Source: Lim (2000). III. Financial Crisis of 1997. Growth Rate of GDP (1971 – 2006) Bank of Korea. Exchange Rate (Won/Dollar) Bank of Korea. The Financial Crisis of 1997. Foreign Debt Crisis
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Growth Rate of GDP (1971 – 2006)
Bank of Korea
In 1997, Korea was fast accumulating foreign debts, mostly foreign short-term loans to commercial and merchant banks in Korea.
Questioning the ability of Korean banks to pay back these loans, foreign banks declined to roll over the loans.
Lacking foreign reserves to pay off debts, Korea turned to IMF, resulting in a rescue program amounting to $57 billion, the largest in IMF’s history.
Because of the dollar shortage and the speculative forces, the Won/Dollar exchange rate skyrocketed from 900 to 1700 over several months.
For most banks, the amount of non-performing loans exceeded equity, and was in a state of bankruptcy.
Left alone, bank runs would break out and paralyze the economy.
The root cause of the crisis
Government select target industries and select Chaebols to develop these industries =>
Government has implicit responsibility to bail out Chaebols if they fail. =>
=> Excessive investment
State-controlled banks channel household deposits and foreign loans to firms designated by the government.
Interest rates are set by government.
Banks absorb losses from bail-out operations dictated by the government.
=> Incompetent banking industry
Lim (2000) pp. 42-55
Park assassinated in 1979.
Chun takes power by a military coup in 1980.
A sharp recession following the second oil shock, political instability and the results of over-investment in late 1970s =>
Korea on the verge of a major financial crisis
Chun adopt the stabilization package recommended by IMF
Consolidating industries and chaebols
Of Chun’s technocrats
Korea outgrew the Korean Model of Development.
The economy became too complicated to be understood and controlled by the government.
The market and the private sector should lead.
Privatizing commercial banks
Interest rates chosen by banks
From State-owed to semi-public.
New Fair Trade Law
limited impact on competition structure
Government tries to regulate the behavior of Chaebols.
Bureaucratic control of the government remains.
Political resistance of vested interestes
Chaebols and bureaucrats
Korea democratized in 1987
Chaebols form a new relationship with presidents and politicians thorough (legal or illegal) campaign funds
In terms of macroeconomics, the Korean economy was doing well.
Low inflation: 5%
Strong Growth: 8%
Current account deficit enlarged, but quickly receding.
Different from Latin American debt crises.
Many thought a Korean crisis is impossible.
Investment surge in 1994-1996
Liberalized non-bank financial institutions.
Deregulation of entries into industries
Short-term debt increased.
High interest rates and wages
Interest rate liberalization.
Democratic labor movements
Terms of trade shock in 1996
Source: Cho (1999)
Korea became a member of OECD in 1996.
Capital market opening
short-term trade credits
allowed merchant banks to deal with foreign loans
Upward pressure on Won/dollar exchange rate
Tried to sustain the value of Won by selling dollars.
Drained most foreign reserves.
Tried to rescue the troubled conglomerates in the old fashioned way.
No persuasive plans for restructuring troubled banks
=> Failed to bring confidence to uneasy foreign investors.
High interest rates in industrializing countries
Low interest rates in advanced countries
Debtor – borrowed too much
Creditor – lent too much?
Crisis occurred in the summer of 1997 in Indonesia, Thailand and Malaysia.
Contagion and herd behavior of international investors.
Both debtors and creditors should be blamed.
Both have to share the costs of the crisis.
IMF should not act as an agent of the US.
Tight monetary policy and high interest rates
Brings down the exchange rate.
Decreases investment and consumption and thereby decrease the current account deficits.
Tight fiscal stance
Consolidation of Chaebols
Spun off non-core business
Korean exports are highly concentrated on a small number of products
Semiconductors, LCDs, Mobile Phones, Steel, Ships, Automobils
Catch-up of China and India
Enhancing the competitive ness of financial sectors
Coping with volatile capital inflows and outflows
Containing bubbles in stock and housing markets
Source: Kyung-Joon Ryu (2007)