VZCZCXRO0398
RR RUEHRG
DE RUEHSO #0624/01 2991801
ZNR UUUUU ZZH
R 261800Z OCT 09
FM AMCONSUL SAO PAULO
TO RUEHC/SECSTATE WASHDC 0007
INFO RHEHNSC/WHITE HOUSE NATIONAL SECURITY COUNCIL WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUEHAC/AMEMBASSY ASUNCION
RUEHBO/AMEMBASSY BOGOTA
RUEHBR/AMEMBASSY BRASILIA 0005
RUEHBU/AMEMBASSY BUENOS AIRES 0001
RUEHCV/AMEMBASSY CARACAS 0001
RUEHLP/AMEMBASSY LA PAZ 0001
RUEHMN/AMEMBASSY MONTEVIDEO 0001
RUEHPE/AMEMBASSY LIMA 0001
RUEHRG/AMCONSUL RECIFE 0003
RUEHRI/AMCONSUL RIO DE JANEIRO 0004

UNCLAS SECTION 01 OF 02 SAO PAULO 000624 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EINV ETRD PGOV PREL BR
SUBJECT: BRAZIL: NEW TAX UNLIKELY TO CURB REAL APPRECIATION 
 
REF: BRASILIA 128; BRASILIA 1099 
 
¶1. (SBU) SUMMARY: The Brazilian government's (GoB) October 20 
decision to re-impose a two percent tax on financial transactions 
(IOF) in order to curb appreciation of the local currency is 
unlikely to have a significant impact controlling the Real's rise 
or on foreign direct investment.  The IOF applies to capital 
inflows by foreigners for portfolio investment, including for first 
time equity investments, where it could reduce some short-term 
inflows.  While the decision created some immediate downward 
pressure on the Real, in the longer term the move is unlikely to 
deter foreign portfolio inflows as Brazil remains an attractive 
market with high interest rates.  The administration's move was not 
carefully coordinated with the Central Bank or Trade Ministry prior 
to announcement. The action represents a political response by the 
Finance Minister to export sector complaints, but one which is 
unlikely to have long-term effects on exchange rates or export 
competitiveness. END SUMMARY 
 
 
 
NEW "OLD" TAX MEASURE 
 
--------------------- 
 
 
 
¶2. (U) Following a 36 percent rise of the Real against the U.S. 
dollar this year, and amidst strong complaints from Brazil's 
exporters, the GOB announced October 20 the re-imposition of a two 
percent per transaction tax on portfolio investment inflows.  The 
measure, previously limited to fixed income investment and set at 
1.5 percent, was suspended in late 2008 when financial flows 
reversed during the onset of the global financial crisis.  With the 
rapid recuperation of the Brazilian economy in 2009, inflows have 
returned strongly, particularly in the equity market that now 
represents about 65 percent of capital inflows.  The GoB decided to 
expand the tax to equity investments as well as bank lending, 
insurance transactions, and fixed income investment.  The IOF does 
not apply to direct investment inflows, including earning 
retentions by foreign multinationals in Brazil. 
 
 
 
UNLIKELY TO CONTROL REAL, BUT COULD HURT LIQUIDITY 
 
--------------------------------------------- ----- 
 
 
 
¶3. (SBU) Most of our contacts agree that this measure is unlikely 
to curb the currency's appreciation, which is mainly driven by 
macroeconomic fundamentals.  International Finance Corporation 
Country Director Andrew Gunther and Federation of the Industries of 
Sao Paulo (FIESP) International Relations Director Mario Marconini 
told Econoffs separately October 21 the IOF will have only minimal 
effects, such as short-term market volatility, which is likely to 
stabilize in the long-run.  Brazil's stock exchange, Bovespa, and 
the Real experienced some very minor volatility as a result of the 
implementation of the IOF, declining by 2.2 and 1.3 percent 
respectively the day after the IOF was implemented, only to make-up 
all of their losses the following day.  Both experts agreed that 
tightening fiscal policy would do more to restrain the Real than 
the re-implementation of the IOF.  Contacts at Brazilian banks 
Bradesco and Itau-Unibanco also suggested that the IOF, while only 
1.9 percent of federal revenues, could actually serve as an excuse 
for the GOB to further delay necessary fiscal reform. 
 
 
 
¶4. (SBU) Consulate contacts such as Bovespa Chairman Arminio Fraga 
and Chief Executive Officer Edemir Pinto warn that Bovespa, which 
has received USD 23 billion in foreign inflows since January 1, 
will be the biggest victim of the IOF.  They expressed concern that 
 
SAO PAULO 00000624  002 OF 002 
 
 
the IOF will effectively export Brazil's equity business to New 
York and drain liquidity from Brazil, thereby increasing price 
volatility and country risk.   Nevertheless, most public criticism 
has focused on skepticism the IOF will halt the Real's appreciation 
rather than negative implications for investment. 
 
 
 
¶5. (SBU) Central Bank contacts note that Governor Meirelles was 
only informed of the measure two hours before it was announced. 
The Central Bank does not support the measure as an effective tool, 
noting that historically, even with taxes as high as nine percent, 
investors both build these taxes into their costs of doing business 
and find ways to circumvent the taxes.  Trade Minister Miguel Jorge 
stated publically that Finance Minister Mantega's suggestion that 
the tax would help the export sector was incorrect, as exports are 
more dependent on global economic growth than on exchange rates. 
Jorge said the tax might help the government with revenue 
collection, but would not help the export sector's competitiveness. 
Receita Federal (IRS-equivalent) believes the tax could yield an 
additional 2 billion reais/year in tax revenues, but Mantega 
publicly denied this was the reason for imposing the IOF. 
 
 
 
MORE MEASURES TO COME? 
 
---------------------- 
 
 
 
¶6. (SBU) Given skepticism about the effectiveness of the IOF, 
speculation has already begun that the Finance Ministry will pursue 
additional measures to restrain the Real.  While President Lula has 
not ruled out taking additional steps, Finance Minster Mantega has 
so far downplayed likelihood of imposing additional measures such 
capital controls on outflows-another area the Central Bank opposes. 
Capital controls would be very unpopular with Brazilian industry 
and banks, as well as significantly more complicated to enforce. 
 
 
 
COMMENT 
 
------- 
 
¶7. (SBU) Experts' skepticism about the IOF's effectiveness, the 
potential harm for equity investments, and indications of weak 
interagency coordination within the GOB, suggest the decision to 
re-impose the IOF was a political maneuver by the Finance Ministry 
rather than a well-coordinated attempt to affect either exchange 
rates or Brazil's export position.  The lack of consultation with 
the private sector or within the GOB suggests that, despite 
existence of mechanisms to ensure interagency review and 
coordination for trade and investment policy, decisions based on 
political factors can still be made quickly, without full 
consideration of economic impact.  The precipitous (and rescinded) 
import licenses decision last year (Ref A) and the proposed oil/gas 
exploration legislation (Ref B) could be considered examples.  As 
Brazil nears the 2010 national elections, the risk of other 
politically motivated "band-aid" measures grows.  However, it 
should be noted that, under Brazilian law, no new measures 
affecting the budget (including program funding, minimum wage 
increases, pension increases, etc) may be implemented within six 
months of the October 2010 elections. 
 
 
 
¶8. (U) This message was coordinated/cleared with Embassy Brasilia. 
 
 
 
WHITE 
White