* Government readies 10 trillion won bond fund as yields spike
* 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 (Reuters) - 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. presidential election.
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 than anticipated.
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.”
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 taken.”
$1 = 1,186.6000 won Additional reporting by Cynthia Kim in SEOUL; Editing by Jacqueline Wong