South Korea plans to impose a levy on non-deposit foreign currency debt held by domestic and foreign banks in a bid to defend itself against capital surges that could threaten the country’s economy, financial authorities said Sunday.
The announcement comes as emerging countries try to control the movement of so-called “hot money” from abroad that they say drives up the value of their currencies and destabilizes their markets. Foreign investors have sought higher returns in fast-growing developing economies amid ultra-low interest rates and other stimulatory monetary policies in advanced countries such as the United States and Japan.
South Korea has already announced limits on investments by domestic and foreign banks in foreign exchange derivatives trading and is moving to bring back a tax on foreign investment in government bonds as ways to shield itself against potential financial instability.
“A surge of capital inflows could lead to inflation and asset price bubbles, and a sudden reversal of such inflows could possibly result in a systemic risk,” said a statement released by the Ministry of Strategy and Finance.
The size of the levy has yet to be determined, though it will be applied on “non-deposit foreign currency liabilities” held by domestic banks and the South Korean branches of foreign banks, according to the statement. The levy on short-term debt, seen as more of a risk, will be higher.
Still, the authorities said the levy would be introduced “under the principle of not causing an excessive burden for financial institutions in procuring foreign currency.”
Related legislation will be introduced to the National Assembly, South Korea’s legislature, in February and is seen taking effect in the second half of 2011, they said.
The plan was announced jointly by the ministry and other financial authorities, including the central bank and regulators. South Korea is the world’s 15th-largest economy and a member of the Group of 20 advanced and emerging countries, which has taken over leadership of the global economy from the Group of Seven after the 2008 worldwide financial meltdown.
Of particular worry to developing economies has been the Federal Reserve’s move to purchase $600 billion of U.S. government bonds in a bid to spark growth and hiring in the United States, an increase in global liquidity they fear will wash into their markets.
South Korea said the bank levy is in line with thinking in the G-20, which agreed at its summit in Seoul last month that emerging market economies could employ “carefully designed macro-prudential measures” to battle “excessive volatility in capital flows” under certain conditions. South Korea also cited moves by Britain, Germany and France to introduce financial levies.
South Korean authorities are particularly sensitive to the dangers of financial turmoil. The country was hit hard during the 1997-98 Asian economic crisis and was forced to seek what was seen domestically as a humiliating international bailout. The country was shaken less severely in 2008.
Other countries have taken steps to control the movement of capital in recent months. Indonesia announced in July a minimum holding period for foreign investment in short-term government debt to deter speculators. In October, Thailand slapped a tax on foreign investment in bonds.
The Asian Development Bank said in a report last month that foreign money poured into emerging East Asia’s bond markets in the third quarter, with the value of outstanding local currency bonds increasing to $5.1 trillion, up 17.2 percent from the same period last year.
South Korea said that its levy would initially be applied to banks, though could be expanded to all financial institutions if needed. The charge will be collected in foreign currency as a means to stabilize the financial market by providing liquidity to “failing financial institutions in an economic crisis,” the statement said.