Macroeconomic Research

Brazil Economic Comment

Fundamentally speaking: The response of the BRL to taxation of capital inflows
In this report, we reexamine in greater detail the impacts of the recent set of FX policy measures specifically, the higher taxation of capital inflows on the behavior of the BRL. For this purpose, we use once again our traditional rolling regression framework, and evaluate the relationship between the actual FX rate and its model-based daily tracking. We still do not find evidence that higher taxation, either recently or back in October 2009, has led to large or sustained depreciation in excess of that driven by fundamentals. In fairness, however, we do find some evidence consistent with a modest temporary weakening of the currency as a consequence of those tax measures, arguably more so in association with the latest episode. But it is exactly with regard to the latest episode that we need to be the most cautious, as the post-tax data sample is still small and it is also hard to distinguish between the impact of the measures actually enacted and the effect on the currency of prevailing uncertainty about possible additional restrictions.

3 November 2010

Eduardo Loyo Economist eduardo.loyo@btgpactual.com +55 21 3262 9707 Claudio Ferraz Economist claudio.ferraz@btgpactual.com +55 21 3262 9758 Rodrigo Melo Economist rodrigo.melo@btgpactual.com +55 21 3262 8883 Livio Ribeiro Economist Livio Ribeiro@btgpactual.com +55 21 3262 9660 Marcelo Castello Branco Economist marcelo.castello @btgpactual.com +55 21 3262 8774

Background
Over the last several weeks, the Brazilian government announced a series of measures with the common objective of curbing the appreciation of the BRL. One group of measures purportedly served to boost the governments ability to intervene in local FX markets, as was the case with the permission for Brazils Sovereign Wealth Fund to invest in foreign currency and the allowance for the Treasury to buy dollars in the market to honor payment obligations maturing up to 1,500 days later (previously the limit was 750 days). Except possibly for operational features, it is not clear whether these new or enhanced channels for official purchases of foreign currency should be very different from concentrating intervention at the Central Banks foreign exchange desk. The second group of measures raised barriers against capital inflows, through a higher IOF tax rate on certain inbound FX operations. On October 4, it was announced that the IOF tax on inflows into foreign fixed income investments would be raised from 2% to 4%. As officials interpreted the rule, the higher tax would also apply to inflows into debentures, equity funds and multi-strategy funds, while keeping investments in equities proper or in derivatives markets subject to the preexisting rates. On October 18, the IOF tax rate was raised once again: inflows recently subjected to the new 4% rate would now pay 6% instead. In addition, the government announced that the 6% rate would also apply to foreign investors margin deposits for futures markets operations, while it

Brazil Economic Comment 3 November 2010

page 2

proceeded to close certain loopholes that would have allowed the new rates to be legally circumvented. Officials made a point of stating that the door remained open to further measures along the same lines, with the maintained objective of discouraging the carry trade and containing short-term capital inflows. We recall that the same approach had already been used last year. Up to that point, the IOF tax on foreign portfolio investment had a lower rate (1.5%) and was not applicable to equity investments. On October 20, 2009, in response to the strengthening of the BRL, the IOF tax on foreign portfolio investment was raised to 2%, applicable not only on fixed income but also on equity investments.

Method
Claims are often made about the effectiveness of such tax measures on the basis of whether or not the currency depreciated in their wake or, at least, appreciated less than it was doing before. Indeed, the appreciation trend of late 2009 halted following the October 2009 IOF rate hike, which was then considered a success (if only partial, as the currency did not visibly depreciate). More recently, right after the IOF tax rates were increased to 4%, the currency actually went on another bout of strengthening, which was taken in some quarters as evidence that, this time around, the measure was a failure. Then, when the rates were again increased to 6% and certain loopholes closed, the currency did depreciate some, suggesting that, once duly reinforced, the measures had finally worked. We have long insisted that none of these judgments is appropriate, as the value of the currency depends on several determinants other than the prevailing IOF tax rate, and those determinants can very well move (or stop moving) at the same time as the IOF rates are changed. In order to identify the true effect of the taxation measure, one should thus control for the oscillations of the currency that would normally have occurred in the absence of the tax measure, as determined by the regular drivers of the FX rate. We have been doing this since last year on the basis of our traditional tracking model for the BRL, on which we regularly report in our Latam Daily at the beginning of each month. The model correlates the currency with a parsimonious set of fundamentals namely commodity prices (measured by the CRB index), the value of the USD against other major currencies (represented by the DXY index) and Brazils risk premium (10-year CDS spreads). We use a rolling regression framework to allow the model parameters to vary over time (we actually find value in the information about the variations of the BRLs elasticities with respect to each fundamental driver). While the changes in coefficients can be significant, they tend to be gradual as we use a one-year sample window of daily data. Our daily tracking model contains an autoregressive component that is, we include among the explanatory variables, alongside the contemporaneous values of the fundamental drivers, the actual value of the BRL/USD on the previous day. Indeed, the pattern of residuals in a regression that includes just the

Brazil Economic Comment 3 November 2010

page 3

contemporaneous values of the fundamentals strongly suggests that the autoregressive specification should be adopted. While the autoregressive specification is clearly preferable from a statistical standpoint, the autoregressive term turns out not to be overpowering, in the sense that its coefficient is not very high and, most of the time, contemporaneous changes in fundamentals keep playing a key role in determining the daily fluctuations of the currency. In any case, the presence of an autoregressive component signifies that the currency tends to respond only gradually to any given change in the values of fundamentals. Considering this inertia presumably, a property of the actual FX rate that the tracking model is merely trying to emulate we may also be interested in knowing the value towards which, at any given point in time, the fundamentals are pulling the currency. We refer to such values as the BRLs stochastic trend, i.e., the point to which the currency would eventually converge if fundamentals (and their estimated regression coefficients) remained indefinitely constant at their current levels.1 Considering both the evolving elasticities and the actual trajectory of the fundamental drivers, our daily BRL tracking and the corresponding stochastic trend behave as shown in chart 1. The tracking closely matches the actual USD/BRL bilateral rate the gap between the two is usually no wider than 2 centavos revealing that swings in our small set of explanatory variables do account for the bulk of the movements in the currency. In fact, within the last 12 months, the only period when this gap seemed to be consistently wider than 2 centavos was around May 2010, on the back of significant swings in the fundamentals themselves, due to the European sovereign debt jitters. The stochastic trend is more volatile, as it should be since it disregards the smoothing autoregressive component. While not as close a day-to-day match for the actual currency movements (which it is not supposed to be), one notes that the stochastic trend does capture the major swings of the FX rate.

If .

is our autoregressive tracking model, the stochastic trend is simply

Brazil Economic Comment 3 November 2010

page 4

Chart 1: Daily BRL tracking and stochastic trend

Source: Bloomberg and BTG Pactual

Effects of the tax measures should show as an atypical decoupling of the actual FX rate from the value indicated by the model at those particular times. Of course, a decoupling of that kind is not a definitive gauge of the impact of changing taxes, as other unobserved factors might, by sheer coincidence, be at play exactly when the tax measures are enacted, being the actual culprits behind the decoupling. Nevertheless, as we have already controlled for a number of key drivers of the currency (and in the process of doing so, also rejected the need to include a number of other usual suspects among the models explanatory variables) there is at least a more reasonable prima facie case in favor of attributing the decoupling to the contemporaneous tax changes stronger, in any event, than the case for attributing to any given tax policy move the overall fluctuation of the currency observed in its aftermath.

A cursory look
As the IOF tax measures supposedly militate in favor of a weaker currency, following their enactment one should see the actual FX rate more depreciated than the tracking model would have suggested. Visual inspection of the relation between the actual FX rate and its daily model-based tracking indicate no significant departure, however. In order to facilitate the comparison, we blow up below the sections of chart 1 that correspond to the periods of tax rate changes. Consider first what happened around the October 2009 increase of IOF rates, as shown in chart 2. For some months, the currency kept fluctuating in the BRL1.70/USD to BRL1.80/USD range instead of continuing in the earlier appreciation trend (observed since mid-2009), and ultimately depreciated again in the latter part of January 2010. But no departure between the actual FX rate and the model-based tracking stands out to indicate that the IOF change had a major impact on the trajectory of the currency.

Brazil Economic Comment 3 November 2010

page 5

Chart 2: Daily BRL tracking (September 1, 2009 to January 31, 2010)

Source: Bloomberg and BTG Pactual

Indeed, neither the interruption of the earlier appreciation trend nor the new wave of depreciation early this year is a puzzle in light of the behavior of the fundamental drivers. The CRB index had been recovering throughout October, but then remained broadly stable until mid-December 2009 (chart 3). It went up further between the end of December 2009 and the first half of January 2010, but then capitulated, closing the month below the range where it had been for most of 4Q09. The CDS spread oscillated strongly up until October 2009, but kept relatively stable between then and the turn of the year, and finally hitched on an upward trend in the latter part of January 2010 (chart 4). The DXY index continued to slide down until November, in a rather mild movement, after which the USD started to gain ground against other major currencies (chart 5). Those drivers combined to keep the model-based tracking of the BRL roughly stable until the end of 2009, thus accounting for the stability of the currency during that period without any reference to the higher IOF rate. In turn, it was once again the movement of fundamentals that led to BRL depreciation in the beginning of 2010.

Brazil Economic Comment 3 November 2010

page 6

Chart 3: CRB index

300

Chart 4: CDS spreads

180

IOF 2%
175 290 170

IOF 2%

CRB
165 280 160

CDS

270

155

150 260 145

140 250 135

240
01-Oct-09 07-Oct-09 13-Oct-09 19-Oct-09 25-Oct-09 31-Oct-09 05-Jan-10 11-Jan-10 17-Jan-10 23-Jan-10 29-Jan-10 01-Sep-09 07-Sep-09 13-Sep-09 19-Sep-09 25-Sep-09 06-Nov-09 12-Nov-09 18-Nov-09 24-Nov-09 30-Nov-09 06-Dec-09 12-Dec-09 18-Dec-09 24-Dec-09 30-Dec-09

130
01-Oct-09 07-Oct-09 13-Oct-09 19-Oct-09 25-Oct-09 31-Oct-09 05-Jan-10 11-Jan-10 17-Jan-10 23-Jan-10 01-Sep-09 07-Sep-09 13-Sep-09 19-Sep-09 25-Sep-09 06-Nov-09 12-Nov-09 18-Nov-09 24-Nov-09 30-Nov-09 06-Dec-09 12-Dec-09 18-Dec-09 24-Dec-09 30-Dec-09 29-Jan-10

Source: Bloomberg and BTG Pactual

Source: Bloomberg and BTG Pactual

Chart 5: DXY index

80

IOF 2%

79

DXY
78

77

76

75

74
01-Oct-09 07-Oct-09 13-Oct-09 19-Oct-09 25-Oct-09 31-Oct-09 05-Jan-10 11-Jan-10 17-Jan-10 23-Jan-10 01-Sep-09 07-Sep-09 13-Sep-09 19-Sep-09 25-Sep-09 06-Nov-09 12-Nov-09 18-Nov-09 24-Nov-09 30-Nov-09 06-Dec-09 12-Dec-09 18-Dec-09 24-Dec-09 30-Dec-09 29-Jan-10

Source: Bloomberg and BTG Pactual

Then consider what has happened around the more recent changes in capital inflow taxation. The currency had been appreciating and continued to do so for several days after the first tax change was enacted; then it reversed course and continued to depreciate after the second round of tax changes (chart 6). More importantly for our purposes, however, is the corresponding behavior of the model-based tracking exercise, which followed the same approximate pattern. The gaps between the model-based estimates and the actual behavior of the currency did not become atypically wide following the policy moves.

Brazil Economic Comment 3 November 2010

page 7

Chart 6: Daily BRL tracking (September 1 to October 29, 2010)

Source: Bloomberg and BTG Pactual

Once again, the trajectory of fundamentals reveals the key factors behind the behavior of the currency during this period. Commodity prices had been rising quite steadily, actually accelerated in early October, and then kept moving sideways, close to the years high (chart 7). The CDS spreads had meanwhile been falling, with an even steeper decline in the first half of October to reach the lowest level in years but then retraced part of the last downward leg (chart
8). The DXY (i.e., the USD) has been weakening but regained strength

marginally at the very end of the period. The BRL had accordingly followed an appreciating trend, which became more marked in early October as hopes became higher with respect to a new round of quantitative easing in the US (affecting, in particular, the CRB and CDS spreads), but then reversed course once the fundamental drivers either changed course (as the DXY and especially the CDS did) or stabilized (as the CRB). The broad picture at least is consistent with a story told first and foremost by the BRLs customary drivers rather than taxation measures.

Brazil Economic Comment 3 November 2010

page 8

Chart 7: CRB index

Chart 8: CDS spreads

Source: Bloomberg and BTG Pactual

Source: Bloomberg and BTG Pactual

Chart 9: DXY index

Source: Bloomberg and BTG Pactual

A closer look
Both in the 2009 and 2010 episodes, a slightly more favorable assessment of the tax measures can be obtained if we sharpen our focus on the pattern of departures between the model-based tracking and the actual FX rate before and after the IOF rates were hiked. Indeed, it remains true that those gaps did not become abnormally wide in any of those episodes, but while remaining within their typical 2 centavos range they did switch from gaps that were more likely positive prior to each increase in the IOF to gaps that were more likely negative afterwards (chart 10).

Brazil Economic Comment 3 November 2010

page 9

Chart 10: Tracking gaps

Source: Bloomberg and BTG Pactual

One may reasonably be tempted to ascribe these changes in the patterns to the IOF rate hikes. Indeed, the tracking gaps did remain consistently negative for some time after the October 2009 modifications, for instance, while for most of the last 12 months the gaps have more often been positive. Little time has elapsed since the more recent tax measures but the sequence of negative gaps already seems more persistent than the standard for the remainder of the oneyear sample. Moreover, the switches in the pattern of tracking gaps precisely coincided with the dates when the IOF was modified in October 2009 and then again when the more recent sequence of changes started. In any case, although the IOF may have been indeed the explanatory factor, the effect was in both instances rather small at most a couple of BRL centavos on average in the BRL/USD rate. Furthermore, as suggested by the visual inspection made above of the actual BRL trajectories and their model-based tracking, swings of this size in tracking gaps are quite small compared to the fluctuations of the currency, and also compared to the portion of those fluctuations that can be accounted for by fundamentals alone. Judging from the 2009 episode, the impact is not very lasting either three months later, the tracking gaps returned to positive territory. Regarding the more recent policy measures, of course, the jury is still out with respect to the persistence of these effects.

A different angle
So far, we have been focusing exclusively on the comparison between our daily tracking model and the actual trajectory of the BRL/USD bilateral FX rate. But one may be able to shed additional light on the issue by considering also the behavior of our stochastic trend for the currency. As it turns out, while that additional piece of information does not seem to change the verdict on the October 2009 measures and on the first batch of IOF changes more recently (that is, when the rate went from 2% to 4%), with some goodwill it may paint a more positive picture when one examines the behavior of the FX rate following the latest batch of tax changes (when the IOF rate went to 6%).

Brazil Economic Comment 3 November 2010

page 10

Consider first what happened in October 2009 (chart 11). Prior to the increase in the IOF, the stochastic trend had been pointing at appreciation, but the actual currency and the model-based tracking were actually moving ahead of it. That was mainly the consequence of a temporary bout of depreciation that the stochastic trend had displayed about a month before, which was not followed either by the currency itself or by the daily tracking. The increase of the IOF rate coincided quite exactly with a reversal of fundamentals in the direction of depreciation, as shown by the stochastic trend, while the currency itself had started to reverse course about a week before, tugging the daily tracking along by the autoregressive component. Here it is not easy to distinguish between some arguable anticipation effect of the IOF change and a mere reassertion of the fundamental value of the currency (the stochastic trend, which had been trailing the actual movements of the currency, eventually reigning back in an FX rate that had gotten ahead of itself). In any case, there is no surprise in the fact that, immediately following the IOF change, the currency itself and the modelbased tracking, given their autoregressive character, should not have fully reflected the depreciation bout coincidentally displayed by the stochastic trend at that juncture. The evidence adduced by the stochastic trend, therefore, seems consistent with the earlier verdict of no major effect from the IOF on that occasion. Chart 11: Daily BRL tracking and stochastic trend (September 1, 2009 to January 31, 2010)

Source: Bloomberg and BTG Pactual

Now consider the effect of the changes announced on October 4, 2010 (chart
12). The currency had been appreciating, again ahead of its stochastic trend.

Following the announcement, the stochastic trend happened to nosedive (by sheer coincidence, as there is presumably no channel for such an effect from the IOF to the fundamental drivers, and hence to the stochastic trend), but the actual BRL and the daily tracking responded in a more muted way to the extra fundamental push for appreciation. That is again no surprise given their autoregressive behavior. By mid-October, the BRL, the daily tracking and the stochastic trend all turned around at the exact same time, the reversal being

Brazil Economic Comment 3 November 2010

page 11

naturally more marked for the stochastic trend than for the two other series. Again, none of these movements seems inconsistent with the IOF having had no major effect on FX rate dynamics. Chart 12: Daily BRL tracking and stochastic trend (September 1 to October 29, 2010)

1.88

IOF 4%
1.86

IOF 6%

Daily BRL tracking

1.84

BRL
1.82 1.80 1.78 1.76 1.74 1.72 1.70 1.68 1.66 1.64 1.62 1.60

Stochastic trend

04-Oct-10

09-Oct-10

14-Oct-10

19-Oct-10

24-Oct-10

05-Aug-10

10-Aug-10

15-Aug-10

20-Aug-10

25-Aug-10

30-Aug-10

04-Sep-10

09-Sep-10

14-Sep-10

19-Sep-10

24-Sep-10

Source: Bloomberg and BTG Pactual

The more interesting piece of evidence, in our view, is that presented by the stochastic trend right after the October 18 announcement. As can be seen in
chart 12 or, in a further magnified version, in chart 13 the stochastic trend

remained rather stable at its prior level, while the actual BRL did depreciate and the daily tracking followed suit (although naturally trailing to some extent, as indicated by the tracking gaps turning more clearly negative). Stability of the stochastic trend means that fundamentals, as they jointly matter for the daily tracking, remained stable as well. Therefore, during the period the daily tracking has been depreciating mainly as a result of the tugging power of its autoregressive term, which is in turn driven by the actual depreciation of the BRL. One may note that, just prior to the October 2009 IOF announcement for instance, the BRL also moved without contemporaneous justification from fundamentals. But it was then reverting to the stochastic trend (as can be seen in
chart 11 above), which might have been just a belated reflection of the current

position of fundamentals, whereas more recently it moved away from that fundamental attractor level. All this suggests that the latest depreciation movement, while closely followed by the daily tracking, has not been truly fundamental in nature (at least not as far as the fundamentals considered in our model are concerned). The coincident timing of the latest IOF changes may suggest, in principle, that these changes are the explanatory factor.

29-Sep-10

29-Oct-10

01-Jul-10

06-Jul-10

11-Jul-10

16-Jul-10

21-Jul-10

26-Jul-10

31-Jul-10

Brazil Economic Comment 3 November 2010

page 12

Chart 13: Daily BRL tracking (October 1 to October 29, 2010)

Source: Bloomberg and BTG Pactual

It is important not to get carried away by that observation, however. So far, the gap between the level suggested by our stochastic trend and the actual value of the BRL has remained quite modest (on October 29, the stochastic trend stood at BRL1.68/USD while the actual FX rate was BRL1.70/USD). There have also been prior occasions in which the BRL depreciated away from the stochastic trend, being partially followed by the daily tracking thanks to its autoregressive term, but such movement was neither associated with contemporaneous changes in the IOF taxes nor, for that matter, was it very lasting either (one such example can be seen in the second half of December 2009, in chart 11 above).

Conclusions
A cursory comparison between the actual trajectory of the BRL and its fundamentals-based daily tracking shows little scope for the changes in IOF taxation since 2009 to have had a significant effect on the FX rate. Looking more closely at the pattern of gaps between the tracking and the actual FX rate, one may find evidence of a small effect. But it is exactly because the effect is indeed small a couple of centavos in the BRL price of one US dollar both in absolute terms and in relation to the overall fluctuations of the currency, that it does not stand out in the more cursory comparison between the tracking and the actual FX rate. Judging from the 2009 experience, this effect is also short-lived. Bringing in evidence from the stochastic trend for the currency (the value to which it should converge, according to the daily tracking model, if the fundamentals remained forever at their current level), the case for effectiveness of the IOF measures gets a little reinforcement. In this connection, one can hardly make much of instances as around the October 4, 2010 measures in which the BRL (together with its daily tracking) moved by less than the stochastic trend, given the characteristic inertial behavior of the FX rate (captured by the

Brazil Economic Comment 3 November 2010

page 13

autoregressive term in the tracking model). Likewise, it is hard to make much of instances in which the BRL moves by more than justified by strictly contemporaneous fluctuations in fundamentals as right prior to the October 2009 measures but does so in order to revert to the stochastic trend which should work, after all, as an attractor for the value of the currency. But, when the BRL depreciates away from the stochastic trend as it did, for instance, following the October 18, 2010 measures one might suspect that the movement was related to the contemporaneous IOF increase. The evidence is not conclusive, as the same phenomenon has been observed at times when there was no IOF change in the immediate vicinity. Moreover, not even the latter effect granting for the sake of argument that it could be attributed to the IOF change of October 18 has been very large. In any event, the analysis above suggests a story for the FX rate in which the main roles are played by the fundamental drivers contemplated in our tracking model namely commodity prices, the country risk premium and the value of the USD against other major currencies and any role played by the taxation of capital flows has been minor. As mentioned above, it is also difficult to distinguish between the effects of any given IOF tax change in its own right and, on the other hand, those stemming from the heightened perception triggered by each such change among market players that other, unknown forms of official intervention in FX markets might be looming.

Eduardo Loyo

Claudio Ferraz

Livio Ribeiro

Brazil Economic Comment 3 November 2010

page 14

Required Disclaimer
This report has been prepared by Banco BTG Pactual S.A. The figures contained in performance charts refer to the past; past performance is not a reliable indicator of future results. Additional information will be made available upon request.

Analyst Certification
Each research analyst primarily responsible for the content of this investment research report, in whole or in part, hereby certifies that: - all of the views expressed accurately reflect his or her personal views about those securities or issuers, and such recommendations were elaborated independently, including in relation to Banco BTG Pactual S.A. and/or its affiliates, as the case may be; - no part of his or her compensation was, is, or will be, directly or indirectly, related to the any specific recommendations or or views contained herein or linked to the pricing of any of the securities discussed herein. Research analysts contributing to this report who are employed by a non-US Broker dealer are not registered/qualified as research analysts with the NASD and NYSE and therefore are not subject to the restrictions contained in the NASD and NYSE rules on communications with a subject company, public appearances, and trading securities held by a research analyst account.

Brazil Economic Comment 3 November 2010

page 15

Global Disclaimer
This report has been prepared by Banco BTG Pactual S.A. (BTG Pactual S.A.). BTG Pactual US Capital Corp. (BTG), a broker-dealer registered with the U.S. Securities and Exchange Commission and a member of the Financial Industry Regulatory Authority and the Securities Investor Protection Corporation, is distributing this report in the United States. BTG assumes responsibility for this research for purposes of U.S. law. Any U.S. person receiving this report and wishing to effect any transaction in a security discussed in this report should do so with BTG at 212-293-4600, 623 Fifth Avenue, New York, NY 10022-6831. BTG Pactual Europe LLP (BTG UK), a firm regulated and authorised by the Financial Services Authority, is distributing this report in the United Kingdom and elsewhere in the European Economic Area. References herein to BTG include BTG Pactual S.A. and BTG UK, as applicable. This report is for distribution only under such circumstances as may be permitted by applicable law. This report is not directed at you if BTG is prohibited or restricted by any legislation or regulation in any jurisdiction from making it available to you. You should satisfy yourself before reading it that BTG is permitted to provide research material concerning investments to you under relevant legislation and regulations. Nothing in this report constitutes a representation that any investment strategy or recommendation contained herein is suitable or appropriate to a recipients individual circumstances or otherwise constitutes a personal recommendation. It is published solely for information purposes, it does not constitute an advertisement and is not to be construed as a solicitation, offer, invitation or inducement to buy or sell any securities or related financial instruments in any jurisdiction. Prices in this report are believed to be reliable as of the date on which this report was issued and are derived from one or more of the following: (i) sources as expressly specified alongside the relevant data; (ii) the quoted price on the main regulated market for the security in question; (iii) other public sources believed to be reliable; or (iv) BTG's proprietary data or data available to BTG. All other information herein is believed to be reliable as of the date on which this report was issued and has been obtained from public sources believed to be reliable. No representation or warranty, either express or implied, is provided in relation to the accuracy, completeness or reliability of the information contained herein, except with respect to information concerning BTG Pactual S.A., its subsidiaries and affiliates, nor is it intended to be a complete statement or summary of the securities, markets or developments referred to in the report. In all cases, investors should conduct their own investigation and analysis of such information before taking or omitting to take any action in relation to securities or markets that are analyzed in this report. BTG does not undertake that investors will obtain profits, nor will it share with investors any investment profits nor accept any liability for any investment losses. Investments involve risks and investors should exercise prudence in making their investment decisions. BTG accepts no fiduciary duties to recipients of this report and in communicating this report is not acting in a fiduciary capacity. The report should not be regarded by recipients as a substitute for the exercise of their own judgment. Opinions, estimates, and projections expressed herein constitute the current judgment of the analyst responsible for the substance of this report as of the date in which was issued and are therefore subject to change without notice and may differ or be contrary to opinions expressed by other business areas or groups of BTG as a result of using different assumptions and criteria. Any such opinions, estimates, and projections must not be construed as a representation that the matters referred to therein will occur. Prices and availability of financial instruments are indicative only and subject to change without notice. Research will initiate, update and cease coverage solely at the discretion of BTG Investment Bank Research Management. The analysis contained herein is based on numerous assumptions. Different assumptions could result in materially different results. The analyst(s) responsible for the preparation of this report may interact with trading desk personnel, sales personnel and other constituencies for the purpose of gathering, synthesizing and interpreting market information. BTG is under no obligation to update or keep current the information contained herein, except when terminating coverage of the companies discussed in the report. BTG relies on information barriers to control the flow of information contained in one or more areas within BTG, into other areas, units, groups or affiliates of BTG. The compensation of the analyst who prepared this report is determined by research management and senior management (not including investment banking). Analyst compensation is not based on investment banking revenues, however, compensation may relate to the revenues of BTG Investment Bank as a whole, of which investment banking, sales and trading are a part. The securities described herein may not be eligible for sale in all jurisdictions or to certain categories of investors. Options, derivative products and futures are not suitable for all investors, and trading in these instruments is considered risky. Mortgage and asset-backed securities may involve a high degree of risk and may be highly volatile in response to fluctuations in interest rates and other market conditions. Past performance is not necessarily indicative of future results. If a financial instrument is denominated in a currency other than an investors currency, a change in rates of exchange may adversely affect the value or price of or the income derived from any security or related instrument mentioned in this report, and the reader of this report assumes any currency risk. This report does not take into account the investment objectives, financial situation or particular needs of any particular investor. Investors should obtain independent financial advice based on their own particular circumstances before making an investment decision on the basis of the information contained herein. For investment advice, trade execution or other enquiries, clients should contact their local sales representative. Neither BTG nor any of its affiliates, nor any of their respective directors, employees or agents, accepts any liability for any loss or damage arising out of the use of all or any part of this report. Any prices stated in this report are for information purposes only and do not represent valuations for individual securities or other instruments. There is no representation that any transaction can or could have been effected at those prices and any prices do not necessarily reflect BTG Pactual S.A. internal books and records or theoretical model-based valuations and may be based on certain assumptions. Different assumptions, by BTG Pactual S.A. or any other source, may yield substantially different results. This report may not be reproduced or redistributed to any other person, in whole or in part, for any purpose, without the prior written consent of BTG Pactual S.A. and BTG accepts no liability whatsoever for the actions of third parties in this respect. Additional information relating to the financial instruments discussed in this report is available upon request. Opinions, estimates, and projections expressed herein constitute the current judgment of the analyst responsible for the substance of this report as of the date in which was issued and are therefore subject to change without notice and may differ or be contrary to opinions expressed by other business areas or groups of BTG as a result of using different assumptions and criteria. Because the personal views of analysts may differ from one another, BTG, BTG Pactual S.A., its subsidiaries and affiliates may have issued or may issue reports that are inconsistent with, and/or reach different conclusions from, the information presented herein. BTG and its affiliates have in place arrangements to manage conflicts of interest that may arise between them and their respective clients and among their different clients. BTG and its affiliates are involved in a full range of financial and related services including banking, investment banking and the provision of investment services. As such, any of BTG or its affiliates may have a material interest or a conflict of interest in any services provided to clients by BTG or such affiliate. Business areas within BTG and among its affiliates operate independently of each other and restrict access by the particular individual(s) responsible for handling client affairs to certain areas of information where this is necessary in order to manage conflicts of interest or material interests. Any of BTG and its affiliates may: (a) have other business relationships, including investment banking relationships, with the companies, or related entities, that are analyzed in this report; (b) be a financial adviser to the companies, or related entities, that are analyzed in this report, or be acting for such entities in a takeover bid by or for any of them; (c) produce this report pursuant to an agreement with any company that is analyzed in this report; (d) have disclosed this report to companies that are analyzed herein and subsequently amended this report prior to publication; (e) give investment advice

Brazil Economic Comment 3 November 2010

page 16

or provide other services to another person about or concerning any securities that are discussed in this report, which advice may not necessarily be consistent with or similar to the information in this report; (f) act as first purchaser, underwriter, manager or arranger and/or buy, offer, place or sell securities as principal or as agent, in relation to securities that are discussed in this report; (g) trade (or have traded) for its own account (or for or on behalf of clients), have either a long or short position in the securities that are discussed in this report (and may buy or sell such securities), or otherwise pursue its legitimate business as a market maker or dealer (including entering into an agreement for the underwriting of an issue of financial instruments) in connection with the securities that are discussed in this report; and/or (h) buy and sell units in a collective investment scheme where it is the trustee or operator (or an adviser) to the scheme, which units may reference securities that are discussed in this report. Any director, employee or agent of any of BTG or its affiliates may receive remuneration that is tied to investment banking transactions performed by BTG or an affiliate, and/or may, although not involved in the preparation of this report, be aware of conflicts of interests of BTG or an affiliate in relation to securities or companies discussed in this report that have not been disclosed by the individuals involved in the preparation of this report. This report is for distribution only to persons who (i) have professional experience in matters relating to investments falling within Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (as amended, the "Financial Promotion Order"), (ii) are persons falling within Article 49(2)(a) to (d) ("high net worth companies, unincorporated associations etc") of the Financial Promotion Order, (iii) are outside the United Kingdom, or (iv) are persons to whom an invitation or inducement to engage in investment activity (within the meaning of section 21 of the Financial Services and Markets Act 2000) in connection with the issue or sale of any securities may otherwise lawfully be communicated or caused to be communicated (all such persons together being referred to as "relevant persons"). This report is directed only at relevant persons and must not be acted on or relied on by persons who are not relevant persons. Any investment or investment activity to which this report relates is available only to relevant persons and will be engaged in only with relevant persons.