South Korea's financial authorities and the central bank vowed Tuesday to take measures to stabilize the local financial markets or increase the supply of liquidity if necessary.
The pledge came as the Financial Services Commission (FSC) and its executive body the Financial Supervisory Service (FSS) held an emergency meeting to address the market rout sparked by last week's U.S. rating downgrade.
"We will draw up necessary market-stabilizing steps after monitoring financial market situations," the FSC said in a statement.
The financial watchdog also called for market participants to stay calm, saying the recent market turmoil would have a limited impact on the local economy, given the country's sound fiscal status and large foreign reserves.
Financial authorities plan to continue to hold such meetings before the daily market opening until the financial market regains its stability, it said.
The Bank of Korea (BOK), the country's central bank, also said in a report to lawmakers that it will strengthen its monitoring of the financial markets and provide ample liquidity to the financial system if necessary.
"The BOK will closely watch cross-border movements of foreign stock funds and check foreign currency liquidity conditions at local financial institutions," the central bank said.
"The BOK will also expand the supply of local and foreign currency liquidities if market interest rates jump and FX liquidity conditions worsen due to massive foreign capital outflows."
Export-dependent South Korea is sensitive to foreign currency liquidity conditions at local financial firms as it learned a painful lesson from the global financial turmoil. Local banks suffered from a severe credit crunch at the height of the global financial crisis even though the turmoil did not originate from Korea.
The financial watchdog and the BOK said Korea's external debt structures and FX liquidity situations sharply improved, a stark contrast with those seen in the collapse of Lehman Brothers in 2008.
The FSS said local banks' short-term overseas borrowing sharply decreased in July while they increased long-term borrowing in a bid to brace for worsening external situations. Banks' short-term refinancing rate fell 40.1 percentage points on-month to 67.3 percent in July.
The BOK said the local financial markets are expected to face high volatility for the time being as a U.S. economic slowdown and Europe's debt crisis are not likely to settle down in the short term.
But the bank said the U.S. credit cut is expected to have a limited impact on the Korean economy even if it would lead to a slowdown in the world's largest economy due to higher borrowing costs and a slump in consumer spending.
The BOK estimated that if U.S. economic growth falls 1 percentage point, the growth rate of the Korean economy would decline by 0.44 percentage point and consumer prices would fall by 0.17 percentage point.
The U.S. credit rating downgrade by Standard & Poor's raised fears that global central banks may decrease the weight of dollar assets in their foreign asset holdings in the short term.
But South Korea said it will not make any significant changes to the amount of its investment in U.S. bonds as they are viewed as "still the most flexible and stable" foreign assets.
"From the mid- and long-term perspective, the central bank's move to diversity its foreign assets will be maintained, but the BOK will refrain from abruptly changing portfolios of foreign reserves," the BOK added. South Korea's foreign exchange reserves reached a record US$311.03 billion as of end-July.
The move came as the Seoul financial markets were jolted by investors' panic selling driven by the U.S. credit downgrade.
The benchmark Korea Composite Stock Price Index (KOSPI) has fallen more than 15 percent since Aug. 2, gripped by fears about a double-dip recession.
The KOSPI crashed as much as 9.88 percent on panic selling at one point in late morning trade although it recouped heavy earlier losses to close 3.64 percent lower on a buying spree by pension funds and other institutions.
The local currency has depreciated to the dollar for the sixth straight session as global recovery woes revived investors' appetite for safe assets. The Korean won has lost about 3.4 percent to the greenback since Aug. 2
Global credit rating agency Standard & Poor's cut the U.S. credit rating by one notch to "AA+" from a top-tier "AAA" on Friday, sending global financial markets into a tailspin.
The Group of 20 leading economies pledged on Monday to cooperate closely to tackle market instability, saying that they will take "all necessary initiatives" to support the world's financial stability. But it was not enough to soothe investors' fears about a potential global double-dip downturn.