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Brazil mysterious interest rate cuts & proposed Euro Rescue package… cause to worry?

Who sets interest rates in Brazil: Is it Central Bank President Alexandre Tombini or the country’s President, Dilma Rousseff? That question hung over financial markets after the Central Bank of Brazil cut the benchmark Selic interest rate by half a point, to 12 percent, on Aug. 31. The move was unexpected: The bank’s rate-setting committee had ratcheted up the Selic at its five previous meetings to combat inflation and had not signaled a change in its stance. Yet Rousseff in an Aug. 30 radio broadcast had said rates should begin to fall as the government curbs spending.

(Interestingly a week later Guido Mantega, Brazil’s finance minister, suddenly proposed a “Bric” rescue package for the eurozone this week, he caught not only other world leaders by surprise but also many of his fellow countrymen.

Even as officials from other members of the so-called Bric grouping – Russia, India and China – said it was the first they heard of the idea, many ordinary Brazilians expressed shock at the notion of bailing out the world’s richest trading bloc. FT 16.09.2011)

The abruptness of the shift in monetary policy left money managers such as Guilherme Figueiredo, director of M. Safra, a São Paulo investment firm, with the impression that Tombini had caved in to political pressure. “This is the worst possible decision our central bank could have made at such a moment,” Figueiredo says. “The loss of credibility is going to be large.” Rousseff’s press office declined to comment when asked about the rate decision.

New data indicate that Tombini may have acted prematurely. On Sept. 6, Brazil’s statistics agency said inflation accelerated to an annualized 7.23 percent in August—its fastest pace since 2005 and well above the 6.5 percent upper end of the target range set by monetary authorities for the full year. In an Aug. 31 statement the central bank defended the rate cut, saying it will help shield the economy from the effects of a “substantial deterioration” in the world growth outlook.

It’s true that Brazil shows signs of cooling. The central bank’s economic activity index shrank in June for the first time since 2008, and business confidence in the second quarter slid to its lowest level since 2009. Economists expect growth to slow to 3.7 percent this year, from 7.5 percent in 2010.

Finance Minister Guido Mantega has pledged that the government won’t resort to fiscal stimulus to spur the economy. Whether Rousseff, who took office on Jan. 1, can discipline the spending habits of the multiparty ruling coalition remains an open question, however. Congress rebelled against her first attempts at frugality by proposing bigger salaries for police officers and an increase in health-care spending. Cutting rates in these circumstances “is really risky, with inflation building and wages set to rise,” says Elson Teles, chief economist at Maxima Asset Management in Rio de Janeiro. The central bank is “weighing such subjective things like whether there’s going to be another global recession. What if it doesn’t happen?”

The bottom line: Brazil’s central bank may have bowed to government pressure for a rate cut, endangering its goal of containing inflation.

Source: Bloomberg, 08. 09.2011is a reporter for Bloomberg News.  Ragir   Bristow is a reporter for Bloomberg News.

Filed under: Brazil, News, Risk Management, , , , , , , ,

Brazil: New Brazilian Derivatives Market Regulation

On July 27, 2011 the Brazilian Finance Minister, Guido Mantega, announced two new prudential measures aimed to avoid currency speculation in the derivatives market, in order to stem the United States Dollar’s fall and prevent the overvaluation of the Brazilian Real. These two measures are commented below.

The first measure is Provisional Measure No. 539, of July 26, 2011 (MP 539/2011), which basically authorizes the Brazilian Monetary Council (Conselho Monetário Nacional – CMN) to establish specific conditions for the negotiation of derivates contracts, for monetary and exchange policy purposes, regardless of the nature of the investor, with powers to also (i) determine deposits over the notional value of the derivatives contract; and (ii) set forth limits, terms and other conditions for the negotiation of such contracts.

MP 539/2011 also amends the Tax on Exchange Transactions (IOF) legislation, namely Decree-Law No. 1,783, of April 18, 1980 and Law No. 8,894, of June 21, 1994, in order to clarify that:

  1. the entities authorized to register derivatives contracts are responsible for collecting the IOF, which is calculated on the amount of the transaction;
  2. in the case of securities transactions involving derivatives contracts, the maximum IOF rate will be 25%. Up to this ceiling (25%), the Executive Branch can amend the applicable rate at any time, considering the monetary and exchange policy goals of the Brazilian Government. However, the current applicable IOF rate for derivatives transactions is 1%, as explained below when the second measure is commented;
  3. the amount of the securities transaction, for IOF purposes, is the adjusted notional value of the derivatives contract. The adjusted notional value is the reference value of the contract (notional value) revised to reflect the difference resulting from the derivatives´ price variation with respect to the underlying assets´ price variation; and
  4. the taxpayer is the holder of the derivatives contract.

As of July 27, 2011 (date of the publication of MP 539/2011 in the Official Gazette of the Union, when this measure came into force), in order to be valid all derivatives contracts must be registered with duly authorized entities, i.e. clearing houses or service providers which have been accredited by the Central Bank of Brazil (Banco Central do Brasil – Bacen) or by the Brazilian Securities and Exchange Commission (Comissão de Valores Mobiliários – CVM) to operate with clearing, settlement and registry.

The second measure is Decree No. 7,536, also dated July 26, 2011 (Decree 7,536/2011), which amends the IOF regulation approved by Decree No. 6,306, of December 14, 2007. This decree repeats many of the same terms already defined in MP 539/2011.

Pursuant to Decree 7,536/2011, the current applicable IOF rate to derivatives contracts is 1% and it is due in the purchase, sale or maturity of financial derivatives contracts, whenever the settlement amount is affected by the exchange rate variation and results in increase in the net short exposure in relation to the amount calculated at the end of the previous business day within the same entity authorized to register derivatives contracts.

The net exposure is calculated as the sum product of the amount of financial derivatives contracts whose settlement amount is affected by the variation of the exchange rate set by the adjusted notional value of each contract.

Netting is permitted between exposures of the same holder cleared by different entities accredited to register derivatives contracts, provided that the holder expressly authorizes such entities to access information necessary for the calculation of the consolidated net exposure.

The applicable rate is reduced to zero in the case of the above mentioned netting as well as in any purchases, sales or maturities of derivatives contracts that at the end of the day result in net short exposure below US$ 10 million made with the same entity accredited to register derivatives contracts. Above this figure, the 1% rate will apply.

Furthermore, Decree 6,306/2011 contains a provision which is not related to derivatives contracts and deals with foreign currency loans. This provision establishes that the 6% IOF rate which is due in the case of transactions contracted for a term of less than 720 days must also be paid in the event of prepayment of loans with maturity exceeding 720 days, plus interest in arrears and a fine, which may vary from 5% to 100% of the total amount of the transaction, and a penalty of up to R$ 100 thousand to be imposed by Bacen. This measure aims to avoid that a Brazilian borrower contracts a long-term loan benefited with zero IOF rate and then agrees to reduce the term of the transaction immediately afterwards.

Source: Mondaq, 01.08.2011

Filed under: BM&FBOVESPA, Brazil, Exchanges, Latin America, Risk Management, , , , , , ,