Press Information Notice: IMF Concludes Article IV Consultation with Korea
IMF News, June 19, 1998
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- Published: June 19, 1998
Background
- Korea experienced a long period of rapid growth, low inflation, and sustained improvement in the standard of living until the financial crisis in late 1997.
- Prudent macroeconomic policies and high domestic savings and investment contributed to Korea's transformation into an advanced industrial economy in four decades.
- An economic reform program, gaining momentum in 1993-96, sought gradual liberalization of financial markets and the capital account, but capital account liberalization was not well sequenced nor accompanied by necessary reforms and strong prudential supervision.
- Controls on short-term external borrowing by banks were eased while controls on medium- and long-term capital remained in place.
- In 1994-96, aggressive investment by conglomerates, financed by large increases in borrowing from domestic banks and sharp increases in short-term external borrowing, created vulnerabilities.
- In 1997, numerous highly leveraged conglomerates went into bankruptcy due to yen depreciation, adverse movements in Korea’s terms of trade, and slowing domestic demand, causing severe deterioration in Korean financial institutions’ balance sheets.
- The crisis in Thailand in mid-1997 amplified concerns; a late-October 1997 correction in the Hong Kong stock market triggered a massive loss of market confidence, credit line reductions to Korean banks, and critically low usable reserves.
- Korea entered into a Stand-By Arrangement with the IMF on December 4, 1997.
Program objectives and policy measures
- The Stand-by Arrangement program had two main objectives:
- restoration of confidence in the basic soundness of the Korean economy; and
- fundamental restructuring of the financial and corporate sectors supported by far-reaching market opening to lay the basis for recovery and growth.
- Short-term measures and outcomes:
- Monetary conditions were tightened to stabilize the foreign exchange market; with stabilization, interest rates subsequently fell substantially.
- Fiscal policy was flexible to avoid aggravating the downturn; the program for 1998 envisaged a fiscal deficit of 1.7 percent of GDP, close to the estimated cyclically neutral deficit, and allowed for increased social safety net expenditures.
- Social safety net improvements included widening coverage and extension of benefits; initiation of a second-round tripartite committee was welcomed.
- Financial sector restructuring measures:
- Establishment of an autonomous consolidated supervisory agency.
- Rationalization of the merchant banking sector, closing about half the original number of banks and approving recapitalization plans for others.
- 12 undercapitalized commercial banks asked to submit recapitalization plans by end-June.
- Plans to bring prudential regulations and supervision closer to international best practices; proposed regulations relating to short-term external borrowing and foreign exchange exposure highlighted as especially important.
- Decisions on recapitalization to be guided by rigorous review of nonperforming loan magnitude; clear conditions on public resource use were emphasized.
- Corporate sector and market-opening measures:
- Large conglomerates required to publish combined financial statements by next year; shareholder rights strengthened; bankruptcy procedures improved.
- Elimination of restrictions on foreign investment in domestic equity, bond, and money markets; substantial liberalization of foreign direct investment.
- Legislation passed to increase labor market flexibility.
- Promoting capital market development to mobilize domestic saving more efficiently, phase out cross-corporate payment guarantees, and strengthen corporate governance and market discipline.
- Crisis mitigation actions and external engagement:
- Debt restructuring agreement with foreign banks finalized at end-March/early April.
- Government issued $4 billion in a global bond issue.
- Current account turned into a substantial surplus: some $14½ billion in the first four months of 1998.
- Usable reserves rebuilt to exceed pre-crisis levels—reaching $34½ billion by end-May.
Executive Board Assessment and policy advice
- Directors commended authorities for steadfast implementation of the stabilization and reform program, which aided rapid rebuilding of usable reserves, strengthening and stabilization of the won, and re-entry into international capital markets.
- Directors cautioned that confidence remained fragile, citing recent equity market weaknesses, severe downturn in economic activity, and regional adverse developments (including the weakening of the yen).
- Key advice and judgments:
- Urged perseverance with determined implementation of the reform program; noted contraction in output would be sharper than anticipated and unemployment expected to continue rising.
- Emphasized maintaining social consensus and stability; underscored need for an adequate social safety net to protect vulnerable groups.
- Recommended continued focus of monetary policy on maintaining exchange market stability; saw scope for further gradual reductions in interest rates provided the exchange market remained stable.
- Considered fiscal policy prudent; many Directors supported further widening of the deficit through automatic stabilizers if downturn worsened and supported modest further widening to allow additional social safety net expenditures.
- Deemed decisive action to strengthen the financial system imperative; welcomed progress in merchant bank rationalization and encouraged focus on creating a sound, more efficient commercial banking sector.
- Stressed that recapitalization decisions should follow rigorous review of nonperforming loans; cautioned against providing public funds to nonviable banks and urged clear conditions on public assistance, using systemic importance and private capital injection as criteria.
- Supported development of capital markets as key to corporate restructuring and efficient mobilization of domestic saving.
- Identified corporate restructuring as a key challenge; urged timely action to address overindebtedness and to bolster credibility of reform effort.
- Recommended putting a framework for corporate debt workouts in place by June; proposed creation of debt workout units in commercial banks with external audits, formation of voluntary creditor committees, and improved disclosure by conglomerates.
- Noted temporary, time-bound, commercially priced trade financing and trade credit guarantee schemes for small and medium-sized enterprises were necessary but should not be directed toward specific industries.
Impact on the real economy (selected observations)
- After growing at 5.5 percent in 1997, real GDP contracted by 3.8 percent in the first quarter of 1998.
- Unemployment rate reached 6.7 percent in April 1998 (compared with 2.5 percent in 1997).
- Despite won depreciation, inflation remained subdued due to falling domestic demand and absence of wage pressures.
- Substantial positive net external demand offset declines in consumption and domestic investment in early 1998.
Korea: Selected Economic Indicators, 1992-98 (key figures preserved exactly as presented)
- GDP: US$442.6 billion (1997)
- Population: 45.2 million (1996)
- Quota: SDR 799.6 million
- Real GDP (percent change)
- 1992: 5.1
- 1993: 5.8
- 1994: 8.6
- 1995: 8.9
- 1996: 7.1
- 1997: 5.5
- Proj. 1998: -1 to -2
- Final domestic demand
- 1992: 3.9
- 1993: 5.3
- 1994: 8.8
- 1995: 7.0
- 1996: 0.8
- 1997: -12.2
- Consumption
- 1992: 6.8
- 1993: 7.2
- 1994: 6.9
- 1995: 3.5
- 1996: -3.5
- Gross fixed investment
- 1992: -0.8
- 1993: 12.0
- 1994: 11.7
- 1995: -27.7
- 1996: (no entry)
- 1997: (no entry)
- Stock building1
- 1992: -0.5
- 1993: -1.0
- 1994: 1.4
- 1995: 1.2
- 1996: -3.7
- 1997: 0.3
- Net foreign balance1
- 1992: 1.7
- 1993: -1.7
- 1994: 0.5
- 1995: 10.9
- Saving and investment (in percent of GDP)
- Gross national saving: 1992: 35.3; 1993: 35.4; 1994: 34.8; 1995: 35.2; 1996: 33.7; 1997: 33.0; Proj. 1998: 32.3
- Gross domestic investment: 1992: 36.6; 1993: 35.1; 1994: 35.8; 1995: 37.0; 1996: 38.4; 1997: 35.0; Proj. 1998: 25.1
- Prices (percent change)
- Consumer price (end-period): 1992: 4.6; 1993: 5.6; 1994: 4.7; 1995: 4.9; 1996: 6.6; 1997: 8.2
- GDP deflator: 1992: 6.1; 1993: 3.4; 1994: 2.4; 1995: 7.8; 1996: (no entry)
- Employment and wages
- Unemployment rate: 1992: 2.8; 1993: 2.0; 1994: 2.7; 1995: 6.5
- Wages (annual percent change)2: 1992: 15.7; 1993: 15.5; 1994: 9.9; 1995: 12.2; 1996: 5.2
- Consolidated central government (in percent of GDP)
- Revenues: 1992: 18.2; 1993: 19.3; 1994: 20.2; 1995: 20.7; 1996: 21.9; 1997: 22.2; Proj. 1998: 22.8
- Expenditure: 1992: 18.9; 1993: 19.0; 1994: 19.7; 1995: 20.3; 1996: 21.7; 1997: 24.5
- Balance: 1992: -0.7; 1993: 0.4; 1994: 0.0
- Money and Credit (annual percent change)
- MCT (end of period): 1992: 22.4; 1993: 24.4; 1994: 23.0; 1995: 17.4; 1996: 11.5; 1997: 10.13
- M3 (end of period): 1992: 20.9; 1993: 18.5; 1994: 26.7; 1995: 19.1; 1996: 16.7; 1997: 13.9; Proj. 1998: 14.93
- Yield on corporate bonds (percent, period): 1992: 16.2; 1993: 12.6; 1994: 12.9; 1995: 13.8; 1996: 11.9; 1997: 13.4; Proj. 1998: 18.16
- Trade (percent change)
- Export volume: 1992: 8.1; 1993: 14.8; 1994: 24.0; 1995: 19.8; 1996: 24.9; 1997: (no entry)
- Import volume: 1992: 21.5; 1993: 21.2; 1994: 1.5; 1995: -11.3
- Terms of trade: 1992: -1.1; 1993: -3.6; 1994: -12.3; 1995: -1.9; 1996: (no entry)
- Balance of payments (in billions of US$)
- Exports, f.o.b.: 1992: 76.2; 1993: 82.1; 1994: 95.0; 1995: 124.6; 1996: 130.0; 1997: 138.6; Proj. 1998: 145.5
- Imports, f.o.b.: 1992: 78.0; 1993: 79.8; 1994: 97.8; 1995: 129.1; 1996: 144.9; 1997: 142.5; Proj. 1998: 118.9
- Current account balance: 1992: -3.9; 1993: 1.0; 1994: -8.5; 1995: -23.0; 1996: -8.6; 1997: 23.1
- Current account balance (in percent of GDP): 1992: -1.3; 1993: (no entry); 1994: -4.7; 1995: 7.3
- Usable gross reserves4 (in billions of U.S. dollars, end of period)
- 1992: 17.1
- 1993: 25.6
- 1994: 28.5
- 1995: 29.4
- 1996: 9.1
- May 1998: 34.56
- In months of imports of goods and nonfactor: 1992: 2.2; 1993: 2.6; 1994: 0.6; 1995: ...
- External debt5
- In billions of U.S. dollars: 1992: 157.5; 1993: 154.4; 1994: 163.3
- In percent of GDP: 1992: 32.5; 1993: 34.9; 1994: 51.5
- Exchange rate (end of period)
- Won per U.S. dollar: 1992: 788.4; 1993: 808.1; 1994: 788.7; 1995: 774.7; 1996: 844.2; 1997: 1,695.8; Proj. 1998: 1,400.86
- Nominal effective exchange rate: 1992: 87.4; 1993: 84.7; 1994: 82.5; 1995: 83.7; 1996: 80.0; 1997: 49.0
- Real effective exchange rate: 1992: 95.2; 1993: 94.8; 1994: 98.9; 1995: 97.2; 1996: 62.4
- Sources noted in the PIN: Bank of Korea, Monthly Statistical Bulletin; IMF, International Financial Statistics; data provided by the Korean authorities; and IMF staff estimates and projections.
- Footnotes included in the PIN: 1Contribution to GDP growth. 2Monthly earnings in manufacturing. 3February 1998. 4Excluding deposits at overseas branches and subsidiaries of domestic banks. 5Includes offshore borrowing of domestic financial institutions and debt contracted by overseas branches of domestic financial institutions. 6May 1998.
Public Information Notice — IMF External Relations Department, June 19, 1998; Executive Board concluded Article IV consultation with Korea on May 29, 1998.