Lula da Silva applied a 3.5% tax on all purchases in dollars in Brazil

The Real, Brazil's currency, suffered a sharp drop on Thursday after the government of the socialist dictatorLula da Silva announced an unusual increase in taxes applied to financial operations, along with a long-anticipated plan to strengthen the country's severe fiscal situation.

The Ministry of Finance, led by Fernando Haddad, projected that the state would collect 20,000 million reais (equivalent to about USD 3,500 million) in 2025 and 41,000 million in 2026 through the increase of the tax locally known as IOF, which affects various financial operations.

What most negatively surprised the markets was the imposition of a 3.5% rate on currency purchases, remittance sending, and transfers executed by funds based abroad.

This tax, described by some analysts as a kind of tax on capital movements, caused a change in investor sentiment and pushed the real to a drop of more than 1%, closing the day at 5.7078 units per dollar.

"Higher obstacles to accessing the real likely imply a reduction in capital inflows to the country and a weaker currency," explained Brendan McKenna, a currency analyst at Wells Fargo, from New York.

The negative effect of the IOF on the markets overshadowed the announcement that the government will freeze 31,000 million reais from the current budget, as part of Haddad's efforts to calm investors who increasingly doubt the dictator Luiz Inácio Lula da Silva's commitment to fiscal responsibility.

However, after the sharp drop of the Real, Lula's government decided to partially annul the decree that raised the Tax on Financial Operations (IOF) on profits from foreign investment funds. Everything else remains the same.

Currently, Brazil faces the highest fiscal deficit in its history, and the Brazilian government seems not to care, as it continues to increase spending, all amid a sharp drop in Lula's positive image, due to the increase in inflation.

Markets fear that the increase in the IOF will further harm credit operations, already restricted by the high interest rates in the country, and negatively affect the investment fund sector by reducing the attractiveness of offshore instruments.