More Thoughts on Brazil

Brazil's 2% IOF tax comes as a wave of profit-taking weighs emerging markets in general. The MSCI EM index is off nearly 8% since Oct 20, while the Brazilian Bovespa entered "correction" territory yesterday with a cumulative decline of a little more than 11% in the same period. In the last 5 days, net-net the Brazil real has slipped about 2.4% against the dollar. From its low on Monday near BRL1.70, through yesterday's high, the dollar appreciated almost 4.7%. This underscores the point we initially made that the volatility of the Brazilian real is sufficiently high as to quickly offset the cost of the 2% tax.

Investors continue to seek ways to avoid the tax. Some investors are looking at some structured product whose return is tied to BRL's performance without having to buy the BRL itself. The largest non-government bank in Brazil is reportedly offering through its European unit three-year structured notes that may yield 10.5%. These would be dollar-denominated notes where the interest and principal payments would fluctuate with the BRL.

Some fixed income investors are considering buying Brazil's dollar-denominated bonds and getting the currency exposure through the offshore non-deliverable forward market.

Some equity fund managers are exploring the liquidity of Brazilian ADRs. The average (20 day) volume of Petrobras ADR in NY is just shy of 14.6 mln, for example, or Gerdau, the steel company's ADR has an average (20 day) volume of about 8.5 mln shares. These are not meant to be equity recommendations but rather simply to illustrate the liquidity of some Brazilian ADRs.

Lastly, we have talked with some longer term investors who see the 2% tax presenting them with new opportunity to by Brazilian assets on a pullback as some of the short-term (hot) money exits.