"Domestic demand has shrunk too excessively in the course of corporate and financial restructuring," a statement issued by the ministry of finance and economy said.

The ministry said it would lower interest rates further through "flexible" monetary and fiscal policies and disburse funds from its supplementary budget earlier than scheduled to boost infrastructure construction.

The plans were among economic policies that finance minister Lee Kyu-sung reported to president Kim Dae-jung during an inter-ministerial meeting on the economy on Wednesday morning, a ministry spokesman said.

South Korean stocks ended the morning session 1.67 per cent higher on the announcement and the sharp rise overnight on Wall Street. The Composite Stock Price Index stood at 314.88, a gain of 5.17 points.

Analysts said the government's steps wouldhelp revive the depressed economy, but could delay the process of restructuring the economy mandated by the International Monetary Fund (IMF).

A batch of recent economic indicators has fanned fears the country's economy was heading for a long-term recession after months of belt-tightening.

Since plunging into a financial crisis late last year and turning to the IMF for a $58.35 billion rescue package, the government has put in place tough austerity measures including interest rates of 20 to 30 per cent in the first quarter.

But the measures have helped to further cripple an already lame economy, analysts said.

The central Bank of Korea has said gross domestic product (GDP) contracted a real 6.6 per cent in the second quarter of this year, against 6.6 per cent growth in the same period a year earlier.

The seasonally-unadjusted unemployment rate rose to a record high 7.6 per cent in July and industrial output fell 12.9 per cent from a year ago, according to government figures.

Capacity utilisationof South Korean manufacturers dropped to a record low of 63.7 per cent in July from 80.3 per cent in the same period last year.