Bloomberg News

S. Korea Bans Banks Buying Kimchi Debt From Local Companies

July 19, 2011

(Updates with analyst comments in fourth paragraph)

July 19 (Bloomberg) -- South Korea will prohibit financial companies from buying foreign-currency bonds sold for domestic use, to help curb short-term external debt that contributed to financial crises in 1997 and 2008.

“Our message is that local firms should raise funds in won when they use the money here,” Kim Han Soo, head of the international planning and coordination team at the Bank of Korea, told reporters in Seoul. The regulation takes effect on July 25, the central bank said in a statement today.

Short-term overseas debt jumped by the most in more than two years in the first quarter, raising a red flag for regulators. The won slumped 26 percent in 2008 after sales of such debt with maturities of less than one year increased for 11 straight quarters. The pattern was similar in 1997, when the Asian crisis halved the won’s value as funds flowed out of Korea.

“The latest step in Korea reflects the ongoing concern that foreign exchange loans are a source of instability,” said Sean Callow, Sydney-based currency strategist with Westpac Banking Corp. Similar liabilities in 2008 “caused tremendous stress as Korean borrowers scrambled to pay back dollars, which were in sudden demand.”

The Bank of Korea’s Kim said local firms used about 70 percent of the proceeds from foreign-currency debt issued locally to generate funding in won, circumventing an existing limit on borrowing overseas for local use.

Non-Koreans Exempt

Foreign-currency bonds issued by non-Korean companies, or issued overseas by Korean companies, are not subject to the restriction, he said.

So-called Kimchi bond issuance has jumped because borrowing costs, even after swapping proceeds back into Korean won, are lower than selling bonds in the local currency, according to Kwon Young Sun, Hong Kong-based economist at Nomura Holdings Inc.

Limiting their use is likely to increase funding costs for companies, Kwon said.

Lotte Confectionery Co. plans to sell about 100 billion won ($95 million) in bonds next week in its first local-currency issuance since 2002, said Kim Sung Ki, a manager in the Seoul- based company’s finance department.

“We had financed mostly in yen as it was cheaper” Kim said by telephone today. “Now we have to fund in won when we need money in local currency.”

Japan’s 10-year government bonds yield 1.1 percent, compared with their South Korean equivalent’s 4.1 percent.

Currency Rankings

The central bank is also seeking to restrain advances in the won, the best performer among Asia’s 10 most-traded currencies this year, to protect exporters including Samsung Electronics Co. and Hyundai Motor Co.

The won has advanced 5.8 percent this year and touched 1,054.10 per dollar on July 14, the strongest level since August 2008, according to data compiled by Bloomberg. It closed at 1,059.73 per dollar as of 3 p.m. in Seoul

Bank of Korea’s Kim defined Kimchi bonds as foreign- currency denominated debt sold in South Korea. The term originally referred to debt sold only by foreign companies and was later widened to include bonds sold by Korean firms.

South Korea’s short-term external debt surged $11.7 billion in the first quarter to $146.7 billion, according to central bank data. This was partially driven by an increase in South Korean companies selling foreign-currency debt in the domestic market, Deputy Finance Minister Choi Jong Ku said April 28.

Foreign Branches

The amount outstanding of foreign-currency denominated bonds issued within South Korea rose by $2.1 billion in the first half of this year to $17.1 billion, after an increase of $1.2 billion last year, according to today’s statement. About 77 percent of those bonds were held by branches of Japanese and other foreign banks in South Korea, the statement said.

“This action is part of our efforts to prepare for possible outflows by regulating capital flows and reducing short-term external debt,” Kim said. “We’re targeting financial companies because we don’t have authority to control the issuers.”

To reduce volatility in capital flows and trading of the won, South Korea initiated caps on banks’ holdings of foreign- exchange derivatives in October 2010 and revived taxes on foreign investors’ bond holdings in January.

Authorities tightened currency-forward positions from July 1 and plan to impose a levy on non-deposit foreign-currency liabilities held by domestic and foreign banks beginning Aug. 1, with short-term debt facing higher charges.

--Editors: Brett Miller, Ken McCallum

To contact the reporters on this story: Eunkyung Seo in Seoul at eseo3@bloomberg.net Kyoungwha Kim in Singapore at kkim19@bloomberg.net

To contact the editor responsible for this story: Paul Panckhurst in Hong Kong at ppanckhurst@bloomberg.net Sandy Hendry at shendry@bloomberg.net


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