Koreans Need to Put Up With More Economic Reform
By Ajai Chopra, Assistant Director of the Asia and Pacific Department
and David Coe, IMF Senior Resident Representative in Seoul
International Monetary Fund
International Herald Tribune
February 20, 2001
SEOUL—South Korea has made substantial progress rebuilding and reshaping its economy since the financial crisis of late 1997. Macroeconomic fundamentals have improved significantly. The economy is more resistant to external shocks, and structural reforms have made it more market-oriented. The Korean people can be justifiably proud of their achievements.
But many Korean companies are in poor health. The corporate sector remains one of the most heavily indebted in the world, and its profitability is too low. According to some studies, one-quarter of Korean firms are not generating enough cash flow to cover interest payments on their loans, let alone repayment of principal. Nonetheless, these companies continue to have access to financing.
Their problems weigh heavily on the financial sector. South Korea's banking industry is unlikely to return to adequate profitability until the corporate sector is restructured and strengthened.
Continued bank credit to nonviable firms means that fewer funds are available for viable companies. It also allows nonviable companies to dump their products on the market, undermining the profitability of viable firms. This misallocation of resources will impose an increasing drag on the economy.
The continued weakness of so many companies suggests that bank-led workouts of troubled firms have not been effective. Take the case of the Daewoo group. It remains in the hands of its creditors, 18 months after its collapse, with very little restructuring and few asset sales. Daewoo assets that could have brought several billion dollars to creditors two years ago have decayed. Without quick resolution, values will erode further.
Lack of creditor action is a key reason for the slow pace of restructuring. Creditors need to take a tougher stance on weak companies and recognize that delaying losses only means more losses later.
Stronger oversight, together with improved corporate governance, enhanced risk management and enforcement of laws against unfair business practices are needed to restrain South Korea's largest family-owned conglomerates, the chaebol, from ill-advised debt-financed expansion on projects with low returns.
Ongoing pressures in the corporate bond market are another sign of the need for further restructuring. The bond market is becoming more discriminating about financing companies. This is a positive step. It is important that government actions not blunt the market's message that further restructuring is needed.
The authorities must ensure that intervention in the bond market does not slow corporate restructuring. New funding for troubled companies should be at penalty rates of interest that encourage continued use of the regular bond market. Government guarantees should not become so widespread that the role of the market in assessing and pricing risk is effectively replaced by the credit decisions of state-owned financial institutions. The government should not exert pressure on the banks to participate.
Finally, the perception that some corporate groups are "too big to fail" must not be allowed to resurface, thereby undoing some of the progress of the last three years.
Although some viable businesses may have to be saved through court-supervised reorganizations, the authorities should not intervene to save owners who have made imprudent, debt-fueled investments. Intervention today often leads to expectations of further intervention tomorrow.
The reforms implemented since the 1997 crisis will help offset the effects of corporate failures. South Korea is far less vulnerable to a balance of payments crisis than three years ago. Reducing corporate weakness will further reduce the risk of crisis or stagnation by removing a major source of vulnerability that hangs over the economy and erodes sentiment.
With the improvements in the social safety net over the last three years, the economy should be able to absorb the temporary dislocation that accompanies reforms. However, it will be important for the government to educate the public as to why further reform and restructuring are necessary. A social consensus that allows a shift from preserving old jobs in shrinking industries to creating new opportunities in more vibrant industries will be in the long-term interest of all Koreans.
They have made many sacrifices since the 1997 crisis. This investment in the future should not now be lost by a return to the old ways of doing business.