The government recently announced measures to stabilize financial markets and support the construction and real estate industries -- but such steps failed to soothe investors’ jitters.

On Tuesday, the credit default swap premium on 5-year forex stabilization bonds issued by Korea rose to a record 4.27 percent on international financial markets. The credit default swap premium on Korean forex stabilization bonds was 0.86 percent at the end of July and 1.8 percent at the end of September.

The premium is much higher than countries with lower sovereign credit ratings than Korea, such as Brazil (3.86 percent), Thailand (2.57 percent) and Malaysia (2.68 percent).

Credit default swaps are derivative products whereby investment banks or other guarantors pay the debt if the bond-issuing company or country goes bankrupt. The rising premium demonstrates increasing fears that the issuing country may go bankrupt. We are experiencing a strange phenomenon where countries whose sovereign credit ratings are higher are being treated as higher-risk cases.

The main reason for the volatile stock and forex markets is foreign investors unloading US$34.8-billion worth of Korean stocks from the beginning of this year until last Friday. Over that same period of time, foreign investors sold $12.2-billion worth of Taiwanese stocks, $11.2-billion worth of Indian shares, $11-billion worth of Japanese shares and $4-billion worth of Thai stocks.

During the first 8 months of this year, foreign investors sold W25.6 trillion (US$1=W1,406) of Korean stocks, but exchanged W31.5 trillion into dollars exported out of Korea. Foreign investors not only dumped Korean stocks, but apparently emptied their safes and fled the country. Figures seem to indicate a major exodus of foreign investors from Korea.

But that’s not the only way to look at the situation. From the beginning of this year until last Friday, Korean shares declined 38 percent in value, while Japanese stocks dropped 43 percent. Taiwanese, Indian and Thai shares also dropped more than 40 percent. Those countries faced far less selling pressure than the KOSPI, yet their share prices dropped much more. Korean shares have fared better.

But the forex market is crumbling under the shock of this “Sell Korea” mindset. The won has weakened by 50 percent against the dollar so far this year. Most Asian currencies have weakened against the euro and other currencies of advanced countries, but only by 5 - 20 percent. In contrast, the Japanese yen has strengthened more than 10 percent against the dollar. It is difficult to attribute the weakening of the won simply to foreign investors bailing out.

Some also blame the weak financial health of Korean banks, saying the amount of loans extended exceeds the reserves in their deposit accounts, while they also depend too much on foreign currency loans to raise capital. Investors’ jitters increased after foreign news media cited these problems.

Often the reasons founding these worries are either exaggerated or false. Moreover, the government’s decision to guarantee foreign currency debts held by Korean banks has eased fears. Unlike the United States and Europe, a run on deposits at banks is not expected. Not only that, U.S. and European banks have also seen their equity capital decrease due to losses from sub-prime mortgage loans. However, Korean banks are profiting. That is why the government needs to use public money to bolster banks’ equity capital.

The same reasoning also applies to the criticism that Korea is overburdened by too much short-term debt. Some say Korea has $175-billion worth of short-term debt, but domestic banks have only $80 billion worth due to mature at the end of June 2009. This amount is well within the range that can be handled by Korea’s $240-billion foreign currency reserves. Moody’s and S&P recently said they were maintaining their “stable” rating on Korea’s economy, citing the government’s healthy fiscal status and ability to handle the financial crisis.

It seems the Korean economy is suffering from a mysterious psychological fever. In times like this, the government must be careful not to fluff the timing of its policy responses. No time must be wasted in correcting problems with economic leadership. Aggressive measures must be taken to publicize accurate information about the Korean economy to foreign investors and media. And diplomatic measures must be undertaken to calm cross-border financial jitters.