Brazil Tightens Currency Controls as Inflation Boils, Threatens Exports

Amid a booming economy, dollars could hurt growth and slow export of IT services

By Greg Brown

Good news: Brazil’s economy is doing great. Bad news: Incoming foreign investment in the form of dollars is killing the real and thus hurting exports, the linchpin of Brazil’s growth.

Aiming to slow the onslaught, the government has raised a tax on foreign loans to corporations to 6% from 5.38% and, importantly, extended the tax to loans of up to 360 days. Previously, the tax applied to loans of up to 90 days.

In October the government raised a tax on foreign purchases of Brazilian fixed-income securities to 6% from 2%, reviving the types of capital controls common in the 1990s in developing markets such as Chile and Malaysia.

Besides stemming a tide of dollars seeking return — U.S., Japanese, and European rates remain at rock-bottom — Brazil needs to slow growth to avoid a bout of inflation. Finance Minister Guido Mantega suggested that the 360-day limit could be extended if dollar inflows continued.

“Three-month loans are not for investments. The inflow of dollars is too strong, damaging the exchange rate, appreciating the real, and harming exporters. We want to avoid that,” Mantega told reporters in a conference call reported by Bloomberg News.

Inflation is a big problem. A new forecast by analysts and economists in the country puts inflation at 6.02% for 2011. The government had targeted 4.5%. The benchmark lending rate is at 11.75%, up from just 8.75% a year ago.

Rising inflation could be a serious test for Brazil’s President, Dilma Rousseff, successor to Luiz Inácio Lula da Silva. A former guerilla, she served as Energy Minister under Lula and eventually as his chief of staff before running for the office.

She will be torn between two powerful constituencies: the exporters who built the economic success enjoyed by Lula and Brazil’s legions of poor, who rely on government spending to keep their heads above water. The trick will be to build domestic growth and jobs at home while keeping spending under control.

Rousseff got at least one vote of confidence this week: Fitch Ratings upgraded the country’s debt, in part on her move to rein in the budget by instituting a freeze. Other ratings agencies said they want to see the government carry out the freeze before raising their own views on its debt.