The government will soon finalize the won-yuan swap expansion deal with Chinese authorities to boost the $26 billion currency swap currently in place, multiple sources at the Finance Ministry confirmed on Thursday.

A senior ministry official said the expansion of the won-yuan swap was proposed by the Korean government on the sidelines of the International Monetary Fund annual meetings in Washington in September.

“The won-yuan swap talk initiated there and that’s when the won-yen swap deal made progress too,” he said on the condition of anonymity.

Should the deal be finalized, it is likely to help stabilize the won as the contract would secure more U.S. dollar funding in the case of a potential liquidity crunch. The progress on won-yuan deal was reported after Korean President Lee Myung-bak and Japanese Prime Minister Yoshihiko Noda on Wednesday agreed to raise their won-yen swap to $70 billion from the current $14 billion in their Seoul summit. The expansion will be effective until October 2012.

A bilateral currency swap arrangement secures cheaper debt for both parties at a rate decided at the time of the contract, offering hedges against sharp volatilities in the market.

The Korean won advanced to a four-week high Wednesday after the deal was announced, reflecting more bets on the currency to be stabilized.

The won closed nearly flat Friday, losing a tiny 2.4 won against the dollar to close at 1,147.4.

“We have been saying that Korea’s $300 billion-plus foreign exchange reserves are enough to weather a possible credit crunch, but the currency swap contract is our preemptive action for uncertainties ahead, because the debt saga in the advanced economies is likely to last a few years,” another senior official said.

Speaking to reporters on the sidelines of a business forum Thursday, Finance Minister Bahk Jae-wan declined to comment on the progress of won-yuan deal, saying “it is not appropriate to disclose the matter yet.”

By Cynthia J. Kim (cynthiak@heraldcorp.com)