New Brazilian tax creating short term volatility

The Brazilian Government's introduction of the 2% IOF tax on foreign exchange inflows will create short-term headwinds for both local equities and the Brazilian Real (BRL).

However, the long-term outlook for both Brazilian equities and the currency remains robust, according to HSBC Global Asset Management - one of the world's largest international managers of Brazilian equities with approximately US$5.7bn in this asset class (as at end September, 2009).

The 2% tax is levied on purchases by foreign investors of BRL-denominated, fixed income securities and stocks. The measures are being taken to avoid excess speculation in Brazilian stocks and in capital markets. Since the start of 2009, the BRL has gained around 25% against the dollar and the benchmark Bovespa stock index has rallied by almost 80% (in local currency terms to 20 October 2009). Jose Cuervo, manager of the US$1.8bn HSBC GIF Brazil Equity fund, said the move would create volatility in the short term for both equities and the currency. This is already being witnessed in market falls in the days since the move took effect (20 October, 2009). He points out that in 2008, when IOF was put on Foreign Investment (FI) at 1.5%, the BRL continued to appreciate in line with other commodity currencies such as the Australian dollar. The impact on the currency from the policy then was very minor and global economic fundamentals quickly took over again as the driver for the currency.

Despite current short term headwinds, Cuervo does not expect the additional tax will have a significant longer-term impact as the drivers for equities and the BRL remain positive. Consequently, HSBC Global Asset Management retains a positive stance on the Brazilian market across its broader emerging markets and BRIC portfolios.

He cited the improvement in Brazil's economy, which rebounded from the global recession within six months. GDP has risen by 1.9% quarter-on-quarter in the second quarter of 2009, driven largely by domestic demand. Industrial production has expanded since the start of the year and retail sales have returned to pre-crisis levels. Companies have resumed hiring - for example Brazil has created about one million formal jobs (in net terms) during 2009.

Despite a strong rebound in equities, the forward price earnings ratio of the market, at 12x, is just above the five year historic average (of 11.4x) and are cheap compared to other major emerging markets such as China (12.8x) and India (16.5x).

HSBC Global Asset Management is among the world's largest managers of emerging market assets with approximately US$70bn emerging market funds under management as at end June 2009.