The International Monetary Fund(IMF) urged South Korea to refrain from stepping into the foreign exchange market in its report released Tuesday, saying the appreciation of the country's currency is caused by its large trade surplus and excessive foreign reserves.

In an external sector report based on the policies of 2013 and the first half of 2014, the IMF said, "In some countries (China, Korea), FX (foreign exchange) purchases for non-spot market interventions were deployed in the context of remaining real exchange rate undervaluations."

Seoul has repeatedly denied its intervention in the currency market, saying dollar purchases have been limited to smooth volatility.

The report deals with the latest development in the rising global tensions over currency devaluations in a bid to make exports more competitive than other exporters.

In a bid to narrow the trade surplus gap, South Korea, Asia's fourth-largest export-oriented economy, needs to implement policies to boost sluggish consumption such as ones that improve social safety nets and reform its financial system, IMF said.

South Korea extended its current account surplus for the 28th consecutive month in June to US$7.92 billion but saw the figure slip from the previous month as the surplus for goods narrowed, according to the Bank of Korea.

In face of growing pressure to decrease its trade surplus, the South Korean government said its large current account surplus was partly due to the lower cost of oil imports and sluggish domestic demand, rather than only a surge in exports.

"Korea continued its path of reserve build-up, amid reserve buffers already adequate from a precautionary perspective," the report said, adding more regulatory measures to resist its currency appreciation would do more harm than good.

IMF said the Bank of Korea also increased its foreign exchange forward position by US$12 billion last year despite a sizable appreciation, noting the South Korean won has gained 13 percent against the dollar as of May compared to its average level in 2012.

The won has continued to strengthen against the greenback this year, hitting a six-year high on July 2.

"Among some of these economies, greater exchange rate flexibility would be useful, given the adequacy of reserves, one-sided reserve accumulation over long periods should be avoided," the IMF report said. (Yonhap)