SKorea supports bond tax to stem foreign cash

[November 18, 2010]  SEOUL, South Korea (AP) -- South Korea said Thursday it favors imposing a tax on foreign investment in government bonds, aiming to fend off a potentially destabilizing flood of outside money after the Federal Reserve's decision to pump $600 billion into the U.S. economy.

The announcement of the government's position comes as emerging countries try to stem a tide of so-called "hot money" that they say drives up the value of their currencies and destabilizes their markets as foreign investors seek higher returns in fast-growing economies.

Indonesia in July announced a minimum holding period for foreign investment in short-term government debt to deter speculators. Thailand last month slapped a tax on foreign investment in bonds, joining other nations in seeking to stem currency appreciation.

Two bills were submitted to the National Assembly last week that would amend existing laws to reimpose a withholding tax on foreigners' capital gains and interest income on South Korean government bonds and monetary stabilization bonds, the Ministry of Strategy and Finance said in a statement.

Reimposing the tax "is appropriate to mitigate the risk of excessive volatility in capital flows, given the rapid increase in foreign investment in Korean bonds," the ministry said.

It warned that "excessive inflows" could cause volatility in the bond and foreign exchange markets as well as stoke inflation and asset price bubbles. Their "sudden reversal," meanwhile, could endanger the financial system, it said.

The ministry said bringing back the tax was justified by an agreement reached last week in Seoul at a summit of the Group of 20 major economies. G-20 leaders said that some emerging economies may use "carefully designed" measures to ease the risk of excessive volatility in capital flows.

South Korea in May last year abolished a 14 percent withholding tax on interest income and a 20 percent tax on capital gains on the bonds. The ministry said removal of those taxes had "contributed to the recent surge of capital inflows."

The bills submitted by two different legislators call for reimposition of the taxes. One, however, allows for the government to lower the taxes to zero to stabilize markets if needed, according to the statement and ministry spokesman Kim Young-min.

The Federal Reserve's decision announced last month to purchase $600 billion in U.S. Treasurys to lower long-term interest rates to boost the economy has drawn intense criticism from both advanced and emerging countries.

They fear the measure -- known as quantitative easing -- poses a threat to the global economy by potentially driving down the dollar and exposing other countries to an influx of investment.

South Korea cited such measures as well as low interest rates in developed countries as being behind recent "global excess liquidity" that has caused "large swings in capital flows."

The move to reimpose the bond tax comes after South Korea's financial authorities announced measures in June to impose limits on domestic and foreign banks' investments in foreign exchange derivatives trading.

The South Korean bond tax legislation still needs to be debated and approved by lawmakers before it could take effect. One bill calls for it to take effect from the day of promulgation while the other sets a date of Jan. 1, 2011.

[Associated Press; By KELLY OLSEN]

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