The benchmark KOSPI ended down 74.30 points at 1,869.45. At one point the index fell 7.4 percent before clawing back some losses.

"The US credit rating downgrade sparked a retail sell-off," Park So-Yeon, an analyst at Korea Investment and Securities, told Yonhap news agency. "Institutions snapped up shares while foreigners slowed down on their selling."

Standard & Poor's downgraded its rating by one notch from AAA to AA+, citing concerns over its sovereign debt and ability to handle those debts.

"A large part of the selling seems to be due to psychological factors. In the long term, we have to keep an eye on policymakers' efforts to craft a resolution," Park said.

Retail investors sold a net 737.6 billion won ($690 million) worth of shares on the KOSPI, while foreigners sold a net 83.2 billion.

"The sharp fall came as panic swept through retail investors, triggering a massive sell-off," said Kwak Joong-Bo, an analyst at Samsung Securities.

The Korea Exchange suspended programme trading for five minutes after the KOSPI 200 futures nosedived more than 5 percent for more than one minute.

Shares lost ground across the board, with blue chips leading the slump. Samsung Electronics dropped 3.68 percent to 760,000 won and Hynix Semiconductor fell 7.22 percent to 21,850 won.

Financials also plummeted. KB Financial Group lost 7.53 percent to 43,600 won and Mirae Asset Securities slumped 10.6 percent to 42,600 won.

The won closed at 1,082.5 to the dollar, down 15.1 won from Friday's close, as foreign investors sold local shares for the fifth straight session.

Copyright AFP (Agence France-Presse), 2010