In the context of the Brazilian presidential election, the tax exemption for foreign investors is hardly a vote winner. However, the impact in terms of putting further downward pressure on interest rates and so helping economic recovery very definitely is. Brazil’s interest rates are still phenomenally high in real terms and unjustified in the context of low and stable inflation. At the time of writing the latest inflation data (the IGP-10) showed monthly inflation to 10 February at 0.17 per cent and the latest market expectation of 12-month inflation ahead further reduced from 4.57 per cent to 4.49 per cent. This hardly justifies 17.25 per cent interest rates.
Other recent events/efforts to put downward pressure on interest rates take the form of plans to buy back as much as $20bn (€16.8bn) in Brady bonds and other shorter dated eurobonds. The inflow of capital has continued to boost the real and douse any inflationary pressure.
The development of local debt markets is becoming a higher priority across Latin America. Foreign bond investors, sometimes perceived as much a threat as a benefit for developing local markets, are now dominated by underlying investors who have made long-term strategic commitments to the asset class.
Their interest in investing in local currency debt markets is complemented by the growth of domestic savings. Governments are rightly comforted by the knowledge of this structural shift in the emerging debt investor base and also have significant cushions against external shocks in the form of reserves, current account and fiscal surpluses and low inflation.
It is in this context that development of local currency markets through management of government debt profiles is an attractive option, though in the short term this involves creating some increased vulnerability to external shocks by abandoning the comfort of long-dated dollar bond issuance. With the creation of the JPMorgan GBIEM indices for emerging market local currency debt, the onus is on Latin American countries to give foreign investors better access to local currency debt markets.
These measures should enable these debt markets to enter the GBIEM Diversified Index, stimulating more stable external capital. While Chile is already in the index, Brazil’s removal of capital gains tax is insufficient for entry – removal of the CPMF financial transactions tax would be necessary for that.
Dr Jerome Booth, head of research, Ashmore Investment Management.
