Government measures raise the dollar exchange rate.

247 – In the immediate aftermath of the decree establishing a 1% tax on foreign exchange derivatives transactions, which came into effect this Wednesday, the 27th, the government achieved its goal. The dollar experienced its biggest rise in over a year, appreciating 1,35% against the real and closing the day at R$ 1,559. After six consecutive days of declines, the exchange rate experienced a rise not seen since June 2010. A provisional measure also published in the Official Gazette authorizes the taxation of derivatives in general to be increased up to 25%. The provisional measure also opened the possibility of imposing deposits on the contract values ​​and the definition, by the National Monetary Council (CMN), of limits, deadlines, and other conditions on the trading of derivatives. The taxation of foreign exchange derivatives with the Tax on Credit Operations (IOF) will apply to operations that result in an increase in the short position of institutions. Exhibitions under US$10 million will have a zero tax rate.

Finance Minister Guido Mantega explained in a press conference that the exchange rate measures aim to bring more transparency to the derivatives market, requiring over-the-counter (OTC) transactions to be registered. "Most (of these transactions) are done over-the-counter... now we are requiring the registration of these derivatives transactions that are carried out outside of BM&F and Cetip. This will provide greater transparency to the volume of derivatives being traded," he said.

The president of the Central Bank (BC), Alexandre Tombini, said that Brazil will continue to attract investments, despite the measures published today to contain the flow of capital and thus try to prevent the devaluation of the dollar against the real.

"Foreign investment responds to structural factors, long-term conditions that are not affected by this measure. In fact, over time, they make Brazil a safer destination for productive investment, infrastructure investment, and foreign direct investment. Brazil continues to be a receptive country to foreign direct investment, and this measure even serves to strengthen this aspect of the Brazilian economy," stated Tombini, who participated in a lecture at the Superior War College in Rio de Janeiro.

"The Central Bank has been acting to contain the possible repercussions, the potential risks that an inflow of funds or positions in the Brazilian currency could represent. It has been acting to contain these flows, intervening in the banks' short positions, and now this measure concerns notional exposure in derivatives," stated Tombini.

"At a time when international conditions begin to normalize, both in the monetary and financial sectors, we will not have any surprises in the country. Therefore, we have been acting and will continue to act, when necessary, to reduce and mitigate these potential risks to the Brazilian economy. The Brazilian economy will emerge stronger from this measure."

The exchange rate measures announced today by the government were well received by the Brazilian Association of Machinery and Equipment Industries (Abimaq), which, however, has reservations. According to the association's director of competitiveness, Fernando Bueno, the initiative limits the firepower of speculators, but should have a limited effect on the exchange rate as they find ways to circumvent the rules. "It's difficult to quantify the effect, but it reduces the space for speculators to continue operating in the casino. But in 15 days the system will find some way to get around this," he said.

Bueno stated, however, that the measure is valid because it brings an additional concern for speculators. For him, the ideal would be for the government to control all foreign capital entering Brazil. "It would be solved if all capital were taxed and, after verifying the true investment, the difference were returned to the investor," he said. According to him, this would be the way to stop the entry of investors seeking to profit from the high interest rates paid in Brazil compared to other countries.

Another suggestion from Bueno to address the appreciation of the real would be to establish a minimum stay period for foreign capital entering Brazil. According to him, a one-year stay would be an efficient proposal since this period would not be detrimental to the productive sector, but rather to speculators.

Former Central Bank president and partner at Tendências Consultoria, Gustavo Loyola, described the new exchange rate measures announced today by the government as "terrible" and "desperate." He believes one of the side effects of these measures will be the export of Brazil's derivatives market to the Chicago Mercantile Exchange.

"Ultimately, this tends to reduce liquidity here and increase it abroad. I think it's a measure that goes against Brazil," Loyola stated, explaining that foreign investors in Brazil use the Commodities and Futures Exchange (BM&F) to hedge their positions. By resorting to mechanisms that make these operations more expensive, the government, according to him, encourages foreign investors to choose to hedge their positions abroad.

"The Chicago market trades several currencies. The Real doesn't have much liquidity there because it does here. I'm not a purist; I think that eventually you have to take drastic measures in emergency situations. But they have to, at least, work. This one doesn't work," he said.

A Provisional Measure published today in the Official Gazette authorizes the National Monetary Council (CMN) to define specific rules for derivatives trading and to tax the Financial Operations Tax (IOF) of up to 25% on the value of these operations. Taxation begins with a 1% IOF rate on the net short position – the difference between the short position and the gross long position – that exceeds US$10 million. The government also surprised by penalizing those who take out external loans with an average term exceeding 720 days and then prepay them.

Loyola does not believe in a reversal of the current downward trend of the dollar due to this new exchange rate package and argues that the effects of the provisional measure are only temporary. "I think this measure is terrible, very bad. Almost a desperate measure that will have no effect whatsoever and will generate more distortions." According to him, the idea of ​​taxing the derivatives market should also create legal uncertainty, with foreign investors fearing further changes in the rules.

The former president of the Central Bank also points out that the biggest buyer of dollars on the BM&F today is the Central Bank, which has been making regular interventions, thereby removing volatility from the exchange market. "If you want to increase risk and thereby reduce inflows (of resources), you have to let the exchange rate float. When you remove volatility, you make the cost cheaper," he said.