beyondbrics

Brazilian finance minister Guido Mantega stepped up his rhetoric today, describing an “international currency war” among nations that “threatens us because it takes away our competitiveness.”

But Mantega’s war of words, aimed at cooling off the rising real, also included a warning that the government may raise the tax on capital inflows. (Brazil introduced its 2 per cent tax on portfolio investments last October, partly to cool off inflows after Santander’s Brazilian arm’s $8bn IPO attracted a lot of interest.) So just how effective is that threat?

That depends on how serious the central bank is about following through, Nomura analyst Tony Volpon says in his latest note:

Will they act? There are two ways to read these statements. First, like last year, Mantega is giving fair warning that the decision has been taken, and they are waiting for both the Petrobras transaction to close and next Sunday’s presidential election to pass before acting.  Second, that Mantega is just using a conditional threat he hopes not to have to act upon.

If it’s the latter case, Volpon warns, it’s unlikely to make much of an impression. He notes that while interest rate futures moved after Mantega’s remarks, there was “no real move” in the currency.

“Markets are right to think that, in the end, such taxes punish more the rates market than the currency”, he says. “But the lack of a move in [the real] just shows that verbal intervention that is not followed by concrete measures eventually fall flat.”

What’s more, Volpon points out, Mantega implied that the tax increase would only kick in after further appreciation in the real (most likely to the level currently considered psychologically important by most analysts, 1.70 to the dollar.) That, combined with the central bank’s ongoing interventions in the spot market, would simply reduce volatility in the forex market.

In that case, “the optimal trade is to buy [the real] and enjoy the very high risk-adjusted carry. This is the best policy a carry trader could ask for.”

It looks like the market is in a mood to keep testing the government’s commitment to stemming the real’s rise. If Mantega doesn’t follow through soon on his tax threat, Volpon says, he runs the risk of “subsidis[ing] the losing end of the carry trade.”

Related reading:
Brazil warns of ‘currency war’, FT
Brazil seeks to lower real’s temperature, FT