Korean Crisis 199

1
Korean Financial Crisis

• Jaehyeon Eom
• Ricardo Lopez
• Alex Sanchez

2
Before The Crisis

• Before 1997, average growth rate was about 7 -
  8 and inflation was stable at below 5.
• In December 1996, the country became the second
  Asian member of the Organization for Economic
  Co-operation and Development (OECD).
• Inflation was stable at below 5. Unemployment
  remained below 3 percent.

3
Chaebol Government

• Means Business Family and are actually large
  conglomerates.
• The relationship was one of necessity to increase
  exports in the 1960s and spur economic growth.
• Special Favors were granted to these few large
  companies.
• The government guaranteed repayment should a
  company be unable to repay its foreign creditors.
  

4
Real Estate Bubble

• Transformations of rice paddies and green fields
  in southern Seoul (Gangnam) into the First modern
  residential district in Korea.
• It focused on building residential buildings,
  good infrastructure, and reputable schools.
• The former agricultural land, then worth 300 won
  per 3.3 square meters has become the nations
  most expensive area worth around 30 million won
  per 3.3 square meters.

5
Real Estate Bubble (Continued)

• Similarities with Japanese Real Estate Bubble
• Banks aggressively offered mortgages to companies
  and individuals at low interest rates
• The property tax rate was low while taxation of
  profits from the sale of real estate was high.
• Differences from Japanese Real Estate Bubble
• Private investors are the major buyers in Korea
• Apartment prices rise sharply in specific areas.

6
Policy Missteps

• Korean Won was pegged to the dollar, refusing to
  devalue in tandem with the devaluation of the
  yen.
• Government policy encouraged a very rapid rate of
  growth of real wages, in excess of the rate of
  growth of labor productivity.
• The government adopted a tight monetary policy.

7
Results of Monetary and Fiscal Policy

• Current Account deficit increased from 2 of GNP
  in 1995 to 5 in 1996.
• Exports slowed from 31 to 14.
• GNP declined from 10.8 to 7.8.
• Foreign debt rose from 78 billion (62 of
  exports) to 100 billion (76 of exports).

8
Capital Growth
9
The Scopes of Crisis
10
Macroeconomic Views

• Real Wage Growth gt Labor Productivity
• Korean Interest Rate gt Worlds Interest Rate
• Continuities of High Current Account Deficit
• Major Shocks
• Sudden Capital Outflows

11
Real Wage Growth Rate gt Labor Productivity
12
Korean Interest Rate gt World Interest Rate
13
Continuities of High Current Account Deficit
14
Continuities of High Current Account
Deficit(Continued)
15
Major Shocks
16
Sudden Capital Outflows
17
Policy Response

• The government pumped money into corporations to
  prevent bankruptcy.
• The cooperative creditors group was established
  to help troubled companies.

18
Policy Response Continued

• Increased funding to deal with nonperforming
  loans (NPLs) of financial institutions.
• Enhanced disclosure standards and loan
  classification requirements.
• The Government asked the Japanese and US
  Governments for rescue support, but without
  success.

19
How did the Policy Makers Respond to AD

• Fiscal Policy
• Reducing the Government Consumption (G )
• Increasing the Taxation (T )
• Monetary Policy
• Adopting More Tight Monetary Policy (i )

20
IMF to the Rescue?

• In late November of 1997 the government
  reluctantly approached the IMF for an emergency
  loan. The policy responses mandated by the IMF,
  as part of its conditionality, were mixed.

21
The IMF Plan

• Raise interest rates.
• Pursue a tight monetary policy.
• Increase its fiscal surplus to 1.5 of GNP
  through a combination of higher taxes and lower
  spending.
• Accumulate foreign exchange reserves.

22
Labor Markets Recovery

• Prior to the Crisis, the Korean labor market were
  not as flexible as they were after the crisis.
• Labor unions were weakened making employment
  adjustments easier for corporations.
• The reduction of labor costs helped the companies
  with heavy debt survive.
• Companies were then able to finance directly
  through equities.

23
Equity Market Recovery

• The government deregulated foreign ownership of
  Korean equities and simplified stock market
  transactions.
• Various types of new mutual funds were allowed.
• The rich credit conditions of the private sector,
  together with a household consumption boom
  following the stock market boom, led Koreas GDP
  to grow a spectacular 10.6 percent.

24
The Gold Collection Campaign

• People voluntarily donated or exchange their gold
  to the Korean Currency.
• About 35 million people participated in the
  campaign.
• 227 tonnes of gold were collected (2 billion 170
  million).
• 194 tonnes of them were used to reserve foreign
  currency (1 billion 820 million).

25
After the Recovery

• President Dae-jung Kim announces the end of the
  currency crisis in December 1999.
• Korea repays its 19.5 billion IMF loan.
• In 1999, eighteen of the twenty-seven largest
  Chaebols had financial expenses that exceeded
  operating profits, and seven of those had not
  been profitable for three years.
• Korea returned to a crawling peg system in the
  hope of keeping a trade surplus and a foreign
  reserve surplus.

26
Economic Recovery
27
Lessons Learned

• Fiscal discipline was a very high priority for
  the Korean government as opposed to the
  counter-cyclical stabilization role of fiscal
  policy.
• The credit crunch and financial market melt-down
  in the immediate aftermath of the crisis rendered
  monetary policy extremely ineffective.
• It became clear that fiscal policy should play a
  greater counter-cyclical role in stabilizing the
  economy.

28
Fiscal Policy Changes

• Before the crisis, the government issued only a
  small volume of Korean treasury bonds (KTBs).
• KTBs interest rates were lower than the secondary
  market rate thereby removing incentive to buy
  any.
• After the crisis Fiscal policy became extremely
  expansionary.
• Large issuances of KTBs along with institutional
  reforms led to rapid development of the Treasury
  bond market.

29
Problems Domestic

• Corrupt government loans to mismanaged
  corporations.
• High interest rate regime.
• Workers unions had too much power.
• Refusing to intervene in the foreign exchange
  market to prevent overvaluation of the won.

30
Problems International

• Mistakes were made by both borrowers (Korea), who
  were too eager to rely on cheap but volatile
  foreign short-term loans.
• Lenders (banks in the rest of the world), who
  were initially too eager to extend them and
  subsequently too quick to withdraw them.
• Incompatibility with independent financial policy
  in Korea and unregulated global capital markets.

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Conclusion

• The Crisis was not caused primarily by monetary
  or fiscal policy.
• It was a merging of domestic and international
  circumstances.
• Lack of regulation or impediments of short-term
  capital flows.

32
Any QuestionsLadies and Gentlemen?