Brazil: Brazilian Government's Policy Response To The

By Walter Douglas Stuber and Ricardo Baraldi Macedo 1

I - Introduction

Brazilian stock and currency markets have taken a battering in the last 3 (three) weeks as international investors pulled out of emerging markets to cover losses in Russia and take refuge in safer instruments such as the US Treasuries.

The abrupt outflow of foreign capital, as the expression of the worldwide mistrust in relation to emerging markets, reached in Brazil the impressive amount of 19 (nineteen) billion dollars so far.

In order to contain such accelerated capital outflow triggered by the Russian fallout, Brazil's Government has recently announced a set of rules to draw dollars into the country and thus bolster as well as maintain its foreign currency reserves to protect the Real.

II - The recent set of rules

The most important rules implemented by the Government were:

1) Provisional Measure nr. 1680-9 of August 22nd, 1998

Such new regulation reduced the applicable tax rate of 15% (fifteen percent) on foreign capital fixed rate investment fund's earnings to 0% (zero percent) until March 31st, 1999.

2) Circular nr. 2.832 of August 24th, 1998 and Circular Letter nr. 2.810 of August 24th, 1998 of the Central Bank of Brazil

These rules allow investments deriving from foreign individuals and legal entities to enter the country, as an "Advancement for the Future Increase of Capital", when such resources are destined to join National Privatization and Financial System Reorganization programs.

3) Circular nr. 2.833 of August 24th, 1998 of the Central Bank of Brazil

Re-establishes conditions under which resources arising from international inter-banking loans, pursuant to Central Bank's Resolution nr. 2.483 of March 26th, 1998 (known in the financial market as "Resolução 63 operations"), be used for the investment in Government securities.

Financial Institutions are duly authorized, until December, 1998, to obtain funds overseas and thus invest 100% of such capital in Brazilian Government securities. Formerly, 50% (fifty percent) of the funds obtained with Resolução 63 operations had to be used for rural financing purposes.

Such an operation will prove most profitable for Brazilian banks since they will be able to contract loans overseas at low interest rates and invest in Brazilian Government securities at higher rates.

With this measure, the Government expects to stimulate the renovation of approximately 2 (two) billion dollars in pending Resolução 63 operations.

4) Circular nr. 2.834 of August 24th, 1998 of the Central Bank of Brazil

Reduces minimum terms for the duration, renovation and postponement of international loans. Until December, 1998, the minimum terms for payment of international loans* and their renovation are respectively 1 (one) year and 6 (six) months.

With short-term loans, Brazilian companies can lower internal interest rates, considering that they will be paying less interest.

5) Resolution nr. 2.543 of August 26th, 1998 of the Central Bank of Brazil

With this rule, the National Monetary Council ("CMN") allowed Financial Institutions to capitalize via an Adjusted Shareholders Equity Account, two new kinds of operations: the so-called "capital and debt hybrid instruments" and "subordinated debt securities" (known in the financial market as "tier 2 capital").

Although Brazilian Financial Institutions were already allowed to perform such operations (for example, the issuing of redeemable priority shares or securities representative of preferred debts), a market was not yet formed, as the resources arising out such operations could not be accounted for the company's own capital (equity).

Since the current concept of Adjusted Shareholders Equity is now different, Financial Institutions can better capitalize their assets. Being it so, their investment margin will also expand, as long as it is calculated proportionally to Adjusted Shareholders Equity rates. The Government expects, thus, to broaden Financial Institutions' business opportunities, specially with foreign partners.

6) Circular nr. 2.835 of September 4th, 1998 of the Central Bank of Brazil (Rise in the Bank Borrowing Rate)

As a result of Circular nr. 2.835, Central Bank announced that it would lend to Financial Institutions temporarily (until September 30th, 1998) only at its higher TBAN (Taxa de Assistência do Banco Central) assistance rate of 29.75% (twenty nine and seventy five percent) per year and would therefore no longer lend at its prime lending TBC (Taxa Básica do Banco Central) rate of 19% (nineteen percent) per year.

Using the prime lending TBC rate, Financial Institutions were contracting loans at relatively low interest rates and converting such resources into dollars for foreign investment purposes.

Operations of such kind will now tend to disappear, provided that internal interest rates are maintained higher.

7) Circular nr. 2.836 of September 8th, 1998 of the Central Bank of Brazil

This rule is part of the Special Export Program, recently enacted by the Government, with the objective of reducing the current commercial deficit.

Minor exports, so considered those inferior to US$ 10,000.00 (ten thousand dollars), are now subject to a simpler export procedure:

(i) the exchange process is less bureaucratic: the exporter will no longer need to deliver to the Central Bank all the documents related to the operation. Basic data, such as the Taxpayers' Register Card, the total amount of the export in foreign currency, the correspondent value in Reais and the form of payment will now be enough; and
(ii) the importer is now allowed to pay the operation via internationally accepted credit card.

8) Decree nr. 2.773 and Provisional Measure nr. 1.716 of September 8th, 1998

The Brazilian's Government intention with these rules is to (i) determine a 3.42 billion Real emergency cut from Government's social and infrastructure spending during the year of 1998, (ii) establish a minimum Primary Fiscal Superavit (revenues minus expenses) mark of 5 (five) and 8 (eight) billion Reais for 1998 and 1999, respectively, and (iii) create a special commission (Fiscal Management and Control Commission) with powers to inspect, manage and control Federal, State and Municipal governamental accounts.

All such measures aim to reduce the current fiscal deficit, which is considered one of the major economic issues that Brazil must face in order to maintain its stability.

9) Resolution nr. 2.545 of September 9th, 1998 of the Central Bank of Brazil

By means of this measure, Central Bank launched new dollar-indexed notes linked to the dollar rate in the floating exchange market (called Notas do Banco Central, Série Flutuante - NBC-F), as an attempt to provide the market with hedge instruments and thus minimize the growing capital outflow.

Formerly, Brazilian dollar-indexed notes were indexed to the dollar rate in the commercial foreign exchange market, what gave traders in the floating exchange market no hedge instruments.

By linking the NBC-F to the dollar rate in the floating exchange market, the Government also signalized that it does not intend to modify the current floating exchange rate policy.

III - Conclusion

As we can see from the above-mentioned recent rules, Brazil's Government is offering international investors safer and profitable investment conditions, hoping to maintain the current level of foreign investment. The recent measures show, besides a strategy against the capital outflow, a conscious Government policy in response to the "Russian crisis".

The content of this article is intended to provide a general guide to the subject matter. A specialist's advice should be sought in order to provide professional advice on a case to case basis which will meet specific circumstances.

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