* Capital tax will have short-term impact on Brazil's real
* Economic fundamentals to bolster currency in long run
* Mexican peso may benefit as investors shift funds
By Ana Nicolaci da Costa
BRASILIA, Oct 20 (Reuters) - Brazil's new tax on capital inflows will pressure its currency and may prompt investors to take refuge in other emerging markets, but its impact is likely to fade over time as the country's economic fundamentals keep attracting a flood of money from overseas.
The 2 percent levy on foreign investment in Brazilian stocks and fixed-income securities has raised doubts about fiscal and monetary policy in Brazil, while also sparking concerns it could be replicated elsewhere in Latin America.
The tax went into effect on Tuesday, triggering a sell-off
in local stock and currency markets while bolstering the
outlook for the Mexican peso
The government adopted the tax in a bid to prevent the real from strengthening further, bowing to pressure from exporters who were complaining that the strong currency was making Brazilian goods less competitive on world markets.
But with Brazil's economy on the rebound and global investors chasing lofty returns in emerging markets, the measure is unlikely to hold back the real for long.
"In the medium term, the measure will have a limited impact," said Roberto Padovani, chief economist at WestLB in Sao Paulo. "The fundamentals point to a stronger real, with commodities rising and the dollar weakening globally."
The real has rallied 33.5 percent this year, buoyed by growing investor appetite for risk as Brazil's economy weathered the global financial crisis better than most. A declining U.S. dollar globally has also propped up the real.
Even with the tax, appetite for high-yielding Brazilian assets is likely to remain strong.
"The long-term outlook for U.S. equity returns looks like something between zero percent, maybe 5 percent," said Richard Kang, chief investment officer and director of research at Emerging Global Advisors in New York.
"But, in Brazil, it's going to be 2 percent of likely double-digit returns, so I think investors are going to say: 'There is a little bit of friction in these 2 percent but, in the big scheme of things, it's not a big deal.'"
RED FLAGS
For the government, the measure will give a much-needed boost to declining tax receipts, though Finance Minister Guido Mantega insisted the objective is to prevent a bubble from forming in Brazil's financial markets.
On Tuesday, the government estimated the tax will bring in 4 billion reais ($2.3 billion) a year in extra revenue.
Some analysts said the new tax raises some red flags about fiscal and monetary policy going forward. The levy, which was implemented by executive decree, will eventually have to be voted in Congress, potentially delaying other important bills.
Others were disappointed that the government resorted to an emergency measure as a toll on foreign capital instead of focusing on structural issues such as reducing public spending, which would have help compensate the decline in tax revenue.
The tax also raised concerns that other Latin American
countries, like Peru and Colombia, which have used capital
controls in the past, could follow suit. Such worries pushed
the Colombian peso
Brazil's tax may also have a spill-over effect in Mexico, at least in the short term, as investors shift funds into the peso. Mexico's currency initially firmed over 1 percent on Tuesday on expectations of greater inflows because of the Brazilian levy, but later reversed course on worries about the country's own tax reform proposal in Congress. [ID:nN20449201]
"We have seen quite a bit of flows out of Brazil and into Mexico," said Gerardo Margolis, vice president of emerging markets trading at TD Securities in Toronto, adding that the trend is likely to be short-lived.
"This wont have any negative impact on Brazil in the long term, on the mid to long term it is a positive, it means there will be less speculative flows into Brazil," he said. ($1=1.748 reais) (Additional reporting by Silvio Cascione and Aluisio Alves in Sao Paulo, Walter Brandimarte in New York, Michael O'Boyle in Mexico City; Editing by Kenneth Barry)