BOK expects continued 'contraction' in debt market following Legoland-caused turmoil

SEOUL, Oct. 26 (Yonhap) -- South Korea's bond market is expected to suffer continued "contraction" as uncertainty grows from aggressive monetary tightening in major countries and heightened volatility in financial markets, a central bank report showed Wednesday.

The assessment came as the local corporate bond market has been hard-hit by a default on municipal government-guaranteed debt worth 205 billion won (US$143.5 million) raised for the construction of the Legoland theme park in Gangwon Province, sending yields soaring and making it tougher for businesses to borrow money.

The debt market turmoil has added to uncertainty for many businesses already grappling with fast-rising borrowing costs from the Bank of Korea (BOK)'s aggressive move to hike its benchmark interest rate to tame inflation amid global monetary tightening.

"Given that major countries will beef up monetary tightening and high levels of uncertainty will likely persist for the time being, the current contraction in the credit and bond market will not likely improve much in the short term," the report said.

"It is necessary to explore policy response for market stabilization, while keeping close tabs on market situations so as to prevent credit and bond market instability from spreading on a wide scale," it added.

To ease bond market turbulence, the government on Sunday announced a set of measures to inject an additional 50 trillion won into the market, including large-scale bond-buying schemes.

The measures include tapping into a 20 trillion-won bond stabilization fund and the doubling of the ceiling of state-run banks' corporate bond buying to 16 trillion won, a move aimed at supplying liquidity and capping market interest rates.

The government also reassured investors that municipal governments will do their best to honor their guarantees for such debt issuance.

Despite those measures, the corporate bond market remains unstable as investors are on edge over whether their money could be paid back at a time when a municipal government deemed to be highly trustworthy has failed to honor its debt guarantee obligations.

Calls are growing for more stabilization steps. The BOK is currently considering whether to expand the scope of collateral it receives when making loans, a move expected to help banks secure necessary capital amid worries over a credit crunch.

Meanwhile, touching on overall economic situations, the report said that global economic growth will likely slow down at a faster-than-expected pace for next year amid growing recession woes, which it said would lower demand-side price pressure and result in less upward pressure on core inflation that excludes volatile food and energy costs.

The report voiced worries that the fast depreciating local currency and the possibility of a rebound in crude oil prices remain downside risks on the economy going forward.

kokobj@yna.co.kr
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