Korea takes centre stage

Korea chairs the G20 club of industrialised nations this year and is keen to set a new world agenda, while worries about debt mount at home.

While South Korea's speed skaters were winning a record haul of medals at the Vancouver Winter Olympics in late February, its civil servants were busy preparing for a meeting that would inaugurate the country's ascendancy in another way. Less dramatic, perhaps; just as significant, certainly.

Intense, excited officials and their researchers were bunkered in Samchungdong in central Seoul, putting the final touches to the agenda for a meeting in Songdo, Incheon, of deputy finance ministers and central bankers from the world's major industrialised nations. The meeting officially opened the G20 process in 2010, which this year is chaired by South Korea for the first time.

And although most eyes were simultaneously focused on LG plasma TV screens when 19-year old figure skater Kim Yu-na was crowned the "golden queen" with a world record-shattering victory, the bureaucrats were aware of their own historic opportunity: 2010 offers Korea its chance to set the world economic agenda.

"South Korea's unique experience and history means it can offer original and special lessons to the world. It has made the transition from a poor to a rich country, from a recipient of aid to a donor in the space of 50 years," Shin Je-yoon, deputy minister for international affairs at the Ministry of Strategy and Finance (Mosf) and co-chair of the February 27-28 meeting, told FinanceAsia in an interview.

Korea's ambitions for the G20

Two summits will be held this year. The first in Toronto in June is likely to focus on assessing and coordinating exit strategies from stimulus packages, as agreed at Pittsburgh last autumn. But, at the Seoul summit in November, Korean officials want to turn the spotlight on future post-crisis economic management. Shin identifies at least six policy areas where progress can be made.

First, Korea sees value in erecting financial safety nets, so that developing countries -- especially those with small, open economies -- aren't forced to build up costly FX reserves to protect themselves during crises.

"Last year we set up bilateral credit lines with the US, China and Japan, and the regional Chiang Mai initiative took further steps forward, but little progress was made on a global arrangement. We also need to improve the conditionality of loans -- and Korea is taking the lead," Shin said.

Second, the government is keen to bring development-related issues under the G20 umbrella. Mosf officials argue that global rebalancing is not confined to macroeconomic imbalances between deficit and surplus countries; imbalances also arise from gaps in income and development.

Third (perhaps fuelled by what many Koreans believe was an intrusive and even destructive involvement of the IMF during the Asian financial crisis 12 years ago), Korea is "committed to making 2010 a watershed year in the reform of international financial institutions (IFIs)". Il SaKong, chairman of the presidential committee for the G20 Summit, noted in a preparatory paper that the current crisis "has provided painful evidence that the IFIs were not equipped to conduct proper surveillance and provide early warning of macroeconomic and financial risks". He is keen that IMF quota and governance reforms be taken up at the November summit.

Fourth, Korea wants to improve financial-sector surveillance, ensuring more appropriate regulatory regimes throughout the world. And fifth, it believes that the burden of government bail-outs and fire-fighting should be shared between the public and "resuscitated institutions", such as banks -- here it points to its own policies after 1998.

Finally, as a major trading nation where exports make up between 40% and 50% of its economy, Korea will push to sustain the G20's resistance to protectionism.

Arguably, that sixth point is the critical one -- despite the lofty aspirations of re-shaping a new world order. Korea's open economy and reliance on trade makes it vulnerable to outside forces. Yet, countries with Olympian ambitions need to stand as tall and strong as Yu-na, Korea's ice-skating queen.

Korea's vulnerability

And although Korea has recovered vigorously from the global crisis, it faces problems. Shin identifies four main concerns, in addition to the constant unpredictability of North Korea: the borrowings by small and medium-sized enterprises, household debt, the sudden rise in capital inflows last year and the fiscal deficit.

While the country's big conglomerates have benefited from tax cuts and other measures, and have enjoyed a rebound in export earnings, smaller firms are suffering. Samsung Electronics, LG Electronics and Hyundai Motor, for instance, have posted record profits on growing demand for semi-conductors, panel displays and autos, and have been helped by the depreciation of the won last year. But there is a dangerous polarisation between big and small corporations.

On February 22, the Bank of Korea warned that local companies' debts totalled W1,501 trillion ($1.3 trillion) last September, or 146% of GDP, up 5.6% from a year earlier and almost double the amount in 2004. The worry is that a large number of heavily indebted, loss-making small and medium-sized businesses may face bankruptcy if the government unwinds its fiscal stimulus and the central bank hikes interest rates. And in a report by the LG Economic Research Institute, as many as 22% of 1,596 stock exchange-listed firms are teetering on the brink of insolvency because their debt has exceeded their revenue, or because their capital has been eroded by losses during the last two years.

The government started a process of restructuring struggling businesses in 2008, but it was put on hold during the crisis as unemployment started to rise. So, unprofitable companies have been propped up by government aid and by banks that haven't called in loans that might harm their own key ratios.

Mosf's Shin admits that "some medium-sized conglomerates with high exposure to the construction and shipbuilding sectors have debt and liquidity problems similar to Kumho Asiana, [a middling chaebol rescued by Korea Development Bank in January]".

Meanwhile, household credit has risen by about 26% during the past three years, and now amounts to W734 trillion, according to Bank of Korea figures. That's the equivalent of W15 million for each Korean, and represents an increase of 6.6% compared with the end of 2008. Job insecurity and the failure of the private sector to create new employment means these numbers are causing both official and personal anxiety, and a drop in property prices would exacerbate the problem.

Capital inflows

Shin's concern about the surge of capital inflows is an inevitable consequence of the country's success and its attractiveness to portfolio fund managers. Foreign investors own securities worth $270 billion, or 33% of the market capitalisation of the Kospi, but below the 44% of the Kospi they owned in 2004, pointed out Chanik Park, managing director and head of Korea equity strategy at Morgan Stanley.

Yet, the market is still trading at a 30% discount to its Asian peers, according to Park, who doesn't expect much downside risk to corporate earnings this year. So, inflows into the country are likely to continue.

The government's fiscal deficit ballooned last year to 4.6% of GDP -- and that number excludes the corporate liabilities it had absorbed. But, Shin, like other officials, is aware that Korea is an aging society, and recognises that it is important not to over-burden future generations with debt. Hence, the government plans to reduce the deficit to 1.6% of GDP this year, and bring the debt-to-GDP ratio down to 35% by 2012.

"The timing and sequencing of polices is very important, but so is caution. All countries have the dilemma of when to withdraw government fiscal stimulus and hand it over to the private sector: too early and they run the risk of undoing economic recovery, too late and there is a danger of asset price bubbles and inflation. We need to coordinate our exit strategies," said Shin.

And that's a message he wants Korea to convey to the other 19 members of the industrialised club this year.

This article was first published in the March 2010 issue of FinanceAsia magazine.

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