Japanese Money Trapped by Mantega Tax as Real Beats Aussie: Brazil Credit

The foreigners’ tax that Brazil tripled last year to keep out cash may now be discouraging Japanese investors from pulling their money from the country after last week’s earthquake, currency trading shows.

While Brazil ranks one spot behind Australia as the fourth- biggest overseas market for Japanese retail investors, the real has surged 3.1 percent against the Australian dollar this week and touched a three-month high. Japanese families are leaving their Brazilian bondholdings untouched as they look for other places to withdraw capital and fund reconstruction, said Kevin Daly, who helps oversee about $6 billion of emerging-market debt at Aberdeen Asset Management Plc.

Investors are hesitant to pull money from Brazil because they want to avoid paying the 6 percent tax should they decide to move money back in, according to Bank of America Corp. The bank said in a March 15 report the tax is preserving the real’s value this week, the opposite of what Finance Minister Guido Mantega intended when he raised it in October. The real has gained this week against four of the five most-traded emerging- market currencies, falling only against the Taiwanese dollar.

“The one consideration they have to have is if they take their money offshore, it’s going to be pretty expensive to go back in,” Daly said in a telephone interview from London. “We haven’t seen any overt signs of outflows from Japanese investors in Brazil.”

Yield Gap
Brazil’s 10-year real-denominated bonds yielded 12.74 percent yesterday, or 11.39 percentage points above similar- maturity Japanese debt, according to data compiled by Bloomberg. Emerging-market local bonds yield 6.6 percent on average, according to JPMorgan Chase & Co.

Japanese investors’ holdings of Brazilian assets surged almost sixty-fold to 2.8 trillion yen ($35.6 billion) from 5.4 billion yen in 2005, making it the Asian nation’s fourth-largest foreign holding after the U.S., Europe and Australia, according to the Investment Trust Association.

Mantega boosted the so-called IOF tax on overseas purchases twice in October to stem inflows that have sparked a two-year, 38 percent rally in the real. Near-zero interest rates in Japan, Europe and the U.S. have fueled demand for fixed-income assets sold by Brazil, whose inflation-adjusted rates are the highest in the world after Croatia, according to data compiled by Bloomberg.

“The 6 percent IOF tax on new inflows ironically creates an important disincentive to temporary unwinds as an eventual reversion of these repatriations would only occur at a substantially lower rate,” wrote Virgilio Castro Cunha and David Beker at Bank of America Corp. on March 15. “Japanese investors are likely to turn to other investments before pulling money out of Brazil.”

Monitoring Market
Mantega told reporters in Brasilia on March 15 that he’s monitoring the market to assess possible currency measures. The main consequence of the earthquake in Japan for Brazil is market volatility, he said.

The Finance Ministry declined to comment in an e-mailed statement.

Speculation Japanese will repatriate funds is growing after the March 11 earthquake and subsequent tsunami shut manufacturing plants at Sony Corp. and Toyota Motor Corp. and sent more than 350,000 people to emergency shelters. Insurers and reinsurers may face 2.8 trillion yen in claims from the 9- magnitude quake, excluding damage from the tsunami, initial estimates from catastrophe modeler AIR Worldwide show.

The extra yield investors demand to own Brazilian government dollar bonds instead of Treasuries narrowed 6 basis points to 185 at 8 a.m. New York time, according to JPMorgan.

Rate Futures
The cost of protecting Brazilian bonds against default for five years rose 2 basis points to 119, according to CMA DataVision prices. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements.

Yields on interest-rate futures contracts due in January 2012 fell 1 basis point to 12.30 percent, suggesting traders are betting the central bank will boost the benchmark rate to 12.75 percent by year-end. The benchmark Japanese rate is 0.1 percent.

The real rose 0.1 percent against the U.S. dollar to 1.6720. The greenback fell to the lowest since World War II against the Japanese yen as the risk of radiation leaks from a crippled nuclear plant stoked prospects insurers and investors will redeem overseas assets to pay for damages.

The IOF tax will fail to deter Japanese from repatriating Brazilian holdings because their investments are in markets not subject to the levy, according to Kieran Curtis, who helps manage about $2 billion in emerging-market debt at Aviva Investors in London. Japanese investors buy the real in the non- deliverable forwards market and purchase real-linked bonds that trade overseas, he said.

Cultural Ties
They are likely to repatriate other assets before selling their Brazilian holdings in part because of the cultural ties between the countries, according to Marjorie Hernandez, a currency strategist at HSBC Holdings Plc in New York.

About 1.6 million Japanese nationals or people of Japanese descent live in Brazil, the biggest community outside of the Asian country, according to the country’s embassy in Brasilia. Japanese started to immigrate to the South American nation in the early 20th century as laborers working in coffee plantations.

“You take it out of elsewhere first, that’s my feeling,” Hernandez said. There’s a “cultural link that is very strong” and “they believe in it,” she said.