* Government readies 10 trillion won bond fund as yields
* Outflows not a problem yet but won and bonds have sold off
* Rising dollar, higher U.S. rates may spark outflows
By Vidya Ranganathan
SINGAPORE, Dec 19 South Korea has re-activated
its crisis-period market stabilisation fund, taking no chances
over the upswing in bond yields since Donald Trump won the U.S.
Even though analysts say the traditionally volatile won
markets are not at major risk from the ongoing global bond
sell-off, Korean authorities are keen to prevent capital
outflows that could freeze their credit markets.
The finance ministry said last week it is prepared to use
its Bond Market Stabilization Fund, last deployed in the 2008
global financial crisis, to buy bonds at the turn of the year.
Investors are not dumping South Korean assets yet, but a
rising U.S. dollar and the Federal Reserve's hawkishness after
its rate rise last week have put the spotlight firmly back on
Asia's proverbial canary in the 'capital flows' coalmine.
The won has been emerging Asia's worst performer
since Nov. 9, after Trump's victory. It is close to its weakest
levels in six months and Korean 10-year bond yields have climbed
by a third in that period.
"They've had so many near crises that they are very
determined to nip these things in the bud," said Tim Condon,
head of economics research at ING in Singapore.
The bond market sell-off so far is rooted in fears that a
Trump administration will mean more trade friction and
protectionism, painful for a country whose exports comprise half
of economic output and whose growth this year has been weaker
The Fed also seems to have sparked selling across global
bonds, spurring concerns over the Korean bond market's huge
exposure to hot foreign money.
As of early November, foreigners held about $75 billion
worth of Korean government debt.
"What we're talking about is a bond market sell-off and
Korea's not going to be immune to it," Condon said
"But my baseline is that this doesn't spiral into anything
more serious and it is contained in the bond market. I don't see
contagion spreading from bond yields to the currency market."
ACTIONS SPEAK LOUDER
Speaking after the Fed raised rates last week, Vice Finance
Minister Choi Sang-mok said higher U.S. rates should have a
limited impact on the local economy and financial markets if
they are communicated well to market participants ahead of time.
But the bond fund - a 10 trillion won ($8.43 billion) buffer
that will be used to buy corporate bonds and bank debentures to
provide liquidity to debt-ridden companies - suggests the
government is worried.
The country has one of the most open capital accounts in
emerging Asia. Its markets was whipsawed during the 2008 global
financial crisis and more recently after the 2013 'taper
tantrum' and early 2015 emerging market sell-off.
This time, the government is wrestling with a political
crisis that has embroiled President Park Geun-hye and a bird flu
outbreak. And the central bank has little leeway to loosen
policy when the benchmark interest rate is at a record low of
1.25 percent, barely above dollar yields.
The other risk is that foreign flows into Korea tend not to
be fully hedged, unlike flows into markets such as Japan, said
Cliff Tan, East Asian head of markets research at Bank of
Tokyo-Mitsubishi UFJ. As of November, Korea had $472 billion of
foreign holdings of its bonds and stocks.
Currency reserves were $371 billion but the country has the
comfort of a substantial current account surplus of more than 7
percent of its GDP.
Morgan Stanley analysts say Korea's low real yields and high
dollar debt are risks. They estimate corporate debt denominated
in U.S. dollars is about 32 percent of GDP, higher than in other
large emerging markets such as Turkey, Russia or Brazil.
"There is not one thing in our economy that is not serious,"
Bank of Korea Governor Lee Ju-yeol said on Friday. "I believe
the focus should be placed on stabilising financial markets and
exchange rates and when needed, aggressive responses should be
($1 = 1,186.6000 won)
(Additional reporting by Cynthia Kim in SEOUL; Editing by