Brazil scraps tax on currency derivatives

Tax applied to currency trades

Brazil’s government eliminated a tax on currency derivatives in a bid to arrest the decline of the real that is at a four-year low.

The 1 percent tax that will be removed tomorrow was applied on bets against the dollar in the country’s futures market in a bid to weaken the Brazilian currency. The so-called IOF tax was implemented in July 2011.

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

As a means to stem the real’s decline, 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 dial back its bond-buying program.

“I don’t know if this is enough to regain the FX market’s trust, because they change the rules of the game all the time,” Andre Perfeito, chief economist at Gradual Investimentos, said by phone from Sao Paulo after today’s announcement. “They cut the IOF now, but if winds change in the near-future they might put it back. But it is a good step in the right direction.”

A weaker real threatens to derail Brazil’s efforts to tame inflation that is running at the top of the 2.5 percent to 6.5 percent target range. Last week, the government eliminated a tax on foreign purchases of bonds.

Brazil’s real today closed at a four-year low of 2.1564 per U.S. dollar. The currency has lost 5 percent over the last three weeks, making it the second-worst performer against the dollar of 16 major currencies tracked by Bloomberg.

Mantega announced on June 4 the elimination of 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.

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