Asia Times: Seoul's masterclass in economic recovery



	February 26, 2000	atimes.com

Asian Crisis

Seoul's masterclass in economic recovery
SEOUL - South Korea has turned around a very sharp and painful recession within a remarkably short amount of time. It has already declared that it needs no new loans from the IMF or the World Bank to help its recovery. However, whilst many other countries could benefit by emulating Korea's recovery-oriented policies, there are those who doubt the solidity of the recovery, and that are looking for further financial and economic reforms to cement it in place. OECD Secretary- General Donald Johnston, presently visiting Seoul, wrote about South Korea's recovery in an email interview.

Q: Korea has been much praised as a ''star pupil'' of the IMF with its remarkable economic recovery last year. It declared last year that it will no longer need new loans from the IMF and the World Bank. How do you view Korea's recovery since its crisis in December 1997?

A: Korea's recovery from the financial crisis at the end of 1997 and the severe recession during 1998 has indeed been impressive. Three factors appear to be primarily responsible for the strong turnaround.

1. Supportive macroeconomic policies. The decline in short-term interest rates from exceptionally high levels in the wake of the crisis to under 5 percent by the spring of 1999 was a key factor in the recovery.

The easing of monetary policy was accompanied by increases in government expenditure, focused on efforts to assist the unemployed. In addition, the government launched an ambitious program - financed by publicly-guaranteed borrowing - to rehabilitate the financial sector.

Thus far, 70 trillion won ($61.5 billion) has been spent to recapitalize financial institutions and to address the non-performing loan problem. This program, combined with credit guarantees for small and medium-sized enterprises, helped overcome the credit crunch conditions that prevailed during 1998.

2. A favorable external environment. Korea has benefited from such factors as the recovery of demand in Southeast Asia, the appreciation of the yen and strong demand for electronic products.

3. Progress in implementing structural reforms. By addressing the structural weaknesses that had made the country vulnerable to contagion from the crisis in Southeast Asia, Korea restored the confidence of investors, both domestic and foreign, in its economic prospects.

The recovery in confidence was symbolized by the upgrading of Korea's credit rating to investment grade in early 1999. Moreover, inflows of foreign direct investment soared to $8.3 billion in 1998 and further to $15.5 billion in 1999.

Q: What do you think made Korea stand out among other crisis-hit Asian countries? Were President Kim Dae-jung's policies in the right direction?

A: Korea stands out from other crisis-hit countries in its successful and rapid implementation of a wide-ranging program of structural reforms.

The strong recovery and the large-scale foreign investment in Korea demonstrates that President Kim Dae-jung's policies were indeed in the right direction.

Perhaps the greatest progress in structural reform has been achieved in restructuring the financial sector along market-oriented lines.

Since the crisis, the authorities have moved quickly to lay the foundations of a new system based on strict enforcement of prudential rules by a newly-established regulator, the Financial Supervisory Commission (FSC).

In this new system, market forces are to play the major role in resource allocation while financial institutions seek profit while observing rules of prudential soundness.

To create a better framework for restructuring the corporate sector, the government has introduced important reforms to the corporate governance.

First, transparency has been improved by strengthening auditing procedures and requiring the chaebol to prepare combined financial statements.

Second, shareholder rights have been strengthened by easing the requirements for actions such as derivative suits against directors.

Third, listed companies were required to fill one-fourth of their boards of directors with outsiders, while the legal responsibility of directors, including de facto directors, has been established.

Fourth, the market for corporate control has been liberalized with the relaxation of regulations on portfolio and direct investment and the decision to allow hostile takeovers by foreign investors.

Fifth, insolvency procedures have been improved to deal with failed companies.

Labor market flexibility has been increased by allowing firms to lay off workers for managerial reasons.

The government has eliminated half of the 11,000 regulations in existence at the beginning of 1998 and improved another 2,400 regulations.

Q: Some worry reforms will slow down in line with the country's quicker-than-expected recovery. Do you agree? If so, in what area do you suggest Korea should most accelerate reform?

A: While many observers have warned of the risk of complacency in implementing reforms, there seems to be little evidence of a slowdown in the reform agenda.

As noted above, the government has established new institutions and frameworks in a number of areas to establish a more market-oriented system.

The biggest challenge at present is to fully implement and activate the new system by changing the behavior of economic agents.

To cite an example, banks in the past relied on credit guarantees as a basis for lending and were subject to government influence in making those decisions.

Now, such guarantees have been prohibited between chaebol affiliates and government interference in lending decisions is to end. Consequently, banks will need to develop credit analysis skills.

A second example is the new corporate governance framework. Outside directors, institutional investors and minority shareholders will need to learn their new roles in order to prevent the founding families of the chaebol from using their relatively small ownership position to controls the chaebol.

One area where reform is needed is the system of social protection. In the wake of the crisis, the government responded quickly with programs, such as public works jobs, to assist the unemployed. While labor market conditions have improved considerably, it is important to establish a permanent framework to assist those who cannot find jobs as well as those who cannot work.

The public pension system is another area where reform is needed. Measures to improve the long-term sustainability of the system at an early stages of population aging would be beneficial.

Q: Restructuring in the financial and corporate sector has thus far been mainly led by the government. Do you think this was unavoidable to implement effective reforms and what do you propose as the appropriate government role in implementing further reforms?

A: To some extent, government direction of financial and corporate restructuring has been inevitable.

In the immediate wake of the crisis, markets ceased to function. Moreover, the size of some of the problems in the financial and corporate sectors posed systemic risks.

For example, the collapse of Daewoo, with debts equivalent to almost a fifth of GDP, required the government to play a coordinating role.

At present, with a strong recovery underway and new financial and corporate governance systems established, the rationale for government interference has been greatly weakened.

Indeed, phasing out government intervention will be a key to the success of the reforms in the financial and corporate sectors and to establish a more market-oriented system.

In this regard, it is important to phase out the currently high level of government ownership of the banks. While its current position is, to some extent, unavoidable, it gives the government significant influence on bank restructuring, as well as in corporate restructuring.

In addition, following through on the plan to privatize state-owned enterprises would also be beneficial in this regard. Overall, the government should focus on providing an appropriate legal, institutional and regulatory framework, which would encourage private initiative.

Q: There are worrisome signs for the country's economy that threatens its growth and current-account surplus target for the year. Rising oil prices and depreciation of the yen and won raise inflation and trade concerns.

The country has seen a trade deficit for the second consecutive month this year and private economic institutes are revising their economic forecasts for the year amid the aggravated economic situation.

Do you share the concerns and what is your forecast for the country's economy?

A: The OECD makes economic projections twice each year for its member countries, as well as major non-member economies. In our last projections made last November we expected growth of 6-7 percent in 2000. Growth in this range still seems likely for this year.

Regarding the external side, we realize that the government attaches great importance to its current-account surplus objective. Indeed, the large surpluses in 1998 and 1999 played an important role in building foreign exchange reserves and boosting confidence in Korea.

At present, though, Korea is a net creditor nation as its foreign assets exceed its foreign liabilities. Moreover, its foreign exchange reserves are twice as large as short-term foreign debt and Korea has become a major recipient of foreign direct investment.

In this context, maintaining a current-account surplus has become less important. With a strong recovery underway, a major goal should be to keep inflation low. It is clear that a strengthening currency has positive effects in this regard.

(Asia Pulse/Yonhap)