S. Korea Ruling Party to Seek Tax on Foreigners' Bond Holdings

South Korea may revive a 14 percent tax on domestic Treasury and central bank bonds held by foreigners as early as January to curb foreign-exchange volatility, a ruling party lawmaker said.

“If we don’t do it right now and the situation worsens, we may have to set up higher barricades,” Kim Song Sik, a member of the Grand National Party and the legislature’s financial committee, said in an interview yesterday in Seoul. He also called on the central bank to raise interest rates to head off asset-price bubbles.

The bonds initiative is part of a series of measures across Asia aimed at defusing the danger of hot money, or inflows of capital that push up currency and asset values in the search for short-term gains. Taiwan yesterday said it will restore curbs on foreign investment in its debt, only allowing offshore funds to have as much as 30 percent of their portfolios invested in all types of government bonds and money-market products.

Kim said that a bill to resurrect South Korea’s levy will be submitted to parliament this weekend or early next week, and predicted passage by the end of the year.

“What I’m proposing is a predictable and reasonable hurdle for capital flows in and out of the nation,” Kim said.

Won’s Gain

The won has advanced more than 9 percent against the dollar since June, the second-best performer in Asia outside Japan, after Thailand’s baht. It was little changed today at 1,113.75 per dollar as of 12:10 p.m. in Seoul, according to data compiled by Bloomberg. An appreciating currency threatens trade gains in the export-led economy.

Thailand is ending foreigners’ 15 percent tax exemption on income from domestic bonds, while Brazil last month tripled a tax on purchases of local fixed-income assets by overseas investors. Nations from China to South Africa have also strived to limit currency gains as near-zero borrowing costs in advanced economies spur demand for higher-yielding emerging-market assets.

Asian economies may need capital controls as U.S. quantitative easing threatens to stoke asset bubbles in their stock, currency and property markets, the World Bank said yesterday.

The risk is that the restrictions diminish the appetite of foreign investors on a more lasting basis, said strategist Christian Carrillo.

Long-Term Risk

“The re-imposing of the withholding tax could weaken the Korean won temporarily but damage to foreign confidence on KTB investments will be long-lasting,” Carrillo, head of Asia- Pacific rates strategy at Societe Generale SA, said in Tokyo yesterday, using the acronym for Korean Treasury Bonds.

Overseas investors currently don’t have to pay the 14 percent tax applied to domestic buyers. South Korea will “seriously consider” whether to withdraw the exemptions, Finance Minister Yoon Jeung Hyun said on Oct. 19.

“I’m pretty confident about the possibility of the bill passing” this year, Kim said. “If approved, the bill will take effect in January.” The tax on interest income and capital gains would apply only to new purchases from that month.

The ruling Grand National Party controls 171 seats in the 299-member legislature. Kim said that opposition Democratic Party lawmakers want even tougher capital control measures such as a transaction tax.

‘Lot of Discussion’

“If the proposal is submitted to parliament I expect a lot of discussion on it,” said Hae Yung Woo, director of the government bond policy division at the Ministry of Strategy and Finance.

South Korean regulators began an audit of banks handling foreign-currency derivatives on Oct. 19 to tackle speculation. Financial Supervisory Service Governor Kim Jong Chang said this week the country may tighten curbs on bank trades of the derivatives and penalize institutions acting improperly.

Overseas investors held 79 trillion won ($71 billion) of South Korean debt in October, data from the Financial Supervisory Service this month showed. Foreigners owned 7.1 percent of the country’s outstanding bonds.

The Grand National Party’s Kim also called on the Bank of Korea to take prompt action on monetary policy to avoid asset bubbles.

“If I were a central bank board member, I would raise interest rates next week,” Kim said. “We need to normalize the rates as we’re getting out of the crisis and secure some policy tools to counter another possible crisis. It is critical to send a clear signal of normalization and regain the market trust.”

The central bank kept the benchmark interest rate unchanged at 2.25 percent after raising it by 25 basis points, the first advance since the global financial crisis. The board meets next week to decide interest rates.

To contact the reporters on this story: Eunkyung Seo in Seoul at eseo3@bloomberg.net; Frances Yoon at fyoon2@bloomberg.net

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