WORLD TRADE
ORGANIZATIONWT/WGTI/W/69
30 March 1999
(99-1281)
Working Group on the Relationship
between Trade and InvestmentOriginal:  English
COMMUNICATION FROM KOREA
The following communication, dated 19 March 1999, has been received from the Permanent
Mission of Korea with the request that it be circulated to Members.
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FDI Flows and the Asian Financial Crisis:  Korea's experience
I. INTRODUCTION
1. Foreign direct investment (FDI) plays an importa nt rôle in the growth and development of an
economy. Among other things, inward FDI acts as a useful supplement to domestic investment and
accounts for a considerable share of exports in some industries. Maintaining and increasing the level
of FDI flows can therefore assist economic recove ry in a country that has experienced a severe
economic downturn.
2. Since the outbreak of the financial crisis in Korea at the end of 1997, the Korean Government
has dealt with the liquidity crisis and taken important steps to correct structural weakness, enhance
transparency, and further liberalize its trade and investment régime. These economic reforms have
also contributed to restoring international confidence and attracting FDI.
II. THE RÔLE OF FDI IN A CURRENCY CRISIS
3. The Asian currency crisis in 1997 spawned many studies on the nature of the crisis, with a
particular focus on its causes. In these studies, two factors are identified as major causes of the crisis:
moral hazard of economic agents including domestic financial intermediaries, and bank runs by
foreign investors triggered by an abrupt loss in confidence. The Asian crisis can be explained by the
combination of these two factors.
4. Some empirical studies have emphasized the rôle of FDI in preventing a currency crisis.1
They demonstrate that a low level of net foreign direct investment (FDI inflows minus FDI outflows)
correlates strongly with the occurrence of currency crises.
5. According to the authors, FDI flows are more st able than portfolio investments. Following a
crash, investors can suddenly dump their securities holdings and banks can refuse to roll over short-
                                                     
1 Jeffrey A. Frankel and Andrew K. Rose, “Currency Crashes in Emerging Markets: An Empirical
Treatment,” Journal of International Economics 41, 1996,  pp.351-366; June-Dong Kim and Sang-In Hwang,
“The Rôle of Foreign Direct Investment in Korea’s Economic Development: Productivity Effects and
Implications for the Currency Crisis”, KIEP Working Paper 98-04, 1998; Daekeun Park and Changyong Rhee,
“The Crisis in Korea: How Has It Been Aggravated?”, mimeograph, Seoul National University, 1998.WT/WGTI/W/69
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term loans. Multinational corporations, however, cannot quickly pack up their factories and go home.
A country in which multinational firms have a dominant presence is more likely to endure or
overcome a currency crisis without being forced to resort to IMF bailout loans. Unlike other domestic
firms, thanks to their parent firms, subsidiaries of multinational firms in crisis-ridden countries do not
suffer drops in credit ratings or encounter difficulties in importing raw materials or getting tradefinancing.
6.  These studies show that inward FDI (both flows and stocks) is negatively correlated with the
occurrence of currency crises and IMF rescue loans
2. By quantifying the predicted probabilities of
currency crisis in the five crisis-ridden Asian countries, the authors also show that the predicted
probability for Korea was the highest among them3. Such a finding can be attributed to Korea’s
relatively high portion of short-term debts and the low ratio of FDI flow to total debt, which in turn
implies that inward FDI can play an important rôle in preventing currency crisis.
III. FINANCIAL CRISIS AND KOREA’S FDI TRENDS
7. Despite the financial crisis at the end of 1997, total foreign investment in Korea registered
US$8.852 billion in 1998, a 27 per cent increase from 1997. It represents the sixth consecutive year of
increase.
Recent Trends of Inward FDI in Korea
                                                                                       (Unit: US$ million, %)
1993 1994 1995 1996 1997 1998
Amount 1,044 1,317 1,941 3,203 6,971 8,852
Growth rate* 16.8 26.1 47.4 65.0 117.6 27.0
       *In comparison with the previous year
8. The FDI increase in 1998 can be explained by the expansion of economic opportunities for
foreign investors. The currency devaluation combined with property price decrease have reduced theforeign currency costs of acquiring fixed assets and plunging equity prices in the aftermath of the
financial crisis has drastically reduced the costs of acquiring firms. During July 1997 - February 1998,
the Korean won depreciated by 83 per cent and stock price index decreased by 63.1 per cent.
9. The FDI increase was also helped by Korea’s improving international credit standing as a
result of the Government’s active reform program, including legislative reforms to induce foreigninvestment, an example of which is the Foreign Investment Promotion Act that took effect on
17 November 1998.
10. As corporate restructuring produces tangible results, and as Korea’s international credit
standing improves, more foreign investment is expe cted to flow into Korea in 1999 in such areas as
finance, tourism, and the petrochemical industry.
11. Another salient feature of FDI in Korea in  1998 is the increasing number of foreign
investment deals concluded through mergers and ac quisitions (M&As) of domestic corporations. The
restructuring of firms faced with large debt repayments and rising interest rates, lower stock prices
and the Government’s more liberal policy towards M&As have combined to expand opportunities for
foreign investors to make direct investments in Korea through M&As.
                                                     
2 Frankel and Rose and Kim and Hwang, Ibid.
3 Kim and Hwang and Park and Rhee, Ibid.WT/WGTI/W/69
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12.  In 1997, FDI in the form of M&As of domestic corporations amounted to US$699 million,
representing 10% of total FDI. In 1998, the amount of FDI in the form of M&As reached
US$4.7 billion, accounting for 53% of total FDI in Korea. As corporate restructuring moves forward,
FDI in the form of M&As is predicted to further increase.
13. Investment from the United States (33.6%) and the EU member countries (32.6%) took up
66.2 per cent of total inflow of foreign investments. Investments from Japan, while representing only
5.7% of total FDI inflow, jumped by 89.1 per cent from the 1997 level to US$503 million.
Recent Trends of FDI from Major Partners
                          (Unit: US$ million, %)
1997 1998 Growth/Decline
Japan 266 503 89.1%
USA 3,190 2,976 - 6.7%
EU 2,305 2,889 25.3%
14. The share of foreign investment in the manufacturing sector in 1998 was 64.8 per cent of total
foreign investments, compared with 33.7 per cent in the previous year.
IV. CONTINUOUS STRUCTURAL REFORMS NEEDED: INCREASING
ATTRACTIVENESS TO FDI
15. The shortage of capital, not only for investme nt but also for financing production operations
and trade, combined with the Government’s recogni tion of the rôle that FDI can play in restoring
growth and development, has led to increasing flexib ility toward FDI in Korea. As a result, Korea has
substantially liberalized its FDI régime. In addition to unilateral measures and measures taken toimplement multilateral commitments, liberalization measures have also been taken in the context of
the adjustment programs linked to the financial support package from the International Monetary
Fund. Recent moves include opening industries such as banking and other financial services to FDI,
and relaxing rules with respect to ownership, mode of entry, and financing.
16. While it appears that Korea has turned the corner in overcoming the current crisis, difficult
challenges still remain ahead. Although a large part of short-term foreign debts has been transformed
into long-term ones, the total sum of foreign liabilities has not decreased since the crisis broke out and
still amounts to 45 per cent of GDP.   Moreover, indus trial activity still lags far behind the level prior
to the financial crisis and debt-to-capital ratios of Korean firms and banks remain high.
17. To deal with the difficulties ahead, the thrust of policies should be focused on accelerating
reforms that address the roots of structural ineffici encies. It will serve to attract more FDI into Korea,
thereby helping to decrease foreign debts, raise the level of competitiveness and efficiency of
industries through recapitalization, and restructure foreign debt maturities. For Korea, the sum effect
of all these would be to further restore international confidence and thus secure greater liquidity.
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