By Kim Soo-yeon
SEOUL, Aug. 20 (Yonhap) -- In an apparent bid to diversify its foreign reserves, China has snapped up South Korean treasuries this year, triggering concern among some watchers that it could become a destabilizing factor for the local financial market.
According to Seoul's financial watchdog, China, the world's largest holder of foreign exchange reserves, bought a net 2.48 trillion won (US$2.11 billion) worth of South Korean bonds, mostly government debt, in the January-July period.
"China has increased its investment in South Korean bonds since late last year and their purchase momentum stood out this year," said an official at the Financial Supervisory Service. "The move is seen as part of China's efforts to reduce the weight of dollar holdings out of its foreign reserves and the trend is likely to continue."
Most analysts said China's strong appetite for Korean bonds points to the strength of South Korea's economic fundamentals. Also fueling China's buying spree are signs of a slowing U.S. economy and the eurozone debt crisis, the analysts said.
South Korean treasuries are viewed by foreign investors as attractive investment vehicles as they offer relatively higher yields, and an expected appreciation of the Korean currency gives them chances to chalk up foreign exchange profits as well.
"Given China's willingness to diversify its foreign exchange reserves and the weight of South Korea's trade with China, China is likely to continue to scoop up Korean bonds," said Yum Sang-hoon, a fixed-income analyst at SK Securities Co.
China's holdings of South Korean bonds reportedly make up for a mere 0.1 percent out of its $2.45 trillion reserves. But experts say that given the importance of South Korea as China's main trading partner, there is room for the world's fastest growing economy to purchase more Korean debts.
But some market watchers warned that China's continued buying of South Korean government debt could destabilize the local financial market by increasing the nation's money supply and undercutting the intended effect of a rate hike by the Bank of Korea (BOK).
"Assuming that China increases the amount of investment in Korean debts, the move could hamper an intended effect of the monetary tightening because a run of foreign capital flows adds to already ample market liquidity," said Yoon Yeo-sam, an analyst at Daewoo Securities Co.
In an effort to curb rising inflationary pressure, the BOK raised the key interest rate to 2.25 percent from a record low 2 percent in July, ending the 16th straight month of a stand-pat run.
The rate hike heralded the start of South Korea's stimulus exit, and the BOK is widely expected to hike borrowing costs once or twice within this year.
A rate hike usually drives up market interest rates, making the local currency-denominated bonds look attractive due to the widened interest rate gaps with other nations. It also puts upward pressure on the local currency against the greenback, and expectations for the currency's appreciation give foreign investors incentives to reaping foreign exchange gains by investing in such assets.
"A stream of foreign capital influx could cut the effectiveness of the monetary policy," said Shin Dong-jun, an analyst at Dongbu Securities Co. "But it is not just the case of South Korea. Emerging countries whose assets look attractive are facing similar situations."
Currency analysts added that China's move will likely add upward pressure on the Korean currency, which has risen about 0.7 percent to the dollar amid brisk exports so far this year.
Some expressed worries that the won is feared to sharply gain to the greenback, hurting price competitiveness of Korean exports in overseas markets.
"China's increase of Korean bond holdings is likely to put upward pressure on the Korean currency," said Jeon Seung-ji, a currency analyst at Samsung Futures Co. "But the move is not likely to send the won surging against the greenback unless the monthly amount of its bond purchases steeply rises,"
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