Brazil wheels out unconventional weapon to control currency, stock market bubbles in the making

10/21/2009 8:30 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Brazil slapped a 2% tax on overseas investments in Brazilian stocks on October 20.

The tax is a serious but most probably ineffective attempt to slow the rise of the real, the Brazilian currency, and to curb cash inflows that are pushing up both Brazilian stock prices and inflation.

Brazilian stocks are up 70% in 2009.

The Brazilian central bank highlighted the seriousness of the problem by releasing a survey predicting an increase in Brazilian short-term interest rates to 10.5% in 2010 from the current 8.75%. Inflation, the bank projected, would climb modestly from a high 4.3% in 2009 to 4.41% in 2010. That’s still down from an inflation rate of 5.9% in 2008.

Unfortunately, even with the tax on investments, the bank is projecting that the real will continue to appreciate against the U.S. dollar. That would push the country’s trade surplus down to $16.5 billion in 2010 from $25.85 in 2009 as a rising currency made Brazilian goods more expensive on world markets. The real is up 33% against the U.S. dollar this year.

Brazilian stocks fell on news of the tax, but I don’t expect the effect to last for long.

Investors can easily work around the tax by buying the ADRs (American Depository Receipts) of Brazilian stocks in New York rather than buying the shares themselves in Brazil.

And the continued out performance of the Brazilian economy, which moved out of recession in the current quarter, and relatively high interest rates guarantees the continued flow of overseas cash into Brazilian financial assets.

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