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Japan-South Korea Currency Swap Poised to Lapse Amid Tension

Japan and South Korea said they will let a $57 billion expansion of a currency-swap agreement expire on Oct. 31, amid tensions between Asia’s second and fourth-biggest economies over disputed islands.

Japan’s Finance Minister Koriki Jojima told reporters in Tokyo that the extra money was now “unnecessary,” leaving a $13 billion deal in place. The Bank of Korea said separately that the decision reflects the nation’s “improved resilience to external shocks.”

The dispute over islands known as Dokdo in Korea and Takeshima in Japan escalated after South Korean President Lee Myung Bak visited them in August. The spat has threatened economic ties, with Japanese auto sales falling in the country and South Korea saying resuming talks on a free-trade deal would be difficult until the issue is resolved.

“Korea has lost one of its reliable financial safety nets, a victim of the soured political relationship between the two countries,” said Lee Sang Jae, a senior economist at Hyundai Securities Co. in Seoul. “Korea may have become more resilient, but the global financial and economic crisis is not over yet.”

Jojima said that the decision to let the swap deal expire won’t prevent any further cooperation with South Korea if needed.

“This is not a political decision, it is based on economic and financial factors,” he said. “Macroeconomic conditions are healthy and financial markets are stable.”

Buying Bonds

A senior official at the Japanese finance ministry told reporters today that Japan will still consider buying South Korean bonds, speaking on condition of anonymity due to the ministry’s policy.

Junko Nishioka, chief economist at RBS Securities Japan Ltd. in Tokyo and a former central bank official, said that the decision came amid improved funding conditions in global markets.

“There was no need to expand the swap line because the U.S. Federal Reserve and European Central Bank have provided liquidity to global markets,” she said.

Sales of Japanese carmakers in South Korea in August dropped 12 percent, and companies attributed the decline to the dispute, according to the Korea Chamber of Commerce and Industry. Japan is South Korea’s second-biggest trading partner, with commerce between the two rising 16.8 percent to $108 billion in 2011, according to the Korea International Trade Association.

Fish, Natural Gas

The islets are 87 kilometers (54 miles) east of the closest South Korean territory and 158 kilometers from the nearest Japanese land. Sovereignty over the area means control of fishing grounds and natural gas reserves, and South Korea has bolstered its claims by stationing coast guard personnel there year-round.

In a separate stand-off, China and Japan are at odds over islands called Senkaku in Japanese and Diaoyu in Chinese. Naoyuki Shinohara, a deputy managing director at the International Monetary Fund, said today that any escalation could hurt both countries and the global economy.

The IMF today cut its global growth forecasts as the euro area’s debt crisis intensifies and warned of even slower expansion unless officials in the U.S. and Europe address threats to their economies. The world economy will grow 3.3 percent this year, the slowest since the 2009 recession, and 3.6 percent next year, the IMF said.

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