Brazil and exchange traded funds tracking the country have benefited from capital flowing into the country, but foreign investment also brings dangers, according to a report Tuesday.

Investors have been enticed by optimistic growth projections for Brazil, but all that liquidity is fueling concerns that asset prices are being artificially boosted.

The iShares MSCI Brazil (NYSEArca: EWZ) is down 6.06% over the past week and down 21.32% year-to-date. Wisdomtree Dreyfus Brazilian Real Fund (NYSEArca: BZF) is down 5.41% over the past week but up 0.79% year-to-date.

Liquidity has buffered riskier bank loans and fueled the rise in Brazil’s real estate market, reports John Lyons for The Wall Street Journal. The Brazilian real has arguably become the world’s most overvalued currency, and domestic factories are losing their global competitiveness as a result.

Brazilian industrial production dropped 1.6% in June from May, the first month-over-month decline since the 2008 financial crisis, as exporting countries with cheaper currencies beat out Brazilian prices.

“We have to defend ourselves from this immense, fantastic, extraordinary sea of liquidity that finds its way to our economies in search of returns that it can’t find in its own,” Brazil President Dilma Rousseff promised.

Brazil’s central bank reduced the interest rate to 12% in an attempt to depreciate the Brazilian real but its actions may only further fuel inflationary pressures – inflation has become a growing concern as the standard of living in urban centers like Rio de Janeiro and São Paulo have become on par with prices in New York. However, the high interest rate attracts foreign investments, which strengthens the Brazilian real. [Brazil ETFs May Get Boost from Surprise Rate Cut]

“Capital flows have significantly exacerbated domestic problems like bubbles and inflation that could potentially throw emerging economies off their growth paths and produce social instability,” Cornell University economist Eswar Prasad stated.

“I don’t see a bubble. Capital flows are a natural outcome of all the good news in Brazil,” Fabio Barbosa, the chief executive of Abril SA and a board member Petroleo Brasileiro SA, remarked. “The issue is how can we remain competitive within a scenario of a stronger currency, which in my opinion is here to stay.”

iShares MSCI Brazil

For more information on Brazil, visit our Brazil category.

Max Chen contributed to this article.

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