Japan-S. Korea Currency-Swap Deal Put at Risk by Island Squabble

Japan will reconsider a decision to expand a foreign exchange swap agreement with South Korea amid rising tensions over a disputed island chain that have strained diplomatic ties.

“We made the agreement considering the severe economic situation in South Korea at that time,” Japan’s Finance Minister Jun Azumi told reporters today in Tokyo. “We will reconsider the handling of the temporary expansion.”

Japan has curtailed its cooperation with South Korea following President Lee Myung Bak’s visit to a string of islets claimed by both nations on Aug. 10. Japan recalled its ambassador to South Korea in protest and Azumi canceled a meeting scheduled for this month with his counterpart Bahk Jae Wan.

An existing swap agreement between the two sides was expanded to $70 billion in October from $13 billion during a meeting between Japanese Prime Minister Yoshihiko Noda and Lee. The swap was designed to offer the nations protection from funding shocks as Europe’s sovereign-debt crisis deepens and demand in South Korea and Japan’s largest export markets slow.

Separately, Japan, China, South Korea and 10 Southeast Asian nations agreed in May to boost the so-called Chiang Mai Initiative Multilateralization agreement, which involves a pool of foreign-currency reserves, to $240 billion from $120 billion.

Chiang Mai

“There is nothing to worry about even if Japan decides against extending the currency swap because South Korea already has the Chiang Mai initiative,” South Korean Presidential Spokeswoman Lee Mi Yon said yesterday by telephone, ahead of Azumi’s remarks.

The rift between two of Asia’s largest economies deepened on Aug. 14 when Lee called on Japanese Emperor Akihito to “sincerely” apologize to resistance fighters who died during Japan’s colonial occupation. Azumi cited Lee’s demand as one factor in his decision to cancel his trip, along with the dispute over the islands known as Dokdo in Korean and Takeshima in Japanese.

“I’ve decided to cancel my trip because of President Lee’s visit to Takeshima and following his remarks about the Japanese Emperor, which I consider incredibly rude,” Azumi said today.

The two countries are also mired in a dispute over compensating women who served as sex slaves during Japan’s colonial occupation of Korea, which contributed to the last minute postponement of a defense pact in June.

To contact the reporter on this story: Mayumi Otsuma in Tokyo at motsuma@bloomberg.net

To contact the editor responsible for this story: Paul Panckhurst at ppanckhurst@bloomberg.net

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