Tax Bond South Korea may stimulate other emerging markets to raise barriers

South Korea's reactivation of a tax on foreigners investing in bonds can drive more emerging markets to act to curb the flow of funds pushing up their currencies.

The government will back legislation to restore a 14 percent tax on bonds and expedite its passage by the National Assembly, the Ministry of Finance said yesterday.

The Group of 20 in Seoul last week gave the emerging nations more space for growing counterpart funds in higher yielding markets. Officials from Africa to Asia and Latin America have taken steps this year to reduce and limit the entries in their currency to protect exporters and prevent asset bubbles.

"Other emerging countries may follow suit as the G-20 gave them license to use some capital controls as a shield," said Oh Suk Tae, an economist at SC First Bank Korea Ltd. in Seoul. "They know they can not reverse the flow of global funds. They just want to slow them."

The most advanced won against the dollar of 16 major currencies yesterday and has gained 29 percent since March last year. The tax can not be revived while moving the funds into the country after the Bank of Korea this week raised interest rates and the U.S. Federal Reserve said it would buy 600 billion U.S. dollars of Treasury bonds, which could encourage foreign capital.

"The question now is whether to impose the tax returns will be sufficient to deter foreign investors," said Lim Ji Won, an economist at JPMorgan Chase & Co. in Seoul. "We will be watching to see if the government needs to do more, such as setting rules on foreign currency derivatives in foreign banks."

The higher yields

The government bond yield of 4 percent due September 2015 rose 5 basis points after the announcement, according to the Korea Stock Exchange. The won rose 0.9 percent to 1,134.53 per dollar at the 3 pm close in Seoul, according to data compiled by Bloomberg.

Recognized G-20 nations may be necessary to curb capital inflows after the Fed's November decision to raise three asset purchases, a strategy known as quantitative easing.

Thailand is to stop for foreigners 15 per cent tax exemption on income of national obligations, while Brazil last month tripled the tax on local purchases of fixed assets of foreign investors. Taiwan, which announced a 9.8 percent third-quarter economic growth yesterday, this month restored curb foreign investment in debt originally scrapped in 1995.

The Asian Development Bank said that while capital controls may be appropriate at times, political leaders must have a plan to kill them.

'Something controversial "

"We see maybe a role for temporary capital controls, well designed," said Joseph Zveglich, assistant chief economist at the bank, in an interview in Tokyo yesterday. "But this is something that will always be somewhat controversial, partly because there is a tendency for temporary measures become permanent and can cause some distortion."

Song Sik Kim, a lawmaker from South Korea's ruling Grand National Party, last week introduced a bill to revive a tax of 14 percent on the bonds by foreigners to curb volatility. Gil Kang Boo, another member of parliament from the ruling party on 12 November presented a bill that would introduce a tax rate on investment earnings flexible Korea treasury bonds and central bank in the hands of investors foreign.

The ruling Grand National Party controls 171 seats in the legislature of 299 members. Kim told opposition lawmakers in the Democratic Party want to control even more difficult measures such as a capital transaction tax.

Asset bubbles

"The purchase excess bond foreigners can make markets more volatile, which in turn can put the whole economic system at risk," said Deputy Finance Minister Yim Jong Yong reporters today in Gwacheon, south of Seoul. "You can create inflation and asset bubbles and threaten the country's international credibility if the funds leave the country at a time."

Yim also said that South Korea possibility of more measures of capital inflows if necessary. In May 2009, Korea eliminated the tax for foreign investors to attract more investment.

"This is a mistake," said Christian Carrillo, head of interest from Asia and Pacific rates strategy at Societe Generale SA in Tokyo, the bond tax plan. "It will not keep the cattle is raised the current account surplus is greater than the KTB flows," he said, referring to Treasury of Korea.

The Bank of Korea on November 16 raised the repurchase rate of seven days by 0.25 percentage point to 2.5 percent, higher interest rates again this year, after inflation climbed the roof of the bank last central.

Consumer inflation in prices accelerated to a maximum of 20 months from 4.1 percent in October. The central bank targets a 2 percent to 4 percent on average through 2012.