(Reuters) – Investors are buying more long-dated bonds and overseas-listed shares in key emerging markets, suggesting capital controls set up in these countries may be helping curb volatile portfolio flows and currency swings.

While it is hard to gauge the net impact of controls set up in some developing countries, the experience of Brazil and Indonesia suggests it is possible to deter big speculative flows or redirect portfolio cash to less volatile assets without necessarily scaring investors off.

Last October, frustrated by a 30 percent surge in the real, Brazil slapped a 2 percent tax on foreign flows into its stocks and bonds. It was followed by Taiwan, Indonesia and South Korea, which have imposed a variety of milder curbs on capital.

Nine months on, investors say they are still putting cash in Brazil while Finance Minister Guido Mantega has been quoted as saying that the levy has changed the “irrational course” of the markets and that the real currency is now less volatile.

Fund managers say the tax has also raised millions of dollars in government revenue.

“Has this tax made my life tougher? Definitely yes. Has it put me off investing in Brazil? Definitely not,” said Jose Cuervo, who looks after $6 billion in Brazilian stocks at HSBC.

Cuervo says the 2 percent levy has to be seen against the backdrop of 20 percent-plus corporate earnings growth.

To avoid the tax but still invest in Brazil, he buys American Depositary Receipts in Brazilian firms instead of the underlying Sao Paulo-listed stocks where possible. ADRs are priced in dollars and enable investors to sidestep cross-border and cross-currency transactions.

The tax has also slowed some cash outflows.

“In the past when we sold positions in local bonds we would move returns back offshore into dollars. But now we look to keep the money onshore in Brazil,” says Brett Diment, who oversees $5 billion in emerging debt at Aberdeen Asset Management.

Data from Indonesia, another popular emerging market, suggests steps enacted there in June may have helped push out some foreign accounts from short-dated debt.

Jakarta now requires buyers of one-month central bank bonds to hold them for at least 28 days, making the short-term debt less attractive to cut-and-run speculators.

Foreign holdings of six-month Indonesia bills surged 37 percent in July, data shows. As foreigners raised duration, one-month yields rose while six-month and one-year yields fell 25-30 bps.

“The results are in line with what the government wanted: more investors in longer-dated bonds, but at the same time foreign ownership of Indonesian bonds is at a record high,” said Standard Chartered currency strategist Thomas Harr.

TOO SUCCESSFUL?

Ironically, investors fear the relative success of Brazil’s levy may tempt the government to raise it further.

“Brazil’s local bonds are among the most attractive assets in EM, but if the real breaks much higher the market will be concerned about further measures,” Diment said.

“So from that point of view (the tax) has been a successful measure in that it is limiting currency appreciation.”

Some also worry that countries such as Colombia or Peru could follow Brazil’s example.

The Institute for International Finance has cut its 2010 forecasts for emerging market capital flows, citing fear of more controls.

Across emerging markets, flows into equities have dipped from last year’s highs and currencies have weakened, while bond flows are at record highs. This is significant as equities are widely seen as a key destination for speculative cash.

Central bank reserve growth, often used for calculating the ebb and flow of hot money, has also slowed. Developing countries’ reserves grew $80 billion in the first three months of 2010, IMF data shows, versus a $200 billion jump the previous quarter.

Still, analysts are reluctant to pin these developments entirely on capital controls, noting that the industrialized world’s poor growth outlook is weighing on emerging markets and creating a friendlier environment for bonds than stocks.

“In the past whenever G3 growth collapsed, flows to EM have slowed,” says Claire Dissaux, strategist at Millennium Global citing 1998 and 2002. “You would have to believe in true decoupling to expect flows to continue at the same level.”

Emerging central banks say it is not currencies or portfolio flows that they aim to curb, though, but hot money flitting from market to market in search of yield — the type of cash that is widely blamed for past emerging market crises.

They may be fighting an uphill battle as emerging interest rates are rising, creating a powerful driver for speculative capital seeking returns in short-term deposits.

But multilateral lenders’ surprising endorsement of calibrated controls may be tacit acknowledgement that the curbs do indeed discourage hot money.

A February paper by IMF economists noted “an effect on the composition of inflows rather than the aggregate volume” resulting from such curbs — just the result the emerging economies are looking for.

(Editing by Hugh Lawson)