Download Korea: Country Paper on Macroeconomic and Financial Stability

Korea: Country Paper on Macroeconomic and
Financial Stability
Ehung Gi Baek
Sangmyung University
September 1999
* This paper is prepared for the International Conference on the Challenges of
Globalization organized by the Faculty of Economics, Thammasat University.
I. Introduction
Since the Korean government requested a bailout loan from the IMF to escape its external liquidity
crisis in December 1997, the Korean economy has been passing through a long dark tunnel of financial
crisis. As such, the nation has undergone drastic changes in its economic system as well as its
institutions.1
The financial crisis has brought unprecedented economic and social distress to the Korean people.
While the average growth rate in the 30 years prior to the crisis was well above 8%, it plummeted to –
5.8% in 1998. Due to the rapid depreciation of the Korean won, the import price index rose by 28%,
which influenced the consumer price index by 7.5% in 1998. Such an increase in the CPI is not
terrifying in itself, but it certainly was a major factor in reducing the level of public welfare during the
recession, given that inflation rates prior to the crisis had stabilized at around 4% for three consecutive
years. Korea’s previously steady trend of unemployment also reversed, more than tripling after the
crisis. No one expected such a severe contraction.
The financial sector was afflicted with a credit crunch which has yet to be fully resolved. This credit
crunch has much to do with the conditions attached to the $57 billion IMF standby agreement, in that
these stipulated Korea undertake both macroeconomic stabilization and structural reforms. Korea’s
monetary policy supported a high interest rate to stabilize the exchange rate in a short time period and
to lash the corporate sector toward restructuring. However, although currency stabilization was
achieved, the costs were severe, even after the policy was adjusted in the first half of 1998. The trend of
the market interest rate and loans by deposit money banks (DMBs) show how severe it was. The
interest rate represented by corporate bond yields doubled after the crisis. The average loan increasing
rate by DMBs shrank to 0.1% in 1998, although since then it has risen to about 12-16%. Loans to the
manufacturing sector and to households were especially reduced on an extensive scale.2
The aim of this paper is to discuss Korea’s strategy for macroeconomic and financial stability. Chapter
II describes the recent macroeconomic trends.3 We verify that all of the important macroeconomic
1
Choi (1999), Park and Rhee (1998) describe the chronology of the Korean crisis from its inception, including
discussion on the fragile financial sector, lax supervision, and the contagion effect.
2
There is vast literature on the relationship between the financial and real sectors centering around the
transmission mechanism and bank lending channel. See Bernanke and Gertler (1995). Baek (1999) constructed
an empirical model of the credit crunch in the Korean economy.
3
For an extensive review of the recent Korean economic trends and ongoing issues, see OECD (1999).
1
variables demonstrate strong upturn signals. However, regardless of the numerical recovery, Korea’s
prospects for completely recovering from the crisis in a short period of time are not clear. Chapter III
addresses issues involving financial stability. While real sector recovery is magnificent, the financial
sector still quakes with its colossal scale of non-performing loans. Intrinsic restructuring needs to
continue regardless of improved performance. In particular, the success of efforts made for stabilizing
the Korean economy depends on restructuring of the inefficient corporate sector. Chapter IV deals with
the progress of restructuring and policy evaluation. Here we list some of the more important issues of
the program. The recent rapid economic upturn is largely attributed to the government’s low interest
rate and expansionary fiscal policy. Yet if the rapid pickup of the growth rate has the incidental effect of
a slackening in economic reform and restructuring progress, these policies are not appropriate in the
long run. Also in this chapter, we make suggestions for desirable future policy directions.
II. Recent Macroeconomic Trends
The Korean economy has been quickly recovering since the first quarter of this year. The factory
utilization ratio reached 81% in July 1999, the highest in 27 months, while industrial output marked a
33.1% rise on a year-on-year basis, recovering to the level seen before the November 1997 financial
crisis (Figure 1 and Figure 2).
< F ig 1 >
A ve ra g e M a n u fa c tu rin g U tiliza tio n R a tio
90
85
80
75
70
65
60
55
2
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
50
< F ig 2 >
In d u stria l P ro d u c tio n G ro w th (% )
40
30
20
10
1999
1998
1997
1996
1995
1994
1993
1992
- 10
1991
0
- 20
Also in July, the coinciding composite index was up 1.4% points on a month-on-month basis, the fifth
consecutive monthly rise. The leading composite index rose 1.5% points from the previous month, an
expansion of 23% over the same time period a year ago. Overall industrial activity is evidently showing
revitalization.4
Such a remarkable recovery in the real economy became evident in the first quarter of this year. During
this period, the GDP grew 4.6%, followed by 9.8% growth in the second quarter, outpacing
expectations in terms of the speed of recovery. Private consumption recorded a 7.6% increase during
the first half compared to the 10.6% decrease recorded in the first half of 1998. Also in the second
quarter, fixed investments narrowly broke from the negative growth trend set during the previous seven
quarters (Figure 3). Exports, which are seen as the engine of the Korean economy, rose 15.9% in the
first half in terms of export volume.
< F ig 3 > R e a l G ro w th , C o n su m p tio n , F ixe d C a p ita l
R e a l G ro w th
C o n su m p tio n
4
1999
1998
1997
1996
1995
1994
1993
1992
1991
25
20
15
10
5
0
- 5
- 10
- 15
- 20
- 25
- 30
F ixe d C a p ita l
Other East Asian countries experiencing the financial crisis have also showed strong recovery since 1998. For
reviewing the East Asian financial crisis and its aftermath, see Park and Song (1998), Cho and Rhee (1999).
3
While the fast recovery acts to restore investor confidence in the Korean economy, concerns persist
regarding the speed of the current growth rate. Specifically, the issue has been raised that such a high
growth rate can possibly delay the restructuring schedule, with the result that the Korean economy
returns to its former habitude. There is, however, a refutation against this view. Since the growth rate of
this year is a mere reversion from the sharp economic downturn in 1998, the current recovery speed is
not fast. If the domestic demand continues to grow and a favorable economic atmosphere prevails,
such as the strong yen, the Korean economy is expected to grow nearly 8% in 1999 in contrast to the
5.8% contraction last year.
We believe that the recent high growth rate is not so much a reflection of economic reform or
restructuring but rather is attributable to a favorable environment and macroeconomic policies.
Therefore, the economic reform and restructuring process is likely to go on toward achieving the
rehabilitation of Korea’s economic growth potential. The government also holds the view that the
current economic recovery can be sustained only by successfully completing economic restructuring.
Macroeconomic variables other than the GDP and its components have also demonstrated strong
recovery signs in the first half of 1999. Consumer prices increased by 0.6% in this period, which is the
lowest rate of increase ever recorded over the 30 years of the nation’s economic development (Figure
4).
< F ig 4 >
12
In fla tio n R a te
10
8
6
4
2
19
99
19
98
19
97
19
96
19
95
19
94
19
93
19
92
19
91
0
Overcapacity and the favorable price of imported goods due to the strong won helped keep the inflation
rate down. Even though inflationary pressure is expected in the latter half due to rapid economic
recovery, inflation in 1999 is likely to stabilize around 2%, lower than last year’s 7.5%.
Between January and July 1999, the current account surplus reached US$15.5 billion, as the goods and
current transfer accounts showed a surplus. The capital account recorded a minor deficit of US$0.3
4
billion (Figure 5 and Figure 6). The current account surplus is expected to total US$20 billion this year.
Exports of heavy and chemical industrial products were strong, while those of light industrial products
were weak. Imports of raw material grew slow relative to other items, while those of capital and
consumer goods increased significantly.5
< F ig 5 >
C u rre n t a n d C a p ita l A c c o u n t B a la n c e (M illio n U S $ )
6000
4000
2000
0
- 2000
- 4000
- 6000
C a p ita l A c c o u n t
< F ig 6 >
14
12
10
8
6
4
2
0
- 2
- 4
- 6
1990
1991
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
- 8000
C u rre n t A c c o u n t
C u rre n t a n d C a p ita l A c c o u n t B a la n c e /G D P (% )
1992
1993
1994
c b /g d p
1995
1996
1997
1998
kb /g d p
The deterioration of Korea’s terms of trade is pointed out as one of the main causes of the financial
crisis. The index of terms of trade began to deteriorate persistently from October 1995 because the
prices of Korea’s main export items, such as semiconductors, steel, electronics in general, and
petrochemical products began to fall. After hitting the lowest level in December 1997, the terms of
trade improved 43.5% until April 1998, when it began to deteriorate again because of the recent price
hike of crude oil and raw materials (Figure 7).
5
Between January and July 1999, exports of heavy and chemical industrial products grew 7.9% and those of light
industrial products rose –11.5%. During the period, imports of raw materials grew 9.6% while those of capital and
consumer goods increased 28.8% and 19.8% respectively.
5
< F ig 7 >
T e rm s o f T ra d e
120
100
80
60
40
20
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
0
Unemployment remains an important issue in Korea, where historically high labor demand boosted by
high growth was always sufficient to keep the unemployment rate around 2%. In February 1998, the
unemployment rate soared to a record-high level of 9.3% due to increased labor market adjustments
after the outbreak of the crisis. Increased unemployment may be inevitable in the process of structural
reform, but in a country without an adequate social safety net like Korea, restructuring may unleash
political and social unrest that can obstruct structural reform. At the beginning of this year, employment
prospects were highly uncertain, thus, the unemployment rate was forecasted to rise even higher than
that of the previous year. However, the economy’s continued strong performance has allowed an
employment increase of 479,000 compared to a year ago. These additions helped the unemployment
rate decline to 6.2% (or 1.35 million) in July 1999 (Figure 8). Influenced by the faster-than-expected
recovery, the unemployment rate is forecasted to drop to a 5% level (or 1.2 million) by September or
October.
< F ig 8 >
U n e m p lo ym e n t R a te
10
9
8
7
6
5
4
3
2
1
6
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
0
III. Financial Stability
In general, a real exchange rate appreciation may cause a loss of competitiveness and structural
worsening of the trade balance, which in turn, makes the current account deficit less sustainable. The
Korean won depreciated against the US dollar by 8.6% in 1996 and 5.8% during the first quarter of
1997. Thanks to this normal depreciation, the real exchange rate vis-à-vis the dollar also significantly
depreciated in 1996, returning to early 1990’s levels. The Japanese yen also depreciated against the
dollar and the Japanese inflation rate was very low during this period. As a result, between 1993 and
1996, the Korean won actually appreciated against the yen by 12.1% in real terms. Park and Rhee
(1998) argue that the won was overvalued for most of the 1994-1996 period, but the degree of real
appreciation does not seem to be great. Moreover, by the end of the first quarter of 1997, the real
exchange rate index returned to the 1993 level when Korea’s current account was largely at a balance.
This is in contrast with the cases of other East Asian countries whose currencies were significantly
overvalued at the time of their crises.6
At the beginning of Korea’s currency crisis, the nominal exchange rate marked more than 1,900 (965
Won/US$ at the end of October 1997). But since March 1998, it has shown a downward trend (Figure
9).
< Fi
g 9>
E xchange R ate (K R W /U S D )
1800.0
1600.0
1400.0
1200.0
1000.0
800.0
600.0
400.0
200.0
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
0.0
Dollars have been in oversupply due to the current account surplus, the influx of foreign investment,
and sufficient foreign currency at financial institutions.7 In addition, Korea’s usable foreign reserves
6
This is consistent with Corsetti et al. (1998). They contended “… with the exception of Korea, all the currencies
that crashed in 1997 had experienced a significant amount of real appreciation”.
7
Four figures (Figure 10-13) show that direct investment balance and net stock investment rose significantly from
1998 even though some foreign stock investors have recently pulled out their funds from the Korean market.
7
have rebounded, totaling US$64.7 billion at the end of August 1999, while Korea’s international
credibility has improved (Figure 14).8
< F ig 1 0 > D ire c t In ve stm e n t B a la n c e (m illio n U S $ )
1000
800
600
400
200
0
- 200
- 400
- 600
< F ig 1 1 >
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
- 800
D ire c t In ve stm e n t A b ro a d , F o re ig n D ire c t
In ve stm e n t(m illio n U S $ )
1500
1000
500
0
- 500
- 1000
D ire c t In ve stm e n t A b ro a d
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
- 1500
F o re ig n D ire c t In ve stm e n t
< F ig 12> C ap ital A cco un t: N et S to ck In vestm en t(m illio n U S $ )
2000
1500
1000
500
0
- 500
8
1999
1998
1997
1996
1995
1994
1993
1992
- 1000
The existence of large foreign reserves facilitates the financing of the current account deficit when a country’s
exchange rate is pegged. Since Korea virtually had exhausted its usable foreign exchange, it was unable to meet
its foreign debt obligations in December 1997.
8
< F ig 1 3 >
C a p ita l A c c o u n t: S to c k In ve stm e n t(m illio n U S $ )
4000
3000
2000
1000
0
- 1000
- 2000
- 3000
- 4000
In flo w
1999
1998
1997
1996
1995
1994
1993
1992
- 5000
O u tflo w
< Fi
g 14> Fo rei
gn E xchange R eserve(m i
l
l
i
o n U S $)
70000
60000
50000
40000
30000
20000
10000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
0
All these factors mean that market participants have greater confidence in the stability of the foreign
exchange rate than several months ago.
At the time of crisis, the undermining of foreign investors’ confidence in Korea had much to do with
the mismatch between foreign exchange reserves and short-term external liabilities. Figure 15 shows
the total and net external debt of Korea just after the crisis struck. The total external debt reached
US$158.1 billion as of the end of 1997, having grown by almost 200% from 1993. However, between
January 1998 and June 1999, Korea’s total external debt dropped by US$16.7 billion to US$141.4
billion (Table 1).
< F ig 1 5 >
E xte rn a l D e b t, N e t E xte rn a l D e b t(b illio n U S $ )
180
160
140
120
100
80
60
40
20
0
1993
1994
1995
1996
E xte rn a l D e b t(b illio n U S $ )
9
1997
1998
N e t E xte rn a l D e b t(b illio n U S $ )
1999
Also, there has been remarkable change in the maturity structure of the external debt. The proportion of
short-term debt to total external debt was 62.2% in 1996, which implies that most offshore borrowings
of domestic banks were short-term financed. The short-term borrowings of Korean banks consisted
mainly of inter-bank loans. Since financial institutions usually maintain steady and trustful long-term
relationships with one another, these short-term debts could be rolled over without difficulty in normal
times. Also, Korea’s external debt was mostly private debt without explicit government guarantees,
therefore, an increase was not expected to affect sovereign risk directly. However, we have learned ex
post that it did not make much difference in the evolution of the crisis whether the debt was private or
public and whether the borrowers were financial institutions or not. In view of the current structure of
Korea’s external debt, the risks of a currency crisis have been lessened by the fact that the foreign
exchange reserves amount to more than double the total of existing short-term external debt.
<Table 1> Total External Debt
(End of Period, US$ billion, %)
1996
Long-term
(ratio)
Short-term
(ratio)
Total liabilities
1997
1998
June 1999
45.2
94.8
(37.8) (60.0)
74.5
63.2
(62.2) (40.0)
118.5
(79.3)
30.8
(20.6)
109.3
(77.3)
32.1
(22.7)
119.7
149.4
141.4
158.1
As for interest rates, the long-term market rate jumped to above 24% just after the onset of the crisis,
but between November 1998 to June 1999, it stabilized below 10% (Figure 16).
< F ig 1 6 > K o re a a n d U S In te re st R a te
30
25
20
15
10
5
D o m e stic In te re st R a te
10
U S T - b ill R a te
19
99
19
98
19
97
19
96
19
95
19
94
19
93
19
92
19
91
19
90
0
The interest rate gap between Korea and the U.S. is getting smaller even though U.S. interest rates
began to increase from May 1999 (Figure 17). Korea’s interest rate stability has been restored in line
with the change in monetary policy stance in the second quarter of 1998.
< Fi
g 17>
In te re st R a te D i
ffe re n c e (% )
25
20
15
10
5
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
0
Initially, the IMF prescribed a contractionary monetary and fiscal policy against the crisis. The rationale
behind this was that the key to overcoming Korea’s foreign exchange crisis lay in building up sufficient
foreign reserves for honoring external debts, to be achieved mainly by a current account surplus. A
contractionary policy is appropriate for shifting the current account into a surplus in a normal business
cycle. Chung (1999) raises the criticism that the IMF underestimated the damage that would result
from the high-interest policy, a key element of the IMF’s countermeasures. A high-interest policy is
believed to be an effective tool for restructuring because it discourages investments in risky projects
and accelerates the exit of marginal firms. However, what happened in Korea under the austere IMF
policy was that many solid firms were forced into insolvency. Therefore, the government’s monetary
authority and the IMF agreed to ease the tight monetary policy to avoid cataclysm in the second half of
1998.
In monetary policy, the Bank of Korea has recently been using interest rates rather than money growth
rates as a monetary target since the relationships between monetary aggregates are not stable. For
instance, trends of M2 and M3 growth rate are contrary to each other. Since the second quarter of 1998,
the M2 growth rate has been increasing while the M3 growth rate is moving in the opposite direction
(Figure 18). The downward trend of the M3 growth rate reflects the lagging money demand due to
inactive economic activity.
11
< F ig 1 8 >
M o n e y G ro w th R a te
40
35
30
25
20
15
10
5
m 2
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
0
m 3
The turnabout to an expansionary fiscal policy has received much attention. The fiscal deficit scale to
GDP is the largest since 1990 (Figure 19). Chung (1999) has directly criticized the current massive
expansionary fiscal policy. He claims that the ultimate judgement on the wisdom of the current
expansionary policy stance should depend on whether it obstructs or aids the restructuring effort. He is
concerned that a fiscal stimulus package can very well allow marginal or non-viable firms to prolong
their lifespan of inefficiency.
< F ig 1 9 >
G o ve rn m e n t D e fic it/G D P (% )
1
0
1990
1991
1992
1993
1994
1995
1996
1997
1998
- 1
- 2
- 3
- 4
- 5
The record-low market interest rates make investment in fixed-income securities less attractive.
Therefore, loan officers at commercial banks have become more active in extending loans. Even
though the issuance of corporate bonds this year has declined relative to last year, stock issuance has
increased dramatically, reflecting the bullishness of the stock market. While the KOSPI (Korea Stock
Price Index) even fell below the 400 point level (460 at the end of October 1997), it rose above 960
points in September (Figure 20). In contrast to the reinvigorated stock market, the real estate market
shriveled in 1998 (Figure 21). Removal of the greenbelt in the provinces may stimulate real estate
transactions in the second half of 1999.
In this chapter, we understand that the Korean financial market is seeing restored stability. Yet in order
to completely recover from the crisis, Korean financial institutions must improve their financial
12
structures. In light of this, we must consider the shock impacted on the Korean economy by Daewoo,
the second largest conglomerate in Korea.9 Since first felt in June 1999, the stock market has been
bearish and interest rates have reached a two-digit figure again. Investors are concerned. We will
describe the Daewoo problem briefly in the following section.
< Fi
g 20>
S to c k P ri
c e In d e x
1200
1000
800
600
400
200
< Fi
g 21>
19
99
19
97
19
98
19
96
19
95
19
94
19
93
19
92
19
91
19
90
19
88
19
89
19
87
19
85
19
86
19
84
19
82
19
83
19
81
19
80
0
A ve ra g e L a n d P ri
ce C hange o f B i
g C i
ti
e s a n d S to c k P ri
ce
C h a n g e (% )
100
80
60
40
20
0
-20
1980
1981 1982
1983
1984 1985
1986 1987
1988
1989 1990
1991 1992
1993 1994
1995
1996 1997
1998
-40
-60
A ve ra g e L a n d P ric e C h a n g e
S to c k P ric e C h a n g e
Outline of Daewoo Problem
The Daewoo problem originated from delays in the corporate restructuring program developed as part
of Korea’s crisis management. The government and the five largest chaebols agreed to the Capital
9
The Daewoo group had 37 affiliates and 253 overseas units as of the end of 1998. Among the affiliates, Daewoo
Corp., Daewoo Heavy Industry, Daewoo Motor, and Daewoo Electronics account for 82% of the group’s total
assets. The total number of employees at the 37 affiliates amounts to 96,753. The group’s borrowings continued
to increase after the eruption of Korea’s financial crisis in late 1997. This was attributed to the group’s
management set on expansion. Daewoo came to rely heavily on corporate bonds and CP issuance to inject
liquidity as it faced increasing difficulties in bank financing. Meanwhile foreign currency denominated
borrowings that Daewoo’s overseas subsidiaries raised in foreign markets stood at US$6.84 billion as of June
1999. Of the foreign currency borrowings by overseas units, US$ 4.7 billion is due by the end of 1999, of which
US$ 2.7 billion are from foreign financial institutions.
13
Structure Improvement Agreement to restructure the chaebols’ financial configuration through the
divestiture of affiliates and the division of business units.10
The Daewoo group’s restructuring plan had targeted the streamlining of its affiliates and subsidiaries
with the goal of reducing their number from 41 to 10.11 However, due to prolonged and unsuccessful
negotiations with a foreign company, important segments of Daewoo’s restructuring plans were
continuously delayed. This delay significantly eroded market confidence in the group’s restructuring
commitment. On July 19, Daewoo subsequently offered an excess of 10 trillion won in assets as
collateral to alleviate its short-term liquidity problems. In return, the creditor institutions met and agreed
to a six-month extension of debt of 12.4 trillion won whose maturity was on July 24. Furthermore, to
meet the immediate repayment pressure of call loans, the group extended loans worth 4 trillion won
through the repurchase of commercial papers (CPs) and corporate bonds that were repaid by the group
from the beginning of this year.
When the financial trouble of the Daewoo group was revealed, turmoil resulted in the domestic
financial market. Many investors started to pull their money out of fixed income funds managed by
investment trust companies (ITCs) since they realized that these trust companies bought a total of 25
trillion won worth of CPs and corporate bonds issued by Daewoo. On August 13, the Financial
Supervisory Service (FSS) announced a countermeasure which effectively discouraged individual,
institutional, and corporate investors from withdrawing their money from ITCs. The FSS announced
that ITCs should calculate the percentage of assets invested in Daewoo bonds and CPs for each fixed
income fund they manage. Then they should allow investors, except for financial institutions, to
withdraw their money, excluding the proportion invested in Daewoo’s bonds and CPs plus a certain
percentage invested in Daewoo. After the new measures, the withdrawal of funds by investors slowed
down. However, many economists worry that the government measures effectively restrict the loss of
investors up to 5% if they withdraw their money after next February. Therefore, a bank run may still
occur, driving some ITCs and securities firms into a severe liquidity shortage, even with the
government emergency liquidity support.
10
11
Chaebol is a conglomerate usually managed by a family.
The number of affiliates at the end of 1998 was 37.
14
IV. Restructuring and Policy Evaluation
The microstructure of the IMF program as relevant to Korea had fundamental institutional reform as its
final goal. Objectives of the program include effecting a transition to a true floating exchange rate
system; financial reform to establish clear and strict exit rules and the promotion of market competition;
and corporate reform to increase transparency and improve over-leveraged balance sheets. In spite of
the magnificent intention of the program, restructuring efforts to date have been disappointingly
sluggish.
Progress of Corporate Sector Restructuring
Corporate reform has focused on five core principles: the enhancement of corporate governance, a ban
on cross-debt guarantees between business affiliates, strengthening the accountability of governing
shareholders and management, improvement of corporate financial structures, and concentration on
core competence. Laws have been revised to facilitate corporate-wide implementation of the first three
principles to date. The remaining two principles are being pursued on an ongoing basis.
On December 7, 1998, the top five chaebols – Hyundai, Daewoo, Samsung, LG, and SK – reached an
agreement on reducing their debt-equity ratios to below 200% by the end of 1999 (Table 2 and 3). The
five chaebols and their creditor banks signed what is called a Financial Structure Improvement Plan
which stipulates debt-equity targets. The agreements on corporate restructuring are strictly being
observed under the supervision of creditor banks. For middle and small-sized firms, fresh loans have
only been provided to facilitate the structural reforms of those firms who have promised to reduce their
debt ratios, sell assets, and recapitalize themselves. As we saw in the Daewoo problem, reforming
chaebols and corporate sector restructuring is a long-term process. Successful restructuring depends
much on the government’s response to corporate rebuffs to reform.
15
<Table 2> Financial Structure of Top Five Chaebols
(End of Year, Unit: trillion won,%)
Debts
Assets
Debt-Equity Ratio
1997
1998
1999 (Plan)
220.4 (42.8)
46.9 (9.0)
470.2 (473.6)
225.1 (59.5)
58.3 (11.4)
386 (527)
165.7 (30.4)
83.6 (15.2)
198.3 (199.5)
Note: Daewoo numbers are in parentheses.
<Table 3> Debt-Equity Ratios of Manufacturing Industry
Debt Ratio
1990
1991
1992
1993
1994
1995
1996
1997
1998
285.5
306.7
318.7
294.9
302.5
286.8
317.1
396.3
303.0
Progress of Financial Sector Reforms
The speed of financial sector reforms is not satisfactory. The government has not yet even started the
restructuring program for ITCs, as we discussed in the Daewoo section. As for the implementation that
has been made, reform is being undertaken under the following three principles. First, reforms are
implemented swiftly to regain vitality in the financial system. Second, non-viable financial institutions
are immediately liquidated while public money is injected into viable institutions to turn them into
sound ones.12 In order to enhance the soundness of financial institutions, both prudential regulation
commensurate with international standards, and financial management aimed at profitability are
established.
Prompt actions are being taken to remove non-viable financial institutions from the market. As of July
14 1999, 144 financial institutions have been liquidated, 48 have been merged, and 59 have had their
licenses suspended (Table 4). In this process, public money has been provided to financial institutions
that have merged or acquired ailing financial institutions. As a result, nearly all banks’ BIS-required
capital adequacy ratios now surpass 10%.
12
Public money is injected only when the stockholders and staff of the financial institutions promise to share the
losses.
16
<Table 4> Suspension and Closure of Financial Institutions
Banks
Non-banking
Institutions
Total
33
5
4
9
27.3
2,069
54
44
144
242
11.7
2,102
59
48
144
251
12.0
Number of Institutions
License Suspended
Merged
Liquidated
Total
Ratio (%)
Since the onset of the financial crisis, the total amount of NPLs held by commercial banks has rapidly
increased while profitability has greatly deteriorated, even though capital adequacy ratios have
somewhat improved (Table 5). As of July 1999, the government mobilized fiscal resources of 64
trillion won to help the troubled sector recover from the crisis. Out of this 64 trillion won, 51.1 trillion
won has been injected into distressed banks.13 The process of recovery of financial institutions will be
closely monitored as well.
<Table 5> Banking Sector: NPL14, Capital Adequacy Ratio, ROE
1990
1991
1992
1993
1994
1995
1996
1997
1998
NPL (1)
NPL (2)
2.1
8
1.8
7
1.7
7.1
1.8
7.4
1
5.8
0.9
5.2
0.8
4.1
2.7
6
3.5
7.4
Capital
Adequacy
Ratio
9.1
8.7
11.18
11
10.62
9.33
9.14
7.04
8.23
ROE
6.28
6.58
6.69
5.9
6.1
4.2
3.8
-14.18
-52.53
Note: NPL (1): Doubtful + Losses
NPL (2): Substandard + Doubtful + Losses
Evaluation of the Current Economic Policy
13
Approximately 30.8 trillion won was used to recapitalize financial institutions and the remaining 20.3 trillion
won was injected to support the disposal of NPLs.
14
Substandard: More than 6 months past due, secured; Doubtful: More than 6 months past due, unsecured;
Losses: Expected Losses.
17
The current rapid economic recovery can largely be attributed to flexible macroeconomic policies, such
as the low interest rate and expansionary fiscal policy. Despite the significantly sanguine
macroeconomic prospects, downside risks still remain because of stagnant progress in both financial
and corporate sector restructuring. Although corporations face lower default risks owing to improved
cash flows as compared with several months ago, they are vulnerable to changes in business cycles
because of their weak financial structure and still unresolved over-capacity problem. If the economy
maintains the current recovery trend, but economic restructuring lags behind macroeconomic
performance, the economy is likely to be subject to severe systematic risks in the financial system.
Therefore, the pace of economic restructuring, including corporate restructuring, needs to be stepped
up.
Future Policy Directions
Monetary policy should focus on stabilization so that the current recovery can be translated into
sustainable growth. With regard to fiscal policy, the government should restrain the consolidated
budget deficit within 4% of GDP for this year, and restore the budget balance in the next 5 years.
In order to accelerate the pace of both financial and corporate restructuring, especially the improvement
of debt-equity ratios, it will be necessary to provide pertinent incentives for the early resolution of nonperforming loans. In this regard, transparent evaluation criteria for the debt-servicing capacity of debtor
corporations should be established, and, if corporations are deemed unsound according to the criteria,
then the capital adequacy ratio requirement needs to be imposed on loans extended to those
corporations.
Even with all the efforts directed toward restructuring of the corporate sector, enhancing corporate
governance is the most important objective to revamp the prevailing chaebol structure. Without
significant improvement in corporate governance, improvements made with public money will have
no lasting effect. Since the market is still dominated by a few chaebols, there is much inefficiency in
the domestic market. Therefore management authorities should eliminate all inefficient factors and
behave in accordance with market discipline. Since the success of corporate sector restructuring is
crucial to the success of restructuring in the financial sector, we should continue to monitor closely
progress made by the corporate sector in this regard.
18
References
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19