By Park Jung-youn

President Lee Myung-bak dismissed suggestions this week that the country faced a repeat of the Asian financial crisis that pushed South Korea to the edge of sovereign default and senior government officials have repeatedly tried to reassure investors that the banking system can withstand the credit upheaval.

That message was reiterated on Wednesday by Bahk Byong-won, senior secretary to the president, who said the government believed the won's fall was a threat to inflation but liquidity at local banks was not a major problem.

"What I hear from them is that it's not that serious," Bahk told reporters.

Investors remain unconvinced and analysts said that as the global financial crisis continues to hammer South Korea, the won is likely to slide further.

The won slumped as much as 5 percent on the day to 1,398 per dollar, its lowest level since South Korea was beginning to emerge from the ravages of Asia's financial meltdown in 1997/98. It later edged back up to 1,376.90/1,377.10.

This week alone the currency has skidded more than 12 percent in value against the dollar as investors fretted over a global credit crisis that has starved the country's banks of dollars and fueled the worst capital flight from South Korea since the collapse of Asia's markets a decade ago.

"Further losses cannot be ruled out," said Patrick Bennett, strategist at Societe Generale in Singapore. "Portfolio flows are coming out of the market and the level of offshore borrowing by the bank sector remains a risk investors are unwilling to accept - despite the still high level of FX reserves."

In a sign of how worried the government has become, the president called this week for a summit with the Asian economic powers of Japan and China. And the finance minister urged local banks to sell foreign assets to raise dollars that other banks aren't willing to lend them.

SQUEEZE

The tight liquidity in South Korea's banking sector would last until the end of the year, a senior official at state-run Korea Development Bank (KDB) said. He declined to be identified because of the sensitivity of the issue.

The bank plans to raise up to $4 billion from loans, short-term borrowing and private bond deals to help cover an increasingly painful squeeze on foreign currency liquidity in the domestic market, he said.

The government has encouraged state banks to raise funds from bond sales to help ease pressure on commercial banks less able to access funds abroad and because of concerns they could face a struggle to roll over foreign debt payments.

But an official in charge of foreign financing at the country's largest lender, Kookmin Bank <060000.KS>, told Reuters on Tuesday that the dollar shortage was not as severe as the market feared. He also declined to be identified because of the sensitivity of the issue.

Reflecting a global assets sell off, the main Seoul stocks index slumped.

By 0526 GMT, the main index <.KS11> had dropped more than 5 percent, slipping below 1,300 for the first time since August 2006. Taking its cue from big falls on Wall St, the index has fallen 14 percent since late September.

Other stocks markets in Asia are falling sharply. Tokyo's Nikkei average <.N225> was down close to 9 percent on the day.

The won is Asia's worst-performing currency among those monitored daily by Reuters News, having dropped 30 percent this year in a global crisis that began in the United States and has ricocheted across markets from London to Reykjavik.

The won's fall could put more pressure on the economy. Core inflation, which strips out food and oil prices, is already running at a 10-year high of 5.1 percent and the government and central bank expects the current account to swing this year to its first deficit since the Asian financial crisis.

"The impact will be biggest on local inflation, importers and companies with heavy foreign-currency debt. But in general, this fast drop in the won will be very negative to the whole economy," said Lee Sung-kwon, chief economist at Goodmorning Shinhan Securities.

"There's little the Korean government can do here because this is so closely linked to the U.S. crisis," he said.

Still, not all analysts are convinced that South Korea is yet in the sort of crisis that buckled the economy a decade ago.

A combination of the global credit market crisis, the domestic credit squeeze and the falling won combined were a heavy blow to banks, said Ku Yong-uk, an analyst at Daewoo Securities.

But he added: "I can safely say, up until this point, that the situation is far better than it had been during the (Asian financial crisis) since South Korea has ample foreign currency reserves to meet the immediate demand for foreign liquidity."

(Additional reporting by Cheon Jong-woo and Yoo Choonsik, writing by Jonathan Thatcher; Editing by Neil Fullick)