South Korean achieves dramatic progress, but the road ahead is rocky

Global Finance,  Apr 2002  by Field, Graham

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SOUTH KOREA

After leading Asia out of a slump, policymakers find there is a way still to go.

Much as the 1988 Olympics signified South Korea's emergence from years of stern dictatorship, this summer's staging of the soccer World Cup (in conjunction with Japan) marks the consummation of a recovery from the depths of economic crisis.

South Korea's improving fortunes have been mirrored by movements on the Seoul stock market. Hefty inflows of foreign investment in the past few months have pushed the KOSPI index from 451 on September 11 last year to over 700 in early December and 840 in early March. The economy grew by around 3% last year and is expected to deliver something similar in the first half of this year. Helped by a generous slice of government spending, GDP growth should quicken to around 5% in the second half of the year.

But the story is not just one of figures; the South Korea of today is a very different country from the one that plunged into crisis back in 1997. The government responded to the storm by borrowing from the IMF and instituting a rigorous reform program that has impressed those close to the action.

Rapid Reform, Rapid Progress

"The progress today is definitely related to the structural changes that the Korean government has implemented," says Tami Overby, executive director of the American Chamber of Commerce in Seoul. "Of all the countries hit by the Asian flu, Korea has made by far the most dramatic changes. Four years ago, none of us would have imagined that they could come so far in such a short space of time!

Those reforms have helped underpin recovery. But the resurgence also owes a lot to cyclical upturns in key markets. The economy was caught in a painful squeeze in 2001, says Richard Samuelson, managing director of UBS Warburg in Seoul and a 10-year observer of South Korea. Prices for its key exports such as DRAM chips and TFT/LCD screens were falling while costs were rising.

Prices for these export items have improved since the end of last year, giving the economy a powerful shot in the arm. At the same time, South Korea also weathered the storm of IT problems better than some of its Asian neighbors."Korea does not have all its eggs in the IT export basket;' says Aidan Foster-Carter, honorary senior fellow in sociology and modern Korea at Leeds University in the United Kingdom. "Autos were the biggest export last year, and South Korea is the world's fifth-largest auto producer." Also, the country still builds 40% of the world's ships.

But beneath the cyclical recovery, there are other important structural changes occurring. At the end of the 1990s, the South Korean banking system was pulverized by the bad debts from lending to the country's biggest corporations, the chaebols. Unlike Japan, however, the banks have made a clean breast of their non-performing loans (NPLs).

Whereas Japanese prospects are constantly dimmed as more NPLs emerge from the woodwork, Korea has mostly got the bad news out of the way. "I presume that most NPLs have been uncovered," says Hasung Jang, professor of finance at Korea University in Seoul. "If any bank comes forward with more NPLs, the Korean public will not support it and will be willing to let the bank go down!

With no public safety net below them, the banks are having to learn new tricks. And they have turned from wholesale loans to the chaebols to a new category of lending: the retail market. Ready and waiting to take on debt are what Leeds University's Foster-Carter refers to as"Korea's 47 million avid consumers." Says UBS Warburg's Samuelson, "In the past the manufacturing sector was allowed to feast, while consumers were credit-starved." That's changing-and fast. Between June and September of last year alone, total household debt rose from 296 trillion won ($224 billion) to 316 trillion won.Average household debt increased by 1.4 million won to 22 million won over the same period.

That would be sweet music to the ears of Japanese policymakers, struggling to prise open the pocketbooks of its country's stayat-home consumers. But the consequences of the South Korean spending binge are still hard to gauge. "We will have to monitor credit card borrowing and see how credit quality holds up," says Beatrice Woo, who watches South Korean banks for credit rating agency Moody's Investors Service in Singapore.

Credit Boom Boosts Domestic Demand Undoubtedly, there will be some excesses. "It would be naive to assume there will not be mistakes," says UBS Warburg's Samuelson. "But the banks and credit card companies do operate under far more severe prudential regulations than they did previously." In the meantime the credit boom-- fueled by base interest rates of just 4%-is creating a solid platform of domestic demand to buttress South Korea's limp export earnings.

While bank reform has won plenty of plaudits, seasoned Korea-watchers are always on the lookout for a creeping return to the days of "Korea Inc.," the close and cosy relationship between the over-mighty chaebols and the government, which allowed the big industrial groups to disregard the interests of minority shareholders.