MercoPress. South Atlantic News Agency

Fearing lesser global liquidity, Brazil eliminates tax on foreign capital inflows

“We have observed a reduction in the international liquidity coming to Brazil” admits Mantega

Brazil will scrap a tax on foreign investments in local debt, a surprise move that could help stop a sharp depreciation of the country's currency which lost 7.6% in the past three months and that threatens to stoke already high inflation in Latin America's largest economy.

In a press briefing on Tuesday Finance Minister Guido Mantega said that a drop in foreign inflows prompted the removal of the financial transaction tax, known as IOF, on foreign purchases of government bonds and other fixed-income investments.

“We have observed a reduction in the international liquidity coming to Brazil... We are removing the obstacles for the entry of capital,” said Mantega, who added that the move was not aimed at fighting inflation.

Mantega made the statement after meeting with President Dilma Rousseff .

The reduction of capital controls will likely help the Real rebound from near four-year lows and ease pressure on inflation, which has turned into a political liability for President Rousseff as she prepares to run for re-election next year.

Earlier in the day, central bank director Aldo Mendes said Brazil may have to live with a weaker Real if the depreciation was in line with the movement of other currencies.

The Brazilian central bank, which enjoys de-facto independence, surprised investors last week with an aggressive 50-basis-point interest rate hike (to 8%) in a bid to control stubborn high inflation.

The removal of the 6% tax, effective Wednesday, takes away a key barrier Brazil had raised to prevent the Real from strengthening too much and hurt local industries and exporters.

The IOF tax, which was first raised in late 2009, was aimed at limiting the surge of cheap money flowing into the country after developed nations loosened monetary policies to stimulate their economies.

However, worries that the United States would soon cut monetary stimulus has turned things around, dragging down the Real and other emerging-market currencies.

”Today, with the market returning to normal and the (U.S. Federal Reserve) likely reducing its expansionist policy, we can remove this obstacle,” Mantega said.