Sun Ho Choi, Soon Sam KangKi Seok Yang, Sang Jun Yeo

Overview

• Introduction• Causes of the Crisis• Policy Response• Policy Lessons

I. Introduction

• Background (Until 1997)– After Korean war, Economic growth like

miracle after 1960’s. – Korea’s Growth rate surpassed 7%– Inflation remained at moderate levels– Domestic saving increasingly financed

the rapidly rising investment rate

II. Effects of the Crisis

• Recession and terms of trade deterioration

• Corporate Bankruptcy• Banking Crisis• Contagion from foreign currency

crises• Currency crisis

II. Effects of the Crisis

Recession and terms of trade deterioration

8.08.0

4.84.8

1994 1995 19961994 1995 1996

GDPGDP

Q. Deterioration?Q. Deterioration?

A.A. The structure of The structure of Korean Economy ProblemKorean Economy Problem Inventories up, Inventories up, Demand downDemand down Cause production costCause production cost

II. Effects of the CrisisMajor Economic Indicators in Korea around 1997

1993 1994 1995 1996 1997 1998

GDP growth rate 1) (%)

5.7 8.4 8.2 4.8 2.4 -7.1

CPI (rate of change, %)

4.8 6.3 4.5 4.9 4.4 7.5

Current account (bill. US$)

1.0 -3.9 -8.5 -23.0 -8.2 40.3

Unemployment rate (%)

2.9 2.5 2.1 2.0 2.6 7.0

Budget balance/GDP 2)(%)

0.08 0.53 0.45 0.03 -0.02 -2.97

II. Effects of the Crisis

Corporate Bankruptcy

• the chaebols (Korean big business groups) went bankrupt. the chaebols (Korean big business groups) went bankrupt. • The portion of non-performing loans The portion of non-performing loans In total loans of banks rose In total loans of banks rose from 4.1 percent at the end of 1996 from 4.1 percent at the end of 1996 to 6.0 percent at the end of 1997to 6.0 percent at the end of 1997. . 

II. Effects of the Crisis

Banking Crisis• Under these circumstances, Under these circumstances, • the Thailand Baht suddenly plummeted on July, 1997the Thailand Baht suddenly plummeted on July, 1997• signaling the beginning of currency crises signaling the beginning of currency crises in South East Asian countries. in South East Asian countries.

=> No longer loan from abroad => No longer loan from abroad

II. Effects of the Crisis

Currency crisis•The nation's stock of foreign reservesThe nation's stock of foreign reserveswas rapidly depleted was rapidly depleted •Financial institutions failed to recoverFinancial institutions failed to recovercredit-worthiness. credit-worthiness.

In consequence,In consequence, •the Korean government askedthe Korean government askedthe International Monetary Fund for emergency credits.the International Monetary Fund for emergency credits.((IMF)IMF)

II. Effects of the Crisis

Check Point Korean Economy in 1997

•OverinvestmentOverinvestmentExcessive competition, Expand Area.Excessive competition, Expand Area.More and more, low profitMore and more, low profit

•Maturity MismatchesMaturity Mismatches=> No choice, firms rely on short term foreign => No choice, firms rely on short term foreign debt.debt.

•Lack of DisciplinesLack of Disciplines=> Rapidly change but over control=> Rapidly change but over control

II. Effects of the Crisis

• External shocks were weaker, but their effects were much stronger

External Internal•Unstable international oil prices•Turmoil in the international financial market•World-wide economic recession

•Bad harvest•Political and social unrest

III. Policy Response

• Methods molded after general IMF crisis resolution (Stand-by Agreement)– Macroeconomic stabilization policy:

Restructuring policy– Microeconomic Structural adjustment

Policy: Structural Adjustment Policy by two stages

III. Policy Response

Macroeconomic stabilization• Goals

– Restriction of domestic demand and expenditure-switching

– Preventing capital inflows– Correct the balance of payment deficits

• Exchange rates were allowed to depreciate freely and reflect market forces fully

• Money market rates were raised sharply to control the inflationary impact of won depreciation

III. Policy Response

Microeconomic Structural Adjustment• Goal

– Resolve structural problems in each market– Establish the institutional Setting for a well

Functioning market mechanism

• Two stages– First: Establishing basic institutions needed for

smooth operation of a market economic system

– Second: Improving the management and governance of firms and banks through their initiatives

III. Policy Response

First, Institution• three existing financial supervisory

agencies into one agency ① The Financial Supervision Commission ② Expanded the function of Korea Deposit

Insurance Corporation (KDIC).③ Establishing Korea Asset Management

Corporation (KAMCO) to dispose of non-performing loans.

III. Policy Response• Amended Bankruptcy law provisions• Eased M&A restrictions• Strengthened disclosure requirements for

accounting information • Introduced measures to improve corporate

governance • Provided better monitoring and supervision of

corporate or bank managers• Devised measures to restrain over-borrowing by

firms • Government forced extremely troubled banks to

exit the market• Used public funds to buy non-performing loans • Allowed main creditor banks lead the debt workout

programs resolved delinquent firms

III. Policy Response

Second, Improving management and governance

• Includes efforts to correct problems in the financial, enterprise, labor, and public service sectors.

• Addresses issues of regulating the undesirable behavior of economic agents, like moral hazards.– Adopting the global accounting standards– Strengthening the rule of law

IV. Policy Lesson1) Problems intrinsic to the economic system

should be cured fundamentally to prevent recurrence

2) Fixed or managed fixed exchange rates can be dangerous

3) Strengthen financial systems against external financial shocks

4) Deliberate approach on financial liberalization

5) Proper post-crisis resolution policies by a competent government is important