Brazil Action To Curb Strong Real May Be First In A Series

--Brazil extends 6.0% IOF tax to three-year foreign loans
--Tax is designed to curb appreciation of local currency
--Strong Brazilian real hurts exporters and manufacturers


SAO PAULO (Dow Jones)--Thursday's decision by the Brazilian government to extend the reach of a financial operations tax on foreign loans may turn out to be merely the opening shot in another battle of the global "currency war" often cited by the country's finance minister.

The government early Thursday extended a 6.0% tax on foreign loans to operations of up to three years. Previously, the financial operations tax, or IOF, was charged only on loans of two years or less.

"The government is giving a signal that it is vigilant and concerned about the currency appreciation," said Carlos Kawall, a Sao Paulo economist and former Brazilian treasury secretary. "We can expect more action, via central bank interventions in the market or more IOF tax measures."

Behind the measure adopted Thursday is the government's concern over the continued appreciation of the Brazilian real against the U.S. dollar. The real has gained about 10% against the dollar so far this year. The strong real hurts exporters and manufacturers.

Finance Minister Guido Mantega made the government's concern explicit in an interview last week with Dow Jones Newswires. "The U.S. Federal Reserve has signaled low interest rates through 2014," he said. "That means high levels of U.S. dollar liquidity and more money flowing toward emerging market countries such as Brazil. The European Central Bank is also fostering an expansionist policy." Such inflows lead to an unwanted appreciation of currencies such as the real, he said.

Mantega himself coined the term "currency war" in 2010. Last week, he said, "The currency war is heating up again. Everybody wants to undercut everybody else with a weak currency."

Mantega hinted at what actions the government was contemplating, and not contemplating, in efforts to curb the real.

"The central bank will keep buying dollars on the spot market," he said. "We can use the IOF tax again. As for an investment quarantine, we regard that as an outdated instrument. We prefer the IOF tax. It's more effective and more flexible."

The measure ordered Thursday comes after heavy capital inflows resulting from overseas bond issues by Brazilian companies. Kawall said the bond issues have contributed directly to a strengthening of the real in recent days. The real has traded in a range of BRL1.69 to BRL1.72 to the dollar this weak, much stronger than its year-end 2011 rate of BRL1.87.

Overseas bonds issued by Brazilian companies totaled $5.1 billion in January, according to the Brazilian Association of Capital Market Institutions.

"There is a huge demand for investments in Brazilian assets," Ivan Monteiro, vice president of state-run Banco do Brasil (BDORY, BBAS3.BR), said earlier this week. "Due to this fact, we opted to tap the overseas debt market twice this year." The bank raised $1 billion from an overseas perpetual bond in January and decided to reopen the operation in February, raising an additional $750 million.

Heavy dollar inflows are also due to high Brazilian interest rates. Brazil's Selic base rate is currently a towering 10.50%.

Coca-Cola Co. (KO) has been parking much of its cash offshore lately in response to historically low U.S. interest rates, with Brazil a popular destination.

The beverage giant had about $13 billion in cash at the end of December, with about $10 billion of that outside the U.S., including roughly $3 billion in Brazil.

"The interest rates we're collecting on cash in Brazil are very high," the company's chief financial officer, Gary Fayard, said during a question-and-answer session on Feb. 22.