February 4, 1997
New York Times
South Korea: Despite World-Class Economy, Sense of Decline
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By ANDREW POLLACK
SEOUL, South Korea -- During the dirt-poor years following the Korean War, South Koreans were exhorted to extend the lives of pencils by attaching sticks to stubs that had become too short to grip.
Four decades later, the Seoul Education Office is reviving the slogan. "It's time to grasp the used-up pencils again," it said in a recent newspaper advertisement that called on students and their parents to "take the lead in saving our economy."
"Let's turn off the lights, even a single lamp, and save water, even a single drop," the ad said. "Let's correct the habit of showing off by wearing expensive clothes or using imported stationery."
Such penny-pinching might seem out of place in a nation of 45 million people that is now the world's 11th largest economy, with a per capita output that has quadrupled in the past decade to more than $10,000.
But though it has performed an economic miracle, South Korea is now gripped by a deep unease about its future. Economic growth is slowing, the stock market is near a four-year low, the Korean won has sunk to its lowest exchange rate against the dollar in a decade, and the trade deficit has more than doubled in the last year. Banks are hobbled by bad debt, businesses strangled in red tape, and wages are soaring, weakening industrial competitiveness.
Suddenly, it seems to Koreans, the era of fast growth is ending, endangering hopes that their country will make the leap from industrialization to a high-technology economy on a par with the United States and Japan.
The sense of crisis has been punctuated by two events in the last month -- the nationwide strike in reaction to a new labor law that threatens job security, and the stunning collapse of Hanbo Steel, flagship of the nation's 14th largest conglomerate, under nearly $6 billion in debt and a cloud of corruption.
"Most people don't think it's a cycle but that structurally something is wrong," said Kim Pyung Koo, a professor of economics at Sogang University in Seoul. "South Korea is being sandwiched between fully industrialized economies and less developed, low-cost economies like China."
In fact, though, some of the gloom is unwarranted. Yes, the pace of growth has faltered from 9 percent two years ago to an expected 6 percent this year, but that is still more than twice as fast as expected growth in the United States. And while a recent newspaper editorial was headlined "Soaring Unemployment," the jobless rate it lamented was 2.4 percent, a figure most other countries can only dream of.
Moreover, some of the problems are cyclical. One reason for the surging trade deficit, for instance, is that prices of computer memory chips, which account for 16 percent of South Korea's exports, have collapsed to a fifth of their levels a year ago because of an industry glut, not because South Korean companies are losing competitiveness. The fall of the Japanese yen in the last year has made Japanese products more competitive, hurting South Korean exports.
What is happening is that South Korea's economy is maturing. And the development model the country has used -- heavy government direction of business, tightly closed markets, export-led growth and the funneling of resources to industry at the expense of consumers -- is running out of steam, just as it is in Japan, where the model was first perfected.
The government has announced plans to embark on economic reforms -- deregulating the financial system, opening markets, chipping away at the power of the family-owned conglomerates known as chaebol and at lifetime employment, seniority-based pay and other workplace practices that seem ill-suited for a more competitive age.
But the changes so far have been gradual and sometimes half-hearted, just as they have been in Japan. And some critics say that the government of President Kim Young Sam seems adrift. Rather than taking bold measures, they say, it is offering half-measures or symbolic gestures, like exhorting against the consumption of expensive foreign goods.
The issues at the heart of South Korea's economic malaise are serious ones:
-- Wages have quadrupled since 1987, a faster rise than in other Asian "tigers" such as Taiwan and Singapore. That has forced a mass exodus of light industries, such as shoe manufacturing, to lower-wage countries in Asia. Such a migration is now starting for cars, electronics and other heavier industries as well.
-- Banks are weighed down by bad debts and a lack of business acumen that stems from their long-time role as little more than agents of the government, funneling loans to favored industries run by chaebol. Bribery of government officials and bankers by businessmen wanting loans is common.
-- The near-monopoly by the chaebol of credit has allowed them to expand so fast that industry is swimming in overcapacity. It has also frozen out the sort of small, entrepreneurial companies that in the United States have often been the pioneers in new technologies. South Korea also lacks the base of small, nimble parts suppliers that undergird the success of Japan's manufacturing giants. "Korea's industrial structure has an Arnold Schwarzenegger upper body on Woody Allen legs," said Stephen Marvin, head of research at Ssangyong Investment & Securities Co.
-- The current account deficit, the broadest measure of trade, more than doubled in 1996 to about $23 billion, in part because South Korea's dearth of small companies and its technological laggardness force it to import Japanese components and production machines for the cars, videocassette recorders, computer chips and ships it makes.
Now, the need for financial reform seems most urgent. With the financial system nearly closed to foreign capital, interest rates exceed 12 percent, the economy is starved for cash, said Park Ungsuh, president of the Samsung Economic Research Institute. Companies typically take six months to pay bills, meaning that smaller firms live from hand to mouth. "Stronger corporations survive, weaker ones simply collapse," Park said.
The Kim government has lifted some restrictions on bank lending and raised the ceiling on foreign ownership of a South Korean corporation's stock to 20 percent from 15 percent. The president has promised further sweeping reform of the bloated financial sector, but since that would lead to mergers and layoffs, most analysts do not expect drastic action with a presidential election coming up at the end of the year.
One potential sticking point is that if banks are to be strengthened, it might be necessary to end the ban on chaebol ownership of them. But that would only strengthen these conglomerates that many people believe are already too powerful.
Once again Kim appears to be vacillating. He came into office in 1993 pledging to force the conglomerates to concentrate on a few key businesses. But the government then permitted the Samsung Group to enter the automobile business (though it did block the entrance of Hyundai into steel-making).
On Kim's watch, in fact, the share of gross national product accounted for by the 30 largest chaebol actually rose, to 16.2 percent in 1995 from 13.5 percent in 1992, according to the Korea Economic Research Institute.
Some government policies strike some analysts as silly or self-defeating. The push to use pencils down to the nub and other clarion calls to frugality -- like requesting that nightclub owners stop serving imported whisky and that vacationers stop spending so much on foreign travel -- are unlikely to have the desired effect of cutting the trade deficit and might only trigger charges of protectionism by South Korea's trading partners. Besides, far from being profligate, South Korea has one of the highest savings rates in the world.
The government has taken one decisive move to raise the country's competitiveness: a new labor law that makes it easier for companies to lay off workers and tame breakneck growth in wages. But that has led to labor strife, and many economists think the move was necessary.
In many cases, companies are offering bonuses to workers, particularly higher-paid managers in their 40s and 50s, to retire "with honor," though it is usually anything but. News reports and television dramas characterize these humbled men as "fathers with bowed heads."
The seniority system, in which everyone's wages advance together with years of service, is also starting to give way to merit pay, a concept that does not sit well in a nation that prides itself on egalitarianism.
"I don't necessarily like the Wall Street system either," said Milton S. Kim, president of Ssangyong Investment & Securities, referring to the huge salaries paid to Wall Street stars. "But if our market is opening up and Morgan Stanley and Goldman, Sachs are poaching our best people, what choice do I have?"
For all South Korea's travails, other fast-growing nations of Asia, where export growth and economic growth have slowed in the last year, are in the same boat. And for South Korea, at least, the boat isn't about to capsize.
In most industries now at the core of the Korean economy -- steel, shipbuilding, cars and electronics -- the major rival is Japan, where wages are much higher. South Korea can still sell products that are less expensive, if lower in quality, than the Japanese.
"Korea is mid-priced, mid-tech capital and intermediate goods," Marvin of Ssangyong Securities said. "Mid-priced, mid-tech goods are exactly what China needs, it's what Eastern Europe needs and Latin America needs."
Some analysts are even hopeful that the forces of global competition and deregulation will force the chaebol to reform on their own. The Ssangyong Group, for instance, is now negotiating to sell its money-losing automobile business to the Samsung Group, so it can concentrate on areas like cement and oil where it is stronger.
Sakong Il, a former finance minister who is now chairman of the Institute for Global Economics, a Seoul research organization, said that, amid all the economic turmoil, South Koreans must accept that they are moving a notch up the international economic pecking order. That means, he noted, they cannot expect the breakneck growth of old.
"It's like you're doing 80 miles per hour and suddenly you have a speed limit and have to drop to 60," Sakong said. "You have to get used to it."
November 11, 1997
Wall Street Journal
Exotic Currency Focus: Korea Won Seen Further Hit By Yen
By CECILIA M. KANG
AP-Dow Jones News Service
SEOUL -- When it rains, it pours for the South Korean won.
While already down over 15% this year due to financial instability at home, the won is expected to suffer more blows as the Japanese yen continues to fall against the dollar, economists say.
After opening at 999.90 won to the dollar, the South Korean currency recovered somewhat to 989.8 won/dollar at Tuesday's close, on repeated intervention by the central Bank of Korea (BOK).
Although the central bank managed to keep the dollar from rising about 1,000 won, traders and economists say the local currency will soon fall far below that psychologically important level on overwhelmingly bearish sentiment toward the country's financial industry.
And worsening troubles in neighboring Japan only mean more pressure on the local currency, they say.
The dollar rose to a six month high of Y125.06 late in the Asian day Tuesday, from Y124.36 late Monday in New York, amid continued worries about the state of the Japanese economy and stock market.
'A slow gradual depreciation of the won isn't going to be erased quickly but will persist for some time,' says Tim Condon, regional economist at Morgan Stanley Asia Ltd. in Hong Kong. 'If we see a sharp weakening of the yen against the dollar, it would be accompanied by a move in won' versus the dollar.
From a survey of five economists, the dollar is expected to rise to as high as 1,050 won by the end the year and to 1,200 won during the next quarter.
The two largest Asian economies share many of the same exports, including electronics, steel, semiconductors, chemicals and automobiles. Over 50% of Korea's exports compete directly with Japanese products, according to analysts.
Hence, the won's moves against the dollar often mirror the yen's trading movements versus the U.S. currency, as local exporters vie to make their products more attractively priced compared with the products of their Japanese rivals.
'Any positive effects of the won's depreciation are effectively cancelled out by the yen's decline versus the dollar,' says Kim Joo-hyung, head of research at LG Economic Research Institute in Seoul. 'If the yen was stable and the won depreciated by around 10%, then the price competitiveness of Korean export products would be greatly enhanced.'
Kim and others say the won's depreciation could work to help lift Korea out of its current misery, but as long as the yen continues to fall against the dollar, the trade deficit's narrowing trend will be harder to maintain.
Government officials have repeatedly pointed to the country's improving trade balance as evidence South Korea's real economy is improving despite financial market turmoil.
The country's trade deficit in October, sharply narrowed to $21 million from a shortfall of $1.70 billion during the same month last year. The trade deficit during the first ten months of the year narrowed to $10.41 billion from a $17.29 billion shortfall during the like period in 1996.
'You've got tremendous cyclical improvement in the trade account that has failed to offset severe problems in financial markets,' says Morgan Stanley's Condon. 'If Korea can make it over this difficult patch of watching for more problems to emerge from the corporate sector, this period will pass and the strength of trade' will rejuvenate markets.
Some economist, however, say the improvement in the trade balance is distorted because 1996 was a particularly bad year for Korean exporters and that on a month to month basis, the trade balance hasn't improved significantly this year.
Meanwhile, the increasingly shaky banking sector and battered financial markets are undermining a recovery of the won.
The South Korean won's prolonged decline started to accelerate after Kia Group's financial troubles arose on July 15. Since the eighth-largest conglomerate's troubles surfaced, several more of South Korea's largest conglomerates collapsed or fell into financial turmoil. In total, eight of the country's 30 largest conglomerates went bankrupt or are facing severe financial strains this year.
Troubles in corporate Korea have translated into massive amounts of bad debt piled at financial institutions. And as the health of many South Korean commercial and merchant banks worsens, the country's sovereign and corporate ratings have deteriorated.
As it has been increasingly difficult to obtain funds from overseas and as around half of local banks' estimated $66 billion in foreign debts are expected to mature soon, many are wondering where the banks and the rest of the economy will be able to obtain funds to meet their obligations.
Economists say the government's efforts to support the banking sector have done little to ease the liquidity squeeze felt throughout the economy.
They add that the current administration won't have the courage to come up with stronger measures to support the ailing banking industry ahead of the Dec. 18 presidential election.
'With any meaningful reform measures unlikely this year, in view of political considerations and the slowing economy, no significant correction in the bullish dollar-won trend is anticipated,' says Thio Chin Loo, foreign exchange strategist at Banque Paribas in Singapore.
'Indeed further pressure on the (won) is likely ... 1,200 (won per dollar) is possible over the next quarter,' she says.
Meanwhile, concerns the central bank is depleting much of its modest foreign currency reserves in its ardent defence of the won have many worried the country may be running out ammunition in its battle to slow the won's fall.
South Korea's reserves stood at $30.5 billion at the end of October. Economists worry, however, that the central bank may have committed a large chunk of those reserves via forwards market interventions last month and this month.
The central bank refuses to disclose the amount it has spent in currency forwards activity, which is fanning speculation about the size of the commitment. Government officials have responded by saying some market estimates are exaggerated and that the central bank hasn't committed a worrisome level of its reserves in forwards interventions.
The BOK told Dow Jones its liabilities in the forward market are 'far, far less' than estimates of $15 billion.
South Korean shares fell Tuesday, with the benchmark index down 3.21 points to 522.11. Interest rates, measured by yields on three-year corporate bonds, rose 0.1 percentage point to 13.00%.
-By Cecilia Kang; 822-732-2165; ckang@ap.org
South Korea, population 44 million, is heavily reliant on exports of key items such as semiconductors, steel, petrochemicals and automobiles. After years of robust growth, it became the 29th member of the Organization for Economic Cooperation and Development in 1996.
Recent Developments: The health of the country's economy has been challenged in the last two years. South Korea's current account deficit, which had been severely widening amid decreasing demand and a drop in export prices in 1996, has been slowly improving. High wages and guaranteed life employment were challenged by a controversial labor bill rammed through the National Assembly in Dec. 1996, and revised later after three-weeks of labor strikes. The financial sector has been burdened by mounting bad debt after bankruptcies of and financial troubles at major conglomerates.
Chief Risk Factors: Economic recovery may be delayed by more bankruptcies which has caused turmoil in the financial sector and liquidity problems in the local currency, debt and equities markets. Military instability is a consistent threat on the Korean peninsula as an official peace treaty between North Korea and South Korea was never signed after the Korean war. The possibility of North Korean collapsing amid a severe food shortage and drought in 1997 also pose a huge risk to the economy.
Financial performance: All figures are in won.
Latest Yr Yr Ended Yr Ended
Report Earlier 12/31/96 12/31/95
GDP Growth 6.3% 2Q97 6.9% 7.1% 8.9%
Inflation 4.2% Sept 4.0%(Aug) 5.0% 4.5%
Trade Balance -21M Oct -1.70B -15.3B -4.7B
Current Account -425.7M Sept -1.51B -23.72B -8.94B
Industrial Prod. 10.1% Sept 9.7%(Aug) 8.4% 11.9%
Currency, interest rate, stock market history:
End Oct 12/31/96 12/31/95
Won Vs Dlr 964.4 844.20 774.70
Yeilds On 3-Yr Corp. Bonds 12.60% 11.9% 13.8%
KOSPI Index 647.11 651.22 882.94
November 18, 1997
New York Times
South Korea Ends Efforts to Defend Its Currency
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By DAVID E. SANGER
WASHINGTON -- South Korea on Monday suspended efforts to defend its currency with its own, fast-depleting financial reserves as American, Asian and European officials scrambled to determine if the world's 11th largest economy -- and one of America's largest trading partners -- will become the latest Asian nation needing an economic bailout.
The surprise announcement from South Korea came after a series of public and private warnings in the United States that South Korea faces the kind of financial reckoning that has swept through Thailand, Indonesia and Malaysia this year. But South Korean officials, facing a presidential election which the ruling party could lose, said that despite a series of major bankruptcies and reports that banks cannot meet their debts, the country was fundamentally sound.
Monday's announcement by the central bank in Seoul that it could no longer afford to battle the markets and prop up the value of the Korean won was a sign to many investors that the country's troubles run much deeper. And U.S. officials are clearly concerned that a deeper financial collapse in Korea could resound more loudly around the world than the currency crises that have struck far smaller and less strategically vital nations in Asia.
"If a bailout of Korea was needed -- and no one is ready to say yet that it will be -- the size of the effort could be frightening," a senior administration official said Monday.
The official, who spoke on condition of anonymity, would not estimate what would be required, but economists and trade experts who raised the same prospect at a congressional hearing last week said that the costs could run from $50 billion to $100 billion, far more than the cost of the American-led bailout of Mexico in 1995.
South Korea is estimated to have $67 billion to $77 billion in short-term debt owned by financial institutions and investors worldwide, and there is good reason to question whether it has the resources to pay that back.
The country had roughly $30 billion in foreign currency reserves at the end of October but has spent billions defending the won against attack by using those reserves to purchase its currency in the foreign-exchange market, which reduces the supply in circulation and at least temporarily lifts the won's value.
In Seoul, officials refused to disclose the current level of their reserves, and are apparently reluctant to tell American and European officials how much they have left. "These guys are still in denial," one American official said.
As in the case of Mexico, American concerns go beyond the fate of South Korea's overextended banks or its currency woes. U.S. officials are worried about a financial contagion that could easily spill over into Japan, where banks are already teetering from the combined effects of bad loans at home and elsewhere in Asia.
Early Monday, Japanese authorities closed the country's 10th largest bank; a major securities house went under earlier this month. Moreover, because Korea directly competes with Japan in manufacturing a variety of products, any rapid devaluation of the won would create competitive pressure for Japan to allow its own currency, the yen, to weaken so that the country's exports are not sharply more expensive than those of Korea. That would greatly enlarge America's trade deficit, one of the most sensitive economic issues between Japan and the United States.
Concern that the won's depreciation might drag down the yen contributed to an initial surge in the dollar's value against the yen Monday in New York, but the dollar ended lower at 125.50 yen, down from 125.62 Friday.
Earlier Monday, Deputy Treasury Secretary Lawrence Summers was in Japan to urge Tokyo not to export its way out of trouble.
The currency crisis could also affect South Korea's role in the long-delayed talks just about to begin with communist North Korea over a formal end to the Korean War. American officials are concerned that South Korea is entering the talks appearing weak, its economy in free-fall while a contentious presidential election is underway. "It's not an ideal negotiating position," one State Department official said last week.
A third concern focuses on how to organize a bailout if needed. Speaking in Chicago on Monday, Treasury Secretary Robert Rubin avoided any specific discussion of South Korea, apparently concerned that he not worsen the situation by contributing to the weakening of investor confidence. But Rubin made it clear that the United States would not take the lead in any financial rescues, working instead through the International Monetary Fund.
"It is our view that the right way to approach these is through IMF-centered programs," he said. "Some people interpret that as a ceding of U.S. leadership. Not at all. We have been very actively involved with the IMF and countries involved."
Still, on Thursday, before Congress adjourned, it refused to approve $3.5 billion the Clinton administration sought to help create a new fund within the IMF to deal with exactly such emergencies. That is bound to reinforce an impression in Asia that the United States wants to maintain influence in the region, but not contribute financially to solving its problems.
The current financial crisis in Asia began this summer when Thailand, once a booming example of rising Asian economic power, conceded that its banks had lent billions to unsuccessful projects. The Thai currency fell by roughly 40 percent, interest rates soared and growth slowed sharply.
The IMF came to the rescue with a $17.2-billion bailout, but Thailand has yet to comply with all the austerity measures required. The Thai government fell last month, and a new prime minister has promised to comply with the measures.
But the contagion quickly spread, first to Malaysia and then to Indonesia. Late last month, the IMF announced a rescue package for Indonesia that included $15 billion in immediate funds, and agreement by several countries -- including the United States -- to provide "backup financing" if needed.
South Korea is more complicated. Its economy is far larger than any of the troubled Southeast Asian nations; its gross domestic product last year was $484 billion, up from only $253 billion in 1990. That makes it more than twice the size of Thailand's economy, though only about a tenth the size of Japan's.
Already the won has fallen about 17 percent since the beginning of the year to a record low against the dollar, and many economists believe it must fall much further in coming days to make Korea's products -- from semiconductors to auto parts to steel -- competitive with those of Southeast Asian countries that have already withstood devaluations of 30 percent to 40 percent this year.
While traders clearly expect the won to continue to slide, it may not happen as swiftly as in other countries. Korea still limits the won's daily fluctuation to 2.25 percent of its value the previous trading day. At the current exchange rate of roughly 1,008 won to the dollar, that means any daily decline would be limited to about 23 won.
But even that trading band might have to be abandoned if it essentially stopped transactions from occurring, meaning that companies and banks might not be able to convert enough currency into dollars to meet their obligations.
Summers is meeting in Manila with finance ministers and central bankers from throughout Asia for a previously scheduled meeting to discuss how to aid financially distressed nations throughout the region.
South Korea's troubles will clearly be a major subject of conversation. But South Korean officials say they will not turn to the IMF -- perhaps because they do not need to, perhaps because it would be humiliating.
"It is not a certainty, but they are certainly the leading candidate to be next," C. Fred Bergsten, president of the Institute for International Economics, said last week. "The Asian contagion has made its way north."
February 10, 1998
The New York Times
In Korea, Domestic Loans Said to Be Serious Problem
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The New York Times: The Financial Crisis in Asia
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By STEPHANIE STROM
SEOUL, South Korea -- The Nasan Group was a successful apparel manufacturer with a stable of popular local brands until it began an ambitious expansion in 1988, backed by banks that are now suffering the consequences. Flush with easy credit, it branched out into golf courses, resorts and hotels, then added a health-club subsidiary and acquired a construction company.
"Our chairman felt that housing was another medium of fashion," explained Yeom Moon-nam, assistant director of planning. "In the same way that clothing evolved from simply something to keep you warm into a fashion statement, houses are not just for refuge any more."
The group later tacked on a basketball team, department stores and supermarkets and a broadcasting company, assembling a collection of 15 affiliates that by the end of last year made it South Korea's 50th-largest conglomerate.
Last month, Nasan collapsed under the weight of loans that it could not repay. Its debt outweighed its equity by 10-to-1 -- a ratio more than five times the amount that would be considered even marginally prudent in the Western world.
Analysts worry that hundreds of humdrum stories like Nasan's may threaten the fragile South Korean banking system. While the world financial community has been transfixed by last Friday's renegotiation of $23.4 billion in short-term debt owed by South Korean banks to foreign banks, a far larger, messier problem is brewing here at home.
Short-term domestic debt -- the money owed to South Korean banks by local companies -- is more than double that owed to foreign creditors. With interest rates soaring, liquidity fast evaporating and consumption all but coming to a halt, dozens of companies like Nasan are going belly-up every day, with potentially dire consequences both for local banks and for the global financial structure.
Each corporate collapse adds stress to a battered banking system. "It's just one more straw on the back of South Korea's banks," Stephen Marvin, the head of research at Ssangyong Investment and Securities Co. said. "The next Nasan could be the straw that breaks them."
Marvin is one of a growing chorus of South Korea watchers warning that the world's 11th-largest economy could face a financial meltdown, not because of the foreign debt crisis but because of the mountain of domestic debt.
Korea First Bank and Seoul Bank, two large commercial banks that the government bailed out in January, failed because each had more than $2 billion in soured domestic loans.
South Korean banks owe their foreign counterparts some $153 billion, about $23.4 billion of which was short-term debt until it was restructured last month. That total pales beside domestic debt, the money South Korean companies owe South Korean financial institutions, which at current exchange rates is somewhat more than $300 billion, according to analysts.
Between 50 percent and 75 percent of domestic debt is short term, much of it in the form of "oum" notes that come due in three to six months. A Korean tradition, the use of "oum," or promissory, notes, is pervasive in South Korean business.
The system works like this:
Let's say Nasan, which, among other things, manufactures apparel, sold some of the clothing it makes to a Seoul department store. Rather than paying in cash, the store might issue Nasan a promissory note for the amount it owes that comes due in three months.
But Nasan needs cash. It takes the promissory note to its bankers, who swap the notes for cash at a discount that depends on both Nasan's creditworthiness and that of the retailer that originally issued it.
Nasan, however, guarantees payment of the note. Three months later, the department store has gone bankrupt and cannot pay the note. Suddenly, Nasan is on the hook for the face value of the note.
In fact, it was not technically Nasan's $500 million debt burden that crushed it, but two oum totaling $3.5 million. It was oum that brought Halla and Kia, relative leviathans in comparison with Nasan, and scores of other South Korean companies to their knees, and oum will undoubtedly sink hundreds more South Korean businesses this year.
"We're not talking about a long time here, if you think about the fact that most of the promissory notes issued in mid-November when the economic crisis began are coming due in mid-February or March," said Jeff Uscher, editor of Grant's Asia Observer.
Whether the South Korean financial system can absorb a steady stream of bankruptcies is far from certain. In the first week of January, more than 100 companies went bankrupt, and the pace has not abated, which means banks' capital bases have already suffered severe erosion.
"The question is whether the pace of bankruptcies will reach critical mass and set off a detonation in the financial system," said Karl Moskowitz, representative director of KSA Ltd., a consulting firm whose clients are mainly midsized Korean corporations. "The domestic debt problem could lead to the same financial paralysis we had last December, but this one will be much more difficult to solve."
Analysts estimate that at least 20 percent of the domestic loan portfolio, or somewhere between $60 billion and $65 billion, is probably already in default, and other estimates range as high as 30 percent or 40 percent.
Government officials say such estimates are vastly overblown. At the end of November, the Bank of Korea put the value of nonperforming loans at about $20.6 billion at current exchange rates, and it is estimating an increase to $28 billion this year.
Whether or not "oum" are included in those estimates is unclear; different government agencies have different answers. Last week, the government said there were probably trillions of won of problematic "oum" notes in the financial system.
In November, Korea Asset Management Corp. began assuming troubled loans from commercial banks and merchant banks, which are smaller, more speculative institutions, with the goal of selling the collateral and cleaning up the banks' balance sheets. The agency has about 20 trillion won, or $12 billion, at its disposal.
"We think we are very well prepared," said Lee Jong Koo, who was until recently the head of the banking bureau at the Ministry of Finance and Economy. "I don't think there will be a crisis in the financial sector."
But KAMC has already spent one-third of its budget to bail out Korea First Bank and Seoul Bank, along with a smaller bank and a merchant bank that failed last year. That leaves about $8 billion to clean up the rest of the problem, which is not nearly enough, according to analysts.
"Right now, there's a shortfall between what's available and what's needed," said Richard Samuelson, head of research at SBC Warburg Dillon Read in Seoul.
Even those who contend that the government has the tools to circumvent a banking crisis brought on by domestic debt concede that the problem is serious.
"Last year, there was a string of bankruptcies of big companies," said Park Jae-ha, a research fellow at the Korean Institute of Finance, a research center backed by commercial banks. "No bank can make money under those circumstances, and if that kind of thing happened again, it would hurt the Korean banks seriously."
Nonetheless, he is betting it won't. "I'm cautiously optimistic about our financial system," Park said.
But Samuelson expects that at least three and perhaps as many as eight of South Korea's 30 largest conglomerates, or chaebols, will close this year. "I don't believe even the most pessimistic government estimates are factoring in the possibility of eight more going bankrupt this year," he said.
While financial disclosure in South Korea looks rigorous by the standards of other Asian countries, it is scanty by Western standards. The definition of nonperforming loans is less stringent than in the United States, and when Japan recently applied U.S. standards to its banks' loan portfolios, the value of nonperforming loans tripled.
Plus, South Korean companies typically shoulder debt loads more than twice as high as would be considered remotely prudent in the United States. Nasan's $500 million in debt was more than five times that level.
When it became clear late last year that it could not pay off two promissory notes that were coming due in January, Nasan asked its banks, led by the Korea Exchange Bank, for an additional $17 million. But by then, South Korea was in the midst of a credit squeeze, as banks began a long overdue effort to stem erosion in their capital bases.
On Jan. 14, Nasan filed for court protection in a process vaguely similar to filing for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code. It owed money to many of South Korea's commercial banks and several of its merchant banks. It had even borrowed from Peregrine Investments Holdings, the flashy Hong Kong investment firm that went under just two days before Nasan.
Spokesmen for Korea Exchange Bank and Hanil Bank, two of Nasan's larger creditors, said the company's troubles would not hurt them.
But how many collapses like Nasan's would they be able to withstand? "I think there are a lot of other Korean companies in our position," Yeom of Nasan said. "The banks themselves are examples of our situation: They have a large amount of insolvent bills."
The International Monetary Fund acknowledged last week that soaring interest rates had imperiled Korean businesses and, as a result, put pressure on the country's banks. Hubert Neiss, the fund's regional director, said in a statement that "high interest rates have a cost, as they hurt banks and enterprises."
Nonetheless, the statement continued, "The IMF has advised to accept this cost until the foreign-exchange market is durably stabilized."
January 4, 1998
Korean Certainty: No More Business as Usual
By SETH FAISON
SEOUL, South Korea -- An age-old Korean practice, common among housewives, draws together a group of acquaintances to pool their cash savings and trust one among them to manage the pool profitably. Often, that means providing the money to a credit-starved business at a high interest rate.
Kim Yon-jung, a 54-year-old mother of two who runs her family's finances, participated in this kind of arrangement for years and earned well above what she could have on her own. Putting her cash in someone else's hands, Mrs. Kim also found, allowed her to avoid reporting her holdings to South Korea's aggressive tax authorities.
A few weeks ago, however, Mrs. Kim got the shock of her life. The woman in charge of her 30-member group disappeared with all the money, roughly $2 million.
"In the old days, that would never happen," said Mrs. Kim, still amazed that a reliable pillar of her life had disintegrated so swiftly. "My daughter was suspicious of the old way. Maybe now I should listen to her."
South Korea's financial crisis, so much worse than anyone had predicted, is forcing business executives, government officials and ordinary people to thoroughly rethink the way they have done things for decades. Financial methods and practices left over from a simpler era are abruptly clashing with the demands of a more modern society, like accountability and openness, and it is as true for big conglomerates as it is for housewives like Mrs. Kim.
The current crisis emerged from a tight collusion between big companies and government that meant that credit was allocated using political, and not financial, criteria. Only when several of South Korea's enormous conglomerates started going bankrupt did the extent of the problem emerge.
When international bankers gathered in New York, Tokyo and London last week and agreed to defer more than $10 billion in Korea's short-term debt, they were mainly interested in keeping the nation from defaulting in a way that would prevent Korean banks from ever paying back the loans.
But rescue packages and loan holidays, even if they keep South Korea's financial system nominally alive, will not fully preserve the old-fashioned ways of this country. And that is good news for an entire generation of younger men and women who see a bright side to South Korea's financial mess. For them, the weakening of conglomerates means that the traditional emphasis on seniority in the business world may have to yield a few steps in favor of ability. Many well-educated young executives are eager to take over from elders they see as long on loyalty and short on efficiency.
Young South Koreans complain that despite a steady modernization over the past 40 years, the nation's economic and social system in many ways still resembles the strict hierarchy of a small village, built as it is on an ethos of trust in a relatively small number of elders who are only informally accountable to the larger group. That may have been fine in the old village, but now it is badly outdated. Just ask Mrs. Kim.
By and large, Koreans did not seem surprised that a system of bribery, politically motivated loans and fiscal irresponsibility was widely practiced by heads of conglomerates. What was so shocking was the scale of corruption and collusion. The old Korean financial system may have worked as long as the players -- and their misdemeanors -- remained small. But as companies grew into multibillion-dollar operations, the lack of adequate accountability was bound to lead to abuses.
After Hanbo Iron & Steel went bankrupt in early 1997, for example, an investigation showed that the chairman, Chung Tae-soo, had borrowed $6 billion for the company, and used several hundred million dollars of that to bribe officials to keep authorizing cheap bank loans, keeping some for himself.
Even more stunning, perhaps, was the revelation that the head of the conglomerate that owned Korean Airlines had made a beeline for the presidential mansion in 1983 when a Soviet fighter plane shot down KAL Flight 007, killing all 269 people on board. The first concern of the executive, Cho Choong-hoon, was to hand several million dollars to then-President Chun Doo-hwan, to insure that Cho could keep his job.
Chun, whose total take allegedly reached hundreds of millions of dollars in his eight-year rule, was pardoned last week and released from serving a life sentence he was given last year.
The election of the liberal reformer Kim Dae-jung on Dec. 18 seems to have given many young people hope that the political system will veer in a more democratic direction. Yet Kim, who assumes office in late February, is taking over at a time of such financial crisis that it is uncertain how much he can reform the large conglomerates known as chaebol. Even so, the system built around these conglomerates, many of which resemble personal empires rather than efficient businesses, is unlikely to survive in its current form.
One aspect of Korean business life that immediately looks vulnerable, for example, is the kisu system of arranging employees by seniority.
Steadily expanding chaebol have hired a new crop of employees each year, labeling each new group according to number of years the company has been in business -- a tag that is expected to remain throughout an employee's career. Even Korea's main airline had a kisu system for flight attendants.
"When you meet someone new at your own company, you immediately ask what kisu they are," explained a Korean journalist. "Whichever one came earlier -- no matter who is actually older -- treats the other one like an inferior."
This year, few chaebol will be hiring; in fact, those that do not fall into bankruptcy will more likely be laying off people.
"The old kisu will gradually become meaningless," said the journalist.
Yet as Mark Clifford, an American journalist, observed in his prescient book about South Korea, "Troubled Tiger" (M.E. Sharpe, 1995), a system so dominated by the government was bound to run into serious financial trouble.
"The old order is shriveling," wrote Clifford. "But the new one has yet to be born."
New York Times
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By ANDREW POLLACK
SEOUL, South Korea -- During the dirt-poor years following the Korean War, South Koreans were exhorted to extend the lives of pencils by attaching sticks to stubs that had become too short to grip.
Four decades later, the Seoul Education Office is reviving the slogan. "It's time to grasp the used-up pencils again," it said in a recent newspaper advertisement that called on students and their parents to "take the lead in saving our economy."
"Let's turn off the lights, even a single lamp, and save water, even a single drop," the ad said. "Let's correct the habit of showing off by wearing expensive clothes or using imported stationery."
Such penny-pinching might seem out of place in a nation of 45 million people that is now the world's 11th largest economy, with a per capita output that has quadrupled in the past decade to more than $10,000.
But though it has performed an economic miracle, South Korea is now gripped by a deep unease about its future. Economic growth is slowing, the stock market is near a four-year low, the Korean won has sunk to its lowest exchange rate against the dollar in a decade, and the trade deficit has more than doubled in the last year. Banks are hobbled by bad debt, businesses strangled in red tape, and wages are soaring, weakening industrial competitiveness.
Suddenly, it seems to Koreans, the era of fast growth is ending, endangering hopes that their country will make the leap from industrialization to a high-technology economy on a par with the United States and Japan.
The sense of crisis has been punctuated by two events in the last month -- the nationwide strike in reaction to a new labor law that threatens job security, and the stunning collapse of Hanbo Steel, flagship of the nation's 14th largest conglomerate, under nearly $6 billion in debt and a cloud of corruption.
"Most people don't think it's a cycle but that structurally something is wrong," said Kim Pyung Koo, a professor of economics at Sogang University in Seoul. "South Korea is being sandwiched between fully industrialized economies and less developed, low-cost economies like China."
In fact, though, some of the gloom is unwarranted. Yes, the pace of growth has faltered from 9 percent two years ago to an expected 6 percent this year, but that is still more than twice as fast as expected growth in the United States. And while a recent newspaper editorial was headlined "Soaring Unemployment," the jobless rate it lamented was 2.4 percent, a figure most other countries can only dream of.
Moreover, some of the problems are cyclical. One reason for the surging trade deficit, for instance, is that prices of computer memory chips, which account for 16 percent of South Korea's exports, have collapsed to a fifth of their levels a year ago because of an industry glut, not because South Korean companies are losing competitiveness. The fall of the Japanese yen in the last year has made Japanese products more competitive, hurting South Korean exports.
What is happening is that South Korea's economy is maturing. And the development model the country has used -- heavy government direction of business, tightly closed markets, export-led growth and the funneling of resources to industry at the expense of consumers -- is running out of steam, just as it is in Japan, where the model was first perfected.
The government has announced plans to embark on economic reforms -- deregulating the financial system, opening markets, chipping away at the power of the family-owned conglomerates known as chaebol and at lifetime employment, seniority-based pay and other workplace practices that seem ill-suited for a more competitive age.
But the changes so far have been gradual and sometimes half-hearted, just as they have been in Japan. And some critics say that the government of President Kim Young Sam seems adrift. Rather than taking bold measures, they say, it is offering half-measures or symbolic gestures, like exhorting against the consumption of expensive foreign goods.
The issues at the heart of South Korea's economic malaise are serious ones:
-- Wages have quadrupled since 1987, a faster rise than in other Asian "tigers" such as Taiwan and Singapore. That has forced a mass exodus of light industries, such as shoe manufacturing, to lower-wage countries in Asia. Such a migration is now starting for cars, electronics and other heavier industries as well.
-- Banks are weighed down by bad debts and a lack of business acumen that stems from their long-time role as little more than agents of the government, funneling loans to favored industries run by chaebol. Bribery of government officials and bankers by businessmen wanting loans is common.
-- The near-monopoly by the chaebol of credit has allowed them to expand so fast that industry is swimming in overcapacity. It has also frozen out the sort of small, entrepreneurial companies that in the United States have often been the pioneers in new technologies. South Korea also lacks the base of small, nimble parts suppliers that undergird the success of Japan's manufacturing giants. "Korea's industrial structure has an Arnold Schwarzenegger upper body on Woody Allen legs," said Stephen Marvin, head of research at Ssangyong Investment & Securities Co.
-- The current account deficit, the broadest measure of trade, more than doubled in 1996 to about $23 billion, in part because South Korea's dearth of small companies and its technological laggardness force it to import Japanese components and production machines for the cars, videocassette recorders, computer chips and ships it makes.
Now, the need for financial reform seems most urgent. With the financial system nearly closed to foreign capital, interest rates exceed 12 percent, the economy is starved for cash, said Park Ungsuh, president of the Samsung Economic Research Institute. Companies typically take six months to pay bills, meaning that smaller firms live from hand to mouth. "Stronger corporations survive, weaker ones simply collapse," Park said.
The Kim government has lifted some restrictions on bank lending and raised the ceiling on foreign ownership of a South Korean corporation's stock to 20 percent from 15 percent. The president has promised further sweeping reform of the bloated financial sector, but since that would lead to mergers and layoffs, most analysts do not expect drastic action with a presidential election coming up at the end of the year.
One potential sticking point is that if banks are to be strengthened, it might be necessary to end the ban on chaebol ownership of them. But that would only strengthen these conglomerates that many people believe are already too powerful.
Once again Kim appears to be vacillating. He came into office in 1993 pledging to force the conglomerates to concentrate on a few key businesses. But the government then permitted the Samsung Group to enter the automobile business (though it did block the entrance of Hyundai into steel-making).
On Kim's watch, in fact, the share of gross national product accounted for by the 30 largest chaebol actually rose, to 16.2 percent in 1995 from 13.5 percent in 1992, according to the Korea Economic Research Institute.
Some government policies strike some analysts as silly or self-defeating. The push to use pencils down to the nub and other clarion calls to frugality -- like requesting that nightclub owners stop serving imported whisky and that vacationers stop spending so much on foreign travel -- are unlikely to have the desired effect of cutting the trade deficit and might only trigger charges of protectionism by South Korea's trading partners. Besides, far from being profligate, South Korea has one of the highest savings rates in the world.
The government has taken one decisive move to raise the country's competitiveness: a new labor law that makes it easier for companies to lay off workers and tame breakneck growth in wages. But that has led to labor strife, and many economists think the move was necessary.
In many cases, companies are offering bonuses to workers, particularly higher-paid managers in their 40s and 50s, to retire "with honor," though it is usually anything but. News reports and television dramas characterize these humbled men as "fathers with bowed heads."
The seniority system, in which everyone's wages advance together with years of service, is also starting to give way to merit pay, a concept that does not sit well in a nation that prides itself on egalitarianism.
"I don't necessarily like the Wall Street system either," said Milton S. Kim, president of Ssangyong Investment & Securities, referring to the huge salaries paid to Wall Street stars. "But if our market is opening up and Morgan Stanley and Goldman, Sachs are poaching our best people, what choice do I have?"
For all South Korea's travails, other fast-growing nations of Asia, where export growth and economic growth have slowed in the last year, are in the same boat. And for South Korea, at least, the boat isn't about to capsize.
In most industries now at the core of the Korean economy -- steel, shipbuilding, cars and electronics -- the major rival is Japan, where wages are much higher. South Korea can still sell products that are less expensive, if lower in quality, than the Japanese.
"Korea is mid-priced, mid-tech capital and intermediate goods," Marvin of Ssangyong Securities said. "Mid-priced, mid-tech goods are exactly what China needs, it's what Eastern Europe needs and Latin America needs."
Some analysts are even hopeful that the forces of global competition and deregulation will force the chaebol to reform on their own. The Ssangyong Group, for instance, is now negotiating to sell its money-losing automobile business to the Samsung Group, so it can concentrate on areas like cement and oil where it is stronger.
Sakong Il, a former finance minister who is now chairman of the Institute for Global Economics, a Seoul research organization, said that, amid all the economic turmoil, South Koreans must accept that they are moving a notch up the international economic pecking order. That means, he noted, they cannot expect the breakneck growth of old.
"It's like you're doing 80 miles per hour and suddenly you have a speed limit and have to drop to 60," Sakong said. "You have to get used to it."
November 11, 1997
Wall Street Journal
Exotic Currency Focus: Korea Won Seen Further Hit By Yen
By CECILIA M. KANG
AP-Dow Jones News Service
SEOUL -- When it rains, it pours for the South Korean won.
While already down over 15% this year due to financial instability at home, the won is expected to suffer more blows as the Japanese yen continues to fall against the dollar, economists say.
After opening at 999.90 won to the dollar, the South Korean currency recovered somewhat to 989.8 won/dollar at Tuesday's close, on repeated intervention by the central Bank of Korea (BOK).
Although the central bank managed to keep the dollar from rising about 1,000 won, traders and economists say the local currency will soon fall far below that psychologically important level on overwhelmingly bearish sentiment toward the country's financial industry.
And worsening troubles in neighboring Japan only mean more pressure on the local currency, they say.
The dollar rose to a six month high of Y125.06 late in the Asian day Tuesday, from Y124.36 late Monday in New York, amid continued worries about the state of the Japanese economy and stock market.
'A slow gradual depreciation of the won isn't going to be erased quickly but will persist for some time,' says Tim Condon, regional economist at Morgan Stanley Asia Ltd. in Hong Kong. 'If we see a sharp weakening of the yen against the dollar, it would be accompanied by a move in won' versus the dollar.
From a survey of five economists, the dollar is expected to rise to as high as 1,050 won by the end the year and to 1,200 won during the next quarter.
The two largest Asian economies share many of the same exports, including electronics, steel, semiconductors, chemicals and automobiles. Over 50% of Korea's exports compete directly with Japanese products, according to analysts.
Hence, the won's moves against the dollar often mirror the yen's trading movements versus the U.S. currency, as local exporters vie to make their products more attractively priced compared with the products of their Japanese rivals.
'Any positive effects of the won's depreciation are effectively cancelled out by the yen's decline versus the dollar,' says Kim Joo-hyung, head of research at LG Economic Research Institute in Seoul. 'If the yen was stable and the won depreciated by around 10%, then the price competitiveness of Korean export products would be greatly enhanced.'
Kim and others say the won's depreciation could work to help lift Korea out of its current misery, but as long as the yen continues to fall against the dollar, the trade deficit's narrowing trend will be harder to maintain.
Government officials have repeatedly pointed to the country's improving trade balance as evidence South Korea's real economy is improving despite financial market turmoil.
The country's trade deficit in October, sharply narrowed to $21 million from a shortfall of $1.70 billion during the same month last year. The trade deficit during the first ten months of the year narrowed to $10.41 billion from a $17.29 billion shortfall during the like period in 1996.
'You've got tremendous cyclical improvement in the trade account that has failed to offset severe problems in financial markets,' says Morgan Stanley's Condon. 'If Korea can make it over this difficult patch of watching for more problems to emerge from the corporate sector, this period will pass and the strength of trade' will rejuvenate markets.
Some economist, however, say the improvement in the trade balance is distorted because 1996 was a particularly bad year for Korean exporters and that on a month to month basis, the trade balance hasn't improved significantly this year.
Meanwhile, the increasingly shaky banking sector and battered financial markets are undermining a recovery of the won.
The South Korean won's prolonged decline started to accelerate after Kia Group's financial troubles arose on July 15. Since the eighth-largest conglomerate's troubles surfaced, several more of South Korea's largest conglomerates collapsed or fell into financial turmoil. In total, eight of the country's 30 largest conglomerates went bankrupt or are facing severe financial strains this year.
Troubles in corporate Korea have translated into massive amounts of bad debt piled at financial institutions. And as the health of many South Korean commercial and merchant banks worsens, the country's sovereign and corporate ratings have deteriorated.
As it has been increasingly difficult to obtain funds from overseas and as around half of local banks' estimated $66 billion in foreign debts are expected to mature soon, many are wondering where the banks and the rest of the economy will be able to obtain funds to meet their obligations.
Economists say the government's efforts to support the banking sector have done little to ease the liquidity squeeze felt throughout the economy.
They add that the current administration won't have the courage to come up with stronger measures to support the ailing banking industry ahead of the Dec. 18 presidential election.
'With any meaningful reform measures unlikely this year, in view of political considerations and the slowing economy, no significant correction in the bullish dollar-won trend is anticipated,' says Thio Chin Loo, foreign exchange strategist at Banque Paribas in Singapore.
'Indeed further pressure on the (won) is likely ... 1,200 (won per dollar) is possible over the next quarter,' she says.
Meanwhile, concerns the central bank is depleting much of its modest foreign currency reserves in its ardent defence of the won have many worried the country may be running out ammunition in its battle to slow the won's fall.
South Korea's reserves stood at $30.5 billion at the end of October. Economists worry, however, that the central bank may have committed a large chunk of those reserves via forwards market interventions last month and this month.
The central bank refuses to disclose the amount it has spent in currency forwards activity, which is fanning speculation about the size of the commitment. Government officials have responded by saying some market estimates are exaggerated and that the central bank hasn't committed a worrisome level of its reserves in forwards interventions.
The BOK told Dow Jones its liabilities in the forward market are 'far, far less' than estimates of $15 billion.
South Korean shares fell Tuesday, with the benchmark index down 3.21 points to 522.11. Interest rates, measured by yields on three-year corporate bonds, rose 0.1 percentage point to 13.00%.
-By Cecilia Kang; 822-732-2165; ckang@ap.org
South Korea, population 44 million, is heavily reliant on exports of key items such as semiconductors, steel, petrochemicals and automobiles. After years of robust growth, it became the 29th member of the Organization for Economic Cooperation and Development in 1996.
Recent Developments: The health of the country's economy has been challenged in the last two years. South Korea's current account deficit, which had been severely widening amid decreasing demand and a drop in export prices in 1996, has been slowly improving. High wages and guaranteed life employment were challenged by a controversial labor bill rammed through the National Assembly in Dec. 1996, and revised later after three-weeks of labor strikes. The financial sector has been burdened by mounting bad debt after bankruptcies of and financial troubles at major conglomerates.
Chief Risk Factors: Economic recovery may be delayed by more bankruptcies which has caused turmoil in the financial sector and liquidity problems in the local currency, debt and equities markets. Military instability is a consistent threat on the Korean peninsula as an official peace treaty between North Korea and South Korea was never signed after the Korean war. The possibility of North Korean collapsing amid a severe food shortage and drought in 1997 also pose a huge risk to the economy.
Financial performance: All figures are in won.
Latest Yr Yr Ended Yr Ended
Report Earlier 12/31/96 12/31/95
GDP Growth 6.3% 2Q97 6.9% 7.1% 8.9%
Inflation 4.2% Sept 4.0%(Aug) 5.0% 4.5%
Trade Balance -21M Oct -1.70B -15.3B -4.7B
Current Account -425.7M Sept -1.51B -23.72B -8.94B
Industrial Prod. 10.1% Sept 9.7%(Aug) 8.4% 11.9%
Currency, interest rate, stock market history:
End Oct 12/31/96 12/31/95
Won Vs Dlr 964.4 844.20 774.70
Yeilds On 3-Yr Corp. Bonds 12.60% 11.9% 13.8%
KOSPI Index 647.11 651.22 882.94
November 18, 1997
New York Times
South Korea Ends Efforts to Defend Its Currency
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By DAVID E. SANGER
WASHINGTON -- South Korea on Monday suspended efforts to defend its currency with its own, fast-depleting financial reserves as American, Asian and European officials scrambled to determine if the world's 11th largest economy -- and one of America's largest trading partners -- will become the latest Asian nation needing an economic bailout.
The surprise announcement from South Korea came after a series of public and private warnings in the United States that South Korea faces the kind of financial reckoning that has swept through Thailand, Indonesia and Malaysia this year. But South Korean officials, facing a presidential election which the ruling party could lose, said that despite a series of major bankruptcies and reports that banks cannot meet their debts, the country was fundamentally sound.
Monday's announcement by the central bank in Seoul that it could no longer afford to battle the markets and prop up the value of the Korean won was a sign to many investors that the country's troubles run much deeper. And U.S. officials are clearly concerned that a deeper financial collapse in Korea could resound more loudly around the world than the currency crises that have struck far smaller and less strategically vital nations in Asia.
"If a bailout of Korea was needed -- and no one is ready to say yet that it will be -- the size of the effort could be frightening," a senior administration official said Monday.
The official, who spoke on condition of anonymity, would not estimate what would be required, but economists and trade experts who raised the same prospect at a congressional hearing last week said that the costs could run from $50 billion to $100 billion, far more than the cost of the American-led bailout of Mexico in 1995.
South Korea is estimated to have $67 billion to $77 billion in short-term debt owned by financial institutions and investors worldwide, and there is good reason to question whether it has the resources to pay that back.
The country had roughly $30 billion in foreign currency reserves at the end of October but has spent billions defending the won against attack by using those reserves to purchase its currency in the foreign-exchange market, which reduces the supply in circulation and at least temporarily lifts the won's value.
In Seoul, officials refused to disclose the current level of their reserves, and are apparently reluctant to tell American and European officials how much they have left. "These guys are still in denial," one American official said.
As in the case of Mexico, American concerns go beyond the fate of South Korea's overextended banks or its currency woes. U.S. officials are worried about a financial contagion that could easily spill over into Japan, where banks are already teetering from the combined effects of bad loans at home and elsewhere in Asia.
Early Monday, Japanese authorities closed the country's 10th largest bank; a major securities house went under earlier this month. Moreover, because Korea directly competes with Japan in manufacturing a variety of products, any rapid devaluation of the won would create competitive pressure for Japan to allow its own currency, the yen, to weaken so that the country's exports are not sharply more expensive than those of Korea. That would greatly enlarge America's trade deficit, one of the most sensitive economic issues between Japan and the United States.
Concern that the won's depreciation might drag down the yen contributed to an initial surge in the dollar's value against the yen Monday in New York, but the dollar ended lower at 125.50 yen, down from 125.62 Friday.
Earlier Monday, Deputy Treasury Secretary Lawrence Summers was in Japan to urge Tokyo not to export its way out of trouble.
The currency crisis could also affect South Korea's role in the long-delayed talks just about to begin with communist North Korea over a formal end to the Korean War. American officials are concerned that South Korea is entering the talks appearing weak, its economy in free-fall while a contentious presidential election is underway. "It's not an ideal negotiating position," one State Department official said last week.
A third concern focuses on how to organize a bailout if needed. Speaking in Chicago on Monday, Treasury Secretary Robert Rubin avoided any specific discussion of South Korea, apparently concerned that he not worsen the situation by contributing to the weakening of investor confidence. But Rubin made it clear that the United States would not take the lead in any financial rescues, working instead through the International Monetary Fund.
"It is our view that the right way to approach these is through IMF-centered programs," he said. "Some people interpret that as a ceding of U.S. leadership. Not at all. We have been very actively involved with the IMF and countries involved."
Still, on Thursday, before Congress adjourned, it refused to approve $3.5 billion the Clinton administration sought to help create a new fund within the IMF to deal with exactly such emergencies. That is bound to reinforce an impression in Asia that the United States wants to maintain influence in the region, but not contribute financially to solving its problems.
The current financial crisis in Asia began this summer when Thailand, once a booming example of rising Asian economic power, conceded that its banks had lent billions to unsuccessful projects. The Thai currency fell by roughly 40 percent, interest rates soared and growth slowed sharply.
The IMF came to the rescue with a $17.2-billion bailout, but Thailand has yet to comply with all the austerity measures required. The Thai government fell last month, and a new prime minister has promised to comply with the measures.
But the contagion quickly spread, first to Malaysia and then to Indonesia. Late last month, the IMF announced a rescue package for Indonesia that included $15 billion in immediate funds, and agreement by several countries -- including the United States -- to provide "backup financing" if needed.
South Korea is more complicated. Its economy is far larger than any of the troubled Southeast Asian nations; its gross domestic product last year was $484 billion, up from only $253 billion in 1990. That makes it more than twice the size of Thailand's economy, though only about a tenth the size of Japan's.
Already the won has fallen about 17 percent since the beginning of the year to a record low against the dollar, and many economists believe it must fall much further in coming days to make Korea's products -- from semiconductors to auto parts to steel -- competitive with those of Southeast Asian countries that have already withstood devaluations of 30 percent to 40 percent this year.
While traders clearly expect the won to continue to slide, it may not happen as swiftly as in other countries. Korea still limits the won's daily fluctuation to 2.25 percent of its value the previous trading day. At the current exchange rate of roughly 1,008 won to the dollar, that means any daily decline would be limited to about 23 won.
But even that trading band might have to be abandoned if it essentially stopped transactions from occurring, meaning that companies and banks might not be able to convert enough currency into dollars to meet their obligations.
Summers is meeting in Manila with finance ministers and central bankers from throughout Asia for a previously scheduled meeting to discuss how to aid financially distressed nations throughout the region.
South Korea's troubles will clearly be a major subject of conversation. But South Korean officials say they will not turn to the IMF -- perhaps because they do not need to, perhaps because it would be humiliating.
"It is not a certainty, but they are certainly the leading candidate to be next," C. Fred Bergsten, president of the Institute for International Economics, said last week. "The Asian contagion has made its way north."
February 10, 1998
The New York Times
In Korea, Domestic Loans Said to Be Serious Problem
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By STEPHANIE STROM
SEOUL, South Korea -- The Nasan Group was a successful apparel manufacturer with a stable of popular local brands until it began an ambitious expansion in 1988, backed by banks that are now suffering the consequences. Flush with easy credit, it branched out into golf courses, resorts and hotels, then added a health-club subsidiary and acquired a construction company.
"Our chairman felt that housing was another medium of fashion," explained Yeom Moon-nam, assistant director of planning. "In the same way that clothing evolved from simply something to keep you warm into a fashion statement, houses are not just for refuge any more."
The group later tacked on a basketball team, department stores and supermarkets and a broadcasting company, assembling a collection of 15 affiliates that by the end of last year made it South Korea's 50th-largest conglomerate.
Last month, Nasan collapsed under the weight of loans that it could not repay. Its debt outweighed its equity by 10-to-1 -- a ratio more than five times the amount that would be considered even marginally prudent in the Western world.
Analysts worry that hundreds of humdrum stories like Nasan's may threaten the fragile South Korean banking system. While the world financial community has been transfixed by last Friday's renegotiation of $23.4 billion in short-term debt owed by South Korean banks to foreign banks, a far larger, messier problem is brewing here at home.
Short-term domestic debt -- the money owed to South Korean banks by local companies -- is more than double that owed to foreign creditors. With interest rates soaring, liquidity fast evaporating and consumption all but coming to a halt, dozens of companies like Nasan are going belly-up every day, with potentially dire consequences both for local banks and for the global financial structure.
Each corporate collapse adds stress to a battered banking system. "It's just one more straw on the back of South Korea's banks," Stephen Marvin, the head of research at Ssangyong Investment and Securities Co. said. "The next Nasan could be the straw that breaks them."
Marvin is one of a growing chorus of South Korea watchers warning that the world's 11th-largest economy could face a financial meltdown, not because of the foreign debt crisis but because of the mountain of domestic debt.
Korea First Bank and Seoul Bank, two large commercial banks that the government bailed out in January, failed because each had more than $2 billion in soured domestic loans.
South Korean banks owe their foreign counterparts some $153 billion, about $23.4 billion of which was short-term debt until it was restructured last month. That total pales beside domestic debt, the money South Korean companies owe South Korean financial institutions, which at current exchange rates is somewhat more than $300 billion, according to analysts.
Between 50 percent and 75 percent of domestic debt is short term, much of it in the form of "oum" notes that come due in three to six months. A Korean tradition, the use of "oum," or promissory, notes, is pervasive in South Korean business.
The system works like this:
Let's say Nasan, which, among other things, manufactures apparel, sold some of the clothing it makes to a Seoul department store. Rather than paying in cash, the store might issue Nasan a promissory note for the amount it owes that comes due in three months.
But Nasan needs cash. It takes the promissory note to its bankers, who swap the notes for cash at a discount that depends on both Nasan's creditworthiness and that of the retailer that originally issued it.
Nasan, however, guarantees payment of the note. Three months later, the department store has gone bankrupt and cannot pay the note. Suddenly, Nasan is on the hook for the face value of the note.
In fact, it was not technically Nasan's $500 million debt burden that crushed it, but two oum totaling $3.5 million. It was oum that brought Halla and Kia, relative leviathans in comparison with Nasan, and scores of other South Korean companies to their knees, and oum will undoubtedly sink hundreds more South Korean businesses this year.
"We're not talking about a long time here, if you think about the fact that most of the promissory notes issued in mid-November when the economic crisis began are coming due in mid-February or March," said Jeff Uscher, editor of Grant's Asia Observer.
Whether the South Korean financial system can absorb a steady stream of bankruptcies is far from certain. In the first week of January, more than 100 companies went bankrupt, and the pace has not abated, which means banks' capital bases have already suffered severe erosion.
"The question is whether the pace of bankruptcies will reach critical mass and set off a detonation in the financial system," said Karl Moskowitz, representative director of KSA Ltd., a consulting firm whose clients are mainly midsized Korean corporations. "The domestic debt problem could lead to the same financial paralysis we had last December, but this one will be much more difficult to solve."
Analysts estimate that at least 20 percent of the domestic loan portfolio, or somewhere between $60 billion and $65 billion, is probably already in default, and other estimates range as high as 30 percent or 40 percent.
Government officials say such estimates are vastly overblown. At the end of November, the Bank of Korea put the value of nonperforming loans at about $20.6 billion at current exchange rates, and it is estimating an increase to $28 billion this year.
Whether or not "oum" are included in those estimates is unclear; different government agencies have different answers. Last week, the government said there were probably trillions of won of problematic "oum" notes in the financial system.
In November, Korea Asset Management Corp. began assuming troubled loans from commercial banks and merchant banks, which are smaller, more speculative institutions, with the goal of selling the collateral and cleaning up the banks' balance sheets. The agency has about 20 trillion won, or $12 billion, at its disposal.
"We think we are very well prepared," said Lee Jong Koo, who was until recently the head of the banking bureau at the Ministry of Finance and Economy. "I don't think there will be a crisis in the financial sector."
But KAMC has already spent one-third of its budget to bail out Korea First Bank and Seoul Bank, along with a smaller bank and a merchant bank that failed last year. That leaves about $8 billion to clean up the rest of the problem, which is not nearly enough, according to analysts.
"Right now, there's a shortfall between what's available and what's needed," said Richard Samuelson, head of research at SBC Warburg Dillon Read in Seoul.
Even those who contend that the government has the tools to circumvent a banking crisis brought on by domestic debt concede that the problem is serious.
"Last year, there was a string of bankruptcies of big companies," said Park Jae-ha, a research fellow at the Korean Institute of Finance, a research center backed by commercial banks. "No bank can make money under those circumstances, and if that kind of thing happened again, it would hurt the Korean banks seriously."
Nonetheless, he is betting it won't. "I'm cautiously optimistic about our financial system," Park said.
But Samuelson expects that at least three and perhaps as many as eight of South Korea's 30 largest conglomerates, or chaebols, will close this year. "I don't believe even the most pessimistic government estimates are factoring in the possibility of eight more going bankrupt this year," he said.
While financial disclosure in South Korea looks rigorous by the standards of other Asian countries, it is scanty by Western standards. The definition of nonperforming loans is less stringent than in the United States, and when Japan recently applied U.S. standards to its banks' loan portfolios, the value of nonperforming loans tripled.
Plus, South Korean companies typically shoulder debt loads more than twice as high as would be considered remotely prudent in the United States. Nasan's $500 million in debt was more than five times that level.
When it became clear late last year that it could not pay off two promissory notes that were coming due in January, Nasan asked its banks, led by the Korea Exchange Bank, for an additional $17 million. But by then, South Korea was in the midst of a credit squeeze, as banks began a long overdue effort to stem erosion in their capital bases.
On Jan. 14, Nasan filed for court protection in a process vaguely similar to filing for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code. It owed money to many of South Korea's commercial banks and several of its merchant banks. It had even borrowed from Peregrine Investments Holdings, the flashy Hong Kong investment firm that went under just two days before Nasan.
Spokesmen for Korea Exchange Bank and Hanil Bank, two of Nasan's larger creditors, said the company's troubles would not hurt them.
But how many collapses like Nasan's would they be able to withstand? "I think there are a lot of other Korean companies in our position," Yeom of Nasan said. "The banks themselves are examples of our situation: They have a large amount of insolvent bills."
The International Monetary Fund acknowledged last week that soaring interest rates had imperiled Korean businesses and, as a result, put pressure on the country's banks. Hubert Neiss, the fund's regional director, said in a statement that "high interest rates have a cost, as they hurt banks and enterprises."
Nonetheless, the statement continued, "The IMF has advised to accept this cost until the foreign-exchange market is durably stabilized."
January 4, 1998
Korean Certainty: No More Business as Usual
By SETH FAISON
SEOUL, South Korea -- An age-old Korean practice, common among housewives, draws together a group of acquaintances to pool their cash savings and trust one among them to manage the pool profitably. Often, that means providing the money to a credit-starved business at a high interest rate.
Kim Yon-jung, a 54-year-old mother of two who runs her family's finances, participated in this kind of arrangement for years and earned well above what she could have on her own. Putting her cash in someone else's hands, Mrs. Kim also found, allowed her to avoid reporting her holdings to South Korea's aggressive tax authorities.
A few weeks ago, however, Mrs. Kim got the shock of her life. The woman in charge of her 30-member group disappeared with all the money, roughly $2 million.
"In the old days, that would never happen," said Mrs. Kim, still amazed that a reliable pillar of her life had disintegrated so swiftly. "My daughter was suspicious of the old way. Maybe now I should listen to her."
South Korea's financial crisis, so much worse than anyone had predicted, is forcing business executives, government officials and ordinary people to thoroughly rethink the way they have done things for decades. Financial methods and practices left over from a simpler era are abruptly clashing with the demands of a more modern society, like accountability and openness, and it is as true for big conglomerates as it is for housewives like Mrs. Kim.
The current crisis emerged from a tight collusion between big companies and government that meant that credit was allocated using political, and not financial, criteria. Only when several of South Korea's enormous conglomerates started going bankrupt did the extent of the problem emerge.
When international bankers gathered in New York, Tokyo and London last week and agreed to defer more than $10 billion in Korea's short-term debt, they were mainly interested in keeping the nation from defaulting in a way that would prevent Korean banks from ever paying back the loans.
But rescue packages and loan holidays, even if they keep South Korea's financial system nominally alive, will not fully preserve the old-fashioned ways of this country. And that is good news for an entire generation of younger men and women who see a bright side to South Korea's financial mess. For them, the weakening of conglomerates means that the traditional emphasis on seniority in the business world may have to yield a few steps in favor of ability. Many well-educated young executives are eager to take over from elders they see as long on loyalty and short on efficiency.
Young South Koreans complain that despite a steady modernization over the past 40 years, the nation's economic and social system in many ways still resembles the strict hierarchy of a small village, built as it is on an ethos of trust in a relatively small number of elders who are only informally accountable to the larger group. That may have been fine in the old village, but now it is badly outdated. Just ask Mrs. Kim.
By and large, Koreans did not seem surprised that a system of bribery, politically motivated loans and fiscal irresponsibility was widely practiced by heads of conglomerates. What was so shocking was the scale of corruption and collusion. The old Korean financial system may have worked as long as the players -- and their misdemeanors -- remained small. But as companies grew into multibillion-dollar operations, the lack of adequate accountability was bound to lead to abuses.
After Hanbo Iron & Steel went bankrupt in early 1997, for example, an investigation showed that the chairman, Chung Tae-soo, had borrowed $6 billion for the company, and used several hundred million dollars of that to bribe officials to keep authorizing cheap bank loans, keeping some for himself.
Even more stunning, perhaps, was the revelation that the head of the conglomerate that owned Korean Airlines had made a beeline for the presidential mansion in 1983 when a Soviet fighter plane shot down KAL Flight 007, killing all 269 people on board. The first concern of the executive, Cho Choong-hoon, was to hand several million dollars to then-President Chun Doo-hwan, to insure that Cho could keep his job.
Chun, whose total take allegedly reached hundreds of millions of dollars in his eight-year rule, was pardoned last week and released from serving a life sentence he was given last year.
The election of the liberal reformer Kim Dae-jung on Dec. 18 seems to have given many young people hope that the political system will veer in a more democratic direction. Yet Kim, who assumes office in late February, is taking over at a time of such financial crisis that it is uncertain how much he can reform the large conglomerates known as chaebol. Even so, the system built around these conglomerates, many of which resemble personal empires rather than efficient businesses, is unlikely to survive in its current form.
One aspect of Korean business life that immediately looks vulnerable, for example, is the kisu system of arranging employees by seniority.
Steadily expanding chaebol have hired a new crop of employees each year, labeling each new group according to number of years the company has been in business -- a tag that is expected to remain throughout an employee's career. Even Korea's main airline had a kisu system for flight attendants.
"When you meet someone new at your own company, you immediately ask what kisu they are," explained a Korean journalist. "Whichever one came earlier -- no matter who is actually older -- treats the other one like an inferior."
This year, few chaebol will be hiring; in fact, those that do not fall into bankruptcy will more likely be laying off people.
"The old kisu will gradually become meaningless," said the journalist.
Yet as Mark Clifford, an American journalist, observed in his prescient book about South Korea, "Troubled Tiger" (M.E. Sharpe, 1995), a system so dominated by the government was bound to run into serious financial trouble.
"The old order is shriveling," wrote Clifford. "But the new one has yet to be born."
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