2001 is an important year for the whole of Asia as the liquidity-driven rebound that followed the 1997 crisis has come to an abrupt end. This allowed policymakers to postpone or even avoid some important restructuring decisions. While some countries no longer attract the widespread interest of international investors, due to either an inability to implement restructuring or ongoing and seemingly insoluble political crises, Korea remains the Asian market of choice for many.
However, this sympathy is not open-ended. Restructuring is now into the second round and meaningful laws and financial resources are in place. This is bolstered by solid institutions with able people in key positions. Korea needs to deliver on reform this year or its credibility will be lowered dramatically in the eyes of the investment community.
We argue that the policy focus has shifted towards providing short-term support for the system. While we remain bullish on restructuring we think that policymakers are not willing to hard land the economy. As a result, we will be watching closely what the government does over the next few months. We think that the priority is to stabilize the financial sector.
To that end, we will need to be convinced that the provision of W50 trillion ($39.27 billion) to the banks is a part of a genuine restructuring, rather than just a re-capitalization that does not address some of the problems outlined below.
The crucial factor in determining which path Korea takes this year is political will. President Kim Dae-Jung has refocused domestically following the award of the Nobel Peace Prize and has apologized publicly for neglecting economic reform at the expense of developing relations with the DPRK. Furthermore, the presidential election has to be held by December 2002 at the latest, meaning that the prospects for implementing difficult decisions next year are limited.
But against this is the prospect of slowing GDP growth this year and rising cyclical and structural unemployment. The government is 'not prepared to reduce the economy to ashes', as a senior official on our recent visit put it. This brings out wider points about the Korean economy and national identity that are not immediately apparent, but are very important for international investors to grasp in the context of restructuring.
Our view is that Korea has the political commitment to substantially reform, but investors who expect to see the slate wiped clean and all residual issues finally addressed in 2001 can forget it. We think that the government will try and drive forward financial sector stabilization, and eventually restructuring, as a priority and leave corporate restructuring to the private sector. Nevertheless, the provision of special credit measures (such as the new Korea Development Bank support package for companies discussed below) makes us believe that this process will not be entirely smooth.
In addition to credit market intervention, fiscal and monetary policy measures will be used to try to avert a hard landing. Monetary policy is hamstrung by the credit crunch. Effectively, the banks have stopped lending as they try to repair their balance sheets. The Bank of Korea is providing plenty of liquidity to the system but this is not being translated into credit growth. The banks are just using it to buy government bonds or putting it back to the Bank of Korea as excess reserves. The problem is one of risk-aversion, not the price of money. Nevertheless, we think that the call rate will fall 100 basis points this year, even if such a move has limited practical effect in the short term.
Restructuring is a long and complex topic on which many pages have been written. Perhaps the best way to look at it is to start by studying the current facts and then our expectations of what is realistic. What we think is achievable in 2001 is progress on financial sector restructuring followed by some of the major non-viable corporates exiting if the economy stabilizes. We emphasize what is achievable rather than what is ideal.
Our ideal policy prescription would be to swallow the bitter pill now and disregard the consequences for growth and with extreme reluctance employment. This would require a monetary tightening and more stringent fiscal policy. This has no chance of happening in Korea at the moment for the reasons outlined below.
What Korea must avoid is a Japan-type situation where structural problems have dragged on under a massive government liquidity umbrella. Postponing restructuring to deal with short-term growth problems puts up the cost of capital by increasing risk premia and thus limits long-term growth potential. There is also a risk that restructuring fatigue sets in and many problems never get addressed, just rolled over. Over-leveraging cannot be resolved overnight and needs foreign capital to do so. This requires progress to be made on reform.
The government will find it difficult to keep ailing corporates afloat if the economy experiences a hard landing. In Japan, the wider tax base, triple-A foreign credit rating and robust external position made it easy to create fiscal and monetary conditions that kept the economy from a hard landing. Korea has none of these advantages. If growth surprises on the downside then the authorities will have to let some of the corporates exit sooner than expected. The market will do the job itself.
The key issues on restructuring are unchanged. In the financial sector, there are too many banks and institutions reluctant to foreclose on delinquent borrowers both in case they damage their balance sheets and because of government pressure not to. More foreign buyers are needed for institutions. In the corporate sector there is no defined exit route for ailing firms as many technically insolvent corporates are being kept alive because the government wants to achieve a soft landing.
Enhanced role for KDIC
On financial restructuring, the National Assembly has passed a number of measures that provide a framework for consolidation and recapitalization. Korea Deposit Insurance Corp, which will disburse the W50 trillion of public funds that parliament voted to provide in November 2000, has had its role reinforced.
In future, it will take an active role in the management of banks as one of the conditions for capital injection. W4trillion has been injected into banks to date by KDIC. KDIC issues bonds that it buys itself with money provided by the government and exchanges these for new bank equity. The challenge for KDIC will be to ensure genuine restructuring with the exit of some banks and the sale to foreign owners of others takes place alongside recapitalization.
In the corporate sector, the Ministry of Finance and Economy suggests that out of W65 trillion of bond liabilities due in 2001, some W25 trillion may not be rolled over without special state assistance. Korea Development Bank has just begun an emergency operation to rollover the liabilities of six large corporates. It plans to rollover W5 trillion to W8 trillion of bonds through the issuance of KDB-guaranteed CBOs, which leaves the remainder to be captured by the W20 trillion primary CBO fund put in place last year. The main beneficiary is the Hyundai Group, which we see as a special case because of its political role in relations with the DRPK, as well as the number of jobs it provides.
Twenty percent of the CBOs will be held by the issuers as collateral for repayment. KDB will assume the rest and hold 8% of the whole issue, selling the remainder on to banks. The banks have been invited to participate by the government in the bail out, and all the main banks except KFB (which is owned by the US investor Newbridge Capital) complied. This shows clearly that the government will not tolerate major corporate failures at this moment in time.
Commitment to reform
We believe that Korea is committed to reform. The process is a long-term one though, and we think that current policies are targeted more towards stabilization rather than restructuring. We would argue that the role of expectations is crucial. While the majority of Asian countries have strong political and social elements to economic policy, these are particularly strong in Korea. This does not manifest itself as hostility to foreign capital, but it is important to understand that Korea is not in a position to please international investors with a slash-and-burn approach to restructuring.
Korea was devastated by the time the Korean War ended in 1953. Over 90% of the peninsula was occupied by communist forces, including Seoul. This meant that reconstruction began from a very low base. To have built up such a modern economy from a very inauspicious starting point (admittedly with some US financial assistance to help with reconstruction) is something that Koreans are rightly proud of.
While the government acknowledges the need for change, the reform process will be a transition not a revolution. At the end of the war the nation was divided between two different political systems. There were then long periods of military and autocratic rule. During this period Kim Dae-Jung was sentenced to death for political offences and only avoided execution after the personal intervention of then US president Ronald Reagan. Democracy only became established in the mid-1980s.
As part of this democratic transition, strong pro-labour laws were put in place as part of a culture of establishing democratic rights. Furthermore, although the right to work is not enshrined in law, full employment is very much a part of the heritage of the democratic transition.
Korea has no social safety net for the unemployed. The numbers sleeping rough on the streets of Seoul has risen sharply. Traditionally, the employer provides the necessary social benefits. Therefore, bankruptcies create a number of social problems beyond the control of the authorities.
However, policymakers are increasingly frustrated with the labour unions, which punch well above their weight. Just 10% of Korea's workforce is unionized, mainly in the chaebol, banks and government sector. These are the sectors that need most reform. Policymakers will counterbalance reform with the realities of the social situation. While labour unions will not be allowed to dictate the pace of reform, the authorities do not want prolonged outright confrontation despite their robust approach to the Kookmin and H&CB unions. This is not compatible with the social ethos that frames Korean policy.
The policy of rapprochement with the DPRK (the 'Sunshine Policy') has relied heavily on Hyundai Group. The chairman of Hyundai Group, Chung Ju-Yong, was born in what is now the DPRK and has acted as a conduit to help the policy in many different ways. He brokered the meeting in June last year between Kim Dae-Jung and the 'Dear Leader' of the DPRK, Kim Jong-Il. We would view the support to Hyundai as a special case motivated by political necessity as well as the need to soft-land the economy.
Recent history has created a sense of national unity that is difficult for non-Koreans to understand fully. The impact of this on economic policy is that restructuring will be driven by wider concerns, not just the interests of investors. This does not mean that we will not see progress in restructuring in 2001 we believe that we will particularly in financial restructuring. The IMF has been satisfied with progress to date and remains optimistic. But those who expect to see a repeat of the Anglo-Saxon model with its emphasis on de-industrialization will be disappointed.
The short-term driver of policy will be on preventing a hard landing. The banking sector will be the focus of the government's attempts to stabilize the economy. Restructuring will follow when the government is satisfied that the systemic and macroeconomic risks to the whole economy are under control. We believe that 2001 will see progress on restructuring but this will be limited by the need to control the pace at which activity slows. Nevertheless, if the economy does experience a hard landing, the government will find that many corporates will exit regardless of the economic policy.
Michael Newton is chief economist, North Asia at HSBC in Hong Kong.