The Korean bond market continues to see an outflow of funds for a third month as investors flee to capture rising yields elsewhere and tab on bullish equities.

The investor exodus is led by foreigners who were fast to exit the market to avoid a revived tax of as much as 14 percent on interest income which Seoul imposed in January to limit capital inflows.

Analysts attributed the continued price decline to the inflationary pressure and uncertainty over the currency controls, recently criticized by the U.S. and Japanese private sector.

“Investors aren’t too keen on treasuries right now as the bond prices face uncertainty from the interest rate review meeting by the Bank of Korea this week. Short-term treasuries, especially the three-year one will continue to decline,” Oh Chang-sub, fixed income analyst at IBK Securities said.

Bond prices tend to decline under the inflationary pressure or signs of fast economic growth, as they prompt benchmark interest rate to rise. A rate hike devalues the existing bonds issued at lower rates. Bond yield move inversely to prices.

Balance at mutual fund accounts at local securities firms declined to 50.36 trillion won this month, down more than two trillion won from 52.57 trillion won last month.

Overseas investors sold a net of 1.77 trillion of won-denominated bonds in January. The figure has improved from a net sale of 5.71 trillion won in December but outflow continued under Seoul’s tight oversight of capital inflow.

Analysts also attribute foreign outflow to the 4.1 percent inflation rate in January, which prompted investors to sell off their bonds in the expectation for a rate hike this Friday.

Korea has seen fast inflow of capital and stoking inflation which are threatening to cause asset bubbles. Seoul has been rolling out measures to slow the inflow with taxes and tighter oversight of trading in foreign exchange derivatives.

Declining demand is reflected on the rising bond yield.

Yield on three-year treasuries increased at the fastest rate for the past two months, rising 41 percent from 2.89 percent in the first week of December to 4.07 percent as of Tuesday.

Yield on 10-year KTB is trading at 4.82 percent, up two basis points from Monday.

Analysts say bets are now moving to the bullish stock market.

“The higher yield from continued signs of economy heating up is making some favorable conditions for investors to move to equities,” Kim Jin-young, a Samsung Securities analyst said.

The government is intensifying efforts to recoup government assets by collecting payments on overdue loans to expand revenue.

While demand for government debt is declining, defaulted debts increased over the years to 4.5 trillion won as of 2009. The total amount of debt owed to the government is 164.4 trillion won, according to the Ministry of Strategy and Finance.

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