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Brazil has agreed to negotiate changes in a higher tax on car imports to accommodate auto makers that have disclosed billions of dollars in new investments in the world's fourth-largest vehicle market, but critics of the higher tax say the damage to competition, and the consumer, has already been done.

Last month, Brazil raised what is known as the IPI tax on cars by 30 percentage points, but exempted locally produced cars in a move seen as a way to protect long-established auto companies buffeted by a wave of imports that have flooded the market. Car makers that are building factories in Brazil protested the higher tax, however, because they say they won't be able to immediately meet local-content requirements and so would still have to pay the tax.

Brazil's Trade Ministry now said it is willing to negotiate with companies that are moving production onshore, gradually stepping up local-content requirements to the stipulated 65% in order to give the new companies time to find adequate local suppliers. These changes will be negotiated with each company individually, as the government won't change the executive decree that raised the IPI, the ministry's press office said Tuesday.

Newcomers to Brazil have been consistently eroding the market share of Volkswagen AG (VOW.XE, VLKAY), Fiat SpA (F.MI, FIATY), General Motors Co. (GM) and Ford Motor Co. (F), which together account for about 75% of Brazil's vehicle sales. Imports now account for about 20% of sales, though most of those imports are from factories of the "big four" in Mexico or in Mercosul trade partners, all of which are exempt from the higher tax.

"In the short term, the government tried to defend the big players and the consumer came out a loser," said Tereza Fernandez, auto analyst at consulting firm MB Associados. "Those new companies that are coming are still coming, so it doesn't change anything. My doubt is whether the big companies once again don't do anything in the meantime."

The higher tax, in effect since Sept. 15, has already roiled car sales and is expected to depress already-slowing growth even further, according to Jose Luiz Gandini, president of Kia Motors Corp.'s (000270.SE) Brazilian unit and head of auto importer association Abeiva.

Auto sales have slowed this year as the government moved to curb new credit, and will likely end the year with an expansion of 5%, from growth of 12% in 2010. September sales suffered further as consumers and dealers, hopeful the government would reverse the higher tax, held off on purchases in recent weeks, Gandini said.

Gandini said Kia, along with rival importers, will eventually pass on the higher tax rate to consumers, crimping future demand. He expects locally based carmakers exempt from the tax will raise prices as well in order to recoup profitability.

Yet a deficit in local production means massive imports will have to continue for at least the next four years, according to Morgan Stanley. Production plans in the country are still lagging the expected increase in sales through 2014, when vehicle purchases are set to top four million, from 3.5 million at the end of last year.

The higher tax expires at the end of 2012--the short duration means Brazil is unlikely to see challenges to the protectionist measure at the World Trade Organization, analysts said--but nothing impedes the government from extending it.

Meanwhile, car imports have helped to stabilize prices in a market where the big four had vast pricing power, according to Roberto Marx, a professor of production engineering at Sao Paulo University and Fundacao Vanzolini.

In addition to helping keep prices relatively stable, imports have played another important role by introducing new technology to the nation's cars, Marx said. Though the government also requires research-and-development investment for companies to be exempt from the higher tax, it isn't enough, he said.

"More important than having auto makers here is having auto makers that produce up-to-date cars, with more value added," he said. "The higher IPI means that cars produced locally, on average, are less advanced than those coming in from outside."

The higher tax hasn't yet scared off new car makers. Chinese car maker Chery Automobile Co. is going ahead with construction on its plant, and Anhui Jianghuai Automobile Co. (600418.SH) said last week it still wants to build a factory in Brazil's northeastern state of Bahia. South Korea's Hyundai Motor Co. (005380.SE, HYMLY) likewise has continued work on its new plant, and Japan's Nissan Motor Co. (7201.TO, NSANY) said last week it would invest $1.5 billion in a new factory.

"We're investing for the next 20 [to] 30 years, and we have no doubt that what we're doing is correct," said Carlos Ghosn, chief executive of French-Japanese automotive alliance Renault-Nissan after disclosing a $266 million investment by Renault (RNO.FR) last week.

-By Paulo Winterstein, Dow Jones Newswires; 55-11-3544-7073; paulo.winterstein@dowjones.com

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