Mr. Chon speaks on the topic 'Korea: moving on from the crisis'  (Central Bank Articles and Speeches, 8 Oct 98)
Central bank: bok | Type: speech | Date: 1998-10-08

Mr. Chon speaks on the topic 'Korea: moving on from the crisis' Address by the Governor of the Bank of Korea, Mr. Chol-Hwan Chon, at the 1999 Emerging Marke Roundtable hosted by Euromoney on 8/10/98.I am very happy to be with you today to explain our efforts to reshap economic and financial fabric of Korea.

This is all the more so since I am keenly consci vital role that you as investors play in the international economy.Just under a year ago, Korea faced a very difficult situation.

But the wor specific Korean problems now appear to be over.

Some sectors of the economy are grad returning to a stable track.

Let me take this opportunity to express my hearty thanks t for your cooperative support.

I hope that my words today will help you gain a clear what has been happening in the Korean economy.

## Development and Causes of the CrisisThe

alarm bells should already have been sounding by the mid-nineties. trade and capital market liberalization, firms had found themselves drawn into the glob Nevertheless, they did not adjust to the new environment in which the market ruled, bu pursued the expansion strategies of an earlier development era.

Also, the government establish a market system well geared to the changing world.

The consequent ambitio imprudent investment brought high growth at first, but deepened the high costs-low ef structure of the Korean economy.Deteriorating corporate sector competitiveness pushed up the ratio of the account deficit to GDP from 1 percent in 1994 to 4.7 percent in 1996.

Furthermore, fr last year, a number of highly leveraged large companies that had been hit by sluggish low profitability finally collapsed under their huge debt.

These failures in turn und soundness of financial institutions with large corporate exposures.

A vicious downwar was set in motion.Meanwhile, the contagion of the Thai baht's devaluation last July spread wildfire.

This further unsettled foreign investors who had been apprehensively eye weakening of both companies and financial institutions in Korea.

Reflecting this, S& Moody's downgraded Korea's long-term sovereign rating very sharply last October, w caused foreign investors to withdraw their credit lines hastily.

Liquid foreign exchan drained away rapidly leaving Korea on the brink of national insolvency.

The governmen had to turn to the IMF in late November.The jury is still out on what actually caused the Korean crisis, but there major contributory factors; namely, inefficiency caused by a failure to observe market the loss of market confidence caused by a lack of transparency, and inappropriate responses to the evolving problems.The first of these was perhaps the most fundamental.

The Korean economy h been largely government-directed for many years and lacked true market discipline.

In prapid growth, 'big' had been the name of the game so that the principle of too-big-t become an unwritten law.Financial institutions, under the government's wing, routinely made loans corporate sector without thoroughly screening investment plans.

Workers and deposito turned a blind eye to market principles.

Moral hazard was widespread and high co efficiency problems persisted.The second factor I mentioned was, however, the more immediate cause of financial crisis.

The accounting and disclosure systems of Korea fell short of glob making it difficult to grasp a true picture of firms' condition.

This lack of transpa symptoms of a crisis emerged, led to a rush for the exit since no discrimination could to quality.

But it should be also borne in mind that before the crisis, this obscu foreigners to invest in Korea without scrutinizing carefully the actual status of firmsLast, but not the least, was that the policy responses to the looming cr woefully inadequate; that they were mistimed; and that the markets were sent confusing by inconsistencies among them.

One prime example was the retention of a narrow currency despite the mounting downward pressure on the won.

This several times brought the f exchange market to a halt as the won hit its lower limit shortly after opening.

Anothe was the dithering over what to do with the distressed Kia group.

The failure to procee fairly and on the basis of market principles destroyed the incumbent administration's credibility.

## Response to the CrisisEconomic policies have since last December been closely coordinated with IMF.

On the macroeconomic policy front, the Bank of Korea raised its market interventi from 12 percent to over 30 percent to stabilize the foreign exchange market.

Korea also a free-floating exchange rate system.Along with stringent macroeconomic policy, structural reforms are now under throughout the financial and corporate sectors.The focus of financial sector restructuring is on the exit of unsound f institutions, the resolution of the overhang of bad loans and the strengthening of supervision and disclosure requirements.Five ailing banks have been resolved through a 'Purchase and Assumption' formula.

Korea First Bank and Seoul Bank whose capital was reduced in January w recapitalized by the government's subscription of public enterprise stocks.

Governme shares in these two banks will be sold under open bidding to domestic and foreign i before the end of October.

Sixteen out of thirty merchant banking corporations, wh contributed to the crisis, have been already shut down, and a number of distressed financial institutions, such as securities companies and insurance companies, have been suspended.Also, the bank and merchant banks now in business are being monitored on progress of their target BIS ratios and rehabilitation plans, which includerecapitalization and sharp reductions in branches and staff.

With this pressure to capital adequacy ratios and improve competitiveness, a wave of mergers is taking plac financial industry.

This is supported by the government through the purchase of non-pe loans and capital injection.

Three large mergers among banks have already been announce consolidation of the banking sector is likely to continue for some time.To improve transparency, standards for the classification of non-performing the accumulation of loan loss provisions, and disclosure have all been brought into internationally accepted standards.By revising the General Banking Act, the government allowed a foreign inve to hold more than 10% of a bank's total stocks with the permission of the Financial Su Commission.Restructuring of the corporate sector is now underway across many dimensionsFirst, all new mutual guarantees among companies belonging to a chaebol, wh were a main tool in fund-raising for them, have been forbidden since April 1998.

Membe will also be obliged to retire all outstanding cross-payment guarantees completely 2000.Second, commercial banks are playing a vital role in the exit of faile through agreements between large firms and their main creditor banks on improving c structure.

A first round which slated fifty-five non-viable firms from sixty-four conglo exit was announced last June.

These firms will have their credit lifelines turned off b of fresh bank credit and the calling-in of loans.

The process will continue in the futuThird, the chaebol will have to provide combined financial statements fro fiscal year 1999.

This should strip away the veil that has hidden their true position. to corporate governance, the rights of minority shareholders have also been greatly streFourth, ceilings on foreign investment in Korean equities have now b abolished and hostile takeovers by foreigners allowed.

Foreigners may now also buy and estate on a national treatment basis.

This September, with the passage of the 'Foreign Promotion Act', all foreign investors in foreign investment zones are given full exemp corporation tax and income tax for the first seven years of operation, and after that exemption for a further three years.All of these efforts are focused on shifting our economy from a governm directed to a market-oriented system.

We all recognize that rebuilding the economy on principles is the one and the only way to achieve a lasting recovery from the crisis.

## Recent Economic TrendsSince

the outbreak of the crisis, we have striven for foreign exchange stabilization and overall structural reform.

As a result, the exchange rate has gradua stability.

The won tumbled to about 2,000 won per dollar at one stage but has reco to around the 1,300 to 1,400 won range thanks to the big improvement in supply-dem conditions in the foreign exchange market helped by the large current account surpluswith the improved exchange market conditions, market interest rates have been easing their pre-crisis levels.

For example, the CP rate dropped from a peak of over 40 pe December to 11 percent level recently.But the real sector has been going through serious hardships with the m erosion of consumer and investor confidence, a deepening credit crunch, sharply negati growth, a continuing stream of corporate insolvencies, and a steep rise in unemployment.During the second quarter of 1998, the GDP growth rate registered -6.6 pe The number of the unemployed increased to 1.58 million in August, which was more than times the level of a year ago.

And there is a concern that the present asset-price d trigger more general deflation with the loss of purchasing power.It is true that structural adjustment is never without pain.

However, a prolonged depression could sap the country's growth potential.

And with no adequate safety net in place, a steep run-up in unemployment could unleash social unrest.Concerned to prevent such scenarios, the Korean government decided to incr public spending in agreement with the IMF.However, the government initiative should not be interpreted as full-scale priming.

The overwhelming stress is still on structural reform.

The worry is that t depression might stand in the way of structural reform itself.

A mild stimulus would, in con be beneficial for the structural adjustment process.This year will see sharply negative growth for the Korean economy.

But prov restructuring is successful, there should be a renewal of confidence in the country on international investors.

Macroeconomic fundamentals should then start to look a bit bet second half of next year, with a shift to mildly positive GDP growth, albeit at a meager

## Concluding RemarksTo sum up, Korea has made a concerted national effort to recover from the through

bold structural reforms.

I think, however, there was some trial and error conceived policies were adopted in the process of the structural reform.

As you are wel is very difficult to complete reform at a stroke without making mistakes, because refor fairness in the sharing of the pain among all parties.

I can, though, assert that K determined to bring about a sound and vital economy on the basis of the market mechanis me then earnestly request you not to write off the future of Korea because of shortsighted policies or temporary setbacks in pursuing structural reform.A recent survey by the prominent journal 'The Economist' pointed out t Koreans were optimistic and were confident that the future would be better although t dissatisfied with present life.

This attitude was cited as a driving force for Asi development, by the translation of future hopes into reality through hardwork and thrifKorea, which has endured many ordeals throughout its long history, will another economic miracle with this courage and hope.

I hope that you will t ke note of our efforts and be active in your support.