Download Korea`s Experience with External Debt Management

A Tale of Two Crises: Korea’s Experience
with External Debt Management
Paper Prepared by
Professor Yung Chul Park
Seoul National University
UNCTAD Expert Meeting
Debt Sustainability and Development Strategies
Korea’s Experience
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Small and large financial crises:
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1968-1969; 1974-1975; 1979-1980; 1991-1992;
1997-1998.
In each case the crises were preceded by:
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An investment boom
A growing current account deficit in proportion to
GDP
A real effective appreciation of the currency
Developments leading up to the 19791980 crisis
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Export promotion strategy
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Investment boom
Dramatic rise in inflation in 1980
Appreciation of the real effective exchange
rate
Slowing of growth in 1979
Additional Developments
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Oil crisis 1979
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Assassination of President Park in 1979
Deep Recession in 1980
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Deterioration of Terms of trade
Contraction of investment
Poor Harvest
Increase in current account deficit
1979-1980 Crisis
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Deep Recession
Large current account imbalance
Crisis in the informal credit market
Total debt as a proportion of GDP rose by
more than 10 percent in 1980
Crisis Response and Management
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Devaluation of the won vis-à-vis the US dollar
(27 percent in 1980)
Move to a managed float
Growth-first strategy
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Spending out strategy
Expansionary fiscal policy
High growth of M2 and M3
Recovery and Shift to Stabilization
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Inflation begins to subside in 1981
Current account deficit shrank to 3.3 percent
of GDP by 1982
Resumption of double digit growth in 1983
Shift to stabilization policies 1983-1988
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Reversal of monetary and fiscal policies
Total external debt remained over 47 percent
of GDP
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Heavily laden with short term loans
1997-1998
Capital Account Crisis
Investment Boom prior to the
1997-1998 Crisis
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Steady economic growth (1994-1997)
Strengthening of the yen
Financial liberalization and market opening
Movement to foreign countries as foreign
direct investors
High accumulation of foreign debt of
domestic firms
Bursting of the Investment Bubble
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Depreciation of the yen (Q3 1995)
Deterioration Korea’s of terms of trade
Real effective exchange rate appreciation (Q3 1995)
Slowing of the economy in second half of 1996
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Industrial groups slow to adjusting investment and output
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Rising inventories
Accumulation of debt
Commercial Banks less willing to meet credit needs
Factors contributing to
financial market collapse 1997
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Slowdown of export growth
Deterioration of terms of trade
Soaring levels of corporate bankruptcies
Rapid rise in non-performing loans of financial
institutions (Dec 1996-June 1997)
Additional factors contributing to collapse
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Pending presidential elections (Dec 1997)
 Political uncertainties prompt capital flight
Unclear exchange rate policy
Defense of the won under pressure to
depreciate
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Fall in the Bank of Korea’s reserve holdings
Repeated lowering of sovereign credit rating
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Contributed to further the worsening of market
sentiment and foreign exchange rate depreciation
Management and Recovery of 1997-1998
Crisis
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Government reform package (19 Nov. 1997)
IMF Bailout (3 Dec 1997)
 Package $21 billion
 Conditionality
 Response to bailout package
Emergency financing program (24 Dec 1997)
 Additional funds ($10 billion)
 Government guarantee on private debt
Macroeconomic Policy Adjustments
 Initial tightening of monetary and fiscal policy
 The consequential increase in interest rates contributed to
widespread bankruptcies
 Reversal of fiscal and monetary policies in the face of a deeper
recession to more accommodative stance.
1997-1998 Crisis
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Strong contraction of GDP in 1998 to -6.9 percent
growth
Rise in inflation (7.5 percent)
Strong depreciation of the won vis-à-vis the dollar
Rapid Recovery
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Expansion of growth by 9.5 percent in 1999
Current account surplus in 1998
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Large increase in net exports
Decline in import demand
Rapid Recovery
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Higher level of openness fueled recovery:
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Flexibility of labor market
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Large depreciation
Large trade sector and export orientation
Wage adjustments
Reallocation of resources from non-tradeables to
the tradeables sector
Strong global economy
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Improvement in terms of trade in 1999
Appreciation of the yen
Similarities across crises
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Crises were in part precipitated by an
investment boom financed by foreign
borrowing.
Rapid recovery
Similar ratios of external debt to GDP
Rigid foreign exchange rate systems
exacerbated the crises
Economic fundamentals
Aggressive export promotion policies
Differences between crises
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First case 1979-1980
 Capital account
transactions were tightly
controlled
 No capital flight
 Continued willingness to
finance the CA by
international financial
market
 Spend-out policy adopted
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Expansionary monetary
and fiscal policy
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Second case 1997-1998
 Capital account
deregulation and freer
movement of capital
 Capital flight
 IMF package
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Tight monetary and fiscal
policy in concert with
devaluation of the
exchange rate
Differences between crises
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Policy response
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(expansionary/contractionary)
Economic environments
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Economic liberalization
Market deregulation