Recovery May Still Be Far Off For South Korea's Economy
By MICHAEL SCHUMAN
Staff Reporter of THE WALL STREET JOURNAL
September 3, 1998SEOUL, South Korea -- Is South Korea Asia's first turnaround story?
It could be. Some have started seeing Korea as perhaps the most promising of Asia's sick economies. Yet there is much more pain to come. And unless the government, companies and unions get serious about reform, a recovery could be pushed farther away.
In some ways, the economy has achieved startling stability since the government was forced into a $58.35 billion International Monetary Fund-led bailout nine months ago. The currency, the won, has appreciated 26% since the end of 1997, after a 50% plunge last year. The overnight call rate, or the interest rate at which banks lend to each other in short term deals, topped 30% in December and fell under 10% in August for the first time in more than two years.
Usable foreign-currency reserves were $41.4 billion at the end of August -- almost seven times higher than when Korea turned to the IMF. The current account has swung to a surplus of $25.5 billion in the first seven months of 1998, up from a deficit of $11.1 billion in the same period in 1997.
Sadiq Currimbhoy, a strategist at Merrill Lynch in Hong Kong, told clients in late July to overweight South Korea in their Asia portfolios. Mr. Currimbhoy believes that the large current-account surplus shows that companies are cutting investment and paying down debt, and that government spending will support domestic demand. "That sets the stage for some sort of bottoming out of the economy," says Mr. Currimbhoy, who expects it to happen by early next year.
'Korea Has Value'
"Korea has value for long-term investors," says Charles Howlett, a fund manager at Regent Pacific Group in Hong Kong, which in February invested $10 million in a Korean securities house. "We're bearish on the rest of Asia."
But the stronger won and soaring reserves don't tell the whole story. The domestic economy is enduring the worst recession in the country's modern history. Private estimates predict the economy could contract as much as 8% in 1998. The second half of this year will likely be worse than the first, as exports and domestic demand show no signs of recovery.
The economy is at a critical point: Improved fundamentals have given Korea an opportunity. How government and business leaders act will determine how quickly Korea climbs out of its recession.
Many bankers and analysts believe that not enough is being done. The biggest concern is still the feeble banking sector. Some believe that the banking system will fail unless the government steps in with resources to recapitalize financial institutions and buy their nonperforming loans. The government has committed 64 trillion won ($47.8 billion) to support the banking sector, yet 50 trillion of those funds, promised in May, haven't materialized. The financial-sector regulatory office concedes that the government hasn't decided how to allocate the funds among the banks.
Some analysts worry that if bank reform doesn't progress quickly, Korea's recession will be prolonged. "I've gotten more negative," says Clive McDonnell, an economist at SG Securities in Hong Kong. "They're easing off on bank reforms."
Analysts in Seoul are trying to determine how the banking sector has stayed afloat so far. The banks this year have become huge net borrowers in the overnight call market -- borrowing more in a month than in all of 1997. As their asset quality deteriorates, the banks are using these funds to compensate for losses of regular income and financing. The worst banks, including many corporate banks, have had difficulty raising financing at terms of a month or more, forcing them into short-term markets.
Preserving the Status Quo
The effect is the preservation of the status quo: The borrowing indirectly helps the banks to continue support for some of the most troubled major business groups, called chaebols, thereby preventing the large corporate bankruptcies many analysts had predicted.
The government's efforts at restructuring the banking and corporate sectors is also seen by some critics as misguided. Bank regulators in June took the bold step of closing five weak banks, but then transferred their liabilities, branches and many of the assets to five stronger banks. Many of the employees will also be given jobs at the acquiring banks. In the corporate sector, the government is pushing for asset swaps, dubbed "big deals" by the press, among the biggest chaebols to merge companies in the same industries. The hope is that greater consolidation and specialization can bring benefits, but the plans also perpetuate overcapacity and burden the best companies and banks.
One apparent reason for such methods is the government's fear of unemployment, which, at a seasonally adjusted 8.6% in July, had more than doubled since January. In a move seen as a setback for corporate reform, government negotiators recently had to pressure automobile maker Hyundai Motor Co. to lay off fewer than one-fifth of the workers management had planned to let go in order to end a month-long series of strikes, even though labor laws were reformed earlier this year to make layoffs easier.
But even the watered-down deal didn't appease Korea's unions: Hyundai union members voted this week to reject the pact, unhappy even with minimal layoffs.
Another cornerstone of any recovery is the pace of reform at the chaebols, and doubts remain about the seriousness of their efforts to cut debt and sell assets. According to financial sector regulators, the debt of Korea's listed companies increased in the first half of this year to 3.4 times equity from 2.8 times in the same period in 1997, as debts continue to increase. The continued access to financing, some argue, makes the chaebols, especially the five largest, less likely to reform. The top five chaebols accounted for 78% of all corporate bonds issued in the first seven months of this year, compared with 40% in the same period in 1997.
Foreign Commitments Wane
There are fears that interest in much-needed foreign investment has waned among both Korean and foreign companies. On the positive side, foreign direct investment rose 28% in the first seven months of this year compared with the same period in 1997, because Korean companies have pursued foreign capital like never before. But that may be short-lived. McKinsey Inc. estimates that for every completed deal, as many as 20 other discussions are terminated.
The main stumbling blocks have been demands by Korean companies for prices three to five times higher than the foreign companies are willing to pay, or for continued management control. A U.S. executive pursuing investments complains that lower interest rates and improved liquidity has made Korean companies even more reluctant to compromise.
"The discussions about deals have dramatically fallen in the past two months," says Cuong Do, a principal at McKinsey in Seoul.
What concerns some observers the most is that a sense of denial seems to pervade the economy that may delay reform. In its 1999 budget, the government has assumed that the economy will grow between 2% and 3% next year -- an expectation economists consider unrealistic.
That mood pervaded a bar in a five-star hotel in Seoul recently. There, an executive from a U.S. company bumped into a group of Korean businessmen in their 20s who were smoking fine cigars. The young men lifted their glasses of whiskey, and made a toast: "To the status quo."
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