The deepening woes at Fannie Mae and Freddie Mac, badly stretched central bank reserves and a losing battle to support the won are pushing South Korea towards a full-blown currency crisis this month, analysts have said.

Heavy investment by the Korean Government in Fannie, Freddie and other US-related agency bonds has left a potentially huge liquidity problem - perhaps $50 billion (£27.4 billion) - in the foreign reserve portfolio. Some believe that Seoul might have no ammunition left to prevent a significant flight from the won. Fruitless currency intervention by South Korea - increasingly desperate-looking verbal and financial measures to fight the market trend - cost about $20 billion in July alone.

Attempts to prop up the won come as South Korea’s household and corporate sectors are wincing from the pain of high energy prices and inflation. A summer of strikes by lorry drivers and mass street demonstrations calling for President Lee to resign reflect rising public concern that the economy is in trouble.

The intervention efforts have failed to prevent the currency sliding more than 7 per cent against the dollar in the past month. The won is teetering at a 44-month low against the greenback and, with the central bank’s foreign exchange reserves still dwindling, economists at CLSA, the brokerage, say that it is “a game that Korea can literally no longer afford to play”.

Moreoever, the situation could worsen dramatically: $6.7 billion of Korean bonds mature this month, potentially creating vast downward pressure on the won if a large part of that sum immediately flees abroad.

Korea’s foreign exchange reserves stand at $247 billion. The International Monetary Fund recommends that emerging market economies should hold nine months’ worth of import cover, which would be about $320 billion.

More worrying, according to economists at HSBC, is the level of Korea’s foreign exchange reserves relative to its short-term debt ratio. Korea’s debt maturing within a year has shot up to $215.6 billion because of hedging against the oil price. While that is nominally within the 100 per cent coverage by forex reserves deemed necessary, the Fannie and Freddie crisis in the United States raises the question of whether any sense of security is illusory.

A large part of Korea’s foreign reserves are not government bonds but the kind of US-based mortgage-related bonds that once looked so solid. Depending on how the Fannie and Freddie situation develops, a significant portion of Korea’s forex reserves could turn out to be extremely illiquid, leaving the country ever more vulnerable to external shock.

“The coverage ratio may in reality be not as comfortable as the authorities would like, meaning they have less with which to defend the currency,” said one senior Asia-based economist.

Although few are predicting a financial meltdown such as the one that hit the region in 1997, recent weeks have exposed some unique vulnerabilities in Asia’s third-largest economy. The danger, Sharmila Whelan, CLSA’s senior economist, said, is that South Korea has not recognised the perils of intervention, given the country’s hefty current account deficit.

“The risk is that once investors realise how tenuous Korea’s reserve position actually is, they will start abandoning Korea in droves and send the currency tumbling,” Ms Whelan wrote in a recent note to clients.

Soaring inflation and a legacy of massive borrowings by households add an additional, potent layer of instability. Government insiders in Seoul have told The Times that there is a “credible risk” that the Korean banking system could be ravaged by a self-generated version of the credit crunch that has hit Wall Street and the City.

Analysts predict a rising tide of nonperforming loans, delinquency ratios and bankruptcies and some of the country’s large mutual savings banks are expected to go bust.

Explore Economics

• Pre-Budget Report 2009

• Budget 2009

• World Economic Forum in Davos

• The Times MPC

Times Recommends

• Toyota recalls 437,000 cars including Lexus
• Myners says bonuses are bleeding pension funds
• Japanese company faked safety reports on seats