* Deal on expanded swaps to expire end-Oct as scheduled
* Agreement comes amid diplomatic dispute over islands
* Seoul cites market stability, increased soundness
By Tetsushi Kajimoto and Choonsik Yoo
TOKYO/SEOUL, Oct 9 (Reuters) - Japan and South Korea will not renew a $57 billion currency swap facility designed to protect their economies against financial crisis, a decision they said was not related to a territorial dispute that has cast a chill over ties between the neighbours.
Officials from both countries were quick to stress Tuesday's
decision not to extend the facility, set up last October as concerns mounted about the U.S. budget deficit and Greece's possible default, was made purely on economic grounds.
However, it may raise questions about the network of bilateral swaps many Asian countries have set up if the agreements could be seen to come under pressure due to a diplomatic stand-off.
"It's not that the principle of separating economics from politics has been broken, but that this decision was made purely on an economic point of view," South Korean Deputy Finance Minister Choi Jong-ku said in Seoul.
"It is against principle to extend even when there is no need."
The value of bilateral currency swap arrangements between the two will return to $13 billion at the end of the month from $70 billion, South Korea's central bank said in a statement.
Markets showed little reaction. At 0600 GMT, the won was up 0.1 percent against the dollar, and the yen/won cross rate was quoted at 14.16 won compared with around 14.18 late on Monday.
In contrast, when the deal was announced a year ago, it had lifted the won to a one-month high against the dollar.
<^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ FACTBOX: Korea's FX swap deals ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^> RISKS RECEDE
A political row broke out between Seoul and Tokyo in August after South Korean President Lee Myung-bak visited islands that both countries claim sovereignty over.
Japan is also embroiled in a territorial dispute with China over a different group of islands. Both rows are testing the limits of Japan's economic cooperation with its neighbours.
"While there are political sensitivities surrounding the issue, it is the solid fundamentals of the Korean economy that has most likely driven the decision," said Ronald Man, an economist at HSBC in Hong Kong.
"To some extent, the decision does reflect the relative ease of reopening the deal if necessary."
The expanded swaps were put in place last year as problems in the United States and Europe had sparked fears of a repeat of the 2008 global financial crisis and 1997/98 Asian financial crisis, with South Korea seen vulnerable to capital flight.
The risks of an exodus of capital have receded since then even though the economic outlook remains uncertain, financial market volatility has fallen and South Korea's economic fundamentals have improved.
"Japan and South Korea reached a conclusion that extension would not be needed, while sharing a view that financial markets have stabilised and macro economic situation has become healthy," Japanese Finance Minister Koriki Jojima said in Tokyo.
The remaining swap facilities could be expanded if needed, although there is no automatic right to access extra funds.
In a signal that economic links are still open, a Japanese finance ministry official said on Tuesday the government would consider purchasing South Korean government bonds from now on, although no decision had been made.
(Writing by Stanley White; Editing by John Mair)
Keywords: KOREA JAPAN/SWAP