S.Korea to restore tax on foreign bond purchases: ministry

The move is the latest in a series of measures by emerging markets to curb a flood of capital from the United States and elsewhere, which is pushing up their currencies.

The finance ministry said it supported two bills submitted to parliament last Friday, which would re-impose the tax on capital gains and interest income from the bonds.

One would allow flexibility to cut or remove the tax as needed for market stability and would take effect at the start of next year. The other would restore the 14 per cent withholding tax immediately.

"Excessive capital flows could damage the stability of the economy," the ministry said in a statement, adding it would discuss details of the bills "for prompt revision".

Vice finance minister Yim Jong-Yong said South Korea would take additional measures including the imposition of a bank levy at an early date.

Analysts said the announcement would not lead to a sell-off in bonds, despite market jitters over the possibility of more capital control measures.

"A tax could mean smaller inflows of foreign capital, but it's still not something that would immediately alter the market's current dollar supply-and-demand situation," a foreign bank trader told Dow Jones Newswires.

Bonds have been supported by the market view that the Bank of Korea would not increase its key interest rate in the near future. The rate was raised by 25 basis points to 2.5 per cent Tuesday.

The Federal Reserve's move to pour an additional $600 billion into the US economy has heightened worries about a destabilising flood of capital into emerging markets in search of higher non-dollar returns.

Thailand, Brazil and other countries have already taken measures to restrain the flows.

The Fed's move came in for strong criticism at last week's G20 summit from China, Germany and other nations. They say Washington is effectively devaluing the greenback and encouraging capital inflows overseas.

The ministry said the US "quantitative easing" and ultra-low interest rates in developed countries had triggered large capital inflows into emerging markets.

Apart from potential destabilisation, South Korea fears that the won's ascent -- it has risen more than 15 per cent against the dollar from its May lows -- may damage the export-dominated economy.

In the first 10 months of this year, the ministry said, net investment in Korean bonds stood at 21.1 trillion won ($18.6 billion).

Foreigners at the end of October held 7.1 per cent of all outstanding bonds and 14.9 per cent of Korean treasury bonds, compared to figures of 4.3 and 8.4 per cent respectively at the end of 2008.

The trend was expected to continue due to the expansion of global liquidity, it said.

"Excessive inflows could make both the bond market and the foreign exchange market more volatile," the ministry said, and lead to inflation and asset price bubbles.

Any sudden reversal of such flows "could result in a systemic risk".

The ministry said its withholding tax was in line with decisions reached at the G20 summit in Seoul.

The G20 communique vowed to move towards more "market-determined" exchange rates. But it also said emerging economies with "increasingly overvalued flexible exchange rates" may take "carefully designed macro-prudential measures".

The finance ministry lifted the 14 per cent withholding tax in May last year in an attempt to help the country join the Citigroup-run World Government Bond Index. That did not happen.