South Korea plans to restrict domestic and foreign banks from investing in foreign currency bonds sold within the country for the purpose of won conversion, in a bid to curb short-term foreign debt, the central bank said Tuesday.

Since May, the Bank of Korea (BOK) and the financial watchdog have been inspecting banks' handling of so-called "kimchi bonds,"

foreign-currency debt sold by local and foreign companies in South Korea, as excessive sales of such bonds are blamed for raising short-term overseas debt.

The BOK said Korean banks, local branches of foreign banks and other financial firms are required to check the purpose of selling kimchi bonds if they want to buy them. If such bonds are sold with an aim to convert the dollar into won, those institutions are not allowed to invest in the debt. The move will take effect starting July 25.

"Companies can sell foreign currency-denominated bonds as they are doing so currently. But banks and others will be restricted from investing in foreign currency bonds issued to convert dollars into the won," Kim Han-soo, head of the BOK's international planning and coordination team, told reporters.

He said over the long haul, the move would considerably affect the sales of such debts.

The use of proceeds from the sales of kimchi bonds is originally restricted to foreign-currency transactions, but some local firms have sold kimchi bonds to convert the dollar into the won through local branches of foreign banks, given that the issuance of foreign-currency bonds is cheaper than that of won-denominated ones.

The move came as excessive sales of kimchi bonds have been blamed as the main culprit of rising short-term foreign debt, putting upward pressure on the local currency. The Korean currency has appreciated nearly 7 percent to the U.S. dollar since January.

The sale of kimchi bonds reached $17.05 billion as of the end of June, up $2.09 billion from the end of last year, the central bank said. The issuance of such debt rose to $17.84 billion in April before falling in May and June amid the government's move to curb banks' handling of such bonds.

Local branches of foreign banks are major investors in kimchi bonds, accounting for 76.9 percent of the total bond investments.

According to the central bank, the recent inspection found that about 70 percent out of more than half of such bonds was issued to swap the dollar into the local currency.

A rise in short-term borrowing can become a source of headaches after a surge in foreign debt left local banks vulnerable to external shocks at the height of the global financial crisis. (Yonhap News)