Summary
The enactment today of the 2% financial tax on incoming foreign portfolio purchases shows the stone age mentality of the financial ministry.
Analysis
Today the Brazilian government enacted a 2% tax on incoming foreign currencies intended to invest in the financial markets (IOF or financial operations tax).
The supposed intent was to reverse the over appreciation of the Brazilian real given strong foreign currency inflows. Foreign direct investment is exempt.
Unfortunately the tax will have little effect on the foreign exchange rate, as was shown by a similar measure in 2008. The only effective measure that the government and the industrial associations will not enact is opening up the economy. Brazil is uncompetitive in electronics, white goods, and toys for a start. If it were to reduce tariffs and barriers on just these products, foreign exchange would be sopped up and deflation could be imported. Additionally the service sector would grow much quicker, given more disposable income available to lower economic classes.
What the tax will do is the following: Raise the costs of treasury debt as the growing foreign participation will now be too costly. Stop the dynamic growth of the BMF Bovespa, one of the largest market exchanges in the world. Dry up the liquidity in IPOs, as foreign hedge funds will participate less (foreigners have accounted for 78% of the IPO purchases on average). Raise the cost of doing an IPO. Retard the growth of the asset backed market (FIDC), and the private equity market , particularly for real estate, as FIPs will also be taxed. Raise the barrier for smaller companies to access the capital markets.
Brazil has one of the highest corporate tax rates in the world as a percentage of GDP. Unfortunately there is little bang for the buck and no organized opposition to taxation with little representation.
