Recovery From A Financial Crisis In South Korea - Case Study Example

Financial crisis of 1998 was one of the most serious economic crises that Asian continent has ever lived through. South Korea as one of the largest economic powers in the region was certainly affected by the negative consequences of the crisis; like in other Asian countries its banking sector was overburden with not performing loans. This was one of the deficiencies of banking sectors of most of developing and developed nations in Southeast Asian region in the late nineties. The purpose of this paper is to examine the financial crisis in the South Korea and steps that the Government took to remedy and resolve huge economic problems that it faced at the end of the previous century. The financial crisis in South Korea was worsened by the wave of bankruptcies that occurred in the corporate sector of the South Korea. 1 In spite of the fact that the cause for financial crisis in South East Asia was common for most of the countries, the observers could not agree upon some specific reasons pertaining to the development of Korean economy and especially the level of leverage in the corporate sector of economy of the South Korea. For instance, according to the research of Paola Bongini and Giovanni Ferri, the leverage in pre crisis period was high both for profitable companies and poor performing, less profitable ones. Thus one could not assume that the leverage had been caused by the ingrained inefficiency of the corporations; moreover the results of their research showed that the companies were leveraged because of the high growth; thus the authors concluded that direct relationship between the growth rate of the company and the level of leverage was present.2 The second question that authors addressed was the role that the level of the leverage plaid in the bankruptcies of several corporations in the South Korea. The results obtained by the researchers confirmed the hypothesis that reliance on the banking financing could decrease the probability of bankruptcy whereas the reliance on intermediated credit might increase the possibility of bankruptcy; these results were explained by the fact that bank credits in contrast to the intermediated were more negotiable ones. 3 The findings also showed that there was a correlation between the interest coverage ratios and the probability of the bankruptcy. Companies with low interest coverage ratios had higher probability of the bankruptcy and visa versa; as low interest coverage ratio might indicate the vulnerability of the company that could be worsened by the unexpected sharp increase in the interest rate. Trade credits as the experience of the South Korea showed may increase the possibility of the bankruptcy of the enterprises as trade creditors are less inclined to modify the credit conditions, thus those companies that relied on the trade credits were especially vulnerable. At the end of the nineties many economic researchers attempted to access the role of the huge enterprises plaid in the accumulation of the capital in national economy; most of the researchers agreed that large conglomerations created national capital, however there were some controversies surrounding the efficiency of the internal market capital. On the one hand such scientists as Stein claimed that internal capital market are more efficient than external ones as they decrease transition costs as well as provide better incentives in the process of credit allocation, whereas other researchers asserted that internal capital might reduce value-added process within the group as the managers of the conglomerate may be engrossed in the cross subsidizing process that could hamper the development of the company and would not add the value to the group; apart from this the companies- members of the conglomerate usually have less financial constraints than other companies in the market, that have to rely on their cash flows or on the credits from other financial institutions So the researchers came to the conclusion that leverage coupled with liquidity constraints was the most important determinants of the bankruptcies of the companies during financial crisis in the South Korea in 1998. Corporate assets of the companies were reduced significantly once the illiquidity had entailed the wave of the bankruptcies. Nevertheless despite the fact that the economy of the South Korea benefited from the fact that poor performing companies became bankrupt, the crisis also hampered the development of the economy as many large, more efficient conglomerates were unable to survive this crises either. Some of the observers claimed that the recession that weakened the economy of the Sough Korea, also affected the relationship between unions and the owners of the enterprises, which might have improved at the end the business environment of the country as many benefits acquired by workers at the enterprises such as lifetime employment, the right which had been frequently abused by several unions by staging the strikes, without fearing that workers might loose their jobs, were abolished4. The burden of foreign credits, another huge serious problem faced by the Government of the South Korea was apparent at the beginning of the 1998, when the accumulating debt of the Government of the South Korea and various private enterprises reached 100 billion dollars; the situation was worsened by the depreciation of won (national currency) in the financial market of the country. 5 So by the beginning of the 1998, South Korea faced two problems: huge banking crisis and the instability of the currency market. The government had to sustain the won, as without stable currency it would have been impossible to resolve banking crisis. Despite the fact that IMF provided South Korea with the standby loan that amounted to 13 percent of the GNP of Korea ( the record standby loan at that time), it was unable to augment the crisis of the country and the won continued to depreciate. The currency stabilized once the agreement was reached with private banks on the possibility to maintain exposure as well as rescheduling of various short term debts. The Korean economy was saved by the actions of the US treasury and the efficient policy implemented by the USA; the Korean government was able to convert short term private debt of 24 billions into the longer terms claims backed up by the guarantees of the Government. The arrangement mentioned stabilized won. 6 Apart from transferring short term debts into more long term ones the Government also adopted stricter monetary policy prescribed by the IMF. It was the step aimed to reduce the dimension of the capital flight as well as alleviate the pressure on the foreign exchange markets. The monetary policy was eased once the won had stabilized, though it affected negatively the economic development of the nation as both private consumption and private investments plummeted. Many observers did not applaud the decision of IMF and contended that the monetary policy had little positive effect if any on the economy of the South Korea. Once the government obtained the credits from IMF, it implemented several important steps aimed at the nationalization of the two largest commercial banks - Korea First Bank and Seoul Bank. Moreover apart from this the Government announced about full deposit guarantees for al financial institutions; the step coupled with the nationalization process mentioned helped to stabilize the fiscal system of the South Korea. No performing loans were also purchased by the Government which led to the more thorough control on the part of the Government on all decision making process made by major financial institutions of the country. The government was also persuaded many commercial banks to roll over the credits to medium and small companies; it also induced many commercial banks to decrease the interest rates on the credits for small and medium companies It was evident that the country was managed to recover from financial crisis by implementing strict monetary policy in combination with huge loans from the IMF. The economy renounced as many vital economic indicators improved (for instance GDP growth constituted 10 percent by the end of 1999, unemployment rate decreased due to the new adjustment in the labor market, inflation as well as account deficit improved as well). However all these measures so far have been unable to remedy the problem of the profitability of conglomerations and accumulation of non performing loans; pre crisis foreign exchange regime is still being maintained. These conditions led to the financial crisis in the South Korea in 1998, and they might lead to the new one in the future unless the persistent problems of the large conglomeration and non performing loans are resolved. Works cited. 1) East Asian financial crisis, 2) Paola Bongini and Giovanni Ferri, Corporate Bankruptcy in Korea: Only the Strong Survive, The Financial Review, 35( 2000). 3) Charles S Lee, Korea's chance, Far Eastern Economic Review. Hong Kong: Nov 4, 1999.Vol.162 4) Steve Glain, Michael Schuman, Darren McDermott and Douglas Lavin, Trapped Tiger: Financial Meltdown Drives South Korea Into a Tight Corner --- Nation Faces Nasty Choice: Seek a Bigger Bailout -- Or Default on Its Loans --- Crisis Takes Toll in Europe, Wall Street Journal. (Europe). Brussels: Dec 12, 1997 5) Jahyeong Koo, Sherry L Kiser., Recovery from a financial crisis: The case of South Korea, Economic & Financial Review. Dallas: Fourth Quarter 2001 Read More