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Brazil: Government unveils additional measures to stem rising inflation and currency appreciation

April 7, 2011

On 7 April, the Finance Ministry decided to double the financial operations tax (IOF, Imposto sobre Operac?es Financeiras) on consumers' loans (excluding mortgages) to 3.0%, effective 8 April. The measure was announced several hours following the release of inflation figures for March, which revealed that consumer prices increased by 6.3% over the previous year ? dangerously approaching the upper limit of the Central Bank's target set for this year. One week before, the government had announced a new round of ?macro-prudential? measures aimed at curbing the appreciation of the Brazilian real. The 6.0% IOF on short-term external loans (except export financing) announced on 30 March came on top of a similar tax increase. The decision also followed an IOF hike for credit card purchases in foreign currency announced on 28 March. The government hopes that the measures will reduce short-term corporate issuance on foreign currency, which reached a ten-year high in February. Against a backdrop of a strengthening real and rising borrowing costs in local currency ? the Central Bank raised the benchmark SELIC interest rate twice this year ? businesses have a natural incentive to pursue cheaper loans in foreign currency. That said, the government aims to curb the attractiveness of such operations, in order to preserve the country's financial stability by reducing domestic banks' foreign exchange exposure. If successful, the measures should help to tame the appreciation of the real. On 7 April, the real traded at 1.58 per USD, which is the lowest level since August 2008. However, Consensus Forecast participants believe that the measures implemented will yield only a negligible effect on the exchange rate. Accordingly, panellists maintained their forecast of the real rising to 1.70 per USD by the end of the year, against the 1.72 rate expected one month earlier. For 2012, panellists expect the real to close the year at 1.77 per USD. Meanwhile, the latest IOF hike on loans to consumers ? one component of a broader toolkit of monetary policy instruments ? aims to slow credit expansion, in order to curb demand-side inflationary pressures. According to the local press, Finance Minister Guido Mantega said annual credit growth should slow from 20% to a less severe 12-15% clip. Since last December, Brazilian policymakers have tried to avoid the economy overheating through the use of several ?macro-prudential? measures aimed at reducing liquidity in the domestic credit market, which complement conventional interest rate hikes. The Central Bank had already pushed the SELIC rate up from 10.75% to 11.75% this year, and Consensus Forecast panellists foresee additional rate hikes, expecting the SELIC rate to reach 12.61% by year end. For 2012, interest rates should reach an average 11.33% by year-end.

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