Press Release: IMF Approves SDR 15.5 Billion Stand-by Credit for Korea

IMF News, December 4, 1997

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Press Release: IMF Approves SDR 15.5 Billion Stand-by Credit for Korea

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Bibliographic details

• Published: December 4, 1997

IMF approval and financing schedule

• IMF approved a three-year stand-by credit equivalent to SDR 15.5 billion (about US$21 billion).
• Immediate availability: SDR 4.1 billion (about US$5.56 billion).
• Availability following first review (December 18): SDR 2.6 billion (about US$3.58 billion).
• Availability following second review (January 8, 1998): SDR 1.5 billion (about US$2 billion).
• Subsequent disbursements: made available subject to attainment of performance targets and, in some cases, program reviews.
• The stand-by credit is equivalent to 1,939 percent of Korea’s quota 1 of SDR 799.6 million (about US$1.09 billion) in the IMF.
• Approval used accelerated procedures established under the emergency financing mechanism (EFM) adopted in September 1995.

Background: macroeconomic and financial conditions

• Long-term growth: per capita GDP rising at an annual rate of nearly 7 percent over several decades; transformation from a poor agrarian economy to an advanced industrial economy.
• 1997 macro performance prior to crisis:
  • Real GDP grew by 6 percent during the first three quarters.
  • Inflation declined slightly to 4 percent.
  • External current account deficit expected at 3 percent of GDP in 1997.
  • Fiscal policy: prudent; consolidated central government accounts record only a small deficit for 1997 despite a large tax shortfall.
• Crisis developments:
  • An unprecedented number of highly leveraged conglomerates (chaebols) moved into bankruptcy.
  • Nonperforming loans rose sharply to the equivalent of 7-1/2 percent of GDP.
  • Steep decline in stock prices reduced banks’ equity and net worth.
  • Banking system weaknesses: lack of commercial orientation, limited experience in pricing and managing risk, lax prudential supervision.
  • Resulted in successive downgrades by international credit rating agencies and a sharp tightening in the availability of external finance.

Program objectives and macro policies

• Macroeconomic objectives:
  • Build conditions for an early return of confidence to limit slowdown of GDP growth in 1998 and recover toward potential in 1999.
  • Contain inflation at or below 5 percent.
  • Build international reserves to more than 2 months of imports by end-1998.
• Government program pillars:

1. Strong macroeconomic framework to continue orderly reduction in the external current account deficit, build international reserves, and contain inflationary pressures through tighter monetary stance and significant fiscal adjustment. 2. Comprehensive strategy to restructure and recapitalize the financial sector to make it more transparent, market-oriented, and better supervised. 3. Measures to reduce reliance on short-term debt and allow better diversification of risk in the economy.

• Monetary policy:
  • Tightened immediately to restore and sustain market calm and contain inflationary impact of recent won depreciation.
  • Reversal of large liquidity injections; money market rates raised sharply and maintained at a high level as needed.
  • Day-to-day conduct guided by movements in the exchange rate and short-term interest rates as indicators of monetary tightness.
  • Flexible exchange rate policy with intervention limited to smoothing operations.
• Fiscal policy for 1998:
  • Will remain tight; additional fiscal measures of about 1-1/2 percent of GDP to achieve at least balance, or a small surplus.
  • Measures include: increases in mineral oil taxes (already in effect); broadening of the VAT base; selective increases in income and corporate taxes; cuts in current expenditures; limited cuts in infrastructure and other capital expenditures.

Financial sector restructuring

• Strategy comprises three elements: a clear and firm exit policy; strong market and supervisory discipline; increased competition.
• Exit policy and resolution:
  • Authorities suspended 9 insolvent merchant banks.
  • Merchant banks unable to submit appropriate restructuring plans will have licenses revoked.
  • Restructuring and recapitalization of all banks that fail to meet the Basle Committee capital standards, including mergers and acquisitions by domestic or foreign institutions.
  • Supervisory review of mergers and acquisitions to ensure economic viability; process will entail losses to shareholders.
• Deposit guarantee policy:
  • Current deposit guarantee intended to facilitate orderly restructuring.
  • Government committed to eliminate the guarantee by the end of 2000 and replace it with a regular deposit insurance system protecting only small depositors and financed solely by contributions from the financial sector.
• Transparency and disclosure:
  • Large financial institutions required to have financial statements audited by internationally recognized firms.
  • Disclosure standards to require publication of key data twice a year, including nonperforming loans, capital adequacy, and ownership structures and affiliations.
• Supervision and institutional reforms:
  • Authorities will urgently request passage of a bill to set up an agency to consolidate supervisory functions currently distributed among various agencies.
  • Legislation will allow prompt closure of insolvent financial institutions, replacement of managements, and dilution of shareholders equity when appropriate.
  • Early legislation sought to make the Bank of Korea independent with price stability as its overriding mandate.
• Competition:
  • Authorities will allow foreigners to establish bank subsidiaries and brokerage houses by mid-1998.

Structural policies

• Trade liberalization:
  • Timetable to be set in line with WTO commitments to eliminate trade-related subsidies, restrictive import licensing and the import diversification program.
  • Steps to streamline and improve transparency of import certification procedures.
• Capital account liberalization:
  • Ceiling on aggregate foreign ownership of listed Korean shares to be increased from 26 percent to 50 percent by end-1997 and to 55 percent by end-1998.
  • Ceiling on foreign ownership (unspecified instrument) to be increased from 7 percent to 50 percent by end-1997.
  • By end-February 1998, steps to liberalize other capital account transactions, including restrictions on foreigners’ access to domestic money market instruments and corporate bond markets, and further reducing restrictions on foreign direct investment by simplifying approval procedures.
  • A timetable to be set by end-February 1998 to eliminate restrictions on foreign borrowing by corporations.
• Labor market adjustments:
  • Enhance labor market flexibility by easing dismissal restrictions under mergers and acquisitions and corporate restructuring that rely on time-consuming court rulings.
  • Strengthen employment insurance system and allow private job placement agencies and temporary employment agencies to operate to ease burden of layoffs and expedite reemployment.

Financing needs and international support

• IMF funding: US$21 billion (as part of SDR 15.5 billion stand-by credit).
• World Bank: President indicated readiness to provide up to US$10 billion in support of specific structural reform programs, in accordance with bank policy.
• Asian Development Bank: President indicated readiness to recommend up to US$4 billion in support of policy and institutional reforms, within the framework of bank policy.
• Bilateral contingency support:
  • A number of countries (Australia, Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, the United Kingdom, and the United States) informed IMF they are prepared to consider making available supplemental financing in the event of unanticipated adverse external circumstances, while Korea remains in compliance with the IMF credit arrangement.
  • This second line of defense is expected to be in excess of US$20 billion.

Korea: Selected Economic Indicators

• Real GDP growth:
  • 1995: 8.9
  • 1996: 7.1
  • 1997: 6.0
  • 1998*: 2.5
• Consumer prices (end of period):
  • 1995: 4.7
  • 1996: 4.9
  • 1997: 4.2
  • 1998*: 5.2
• Central government balance (deficit -):
  • 1995: 0.3
  • 1996: -0.5
  • 1997: 0.2
• Current account balance (deficit -) (Billions of US$):
  • 1995: -8.9
  • 1996: -23.7
  • 1997: -13.8
  • 1998*: -2.3
• External debt (Billions of US$):
  • 1995: 78.4
  • 1996: 104.7
  • 1997: 101.5
  • 1998*: 126.8
• Sources: Korean authorities; and IMF staff estimates.
• Note: *Program.

International Monetary Fund

References

• Republic of Korea and the IMF
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