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Brazilian Samba Starting — Time to Get on Board?

Wednesday, 19 Sep 2012 07:39 AM

By Ashish Advani

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I love it when a plan comes together!

Back on Aug. 22, I spoke to you about Brazil. I wrote about the possibilities of the Brazilian real appreciating in value. I cautioned you as to this strategy being a gradual and long-term strategy.

What I did not know was that maybe, just maybe, Finance Minister Guido Mantega and Deputy Finance Minister Nelson Barbosa may have been reading my missives.

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Late on Friday last week, the Brazilian central bank eased the restrictions it had imposed on the incoming capital funds. If you will remember, back in January 2011, the incoming president of Brazil had won the election on the platform of manipulating the value of the real downward and interfering with free markets.

While it was a populist promise, it won her the election. What followed was the big surprise. First, we had a politician keep her promise and actually impose draconian taxes on incoming capital to reduce its inflows and started buying U.S. dollars into reserve to cheapen the real. The central bank played along and imposed its own restrictions.

Interventions in capital markets rarely succeed. This time around when the real reacted to the unreasonable taxes and fell against the U.S. dollar, I suspected it was a temporary move and that the markets have deeper pockets than any individual central bank does. Once again, I have been surprised that the devaluation of the real stuck and the traders moved on to the juicer news of the European crisis, which was picking up steam. As a result, the real devaluation stayed.

Now we have news that the central bank in Brazil has started easing the restrictions on incoming capital. In my opinion, this is the first step in Brazil realizing its folly and reversing last year’s policies.

You see, the reason the currency was forced to devalue was Brazil was facing higher-than-normal inflation, and in an election year, the candidates wanted to appease the public with policy promises that would ease their pain.

What the government did not recognize is that capital flows where it is appreciated. With high barriers to entry and very high taxes on inflows, foreigners stopped investing in Brazil. They found better investment destinations and moved funds elsewhere.

With hosting the Soccer World Cup in 2014 and then the Olympics in 2016, Brazil will be investing heavily in infrastructure development. This is Brazil’s double opportunity to show the world that it has reached its peak and can be considered a world power.

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For this Brazil needs large foreign investments and capital. With the draconian tax laws, there was little to no hope of fresh capital injections and large scale investments. Realizing this, the government is pedaling back on its last year arrogance and inviting capital back in again.

Only time will tell if money starts to flow back to Brazil again. I am in the camp that says it will and I want to get in before the buy real trade gets crowded. I will be going long buying the Brazilian real soon and suggest you consider doing the same yourself.

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