## Korea's Economic Adjustments Under the IMF-supported Program--Presentation by Kunio Saito

_IMF News, January 21, 1998_

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## Bibliographic details
- Published: January 21, 1998

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### I. Introduction
- Presentation context: Sogan University/Korea Economic Daily Conference, January 21, 1998.
- Scope:
  - Focus on "Economic Adjustments to the recent financial crisis under IMF-supported programs", primarily Korea, with references to Indonesia and Thailand.
  - Three guiding questions:
    - How (why) did the crisis occur?
    - What are the key elements of the IMF-supported program for Korea? How does it compare with other programs?
    - Will the program work? How does it work? When will stabilization and recovery begin?

### II. Problems (Drivers of the Crisis)
- Regional framing:
  - Asia’s development characterized as: Asian poverty and stagnation; Asian miracle; Asian crisis.
  - Rapid turnaround from boom to crisis in mid-1997; crisis deepened and widened unexpectedly.
- Scale of international support packages:
  - Packages (including multilateral and bilateral contributions): $57 billion for Korea, $40 billion for Indonesia and $17 billion for Thailand.
  - IMF contributions alone: $21 billion for Korea, $10 billion for Indonesia, and $4 billion for Thailand.
- Common warning signs (regional and Korean specifics):
  - Excessive and sometimes unwise investments financed by short-term borrowing.
  - Banks: excessive lending, high levels of risky and questionable assets, weakening balance sheets.
  - Delayed structural reforms, especially in financial sector, corporate governance, and business practices.
- Korea-specific chronology and mechanics:
  - 1995–early 1996: booming economy; 1996 cyclical downturn.
  - Export growth slowed from 33 percent in 1995 to 3 percent in 1996.
  - Contributing factors: weaker external demand, collapse of computer chip prices, loss of competitiveness due to Yen depreciation, political uncertainty ahead of Presidential election.
  - Resulting corporate failures: Hanbo Steel, Jinro, Dianong, New Core Group, and KIA motors.
  - Banking consequences: rising nonperforming assets, weakened balance sheets, higher foreign borrowing premia.
  - By mid-November, foreign banks began declining rollovers; merchant banks faced liquidity problems and virtual insolvency.
  - Political setback: failure to obtain parliamentary approval of 9 financial sector reform bills in mid-November.
  - Exchange rate and stock market: sharp declines; daily exchange rate band widened to 10 percent on October 20.

### III. IMF-supported Program — Key Elements and Implementation
- Timeline and financing:
  - Government requested IMF support on November 21.
  - IMF program approved on December 4.
  - IMF Board reviews: December 18, December 30, and January 8.
  - IMF disbursed loans totaling SDR9.7 billion so far.
- Three broad program pillars: Exchange market stabilization; Financial policies; Structural reform.

  H3: Exchange Market Stabilization
  - Immediate priority: stabilize the foreign exchange market.
  - Instruments: interest rate and exchange rate policies, external financing strategy, financial sector restructuring.
  - Roll-over efforts in December: initial low roll-over ratios that rose substantially by month-end; coordination among creditor-country governments to encourage rollovers and monitor progress.
  - Alternatives discussed: conversion of short-term private debts to longer-term government bonds; government guarantees for rolled-over debts.
  - Bank of Korea interventions:
    - Provided foreign-exchange loans through a special window when maturing debts were not rolled over.
    - Premium on this window progressively raised—to over 1,000 basis points—to encourage banks to seek other foreign exchange sources.
    - Source of foreign exchange for the window: reserves, including borrowing from the IMF and other international organizations.
  - Exchange rate policy:
    - Market-determined; no particular level targeted.
    - Intervention limited to smoothing intra-day volatility.
    - Once stabilized, intervention will shift toward accumulating usable foreign exchange reserves.
  - Interest rate rationale:
    - High interest rates used to encourage holding domestic currency and increase foreign exchange supply.
    - Rates do not need to remain high indefinitely; they will be lowered once exchange market stabilizes.
    - Korea’s money market rates more than doubled during December to about 27-30 percent.
    - Legislated interest rate caps have been removed; authorities prepared to allow rates to move higher if necessary.

  H3: Financial Policies
  - Dual objectives: ensure credit access for sound enterprises and maintain monetary conditions consistent with macro prospects.
  - Measures to support liquidity and capital adequacy:
    - Issued subordinated debt of W 4.4 trillion (1 percent of GDP) to improve liquidity of bank assets and raise capital adequacy ratios.
    - Provided short-term financing through a W 11.3 trillion liquidity support facility at the average call rate.
    - Increased the ceiling on official export guarantees by W 3 trillion.
  - Importance of prompt financial restructuring, improved corporate governance, and accounting to aid credit risk evaluation.
  - Monetary program targets:
    - Aim to reduce broad money growth (M3) somewhat from about an annual 16 percent registered during the last quarter of 1997.
    - Reserve money growth to be contained at about the same level.
    - Open market operations to be used after targeted liquidity injections are completed.
  - Fiscal policy:
    - Automatic fiscal stabilizers to be permitted given a likely considerable output gap.
    - 1997 budgetary deficit estimated at about 0.5 percent of GDP (W 2 trillion).
    - 1998 deficit currently estimated to be 1-1.5 percent of GDP.
    - New tax measures (special excises and transportation excises) implemented beginning January 10; later strengthened to include gasoline and broaden the special excise tax base.
    - Revenue gains expected to be more than offset by fiscal cost of financial sector restructuring, exchange rate depreciation, and automatic stabilizers.

  H3: Structural Reform
  - Comprehensive program including financial sector, corporate, labor market, and capital account measures.
  - Financial sector actions already taken:
    - Suspended 14 insolvent merchant banks.
    - Placed 2 commercial banks under supervision.
    - Requested other institutions to submit plans for capital restorations needed to meet the Basle standards.
    - Strengthened deposit guarantee and asset management schemes by injecting budgetary funds.
    - Bank of Korea to be given greater autonomy; Government to refrain from intervening in bank management and individual lending decisions.
  - Corporate sector reforms:
    - Enforce Generally Accepted Accounting Standards to improve balance sheet transparency.
    - Overhaul mutual guarantee systems within conglomerates to improve risk management.
  - Labor market reforms:
    - Emphasis on measures to improve flexibility, including enlarging scope for lay-offs.
    - Support measures: improvements in unemployment insurance and labor retraining programs.
    - Formation of a tripartite committee to seek consensus on sensitive labor issues.
  - Capital account and trade:
    - Accelerated liberalization of capital account transactions and removal of some remaining trade restrictions.
    - Many measures implement earlier OECD and WTO commitments on an accelerated schedule; some measures go beyond earlier schedules.
    - Examples: raising ceilings on foreign acquisition of Korean stocks already implemented; other measures scheduled with concrete time-bound plans.
  - Rationale: reforms depart from traditional government-corporate relationships and management styles to improve efficiency, risk management, productivity, flexibility, and investor confidence.

### IV. Economic Outlook (Prospects and Key Projections)
- Overall assessment:
  - Saito’s view: the IMF-supported program "will work" if implemented rapidly and thoroughly; stabilization and a basis for rapid growth will be established, but the adjustment will be long and hard.
- Main macroeconomic projections and indicators for 1998:
  - GDP growth:
    - GDP to increase by no more than 1 to 2 percent in 1998.
    - Domestic demand expected to be sharply lower owing to higher interest rates; net foreign demand to boost growth via a turnaround in the current account.
  - Activity indicators:
    - Machinery orders declined by about 35 percent in November.
    - Consumption growth expected to decrease further due to diminished confidence and declining wage growth.
    - Unemployment has increased to about 3 percent from 2 percent.
  - Inflation and exchange rate pass-through:
    - Rapid feed through of exchange rate depreciation into prices; inflation of 8 to 10 percent and perhaps higher in the first part of 1998.
    - Inflation accelerated to 6.6 percent in December, from about 4 percent, reflecting won-dollar depreciation effects on domestic fuel prices.
    - The depreciation to date implies, on an average annual basis, 25 percent real effective exchange rate depreciation for 1998.
    - Consumer price growth expected to peak in the first and second quarters, tempered by a growing output gap; recent industrial agreements with reductions in nominal wages suggest limited second-round cost-induced price increases.
  - External current account:
    - Movement to surplus of US$3-5 billion (about 1percent of GDP) in 1998.
    - Current account moved into surplus in November due to declining import growth (particularly consumer goods) and growing exports to Eastern Europe and China.
    - Export prospects constrained by domestic financing limits and a backdrop of extremely weak dollar export prices—a 25 percent fall over the past two years—resulting in narrow margins.
  - Structural transition:
    - Large-scale industrial restructuring and labor redeployment expected.
    - Anticipated rise in corporate mergers, associated downsizing, and transitory unemployment.
- Outlook summary:
  - 1998 is projected as a difficult year of consolidation and preparation for future growth.
  - Strong belief that Korea will resume rapid growth once consolidation and restructuring are complete.

### V. Conclusion — Key Policy judgments and recommendations
- Three concluding points:
  - The IMF-supported program is the best—and perhaps the only available—means to address the crisis; rapid and thorough implementation by the government will stabilize the economy and restore the basis for rapid growth.
  - Structural measures (financial sector and corporate restructuring, labor redeployment) are painful short-term but serve the nation's long-term interest by strengthening competitiveness and efficiency.
  - Liberalization of the capital account and remaining trade restrictions has been accelerated; improvements in government-corporate relationships, inter-enterprise arrangements, and corporate management styles will strengthen Korea’s—and east Asia’s—approach to rapid economic growth.

*Presentation by Kunio Saito, Director, Regional Office for Asia and the Pacific, International Monetary Fund, at the Sogan University/Korea Economic Daily Conference, January 21, 1998.*

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## References

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