In sum, despite the large extemrnal debt and the constraints that it imposes on the Indonesian economy, the country has been able to keep growing while the annual inflation rate has remained fairly stable and at moderate levels during most part of the last decade. Overal, Indonesia's economic authorities have been able to avoid major imbalances despite the limited room they have to maneuver. In part this has been the result of pursuing sound exchange rate, fiscal and monetary policies. Also, they have shown their willingness to implement the required adjustrnent policies whenever necessary.

# 5.5 Korea

Although the capital account in Korea remains paitially closed, it has been progressively liberalized since 1984 when direct foreign investment was freed. In 1984 direct portfolio investment by foreigners was also partially liberalized.<sup>32</sup> In 1992 the direct purchase of Korean stocks by foreign investors was further liberalized, although some restrictions still apply. Following the 1984 and 1992 reforms, capital flows into Korea have increased significantly, and particularly so in the last two years. The recent flows have come mostly in the form of DPI<sup>33</sup> . However, the potential problems caused by these capital inflows are not new to the Korean economy, since starting in 1986 and until 1988 and mainly due to the economic recovery of the industrialized countries, Korea showed significant current account surpluses that created the same kind of problems that an increase in capital inflows does, namely excess liquidity, upsurge inflation, and an appreciation of the real exchange rate. During this period the stock of international reserves jumped from US$ 3.3 billion (in 1986) to US$ 16.6 billion (in 1992).

Since 1986, the government and the Bank of Korea have attempted to minimize the effects of the increased liquidity in the economy by increasingly implementing sterilized intervention and paying out foreign debt. Thus, the stock of outstanding government securities increased almost 20 times in real terms from end-1985 to end-1987, and almost doubled between end-1987 and end-1989 (also in real terms). Since then it has remained stable.<sup>34</sup> On the other hand, foreign debt (as a percentage of GNP) has fallen systematically during the second half of the 1980's and the beginning of the 1990's. This is particularly so for the case of long term public (or publicly guaranteed) foreign debt Thus, as a percentage of GNP by end 1991 total foreign debt had fallen to one third of its 1935 level, while long-term public and long term private foreign debt had fallen to one fourth and one half of their 1985 levels, respectively.

Nev ertheless, in recent years inflation has increased -from less than 3%-on an annual basis in 1985, to almost 10% in 1991, and 6.2% in 1992- while the real exchange rate has appreciated by 40% (approximately) during the same period.3<sup>5</sup> An explosion in nominal wares, following the transition to democracy, has been one of the causes of the accelration of inflation.-<sup>6</sup> As a result the international

- 31 See Trends in Developng Economies Vol. 2, The World Bank (1993), and Indonesia Sustaining Development The World Bank (1994).

- 32 After 1984 foreigners were allowed to invest in Korean stocks through investnent funds, and Korean companies were allowed to raise capital through equity-link bonds.

- 33 The opening of the stock market for foreign investors in 1992 meant a capital inflow of nearly US$800 millions during the first quarter of the year alone.

- 34 The stock of govemment securities includes T-bills, Foreign Exchange Stabilization Bonds, and Monetary Stabilization Bonds. (Source: The World Bank).

- 35 The RER is measured as the ratio between the nominal exchange rate and the CPI. 36 Nominal Wages and the CPI increased 156% and 43% between 1985 and 1991 respectively.

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