S.Korea overseas borrowing soars, govt worried

* Overseas borrowing in Sept hits 1-year high

* Government worried about massive capital flight

* Widening interest rate differentials attracts funds

* Current account surplus more than doubles in Sept

By Seo Eun-kyung and Yoo Choonsik

SEOUL, Oct 28 - South Korea's overseas borrowing soared to a 1-year high in September, reinforcing government concerns that the country is increasing the very risk that made it vulnerable during the height of the global financial crisis.

South Korea's widening interest rate differentials, especially with the United States, and moves by exporters to sell their overseas earnings in forward markets, are pushing down the cost of borrowing in dollars and other foreign exchange.

Central bank data on Wednesday showed overseas borrowing jumped seven-fold to a net $5.04 billion in September, the highest level since August 2008, from $0.69 billion in August.

For policy makers, such borrowing is an uncomfortable reminder of the global credit crunch late last year when Korean debtors faced a rush of calls to repay their foreign borrowings, placing a severe liquidity squeeze on the country.

In a matter of five months the won <KRW=> tumbled 30 percent as the credit squeeze undermined investor confidence.

The government has repeatedly warned it may take action to temper the latest borrowing. Vice Finance Minister Hur Kyung-wook said on Tuesday the government was examining all possible ways to stem growing borrowing abroad. [ID:nSEW000168]

A senior Finance Ministry official told Reuters earlier this month that a task force was considering restrictions on foreign bank branches, which have easier access to foreign funds than Korean banks.

But analysts are sceptical the government will take any significant action for fear of hurting investor confidence.

"I don't think the government will come out soon with any strong action aimed specifically at branches of foreign banks because there's little it can do without causing trouble," said Jeong My-young, a currency strategist at Samsung Futures.

INVESTORS SENSITIVE

The latest data did not disclose the borrowings of individual foreign banks present in South Korea, which include JPMorgan Chase <JPM.N> and BNP Paribas <BNPP.PA>.

South Korea's top financial regulator told European business executives based in the country on Wednesday that the government had not considered specific liquidity restrictions for foreign banks and was waiting for the outcome of a global debate on how to improve supervision of currency movements. [ID:nSEO262370]

Funds are now flowing into Korea again on optimism that emerging markets will recover before developed ones from the global downturn.

In Korea's case, many investors are also betting the central bank will raise its 2 percent policy rate in coming months, which will widen its rate premium over G7 countries.

South Korea's 1-year treasury bond yield <KR1YT=KSDA> has risen by 1.5 percentage points over the past eight months, more than doubling the gap with comparable U.S. yield <US1YT=RR> to 3.3 percentage points.

The funds flowing into Korea have propelled the won up more than 30 percent against the dollar since March. The won's rally and a recovery in exports are also responsible for the growing overseas borrowings.

Exporters are hurrying to sell off future dollar revenues for won in anticipation of a continued rise in the won. Those sales are driving down the cost of dollar funds in the swaps market and therefore fuelling demand for those borrowings.

The Bank of Korea data pointed to appreciation pressure on the won. The current account surplus in September more than doubled to a seasonally adjusted $3.66 billion from a revised $1.65 billion surplus in August. (Additional reporting by Lee Chang-ho; Editing by Jonathan Hopfner and Neil Fullick)