South Korea’s alarming recovery

July 31, 1999

SUDDENLY, South Korea’s hard-won stability seems to be crumbling away again. On July 19th Daewoo, the second-largest of the chaebol (family-controlled conglomerates), announced a debt refinancing that was meant to calm the markets. Instead, it spread panic. Interest rates shot up and, within the space of a week, the stockmarket had fallen by nearly 15%. As the government dithered, the investment-trust companies, which own more than one-third of Daewoo’s ruinously heavy debts, were threatened by a run on their deposits. Only a few weeks ago, South Korea was trumpeting its economic recovery. The latest sounds are more like the alarm bells of renewed crisis.

Daewoo is in a mess. The firm’s chairman, Kim Woo Choong, had been hoping that the offer of more than $1 billion of his personal assets as collateral for the group’s borrowing would restore faith among sceptical investors. Then, reasoned Mr Kim, Daewoo could raise the fresh equity it needs if it is to survive. But now that prospect seems farther off than ever—as the government belatedly acknowledged on July 27th, when it put control of the group’s restructuring in the hands of its bankers.

For those who still see in South Korea only the illusion of economic growth, rather than a genuine recovery, this was a cautionary tale indeed. At the other chaebol too, say the critics, restructuring is destined to be a disappointment. The stockmarket rally, which has financed an ephemeral spurt of consumption among the wealthy, will then reverse—and the economy will stall or even slip back into recession.

Surprisingly, that view is as common inside the country as it is among foreigners, even among those Koreans who are doing best out of the recent burst of growth. To take an example, Oh Hyun Jin, a golf-club salesman in central Seoul, is doing good business. Sales are back where they were before the financial crisis of December 1997. But Mr Oh is quick to deny that this is a sign of more general economic recovery. His customers, he says, are only the rich.

The newspapers, meanwhile, are filled with tales of suffering among the middle classes. With the chaebol still in deep trouble, jobs for life are a receding memory. Unemployment has dipped a little, but at 6.2% it is still nearly three times what it was before crisis struck. To many Koreans, the government’s talk of 6-7% growth this year seems at best irrelevant, at worst fantastical. 

Part of the explanation for the grim mood lies with the statistics. As interest rates soared and bank finance dried up last year, South Korean firms were forced to shed their inventories to survive, suppressing growth still more. This year any decrease in stocks is likely to be more modest. Cheong Mun Kun of the Samsung Economic Research Institute estimates that this slowdown in stock-shedding will help boost growth this year to 8%. But Mr Cheong says that, for all the middle-class gloom, there is real growth in demand from other sources.

Net exports, for example. Korean companies have shown lightning speed in taking advantage of a sharply lower exchange rate. Since the 1970s, says Mr Cheong, when South Korea was the world’s biggest exporter of wigs, none of its exported products has occupied the top slot. Last year, it had five: ships, DRAM chips, computer monitors, certain types of LCD screens and mobile telephones. As the chaebol made the most of their powerful overseas networks, they turned a 1997 current-account deficit of 1.5% of GDP into a 12.6% surplus last year. That will shrink this year as South Korea’s currency strengthens. But the won is still 25% cheaper in dollar terms than it was before the crisis hit, so the trade balance will easily stay in surplus. The government is rebuilding its foreign-exchange reserves, which now stand at over $60 billion. This month it said it would pay back IMF loans early. 

High interest rates and a brutal credit crunch had devastating effects on South Korea’s firms last year, at one point putting more than 3,000 out of business every month. But in September, the government injected 64 trillion won ($47 billion) into the banks, thereby nationalising most of the biggest lenders. As the won stabilised, meanwhile, the central bank cut interest rates, from 16% in June, to 7% by the end of September, and then to below 5%.

South Korea has long made its investment and savings plans on the assumption of double-digit interest rates: not since the long boom began in the 1960s has the cost of borrowing fallen below 10%. So rates below 5% have had a highly expansionary effect. Since January, the stockmarket has risen by 70% in dollar terms, even after the recent sell-off. Consumption is increasing, and not just of luxury goods such as golf clubs and airline tickets. After a lag, business investment is picking up too—despite the belief that the economy’s most salient feature is chaebol overcapacity. As one official at the ministry of finance points out, that overlooks smaller companies, which surveys suggest are investing heavily. Strange to relate, there is even talk of overheating. But interest rates will stay low for a while yet. Unemployment and spare capacity make inflation next year’s worry, not this one’s.

The combination of rapid growth and low inflation sounds fine—but not necessarily to those who want faster structural reform. Indeed, the restructuring of the chaebol has slowed down recently, partly because their autocratic chairmen cannot raise much more capital on the booming stockmarket without endangering the control of their empires, which they are loth to do. As one Korean investment banker puts it: “They think with their hearts, not with their heads.” And without more equity to recapitalise their subsidiaries, the chaebol will find it difficult to sell parts of their sprawling groups and bring themselves back to health.

However, restructuring remains essential for South Korea’s long-term growth prospects. The government seems to know this; talk of deliberate foot-dragging is a little unfair. There was a whiff of panic about its decision this week to hand Daewoo’s restructuring over to its creditors. But that action should pave the way for the debt-equity swaps with the bankers that will make Daewoo’s subsidiaries healthy enough to sell, so breaking up Mr Kim’s fief.

Nor is this by any means the only achievement of the government’s in structural reform. In little over a year, it has shut defunct lenders, recapitalised the rest, introduced a new and tougher financial regulator and strengthened corporate-governance requirements (outside directors, for example, are now mandatory). Next year will come the ending of the cross-guarantees that sustain chaebol empires. If it keeps up the pace, despite inevitable resistance from the chaebol themselves, that should help to turn this year’s recovery into something a bit less alarming—and more enduring.