UPDATE 2-S.Korea sells dollars after biggest fall in reserves

Mon Aug 4, 2008 2:52pm IST

(Updates with intervention, more analysts, agencies, markets)

By Cheon Jong-woo

SEOUL Aug 4 (Reuters) - South Korea's foreign exchange reserves suffered their biggest-ever monthly drop in July, when the authorities reportedly spent some $15 billion propping up the won, using the currency as their main tool to fight inflation.

Traders said the authorities sold an estimated $300 million on Monday to further support the won, demonstrating a preference for a firmer currency despite the sharp fall in reserves.

Asia's fourth-largest economy is expected to keep bolstering the currency KRW= to tackle imported inflation, but intervention is unlikely to be as strong as in July due to weaker oil prices and a slowing economy, analysts said.

"As oil prices fell from July, the burden of inflation on the government has been eased," said Kim Jae-eun, an economist at Hana Daetoo Securities. "The authorities will not reverse the market trend of a weaker won although they will slow down the speed of the unit's fall."

Oil prices CLc1 hovered just below $126 a barrel on Monday, much lower than the record high of $147.27 in July.

Monday's intervention was small compared with money market operations in July, when the authorities spent an estimated $5 billion on one day itself to support the ailing local currency.

Before local financial markets opened on Monday, the Bank of Korea said the country's foreign reserves fell $10.58 billion to $247.52 billion by the end of July from a month earlier, citing "efforts aimed at stabilising the foreign exchange market".

It was the biggest monthly decline since the central bank started compiling foreign reserves figures in 1971.

The sharp fall in reserves heightened concerns South Korea could be confronted with an economic crisis similar to the 1997-98 Asian financial crisis, and raised expectations the authorities might intervene less, losing their grip on the won.

But senior officials at two of the world's top credit rating agencies told Reuters that there was no problem with the country's external payment capability despite the drop. [ID:nSEO256291]

NO CHANGE IN FX POLICY

A senior foreign exchange official also told Reuters the authorities saw no reason to change their policy of defending the local currency as one of the main tools to contain inflation.

"The authorities will consider falls in foreign exchange reserves when we manage currency policies, but there is no reason for falls to change the policies," said the official, who declined to be name.

He added that concerns over the drop in reserves had been misplaced.

The remarks, along with actual dollar-selling intervention, helped the won limit its falls, but could not prevent the currency from shedding 0.26 percent against the dollar during the local session.

Analysts agreed with the rating agencies' assessment, saying South Korea's overall external payment capability remained strong.

"The authorities have sufficient ammunition. The reserves' fall in July was smaller than expected, which indicates they have not only the reserves but also other means for intervention," said Lee Tark-koo, a currency analyst at KB Futures Co Ltd.

July's intervention helped lift the won by almost 4 percent against the dollar for the month. The currency had fallen 11 percent for the January-June period.

The authorities were also seen reducing their long-positions on dollar non-deliverable forwards (NDFs) and using dollar sell and buy swaps; selling dollar spots on certain days and later buying dollar futures.

The central bank did not provide the exact number of dollars it and the Finance Ministry sold during the month as they tried to prevent the sliding won from exacerbating high inflation, which has been led by imported commodities.

"We intervened in the market last month to correct mounting speculative trades, but the market usually overstates the intervention size," a Bank of Korea official, who declined to be named, said by telephone without giving the exact value.

But it was unusual for the South Korean central bank, which also attributed some of the decline to losses in dollar terms from non-dollar assets, to admit currency intervention.

Consumer-price inflation climbed to a near 10-year high of 5.9 percent in July, up from 5.5 percent in June.

South Korean authorities are worried accelerating inflation will cut the disposable income of consumers at a time when a slump in domestic demand is expected to dent growth this year. (Additional reporting by Yoo Choonsik and Lee Shin-hyung, Editing by Jonathan Hopfner and Jacqueline Wong)

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