The Recent Financial Crisis and Korea's Economic Future
Dr. Il SaKong
Chairman & CEO
Institute for Global Economics
Good afternoon, ladies and gentlemen. It is indeed my great privilege to address before this audience. I thank the organizers of this meeting for inviting me.
My main purpose, this afternoon, is to present a brief overview of the recent Korean financial crisis to provide you with a perspective for Korea's economic future.
Starting from a typical developing nation with per capita income of less than one hundred dollars in the early 1960s, Korea came a long way to become a member of the OECD in 1996. Indeed, the Korean economic performance of the past four decades went far beyond everyone's best expectation. However, Korea surprised the world by running into a severe financial crisis in 1997, along with its Asian neighbors. Korea ended up receiving an emergency rescue loan from the International Monetary Fund to overcome its worst economic crisis in half a century.
Korea recently surprised the world again by is swift turnaround. Suffering from a negative 5.8% growth in 1998, the Korean economy recovered remarkably fast to achieve the GDP growth of over 10% with the rate of inflation of less than 1% in 1999. Korea's foreign reserves, as of end of February, increase to nearly US$80 billion from US$3.9 billion at the onset of the financial crisis two years ago.
In this connection, you must be interested in, first, what has been happening in the Korean economy after the crisis, and second, whether the rapid economic recovery is sustainable. To help answer these questions, I would like to begin by drawing your attention to the three critical factors involve in the recent Korean financial crisis, namely, the nation's fragile financial system, weak corporate structure, and contagion.
Let me touch on these factors briefly. Let's first take a look at Korea's fragile financial system. It is a well-known fact that Korea's economic development strategy in the past was implemented primarily through the government's direct control of the nation's financial resources. In the process, commercial banks were made to be de facto public enterprises. Consequently, the Korean commercial banks used to behave more like rationing agents rather than genuine financiers with sophisticated modern banking instruments and credit analyses.
In addition, the Korean financial system lacked an appropriate regulatory and supervisory infrastructure before the recent financial crisis. As a result, banks, as well as non-bank financial intermediaries, ended up over-exposing themselves to risks without proper hedging and made themselves vulnerable to any sort of financial shock.
Let me now turn to the second critical factor and that is, the weak corporate structure. It is also well-known that over-leveraging and over-investment were the salient features of the Korean corporate sector, big chaebols in particular. The weak corporate governance and no-transparent decision-making process and financial status are believed to be primarily responsible for such corporate characteristics.
In addition, the prevailing perception of "too-big-to-fail" must have caused moral hazard on the part of big chaebols, further aggravating their corporate structure. In this globalized world where competition is steeper than ever before, business enterprises with such characteristics were bound to hit the limit. In fact, even before the nation's financial crisis occurred, a number of big chaebols had already run into trouble.
The third factor, which triggered the Korean financial crisis, was the contagion. Today, we live in the age of financial globalization, where one nation's financial crisis could spread rather quickly to the rest of the world. Naturally, relatively weak economies would be more vulnerable to the contagion. The Korean economy, with its weak financial and corporate structures, was such a case.
In addition, the Korean government's poor crisis management capability, revealed through a few critical incidents that occurred before the crisis, must have adversely affected the international investors' confidence in Korea. A few such incidents that come to mind are, the poor handling of KIA Automobiles and the failure of labor law revisions and financial reform legislations.
With these multiple causes, Korea had to go through the worst financial crisis and ended up seeking an IMF emergency rescue loan. The loan was made available with various conditionalities. Broadly speaking, the conditionalities can be broken into two components: the first concerns the constraints on the macro-economic management; and second, the requirement of structural adjustments. There has been much criticism of the IMF conditionalities, especially on the macro-economic management constraints, but less on the nations' structural adjustments.
I have already alluded to the necessity of structural adjustments in the nation's financial sector and corporate structure. It is needless to mention that the structural adjustments for both financial and corporate sectors could not be fully accomplished without reforming the nation's rigid labor market to become more flexible.
From this perspective, the IMF conditionalitites regarding these structural adjustment areas could be considered as a blessing in disguised, in the sense that the Korean economy cannot continue to perform well without such restructuring efforts.
The Korean government, with a strong leadership commitment to the nation's economic reform and with the strong support of the Korean people, has been carrrying out those structural adjustment programs to conform with the IMF conditionalitites rather rigorously.
Let me now briefly touch on important aspects of Korea's economic reform efforts.
The nation's financial sector reform involves two major areas: first, strengthening the nation's financial regulatory and supervisory infrastructure; and second, supporting financial sector restructuring. A major legislative effort was made in December 199 to strengthen institutional and regulatory basis of the Korean financial system. The establishment of the Financial Supervisory Commission in April 1998 marked an important turning point in this respect.
Various other measures have been taken to enhance transparency and accountability of financial institutions. The number of commercial banks has been reduced to 17 from 27 and their staff was slashed by a one-third. Of the 12 troubled banks, 5 were liquidated and their assets transferred to other sound banks. One major bank has already been sold to an international investor and another remains in waiting. Of the 30 merchant banks and 31 investment trust companies operating in 1997, 19 and 7 have been either closed or merged, respectively. In doing so, the Korean government put up a huge amount of public funds to clean up the balance sheets of the troubled financial institutions.
The essence of the corporate sector reform lies in three areas, i.e., corporate governance, corporate financial structure, and real competitiveness. With regard to the corporate governance, chaebols were required to comply with international accounting standards, to respect the voting rights of minority shareholders, and to elect outside directors of the board.
The Korean government has taken various measures to improve the corporate financial structure. As a result, the debt-to-equity ratio of the top five chaebols, excluding Daewoo, is now down to 200% from nearly 500% in 1997. The average debt-to-equity ratio for the nation's manufacturing sector as a whole is also down to around 240% from 400% in 1997. Chaebols were required to publish consolidated financial statements. The cross-debt guarantees among chaebols' affiliates were also prohibited.
To enhance the real competitiveness of big chaebols, they were encouraged to concentrate on their core-competence areas by spinning-off their non-core business units. The nation's top 5 chaebols spun-off 549 companies during 1998 and the first half of 1999. The Korean government has allowed hostile takeovers since 1999. They were also encourages to have major business swaps and mergers and acquisitions among themselves.
With regard to the nation's labor market, new laws were introduced to allow layoffs and hiring of temporary workers. The Tripartite Commission was established to facilitate the enhancement of the labor market flexibility through a closer cooperation among the labor, the management, and the government.
No one would have doubts about the expected high payoffs of these economic reform efforts for Korea's economic future. Consequently, these efforts themselves must have contributed greatly towards restoring international investors' confidence in the Korean economy. In any case, the incoming foreign direct investment (FDI) set an all-time record in 1999, surpassing US$15 billion. Thanks to large current account surplus and these capital inflows, Korea was able to replenish its foreign reserves so quickly.
With these favorable external developments, as I preciously indicated, the Korean economy has made a swift recovery last year and is expected to do well this year.
It is critical, however, to realize that it is not the time for "complacency" or to fall into "reform fatigue syndrome". The rapid economic recovery during last year was driven primarily by the catch-up in private consumption and inventory adjustments accommodated by expansionary fiscal and monetary policies. Certainly, the outstanding current macro-economic performance is not fully based on the microeconomic foundation of productivity gains originating from the economic reforms that has been implemented thus far.
The Korean corporate sector has yet to deal with the existing over-capacity and at the same time, it needs to make new investments for restructuring. The nation's financial sector also needs a continued restructuring. Broadly speaking, major efforts so far have been directed towards dealing with past legacies. Continued restructuring efforts should be directed towards enhancing competitiveness of financial institutions for their survival in the age of the financial globalization.
As I mentioned earlier, the financial crisis was a blessing in disguise, simply because it forced the nation to restructure its own economy. Furthermore, it depoliticized many politically sensitive reform issues. It is my view that Korea was successful in seizing the moment well to turn the national mishap into an opportunity for necessary reforms.
For its sustained economic recovery and growth, however, Korea cannot afford to loose the grip on its reform efforts. In addition, Korea has to successfully meet the new challenges of the worsening income distribution, the rapid accumulation of public debt, and the establishment of the nation's productive welfare system.
Before I conclude, I would like to remind you of a few simply facts that are the basis of my optimistic view regarding Korea's intermediate - to long - term economic prospects. I am sure you would agree with me in saying that the Korea economy will become much stronger and more competitive as it completes the economic structural adjustments currently underway.
In addition, Korea, in my view, is adapting quickly to the new paradigm of the information age and the knowledge-based society. One-fourth of the Korean population is already using the Internet. The nation's enthusiasm for the venture business and the digital economy is already amazingly high. The daily trading volume of the KOSDAQ, the equivalent of the U.S. NASDAQ, has already exceeded that of the Korean Stock Exchange. Most importantly, I would like to remind you of the Korean people's zeal for education, which is an invaluable asset in preparing for a full-blown knowledge-based society.
Invest in Korea and Korea's future!
Thank you.