By Jihoon Lee

SEOUL (Reuters) -South Korea’s mammoth state pension fund will hedge foreign exchange risks for up to 10% of its overseas investment compared with zero up to now, the welfare ministry said on Friday, a move expected to ease dollar demand on the onshore FX market.

The fund has grown in size and its increasing purchases of dollars for investment abroad have been blamed for exacerbating the dollar/won’s already rising trend in recent months. South Korea’s currency hit its weakest level in 13 years in October.

The finance ministry last month asked the National Pension Service (NPS), the agency in charge of the fund, to increase the ratio of FX hedging to ease the fund’s market impact from dollar-buying activities.The panel that governs the fund’s investment policies decided to allow it to adjust its ratio of FX hedging to up to 10%, for a limited period, the welfare ministry said on Friday.

“If foreign exchange rates rise to unusually high levels again, it is necessary to temporarily reduce the size of the foreign exchange exposure until the rates stabilise,” the ministry said in a statement after the panel met.

The fund will also be allowed to hold foreign stocks up to 3 percentage points above or below its target ratio in the event of extreme price fluctuations, the ministry added.

The pension fund held 27.6% of total assets in foreign stocks as of end-September, compared with a year-end target of 27.8%.

The change was significant for the market “in the sense that there has been prepared a new source of dollar supply in case of a surge in the dollar/won exchange rate,” said an FX market analyst who declined to be named.

In September, South Korea’s central bank and the pension fund set up a currency swap arrangement of up to $10 billion that is set to expire at the end of this year.

At end-September the NPS held 443.8 trillion won ($339.71 billion) in foreign assets, or 49.6% of total assets, making it the world’s third-largest state pension fund.

($1 = 1,306.3900 won)

(Reporting by Jihoon Lee, Choonsik Yoo and Yena Park; Editing by Tom Hogue, Simon Cameron-Moore, John Stonestreet)