Financial Crisis

BRAC University Department of Economics and Social Sciences (ESS) SUMMER 2015

ECO 432: Money & Banking SEC- 01

TERM PAPER

SUBMITTED BY: MALIHA TASKIN BINTE BATEN ID: 12105013

Korean Financial Crisis of 1997

CONTENT

Introduction .............................................................................. 2 Literature Review .................................................................... 3 Chronologies of Crisis .............................................................. 4 Causes of Crisis ........................................................................ 5 Resolve of crisis ........................................................................ 6 Summary .................................................................................. 7 References ................................................................................ 8

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Korean Financial Crisis of 1997

INTRODUCTION The Asian financial crisis that occurred in July 1997 was an overextended crisis that grabbed most of East Asian countries attention. Due to financial problems at that time, this crisis increased the tensions of a worldwide economic disaster. South Korea had to face the worst hit by economic crisis and its IMF-led emergency rescue programmer cost around US$60 billion.1 Many economists describe South Korea experiences as “The bigger they are, the harder they fall”. In December 1997, the foreign exchange reserves of South Korea were too much exhausted and so the International Monetary Fund (IMF) of the South Korean economy needed aid from others.2 The economic crisis has had vast effects on all sectors of Korean society, particularly on the labor market, while it is argued by some economists that the economic crisis was primarily a financial crisis. The liquidity problem of the foreign exchange rate was one of the main reason of it.3 It is also added that economic foundations which were not strong enough were also responsible for the following crisis. Since the crisis, Korea has applied many institutional and policy reforms not only in line with its agreement with the IMF but also on its own judgment. To its credit, South Korea has also been one of the most active countries in implementing post-crisis economic and financial reforms, and it is now receiving the rewards of these efforts. Korea rebuilds the economy and the society essentially able to come out from the crisis. Which resulted Korea to be named as country that has passed a long way by making its financial sector stronger. 1 This sector helped the country to achieve greater openness with better regulation. In addition, South Korea's economy is now more transparent and flexible, interest rates are lower, and foreign reserves—which at the height of the crisis in December 1997 were down to US8.9$billion—has been increased enormously, to US$243bn as of end-March 2007. 4 The following work will shed light on the chronology, causes and consequences of the Korean economic crisis and how they overcome the crisis.

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Korean Financial Crisis of 1997

LITERATURE REVIEW

In the article “The Korean financial crisis” Irma Adelman & Song Byong Nak (1998) the authors discussed about the chronologies of the crisis. They also talked about the effectiveness of the IMF which helped a lot to handle the situation and also the policies and strategies that were related to the crisis.1 “The 1997 Financial crisis and Governance” by Kwan S. Kim shows us a complete view of 1997 economic crisis and the role of Government.7 It is also observed that during the recession, joblessness, murder, and crime- these types of social difficulties also arise a lot. Kwon Soonman (1999) also mentioned the same. “The 1997-1998 Korean financial crisis: Causes, policy response and lessons” by Kim kihwan (2006) is a brilliant presentation on Korean financial crisis.2 He brings light on main issues that were responsible for crisis and he also presents some lessons that we can easily learn trough this crisis. From this presentation we can at least have an idea about the reformation of South Korean economy step by step. Krishna Gidwani asserts about Korea and International Monetary fund (IMF) in his writing.5 He mentioned what are the structural and policy changes done by IMF and Korean Government to overcome the crisis. The economist from whole world discussed and assumed the economical situation of Korea during recession time. However, the article “Ten years on: How Asia shrugged off ist economic crisis” in The Economist shows us the reality after ten years. A lot has been published and many talked about the depression of Korean economy. Economists mainly emphasized on the of US dollar movements, the Japanese yen weaknesses, domestic and international developments in Korea that occured in 1997, domestic marketing policies, combination of international and domestic development, government’s wrong decision- that are the main factors responsible for the financial crisis in Korea.

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Korean Financial Crisis of 1997

CHRONOLOGIES OF CRISIS

The first apparent sign of crisis in Korea was visible in 1996, when the current account deficit widened from 2% of GNP in 1995 to 5% in 1996, the rate of growth of exports slowed down from 31% to 15% and that of GNP declined from 14.6% to 7.1%.

Table 1: Chronology of Korean financial crisis 1997

Korea

1995

1996

Account Deficit

2%

5%

GNP

14.6%

7.1%

   

 

Foreign debt

78 billion

100 billion

  

*Source: Irma Adelman & Song Byung Nak (1998)1

Hanbo steel went into bankruptcy. Kia motors went default Share market freefall Government asked for loan to IMF & other international agencies. Largest international financial rescue was approved. US secretary of treasury said Korea had stabilized In Feb 1997, 1/3 merchant bank closed. Crisis were replaced by depression. Korea engaged in fundamental restructuring of its financial & corporate sectors.

At the same time, in short term, foreign debt raised from a 78 billion dollars (62% of exports) to 100 billion dollars (76% of exports) from year 1995 to 1996.1 The world prices of garments, ships, automobiles, computer, and chips decreased impulsively and a recession occurred in Europe and Japan. For these decreasing amounts, over 50% of Korea’s total exports were affected at that time. In January of 1997, despite a massive rescue attempt, Hanbo steel, the 14th largest chaebol in Page 4 of 8

Korean Financial Crisis of 1997

terms of assets and 17th largest in terms of sales, went into bankruptcy, followed by the failure of the Sammi steel in March, another steel producer Jinno group in April. In July 1997, Kia motors, the third largest Korean auto maker, went into default and failed to pay $370 million worth of liabilities.5 The stock market responded by a sharp fall by mid-November, it had dropped 50% in compare to its mid-1997 high.1 Korea asked for IMF and international bail-out, which was more than five times the country’s usable foreign exchange reserves.2 On January US secretary of the treasury stated that Korea had overcome the crisis but the President Kim Dae Jung warned, “The worst is yet come”.2 Meanwhile, the crisis has reduced for a while but gradually depression took its place. Korea has been engaged in fundamental restructuring of its financial and corporate sectors.

CAUSES OF CRISIS

The origins of the present Korean financial crisis are complex. A number of theories have analyzed trying to explain why the crisis happened when it did. The main reasons of the crisis can be attributed to both internal and external factors. Past industrial policy inheritance of structural distortions and weaknesses are the main among them. Korean governments were extremely dependent on the chaebols for export success and the latter in turn had privileged access to government-subsidized credit. The chaebols, habituated to rapid growth and under the belief that they were too big to fall. Slowly they became over confident with their investment results. In the early 1990s which the boom year, some external borrowings occurred at this period. These borrowings caused the dramatically increased Current account deficits from, leading to a remarkable accumulation of short-term foreign debt. In 1996, the export growth had been distorted. As a result, the growth rates of industrial productions had split compared to 1995. 6 Debt/equity ratios were very high and profitability very low among the chaebols. The financial situations of the chaebols (conglomerate) and the banks that had lent to them were fluctuant and the possibility of widespread bankruptcy was very realistic.7 Page 5 of 8

Korean Financial Crisis of 1997

In reflection of these conditions, the stock market had fallen sharply (by 36%) in 1995 and 1996 relative to its 1994 peak.6 However, such policies and practices created not only maturity mismatches but currency mismatches as well. More direct external causes can be found in the antagonistic international developments after the mid-1990s when the country’s trade health was severely disintegrated. Besides these external and internal factors, the “poor governance of Yong-Sam Kim” (1992–7) was another responsible factor for this crisis.7 In reflection, two parts of policy failure can be seen. They area) The early decision that was taken in year 1996 by joining the OECD to move forward financial liberalization. b) Government’s late reaction also responsible for the crisis.

RESOLVE OF CRISIS

When the Korean government realized that the nation is in serious financial crisis, the government requested to IMF for a loan. The IMF’s bailout decision was based on the fear of possible default by Korea, which was the world’s eleventh largest economy. The immediate reason of the bailout was to implement a bridging finance to reduce current-account deficits and keeping inflation in check by restricting domestic demands. At the end of November 1997, IMF, World Bank, Asian development bank sent their team to negotiate with Korea. In December 1997 IMF agreed to a $60 billion package of bailout.5 They also concerned about restoring health and stability of Korean economy. Due to the bail out the exchange rate of the economy become more flexible. The government put more emphasys on the monetary policy for reducing the pressures on balancing payments. They detouched the institutions those had unavaliable and weak supervisions and on the other hand they raised foreign institution to take part in the domestic (External Relations Department, 1998) markets. For supporting this, the financial measuring systems were refined to improve the effictiveness of all markets.5 Korean government also raised transparency with regards to fiscal, corporate and banking sectors, as well as economic data (External Relations Department, Page 6 of 8

Korean Financial Crisis of 1997

1998)5. They were also concerned about restoring health and stability of Korean economy. Other reforms include strengthening prudential regulation, reducing moral hazard.2 All the mentioned programms have implemented and developed for maturing the economic condition of Korea.

SUMMARY

Korea made impressive progress in overcoming the crisis in just a year. The recovery of the crisis continued throughout 1999. Korea’s economic rehabilitation speed reflects the fact that the crisis was a liquidity issue but, more significantly, is in large measure attributable to the good governance of the D.J. Kim administration.7 The main plan in corporate restructuring is to reduce the chaebols’ overlapping businesses least possible. The top five chaebols have reshaped the nation’s industry, making the business structure more concentrated.

After two years the exchange rate has stabilized at 1,200 won for a dollar and the rate is even lower than the level before the crisis. 8 The stock market seems to have returned to normal despite the bankruptcy of Daewoo.The recovery process seems to run so fast that most Koreans have forgotten that fundamental reforms were needed to strengthen the South Korean economy. The 1997 Korean economic crisis learns a lot about basic and fundamental economic areas. The policy makers and economists have now a real life example. They know what should be consider to maintain the equity in currency markets , what changes should be done in trade policies between neighboring countries, foreign exchange market how to conduct them to avoid major impact.

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Korean Financial Crisis of 1997

REFERENCES

1

Adelman Irma and Song Byung Nak (1998). “The Korean Financial Crisis of 1997-1998,”

mimeo. 2

Kim Kihwan (2006). The 1997-98 Korean Finanacial crisis: causes policy response and

lessons“ , The high level seminar on crisis prevention in emerging markets, International Monetary Fund (IMF) and Government of Singapore. 3

Calvo Guillermo A and Enrique G. Mendoza (1996) " Mexico"s Balance of Payments

Crisis: a Chronicle of a Death foretold" Journal of International Economics 41 pp 236-264. 4

The Economist (2007), „Ten years on: How Asia shrugged off ist economic crisis.

Krishna Gidwani , Korea and the Asian financial crisis. Citeted 8th August, 2015, from. http://webcache.googleusercontent.com/search?q=cache:eETno0_ilR8J:web.stanford.edu/c lass/e297c/trade_environment/global/hkorea.html&hl=en&gl=de&strip=1&vwsrc=0 5

6

Bartholete, Jeffrey. "Is Korea Ready to Explode?" Newsweek 12 Jan. 1998: 42.

Kwan S. Kim (2000), The 1997 Financial crisis and Governance: The case of Soth Korea, Working Paper; The Helen Kellogg institute. 7

Kwon Soonman (1999), Economic crisis and Social development in South Korea, Asia house Essen. 8

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