Seoul to lift curbs on banks' investment in kimchi bonds

South Korea will lift restrictions on banks' purchase of domestically issued foreign currency bonds, dubbed “kimchi bonds," as part of policy efforts to boost US dollar inflows as individual investors' rush into overseas stocks fuels demand for the greenback.

The Ministry of Economy and Finance on Sunday also announced an increase in the cap on financial institutions' foreign exchange derivatives trading for domestic clients' currency hedging, raising it from the current 100% of their exposure to 125%.

The moves are the latest in a series of deregulations that the government has unveiled since late last year to prop up the Korean currency as the country's foreign exchange reserves shrank to their lowest level in nearly five years in February.

Those new measures will take effect within the first half of this year, the ministry said in a statement jointly released by the Financial Services Commission (FSC), the Financial Supervisory Service (FSS) and the Bank of Korea.

They also eased restrictions on domestic banks' foreign currency lending to Korean companies. Starting on Monday, they will be allowed to lend dollars through overseas offices for conversion into Korean won, thus enabling domestic companies to use them for capital expenditures.

KIMCHI BONDS

Seoul has prohibited financial institutions from buying kimchi bonds since late 2011, as a majority of their issuers converted them to Korean won for domestic use. This pattern was blamed for increasing corporate debts beyond limits and strengthening the won.

The government now expects kimchi bonds to boost dollar supply, counterbalancing the greenback demand from individual stock investors.

Yet analysts remain skeptical about its impact. They pointed out that higher funding costs in the dollar, compared with those in the Korean won, will lessen the appeal of kimchi bonds.

A finance ministry official said that kimchi bond sellers can sharply reduce dollar funding costs through currency rate swaps. Alternatively, they can sell bonds in Japanese yen at home to secure won at lower costs.

FOREX HEDGING LIMITS

Under the new rules, financial institutions will be permitted to hedge up to 125% of their corporate clients' foreign currency exposure.

Since 2010, their derivatives transactions for corporate clients’ currency hedging have been capped at 100%. That means that their currency hedges for clients through derivatives trading could not exceed the latters' forex exposure, or exports.

In December, the government eased the restrictions on banks’ exposure to forward positions and expanded the ceiling of foreign currency loans to be used for conversion to Korean won.

It also increased the foreign exchange swap line between the National Pension Service (NPS) and the Bank of Korea to reduce the pension operator's dollar buying on the domestic spot market.

The policy measures have not reversed the won's weakness, however.

“Foreign currency outflows have continued to exceed inflows since the start of this year amid external uncertainties such as US tariff policies,” the ministry said in the joint statement.

Foreign investors transferred $1.61 billion abroad from the proceeds of domestic stock investments in January, according to the FSS.

In comparison, individual investors poured $10.81 billion into overseas stock markets in the January-February period, according to the Korea Securities Depository.

Write to Ik-Hwan Kim at lovepen@hankyung.com
Yeonhee Kim edited this article.