. The largest non-government bank in Brazil is reportedly offering, through its European unit, three-year structured notes that may yield 10.5%. These would be dollar-denominated notes where the interest and principal payments would fluctuate with the BRL.

Some fixed income investors are considering buying Brazil's dollar-denominated bonds and getting the currency exposure through the offshore non-deliverable forward market.

Some equity fund managers are exploring the liquidity of Brazilian ADRs. The average (20-day) volume of Petrobras ADR (PZE) in New York is just shy of 14.6 million, for example. Or Gerdau (GGB), the steel company's ADR has an average (20-day) volume of about 8.5 million shares. These are not meant to be equity recommendations but rather simply to illustrate the liquidity of some Brazilian ADRs.

Lastly, we have talked with some longer term investors who see the 2% tax presenting them with new opportunities to buy Brazilian assets on a pullback as some of the short-term (hot) money exits.

Disclosure: No positions

Comments

[Mad Hedge F...:]

por I’ve got to comment on Brazil’s (EWZ) idiotic move last week to impose a 2% tax on real stock and bond purchases to scare off foreign investors. It’s like firing off an emergency flare in the night and saying “Come and get me.” If any portfolio manager was living in a cave for the past ten years and somehow missed the attractions of investing in an emerging market that exports food and energy, has an appreciating currency, and an almost perfect demographic profile, they can see it now, clear as day. This lunacy reminds me of Malaysia prime minster Mohamad Mahathir’s rantings and ravings about George Soros’s selling of his country’s markets during the Asian financial crisis, when in fact, George was buying. I sympathize with Brazil’s dilemma, similar to those of the Swiss during the eighties and nineties, when the whole world wanted to buy their currency, forcing the government in Berne to drive interest rates to zero, pushing domestic prices through the roof. But this is the price of economic success. Everyone wishes they had Brazil’s problems. Better to just let things be.

Oct 29 02:18 PM

[surfgeezer:]

They have been thru this before and are doing well because they have learned their lessons well, including looking a gift horse in the mouth. They know too well how fast the money can leave and this is no more than insurance against that as they will be buying foreign treasuries with the revenue.


On Oct 29 02:18 PM Mad Hedge Fund Trader wrote:

> por I’ve got to comment on Brazil’s (seekingalpha.com/symbo...)
> idiotic move last week to impose a 2% tax on real stock and bond
> purchases to scare off foreign investors. It’s like firing off an
> emergency flare in the night and saying “Come and get me.” If any
> portfolio manager was living in a cave for the past ten years and
> somehow missed the attractions of investing in an emerging market
> that exports food and energy, has an appreciating currency, and an
> almost perfect demographic profile, they can see it now, clear as
> day. This lunacy reminds me of Malaysia prime minster Mohamad Mahathir’s
> rantings and ravings about George Soros’s selling of his country’s
> markets during the Asian financial crisis, when in fact, George was
> buying. I sympathize with Brazil’s dilemma, similar to those of the
> Swiss during the eighties and nineties, when the whole world wanted
> to buy their currency, forcing the government in Berne to drive interest
> rates to zero, pushing domestic prices through the roof. But this
> is the price of economic success. Everyone wishes they had Brazil’s
> problems. Better to just let things be.

Oct 29 04:42 PM

[whooper1:]

Mad Hedge:
Yes, I remember in the late 70's or early 80's the Swiss interest rates went negative. If you wanted a Swiss savings account you had to pay the bank the negative interest rate. The US once had this problem. During WWII for a time the US interest rates were negative.

Oct 30 02:46 PM