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SOUTH KOREA'S 1997 FINANCIAL COLLAPSE.   Term Paper ID:25533 Click to get this paper

Essay Subject: Causes, effects, probable outcomes. Corruption, mismanagement, role of govt., debts, currency, bank restructuring, foreign loans.... More...

15 Pages / 3375 Words 16 sources, 51 Citations, APA Format $60.00 Return to List of Papers

Paper Abstract: Causes, effects, probable outcomes. Corruption, mismanagement, role of govt., debts, currency, bank restructuring, foreign loans. Paper Introduction: ASIAN ECONOMIC & FINANCIAL COLLAPSE: CASE OF SOUTH KOREA Introduction This research reviews the causes, effects, and probable outcomes of the economic and financial collapse in the Republic of Korea (South Korea). The broader scope of the economic and financial crisis in East Asia affected the countries in the region differently with respect to both scope and magnitude. The scope of this research, however, is limited to the case of South Korea, where the economic and financial collapse began in late-1997. The findings of this research are presented in five major discussions that deal with a series of interrelated issues. The first of these discussions considers the primary causal factors leading to the economic and financial collapse in South Korea. This Text of the Paper: The entire text of the paper is shown below. However, the text is somewhat scrambled. We want to give you as much information as we possibly can about our papers and essays, but we cannot give them away for free. In the text below you will find that while disordered, many of the phrases are essentially intact. From this text you will be able to get a solid sense of the writing style, the concepts addressed, and the sources used in the research paper. The government will raise the Corporation'sresources to 8.4 trillion won from the then current level of less than onetrillion won by contributing government owned property to the Corporation.The special protection guarantees will continue until 2 1 (Republic ofKorea Ministry of Foreign Affairs 2). Rather, this type of crisis is a result ofan extensive coordination failure." According to Marshall (3), South Korea"could have been cushioned from its fall if the investors had supported"the country and its borrowers. Strict observance of international standards of reportingtransparency and disclosure. The central challenge for macroeconomic policy now is tomitigate the severity of the recession in the domestic economy andfacilitate an economic recovery while consolidating external financialstability." References Aiyer, S-R. http://www.foreignaffairs.org/envoy/documents/v9n1_economic_crisis.html Shim, S. demandstalled, the truth was revealed: the chaebol had a huge debt problem. As a result, labor and capital productivity inmost manufacturing sectors" were "less than half US levels." Akaba, Budde, and Choi (68) found that, from 1988 through 1997, thechaebols accrued "massive amounts of short-term debts." This debt wasmanageable as long as the economy was growing, "even though returns oninvestment were often low because of overcapacity .... To overcome thecurrent difficulties and future challenges, the full cooperation of thepeople of Korea is called for. The systemworked so well ... This action mostdefinitely aggravated and accelerated the development of the crisis,although this action was not an underlying cause of the crisis. The state, through the Ministry ofFinance, directed that capital be funneled to the manufacturing sector andaway from the service sector. Sri-Ram Aiyer (41), Country director, Korea Department, at the WorldBank, stated that: "Thanks to its quick policy response, Korea ... The high levelsof inputs not only came from the state-directed preferential loans, butalso through high levels of well-paid employment. Private consumption increased 4.8 percent in the thirdquarter of 1997 and reached a low point in the second quarter of 1998 witha decline of 13 percent. This system simply wasunsustainable (Atkinson 2). Under most scenarios, such achange would be a highly positive occurrence for the exporting economy.Unfortunately, the withering of capital sources prevents most companies inSouth Korea from taking advantage of this opportunity. To protect depositors during this process, all deposits not honored byailing institutions will be fully covered by the new Consolidated DepositInsurance Corporation. crisis" as regulated competition andgovernment-controlled allocation of economic resources. (21 November 1997). "Is the Asian Flu Fatal?" Reason 3 (May 1998: 18-27. With respect to the purchase of bad loans, the Government introduced anew purchase method to enable the KAMC to absorb additional bad debts.KAMC's Non-Performing Asset Management Fund, currently valued at 3.5trillion won, was increased to 1 trillion won drawing new funds from acombination of sources, including the national budget, central bankreserves, a new bond issue, and international institutions. The unemployment rate in the third quarter of 1997 was 2.2percent. Fixed investment increased by .3 percent in the first-halfof 1997 and reached a low point in the second quarter of 1998, when fixedinvestment decreased by 29 percent. madeconsiderable progress during 1998 in stabilizing its external financialposition. The nextdiscussion provides details on the changes that have occurred within theeconomy of South Korea since the beginning of the economic crisis. On 19 November 1997, as one of his first acts in office, new FinanceMinister Lim Chang Yuel announced a package of measures aimed atstabilizing the volatile financial market in South Korea. 4. Meltzer, A. Jong-Keun, Y, Dr. "Paradigm Shift in Korea." Joint U.S.-Korea AcademicStudies 9 (1999): 9-19. Industrial production grew by four-percent inthe first quarter of 1999 (Yoo 1). A major underlying cause of the economic and financial collapse inSouth Korea was the system that has been referred to as "crony capitalism"that prevailed in South Korea for decades wherein the large family-ownedenterprises, the chaebols, at the heart of the country's economy, wereallowed to thrive and survive on state-directed, preferential bank loans.The operations of the chaebols were characterized by low levels ofproductivity and the preferential, state-directed financial arrangementsprovided no incentives for improvement. The stepsannounced by the government were as follows (Republic of Korea Ministry ofForeign Affairs 1): 1. Little recovery occurred in the second-half of 1998 (Shim 13). Government consumption increased 7.2 percent in the thirdquarter of 1997 and reached a low point in the second quarter of 1998 witha decline of 12.1 percent. Lim, C-Y., Republic of Korea Deputy Prime Minister and Minister ofFinance. The Korean government sincerely requests understanding andcooperation of the people of Korea." The agreement between the government of South Korea and the IMF wasreached on 3 November 1997. Among other steps,laws that essentially had created a lifetime employment system were amendedto promote higher levels of unemployment-a favorite tactic of IMF planners(Jordan A28). 6. Some recovery occurred in the fourthquarter of 1998, when GDP decreased by only 5.9 percent (Shim 13). The Korean government has finally decided to accept suchrecommendation." Lim (1) observed in an understatement that the Korean economy is"expected to undergo a painful process of structural adjustment; themacroeconomics policies and fiscal operations are expected to beconstrained by the conditionality of the IMF assistance, while thefinancial sector restructuring will be accelerated. 2. By contrast,imports are projected to increase by 2 .1 percent in 1999, following a 35.5percent drop in 1998 (Yoo 1). Gross domestic product (GDP), which increased 6.1 percent inthe third quarter of 1997 reached a low point in the third quarter of 1998when GDP decreased by 6.8 percent. 8. Marshall (3) held, however, that investors"became individually anxious on investing so that their uncoordinated butsimultaneous withholding of funds aggravated the crisis." Interactive Effects Between South Korea and Other Countries Stemming from the Economic and Financial Crisis The economic and financial crisis on South Korea has affected theeconomies of other countries, just as actions within those other economieshave had effects on the economy of South Korea. that the country was once labeled 'Korea Inc.' Inrecent years, however, the system has come under fire for its inherentinefficiencies ...." Jong-Keun (1 ) identified the "key elements of the... Republic of Korea Ministry of Foreign Affairs. Consumer prices are expected to increase in the two-percent-to-three-percent range for all of 1999. While most of the elements of thisline of reasoning did occur in the unfolding of the economic and financialcrisis in South Korea, this line of reasoning is too simplistic andsuperficial to define the core problems underlying the crisis. To obtain funds from the IMF, the government of South Korea agreed toreform the country's financial and business sectors. The Government stated anintent to write-off 5 percent of all bad loans in this way by the end of1997 and eliminate all bad loans within two years (Republic of KoreaMinistry of Foreign Affairs 1). The more important of these changes are as follows: 1. Production improved somewhat in the last-halfof 1998, decreasing only eight-percent in the fourth quarter (Shim 12). But when ... Jordan, M. 7. Meltzer (21), professor ofpolitical economy at Carnegie Mellon University, holds that the governmentof South Korea permitted and even encouraged debt-to-equity ratios "whichwere astronomical. 11. The scope of this research, however, is limited to the caseof South Korea, where the economic and financial collapse began in late-1997. Debt-to-equity ratios now commonly range between 5 and 8 ... This system was fundednot only by loans from foreign banks but also by the high rates of personalsavings among the citizens of Korea. Baily, M. H. "The IMF Rescue Package Will Ultimately Benefit the WestFar More Than Seoul." The Guardian (11 January 1998): 2. (2 November 1997): 1-2. Yoo, C-s. Those corporationsin financial trouble will be encouraged to make additional efforts toimprove their financial position, to merge with others to strengthen theirfinancial position, or to transfer their foreign currency denominatedassets and liabilities to state-run banks or city banks that are consideredsound (Republic of Korea Ministry of Foreign Affairs 2). 3. A major flaw in this system was a failure to develop astrong domestic demand for the products of South Korea's manufacturingsector. Consumption improved somewhat by the end of 1998,with a further decline of only 11 percent in the fourth quarter (Shim 13). "The Search For A New Development Paradigm." Joint U.S.-Korea Academic Studies 9 (1999): 21-44. "S. 9. Lim (1) stated that theIMF had assured Korea full support if Korea requested financial assistance. Burton, J., and Halliday, P. L.,Palmade, V., and Zitewitz, E. It seemed to have been triggered byunnoticeable events which paradoxically created a continent-wide economicdepression. "FOCUS-South Korea Central Bank Raises GDP Forecast."Reuters (8 April 1999): 1. "The Korean Economy in 1998." Korea's Economy 15 (1999): 9-15. When demand from the export sector began to falter, there was nodomestic demand for the chaebols to turn to for support. V., Kim, Y. By the end of 1998, the won hadrecovered to 1293 to the dollar (Shim 11). The unemployment rate is not expected toimprove substantially in 1999 (Yoo 1). Jordan, M. The government stated that merger andacquisition activity across industry lines will result in institutions thathave more flexibility to engage in a variety of businesses (Republic ofKorea Ministry of Foreign Affairs 1). The system will examinethe asset and liability positions of each financial institution andclassify them into three types: (1) those that bear watching but canrecover a sound position; (2) those that will need to improve theirfinancial position through an increase in capital or the sale ofsubsidiaries; and (3) those in more difficult straits that must restructureor be merged or acquired by stronger institutions. Koreans Walk Off Their Jobs." Washington Post (28 May1998): A28. By the third quarter of 1998, however, manufacturingwages dropped 1 .1 percent in the third quarter of 1998 (Shim 14). California Trade and Commerce Agency. The motivation of the government was tostimulate exports, which in turn was a part of a strategy to develop andmaintain high international trade surpluses. S., Lewis, W. When the financial visebegan to grip to the point where the government was no longer able tosubsidize preferential loans, the chaebols count not compete in the exportmarkets (Baily, Do, Kim, Lewis, Nam, Palmade, and Zitewitz 76). Under pressure from the IMF, the World Trade Organization(WTO), and the United States, the government of south Korea alsoimplemented a policy at the beginning of 1999 that eliminated restrictionson the import of used automobiles (California Trade and Commerce Agency 6). The enforced restructuring requirement will act as an "early warning"system to detect unsound financial institutions. The South Korean central bank is projecting that exports will increaseby 1.3 percent in 1999, following a 2.8 percent drop in 1998. Such characteristics cannot be accounted for in standardneoclassical economic models. New individual ceilings for foreigninvestors were set at 1 percent (Republic of Korea Ministry of ForeignAffairs 2). Thethird discussion describes the initiatives that were designed andimplemented to restore stability to the economy of South Korea. Purchase of bad loans held by failing banks by the KoreanAsset Management Corporation (KAMC). The high international tradesurpluses were necessary to support the high levels of foreign debt, aswell as to support the low levels of productivity in the country'smanufacturing sector. Wageshave continued to fall. Thefinal discussion addresses probable future outcomes for the economy ofSouth Korea in the wake of the economic and financial crisis. The government contended that bank mergers will result ingreater capitalization for the remaining banks, and increased activity inareas such as securities companies that have not been traditionally a partof banking business in South Korea. Further, when describing non-performingassets, the government will use the same classification criteria as thatused by nations such as the United States and Japan (Republic of KoreaMinistry of Foreign Affairs 2). "Latest Market Intelligence." (5March 1999): 1-7. When demand faltered in mid-1997, theentire system collapsed upon itself. The Korean government firmly believes thatthe economy will get back on track within a short period of time if alleconomic participants including the government, workers, fines, andfinancial institutions work together with the financial assistance from theIMF. N., Do, C. system that led to the ... David Marshall, senior financial economist at the Federal Reserve Bankof Chicago, included foreign banks in the equation that led to thefinancial and economic collapse in South Korea. Akaba, Budde, and Choi (68) found that the hardest hit ofthe enterprises in South Korea have been the banks that extended the loansto the chaebols," although some major companies have become bankrupt andhundreds of smaller firms have folded. The current account changed little in the final two months of 1998(Shim 13). The low levels ofproductivity in the manufacturing operations of the chaebols would havecaused their products to falter in the export markets had not thegovernment of South Korea subsidized these operations through state-directed and state-supported preferential loans. This discussion is followed by areview of the interactive effects between South Korea and other countriesstemming from the economic and financial crisis within South Korea. Overall, this system led to high levels of inputs into South Korea'smanufacturing sector and low levels of productive output. Lim (1) noted in the announcement that, in spite of the sound economicfundamentals in terms of economic growth, price stability, and the externalbalances, the Korean economy was experiencing what he termed as a"temporary liquidity shortage." Lim (1) noted further that the decliningconfidence international in the South Korean economy, "triggered by aseries of large corporate insolvencies, has undermined the overseasborrowing capability of domestic financial institutions, making the roll-over of the short-term debt difficult." Lim (1) also stated that the IMF and "the other allies haverecommended Korea to seek a financial assistance from the IMF in order tosecure firm stability in the financial market and to reinforce our reformefforts. "Middle Class Plunging Back Into Poverty." Washington Post(6 September 1998): A1. Foreign exchange stabilization. Manufacturing wages increased 5.4 percent in the thirdquarter of 1997. Rather, thecompanies in South Korea are themselves becoming targets of companies inthe United States which want to acquire them at fire sale prices because ofthe drop in the value of the won (Atkinson 2). Restructure of the financial industry. http://www.commerce.ca.gov/international/oed/marketintelligence.html Claessens, S., Ghosh, S., and Scott, D. 3. In the absence of productivity increases, thissystem could be maintained only as long as the high levels of inputs couldbe maintained. "Understanding the Asian Crisis: Systemic Risk AsCoordination Failure." Economic Perspectives 22 (Fall 1998): 3-18. The government announced that merchant banking corporations that havefunding difficulties abroad also will be restructured. 2. With respect to transparency and disclosure of financial activities,to strengthen the confidence of the international community in the SouthKorean economy, the government announced that it would hence forth releaserelevant financial data concerning the size and terms of foreign debt andcurrent size of non-performing assets of domestic financial institutions.Additionally, data will be released as to the size of bad loans held byindividual commercial banks. html Marshall, D. Additionallosses were to be covered using fiscal resources. Akaba, Y., Budde, F., and Choi, J. Bythe end of 1998, the inflation rate was down to 6.8 percent (Shim 14). The agreement also obligated the governmentof South Korea to implement policies consistent with the structuraladjustments demanded by the IMF (Burton and Halliday 1 ). Additionally, capital markets wereliberalized to permit foreign investors to purchase corporate bonds withmaturities greater than three years. "The Roots of Korea's Crisis." The McKinseyQuarterly (2nd Quarter 1998): 76-83. "Government Agrees to Terms for IMFLoan." Financial Post (1 December 1997): 1 . The total level of support was expected toreach US$57 billion, with a first tranche loan to occur within daysapproximating US$2 billion. Attraction of new foreign capital. Probable Future Outcomes for the Economy of South Korea in the Wake of the Economic and Financial Crisis In the spring of 1999, the economy of South Korea is growing at afaster rate than had been anticipated. "Restructuring South Korea'sChaebol." The McKinsey Quarterly (4th Quarter 1998): 68-79. Another government policy that allowed the chaebols to continue tooperate inefficiently was the protection of chaebol-manufactured productsin the domestic market through import restrictions on imported products.This protection assured that the chaebols would not be motivated to seekhigher levels of productivity. There are companies there which have four times theamount of debt outstanding as they have equity, as compared to the heavilydebt-burdened European companies, which have 8 percent, 8 -2 split, orthe United States, where it's about 15 percent." Dr. You Jong-Keun (1 ), Senior Economic Advisor to the President ofSouth Korea, wrote that; "Over the past three decades, the remarkablegrowth of the Korean economy has largely been due to an investment andexport-driven development strategy which was overseen by a tightlyinterconnected circle of government, banks, and big businesses. Consumption improved somewhat by the end of1998, with a further decline of only 1 .5 percent in the fourth quarter(Shim 13). Initiatives Designed and Implemented to Restore Stability to the Economy of South Korea After resisting overture from the International Monetary Fund (IMF)when faced with economic difficulties in the past, the government of SouthKorea saw no other way out of the current crisis. South Korea's current account increased by four-percent inthe fourth quarter of 1997 and dropped to a 2.7 percent increase by October1998. Press Release. As Baily, Do,Kim, Lewis, Nam, Palmade, and Zitewitz (76) observed, in spite of "massiveinvestment in the best available manufacturing technology, protectionismand poor corporate governance prevented Korean companies from adopting thebest management practices. The international currency exchange value of the won fellfrom 899 won to the US$ in the third quarter of 1997 to 1613 won to thedollar in the first quarter of 1998. "Korea's Financial SectorReforms." Joint U.S.-Korea Academic Studies 9 (1999): 83-11 . Asian Economic & Financial Collapse: Case of South Korea Introduction This research reviews the causes, effects, and probable outcomes ofthe economic and financial collapse in the Republic of Korea (South Korea). GDP grew at a rate of 3.8 percentin the first quarter of 1999. Thus, the initiativesdesigned and implemented to restore stability to the country's economylargely are those than have been dictated by the IMF (Atkinson 2). Production, which increased 8.8 percent in the third quarterof 1997 reached a low point in the second quarter of 1998, when productiondecreased by 11.6 percent. Unemployment continues to be above seven-percent (Shim14). As Marshall (3) noted,foreign investors and lenders, for the most part, cut off the extension ofadditional funds or the practice of rolling-over short-term debt to SouthKorean companies and banks at the first hint of trouble. http://www.foreignaffairs.org/envoy/documents/v9n1_economic_crisis. 5. W., Nam, V. These policies,according to Jong-Keun (1 ), allowed "a few select companies to be shieldedfrom the forces of competition and the risks of investment." Claessens,Ghosh, and Scott (85) supported this argument, stating that: Difficultiesin the corporate and financial sectors have been at the core of Korea''financial crisis. Statement. 1 . Consumer prices increased by four-percent in the thirdquarter of 1997 and soared by 8.9 percent in the first quarter of 1998. The broader scope of the economic and financial crisis in East Asiaaffected the countries in the region differently with respect to both scopeand magnitude. Exports increased 33.2 percent in the third quarter of 1997and reached a low point of an 8.9 percent increase in the third quarter of1998. Atkinson, M. With respect to restructuring the financial sector of the economy ofSouth Korea, the government announced that it would develop a stronger,more transparent and globally competitive Korean financial industryincluding voluntary and enforced restructuring through mergers andacquisitions. The findings of this research are presented in five major discussionsthat deal with a series of interrelated issues. MaryJordan (A1), writing in the Washington Post, stated that Americansincreasingly view the crisis "in terms of how big as threat it is to WallStreet." Claessens, Ghosh, and Scott (86) stated that the economic andfinancial crisis in Asia that surfaced first in Thailand affected thesituation in South Korea by undercutting investor confidence in theeconomies of East Asia. In turn, this line of reasoning was used to arguethat, as the crisis developed in South Korea, the problems in Koreareinforced investor concerns toward investment in other East Asianeconomies. Little recovery occurred in the final quarter of 1998 (Shim 13). Changes That Have Occurred Within the Economy of South Korea Since the Beginning of the Economic Crisis Major changes in the economic aggregates for South Korea have occurredsince the beginning of the economic and financial crisis in the country inmid-1997. By the third quarter of 1998, the unemployment rate had increasedto 7.4 percent. 4. Within this context,Marshall (3) stated that the Asian crisis that began in "mid-1997 was notforeseen by world economists. Allan H. This protection also acted to dampendomestic demand for products produced within the country because of thehigh prices that ensued from the low levels of productivity and because ofthe unavailability of competition from foreign manufactures. The day after the statement outlining financial reform was issued bythe Ministry of Foreign Affairs, the Deputy Prime Minister and Minister ofFinance Chang-Yuel Lim announced that the government of South Korea haddecided to seek financial assistance from the IMF as a part of thecountry's efforts to deal with the crisis (Lim 1). (Akaba, Budde,and Choi 68). For all of 1998, the economy of South Koreacontracted by 5.8 percent. 5. Somewhat ironically, the economic and financial collapse in SouthKorea that resulted in a massive drop in the international currencyexchange value of the won has caused products manufactured in South Koreato become more competitive in export markets. The first of thesediscussions considers the primary causal factors leading to the economicand financial collapse in South Korea. Primary Causal Factors Leading to the Economic and Financial Collapse in South Korea The short answer to the causes of the economic and financial collapsein South Korea is that it was a chain reaction involving the country'sbanks and commercial firms, wherein Korean banks borrowed heavily fromforeign sources at high rates of interest, in turn loaned this costlycapital to Korean companies which then built up huge levels of costly debt. Overseas borrowingby major public enterprises will be encouraged under the new policyannounced by the government (Republic of Korea Ministry of Foreign Affairs2). The government willcompel institutions that do not comply with these regulations to transferall of their assets and liabilities to other financial institutions.Assistance will be available from the Deposit Insurance Corporation tooffset the losses of healthy financial organizations that merge with oracquire those that are ailing (Republic of Korea Ministry of ForeignAffairs 1). To service this costly debt, Korean companies needed to maintain highlevels of demand for their products. 1. The incentive framework for the financial sector did notlead to an efficient allocation of resources or promote the institutionaldevelopment of financial institutions that adequately appraise risk. With respect to stabilizing the won in the foreign exchange market,the policy that will be followed once the won is stabilized will be toallow the won to float with a trading band of 1 percent as opposed to theearlier band of 2.25 percent. With respect to the attraction of new foreign capital, limits on swapfacilities with the South Korean central bank were increased for foreignbank branches in South Korea to improve capital inflow. If this paper is not what you are looking for, you can search again: Search for: or Click here to request an essay written just for you.