South Korea is examining measures to control currency flows to protect its economy from external shocks, with financial authorities considering regulating forward contracts to reduce currency volatility.

Concerns in Seoul have grown over increasing volatility since the rising geo­political risks on the Korean peninsula caused the won to plunge.

“The events of the past week gave us another reminder of the impact of capital flows driven by short-term market-driven dynamics rather then the economic fundamentals,” said Shin Hyun-song, the South Korean president’s senior adviser on international economy.

Mr Shin said the government was considering “various options” for regulating currency forward positions for domestic banks and the Korean branches of foreign banks. He insisted that any measures would be introduced carefully to allow market participants a “smooth transition.”

Currency forward contracts, which lock in the price for buying or selling a currency on a future date, have often been cited as one of the reasons for volatility. The Korean won slid about 40 per cent in the six months after the collapse of Lehman Brothers in September 2008.

At the end of last year, financial regulators limited the size of forward transactions by local companies to no more than 125 per cent of the revenues they were hedging. Exporters, especially shipbuilders, were accused of overhedging foreign orders, putting upward pressure on the won before the global financial crisis hit the country.

Traders at foreign banks said the pending measures could help reduce foreign currency volatility, but excessive regulation of capital flows would clash with Seoul’s ambitions to become a financial centre.

The won slumped to a 10-month low last week after Seoul blamed Pyongyang for the sinking of a navy ship, which killed 46 South Korean sailors. The won has recovered some of the losses on suspected government intervention.

Financial authorities say the recent fluctuations illustrate the need for some curbs on currency flows.

“South Korea is a small open economy vulnerable to even small changes in capital movement,” said Kim Jong-chang, Financial Sup-ervisory Service governor.

Additional reporting by Robert Cookson in Hong Kong

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