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Key economic policymakers and financial regulators gathered for an emergency meeting on Tuesday, but failed to prevent fallout from the financial meltdown on Wall Street, with local stocks nose diving more than 6 percent and the local currency sliding over 6 percent against the greenback.
Finance Ministry officials said Lehman's failure represented "unavoidable pain" to the South Korean economy, but ruled out serious impact, citing "strong fundamentals” in the economy.
"In the short term, Lehman's bankruptcy filing would affect local bond and stock markets," Vice Finance Minister Kim Dong-soo told reporters at the end of the emergency meeting. "But in the longer term, it could contribute to easing of the credit crunch by quickly removing market instability," he said.
Kim vowed to take “all necessary measures” to prevent turmoil in the financial markets, hinting at government intervention. "We will also keep a close eye on foreign borrowing and the liquidity of foreign capital at individual financial institutions," he said.
The Financial Services Commission, South Korea's financial watchdog, has banned the two Lehman units in Seoul from selling their assets and repaying loans, in a measure to "protect investors at home and prevent potential chaos in local financial markets."
As of the end of July, the Lehman units in Seoul had a total of 1.6 trillion won (US$1.4 billion) in assets, according to the watchdog. The units will also be prohibited from receiving deposits, trading stocks and transferring money overseas.
The central Bank of Korea said South Korean financial institutions had exposure of a combined $1.34 billion to Lehman and Merrill Lynch as of Aug. 31. Merrill Lynch was acquired by Bank of America.
Despite the moves, the country's benchmark Korea Composite Stock Price Index (KOSPI) plummeted 6.1 percent to an 18-month low on Tuesday on panic selling led by foreign investors, who sold a net 600 billion won (US$517 million) worth of stock.
The junior tech-heavy KOSDAQ index plunged a wider 8.1 percent, hit by panic-driven sell-offs by foreign and individual investors. South Korea's financial markets were closed on Monday for a holiday.
The selling spree of foreign investors combined with fears of a crunch of foreign currency liquidity to push down the local currency by 6.1 percent against the U.S. dollar, marking the lowest since August 2004.
Concerns about glitches in foreign currency supply were already mounting after the South Korean government postponed an overseas sale of sovereign bonds worth $1 billion last week in the face of higher rates demand due to fears of a renewed credit crunch.
The decision forced local companies and financial institutions to delay their own plans to issue bonds overseas, which could worsen their liquidity situation.
The country's foreign reserves dwindled to US$243.2 billion in August, down from $262.2 billion last December, with the trade deficit ballooning.
Analysts say the turmoil in local markets reflects the fact that South Korea's export-driven economy is vulnerable to a global economic slowdown and other external risks.
Shares of Hyundai Motor Co., South Korea's largest automaker, which has served as a main engine for the country's exports, fell the most in more than four years on concerns about weak vehicle demand in the United States following the financial meltdown.
Kia Motors Corp., Hyundai's affiliate and the country's second-biggest carmaker, also tumbled 7.7 percent, underperforming the wider market.
"Global demand is expected to weaken following the financial convulsions, which could hurt South Korea's exports," said Lee Kyong-tae, who runs the Institute for International Trade in Seoul.
Analysts say the U.S.-caused global financial crunch would pose a real challenge to President Lee Myung-bak, who took office last February pledging rapid economic growth. Lee's government has been hit by rumors for the past two weeks that the country would slip back into a financial crisis driven by a massive capital outflow.
The so-called "September liquidity crisis" was rampant up until late last week when local bonds worth $6.7 billion held by foreign investors matured, nearly five times higher than the monthly average value of maturing bonds owned by foreign investors.
Rumors had it that the foreign investors would take their money and walk away rather than reinvesting in the domestic bond market, eventually leading to another financial crisis in South Korea.
Officials and regulators intervened in the currency market with words and cash, and no such capital flight took place. Many economists have warned that such rumors could dampen investors’ interest and turn into a real challenge.
