Brazil needs to fine-tune tax on derivatives-Fraga

Brazil’s government, which is fighting to stem massive capital inflows, needs to fine-tune measures aimed at regulating derivatives trading to prevent a decline in long-term investment, the chairman of the country’s biggest exchange operator said on Friday.

Government officials and financial industry leaders are holding a “constructive dialogue” to improve the implementation of such policy steps, which include taxing foreign purchases of local bonds and the use of currency hedging instruments, Arminio Fraga, chairman of BM&FBovespa, said at a seminar.

The risk, he said, is that the mix of taxes and curbs on derivatives trading that is currently hurting the Sao Paulo-based exchange’s business could scare away long-term investment inflows — much needed in Brazil at a time when the nation is in the middle of a $1 trillion infrastructure spending plan, the largest in its history.

“International experience has shown that such policy packages that focus on short-term inflows of capital work better,” said Fraga, whose speech was recorded and broadcast to participants of the BM&FBovespa’s industry summit in Campos de Jordao, Brazil.

Steps to curb the use of some of those instruments only “work for a limited period of time,” he added.

Fraga’s remarks signal a finance industry concern that the government may intensify action against dollar inflows. Those inflows have caused Brazil’s currency, the real, to strengthen to levels not seen since late 1998 and early 1999, just before a financial crisis forced a devaluation and put payment of the nation’s foreign debt in doubt. [ID:nN1E76Q0OW]

President Dilma Rousseff’s administration has taken a flurry of steps over the past year to brake the real’s rise. These measures range from selling reverse currency swaps to slapping reserve requirements on banks’ foreign exchange positions.

Brazil is not alone. Many emerging market economies have seen currency gains as they have recovered ahead of still-struggling industrial nations.

“That’s natural — we have a market with a volatility similar to that of other emerging market nations,” Fraga said. “Derivatives play an important role” in terms of smoothing extreme swings in the price of some financial assets, he added.

The measures have hurt revenue and profits at BM&FBovespa as higher transaction costs brought about by the derivatives taxes hampered average daily trading volumes for equities and other assets and prevented investors from participating in share and bond offerings.

Fraga, a former Brazilian central bank president and a long-time fund manager for billionaire financier George Soros, said Brazil’s economy has the ability to stand out even if the global economy continues to slow.

The world, Fraga said, is going through an atypical set of events, with inflation surpassing interest rates in countries like Switzerland and Singapore — both magnets for global capital flows — and the possibility of a further economic meltdown in some developed economies.

He lauded Rousseff’s crusade against corruption in Brazilian politics, saying it could help increase visibility and confidence in the functioning of Brazilian institutions.