Currency surge sparks calls for tough capital controls

17/03/2012 | Sid Verma and John Rumsey

Former Colombian finance minister Jose Antonio Ocampo proposes tough measures to discourage speculative foreign investment into Latin America

Calls are growing for more punitive capital controls on foreign investors in Latin America amid mounting fears that a tide of liquidity is fuelling export-damaging currency appreciation and asset bubbles in domestic financial markets.

Jose Antonio Ocampo, the former Colombian finance minister, said that Brazil should reinstate a 2% tax on equity market inflows in Brazil, known as the IOF, that was scrapped last year to breathe life into domestic markets.

More controversially, he told Emerging Markets that Brazil should also consider imposing a tax on foreign direct investment (FDI).

His comments came as the Brazilian government yesterday announced a further tweaking of policies designed to boost pressured exporters, exempting them from a 1% IOF tax on derivative positions.

Ocampo, a member of a high-level task force on regulating global capital flows, spearheaded by the Global Economic Governance Initiative at Boston University. Said: “In order for capital controls to be effective, they need to hurt foreign investors.

“In principle, I am against a tax on FDI but it is clear that short-term capital flows are being disguised as FDI in Brazil so some sort of capital tax on this should be extended.”

Foreign investors are accused of circumventing capital controls by disguising portfolio flows as equity investments in local subsidiaries, which then purchase short-term bonds whose proceeds are repatriated abroad as profit or dividends.

“It is no secret that many companies are doing this so in order to circumvent capital controls,” Tony Volpon, Brazil strategist at Nomura, said. The short-term benefits of capital controls on FDI outweighed the potential for market distortions and lower rates of investment, Ocampo said.

On Monday Brazil broadened its 6% tax on foreign debt borrowings to include maturities of up to five years, up from three years previously, in its latest attempt to weaken the real.

The move was seen by bankers as likely to be ineffective in curbing portfolio flows since external corporate bonds were typically issued with 10-year maturities.

Alberto Ramos, chief economist at Goldman Sachs said the Brazilian measures could perturb investors because of their unpredictable nature. That could hasten moves by investors to consider investments in other countries in the region although markets are not as deep or liquid, he said.

Alexandre Gorra, senior strategist at BNY Mellon, said Japanese investors, with up to $50 billion mainly in bonds, were starting to redeem with recent outflows of $750 million. “IOF taxes are not good for investors although some see it as necessary evil,” he said.

However, with firm global commodity prices and historically low interest rates in the developed world likely to remain entrenched, capital flows to South America are set to remain strong.

In Colombia, Ocampo, who imposed capital restrictions as finance minister, said taxes should be imposed on external debt borrowings and foreign investments in domestic securities.

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