The Brazilian government decided to increase the tax to capital inflows (with the exception to direct investment). This is a bad policy but is not enough to overturn the country’s attractiveness to international capital inflows.

Capital controls increase the cost of foreign investment for the economy and therefore diminishes potential growth. The Brazilian government took this measure in order to reduce the appreciation of the BRL (Brazilian Real) given the massive capital inflows. We assume that the government decided that a potential smaller economic growth was a better alternative that a strengthening of its currency and its impact on the economy competitiveness. Moreover, this measure has a fiscal benefit, given that the tax will provide resources for more than 0.3% of the GDP. The increase in tax collection is a secondary effect, nonetheless a positive one. I believe this is a negative measure but it is not significant enough to change my positive outlook on the country and its future growth. I believe that Brazil should concentrate its efforts to increase its productivity so that any appreciating force on the currency will not become a political pressure. The government has a lot of room to maneuver in the current tax structure so to make the terms of trade more efficient, reduce distortions and improve the prospects for investments (by lowering import tariffs, taxes on exports, etc).

This capital control measure is adversary to the efforts to extend the local currency yield curve and it diminishes the availability of resources to finance necessary investments. The general consent believes that this measure is one of a kind and will not be followed by other restrictive ones. We share these same thoughts.

Yesterday’s drop in the Brazilian market seemed like a buy opportunity. We decided to increase our exposure in stocks and bonds in some portfolios. We maintain our view of a continuous appreciation of the BRL, but potentially at a slower pace. This is due not only to the capital inflow tax but also because we expect the Central Bank will continue to accumulate reserves and therefore reduce the speed of the currency appreciation.

In summary, we view this measure as an isolated bad decision, but not as a signal of a sequence of more erroneous policies in the future. We continue to maintain our positive outlook for Brazil and took advantage of the drop in the market to increase our country exposure.