South Korea North Korea

COUNTRY REPORT

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3rd quarter 1999

The Economist Intelligence Unit 15 Regent St, London SW1Y 4LR United Kingdom The Economist Intelligence Unit The Economist Intelligence Unit is a specialist publisher serving companies establishing and managing operations across national borders. For over 50 years it has been a source of information on business developments, economic and political trends, government regulations and corporate practice worldwide. The EIU delivers its information in four ways: through subscription products ranging from newsletters to annual reference works; through specific research reports, whether for general release or for particular clients; through electronic publishing; and by organising conferences and roundtables. The firm is a member of The Economist Group.

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ISSN 1350-6900

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Printed and distributed by Redhouse Press Ltd, Unit 151, Dartford Trade Park, Dartford, Kent DA1 1QB, UK Contents

3 Summary

5 Inter-Korean relations

South Korea 8 Political structure 9 Economic structure 10 Outlook for 1999-2000 15 The political scene 20 Economic policy 22 The domestic economy 22 Production and demand 25 Employment, wages and prices 27 Money and finance 31 Foreign trade and payments 34 Business news

North Korea 37 Political structure 38 Economic structure 39 Outlook for 1999-2000 40 The political scene 44 The economy, trade and investment

47 Quarterly indicators and trade data

List of figures 11 South Korea: forecast summary 12 South Korea: global assumptions 13 South Korea: current-account balance 14 South Korea: economic results and forecasts 20 South Korea: supplementary budget, Apr 1999 23 South Korea: gross domestic product by industry 24 South Korea: seasonally adjusted manufacturing production 24 South Korea: construction indicators 25 South Korea: employment 26 South Korea: wages in manufacturing industry 27 South Korea: price indicators, 1999 27 South Korea: money supply trends, 1999

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28 South Korea: non-performing loans by type of financial institution as of end-Mar 1999 29 South Korea: financial market indicators, 1999 30 South Korea: external liabilities 32 South Korea: exports of selected commodities, Jan-Mar 32 South Korea: imports of selected commodities, Jan-Mar 33 South Korea: current- and capital-account balances, Jan-Apr 47 South Korea: quarterly indicators of economic activity 48 South Korea: foreign trade 50 South Korea: structure of trade 51 South Korea: direction of trade

List of figures

15 South Korea: gross domestic product 15 South Korea: won real exchange rates 23 South Korea: machinery orders 25 South Korea: manufacturing operation ratio index

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July 23rd 1999 Summary

3rd quarter 1999

Inter-Korean relations The navies of the two Koreas clashed in early June. North Korean casualties were high. Hyundai’s cruises to North Korea were halted in late July after North Korea detained a southern tourist. Inter-Korean talks took place in Beijing but little was achieved.

South Korea

Outlook for 1999-2000 Constitutional reform will be deferred until after the April 2000 parliamentary election, but the ULD will not leave the government over the issue. Faster economic growth may persuade Kim Dae-jung to slacken the pace of economic reform. Real GDP will grow by 6.1% in 1999 and by 5.3% in 2000. Growth in 1999 will be driven largely by changes in stockbuilding. The foreign balance will exert a slight drag on growth in both 1999 and 2000. Growth in fiscal spending will slow. Interest rates may rise, but increases will be modest. Inflationary pressures will be muted as a result of excess capacity in the economy and a slack labour market. The current-account surplus will fall to 1.4% of GDP in 2000.

The political scene The NCNP-ULD ruling coalition lost two by-elections in June, owing partly to a succession of scandals involving members of the government. In May Kim Dae-jung reshuffled his cabinet for the first time since taking office. Mr Kim visited Moscow in May, but few substantial issues were resolved.

Economic policy A supplementary budget worth W2.8trn ($2.4bn) was passed by the National Assembly in April, the main purpose of which was to reduce unemployment. A second supplementary budget, centred on tax cuts and subsidies for low- and middle-income earners, was planned but its passage through parliament was blocked by the GNP. The Bank of Korea has continued to maintain downward pressure on short-term interest rates. The near-collapse of Daewoo in mid-July revealed the shortcomings of the government’s corporate reform programme.

The domestic economy • Real GDP grew by 4.6% year on year in the first quarter of 1999. Private consumption rebounded and the contraction in gross fixed investment moderated. Exports of goods and services held up well. Manufacturing production grew by 12.6% year on year in the first quarter, confirming the recovery apparent in the fourth quarter of 1998.

• Unemployment eased to 6.5% in May but remained high by pre-1997 levels. Employment in manufacturing rose by 3.7% between February and May. Wages in manufacturing rose by 12.6% year on year in April, largely as a result of increased overtime. Consumer prices rose by just 0.6% in June, but producer prices fell by 3.2% in the same month, both year on year.

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• M3 growth remained near the government’s target of 13% for 1999 in January-April. Most domestic commercial banks returned to profit in January- June. Non-performing loans at domestic financial institutions rose by 8.5%, compared with the end-1998 level. The local stockmarket performed strongly, thanks partly to a revival of interest from domestic investors looking for higher returns than were available on bank deposits. Foreign direct investment commitments in January-April rose by 147.4% year on year.

Foreign trade and The merchandise trade surplus (fob-cif) fell by 44.4% year on year in the first payments quarter of 1999, as imports rose by 8.1% and exports fell by 5.9%. The current- account surplus shrank by 39% year on year in January-April, owing to a reduced merchandise trade surplus and a widening services and income deficit.

Business news The Hyundai-LG Big Deal business swap was concluded in mid-May, but the Samsung-Daewoo asset swap failed after Samsung Motors was declared bankrupt. South Korea’s two largest life insurance companies, Samsung Life and Kyobo Life, will be listed. Sales of Korea First Bank and Seoul Bank have run into difficulties, owing to differences over asset valuations.

North Korea

Outlook for 1999-2000 Another Taepo-dong missile launch would undermine South Korea’s sunshine policy and could mean the end of KEDO. The Kosovo crisis will add to North Korea’s suspicions about the US’s intentions towards it.

The political scene Some former vice-presidents may have been purged. William Perry visited Pyongyang in May but did not meet Kim Jong-il. India detained a North Korean freighter in July, claiming that it was carrying missile components bound for Pakistan. A senior North Korean delegation visited China in early June, becoming the first high-ranking delegation to do so since 1991.

The economy, trade and Total merchandise trade fell in 1998 by 30% year on year, according to South investment Korea’s national unification ministry. North Korea’s stock of foreign debt rose to $12bn at the end of 1997. The 1999 harvest could be poor. Lack of maintenance may have led to a deterioration in the national system of piped potable water. The first North Korean-built railcars for Hyundai arrived in Inchon in late May.

Editor: Robert Ward All queries: Tel: (44.20) 7830 1007 Fax: (44.20) 7830 1023 Next report: Our next Country Report will be published in November

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Inter-Korean relations

The future of the sunshine Not for the first time, the prospects for inter-Korean relations depend very policy is uncertain— much on North Korea. After the ups and downs of the past few months there is a risk that any further North Korean provocation will undermine support in South Korea for President Kim Dae-jung’s so-called sunshine policy of positive engagement towards North Korea. This would be particularly applicable were North Korea to test-fire another missile, as it did in August 1998 (4th quarter 1998, page 37) and as some recent reports have suggested it may. Such an act would undercut those in the US, Japan and South Korea who support an engagement policy and strengthen those who view engagement as appeasement and prefer to meet force with force.

—as initial success— Rarely have the ups and downs of inter-Korean relations been bumpier, or more puzzling, than in past months. First signs were that the sunshine policy was paying off. On June 3rd the two Koreas agreed to meet in Beijing later that month at vice-ministerial level, for what would be the first such official talks in over a year. South Korea was pleased that North Korea had agreed to discuss reunions of separated families, in return for supplies of 200,000 tonnes of much- needed fertiliser. Unlike in April 1998, this time South Korea offered the fertiliser in advance rather than as a quid pro quo, and deliveries began right away.

—is followed by a setback— What followed was, therefore, all the more unexpected. On June 7th a fleet of North Korean fishing boats crossed the Northern Limit Line (NLL, the maritime extension of the Military Demarcation Line, or MDL) which separates the Koreas, off the Korean peninsula’s west coast. This in itself was nothing unusual for the time of year, which was the blue crab season: the waters in question are especially rich in this delicacy. The normal pattern is for the South Korean navy to chase the intruders back across the NLL, in a game of cat and mouse.

—and the two Koreas’ This time, however, it was different. North Korea’s fishing vessels, supported by navies clash south of Korean People’s Army (KPA) patrol boats, stood their ground south of the NLL. the NLL After several days of stand-offs on June 11th the South Korean navy resorted to ramming North Korea’s ships. This worked, but they came back the next day. On June 15th the south rammed again, and this time were fired on. They returned fire, sinking one North Korean torpedo boat and damaging several more. It was all over in 14 minutes. This was the first direct clash between the two sides’ navies since the end of the Korean war in 1953.

North Korea’s motive may North Korea’s motives are not easy to ascertain. While the crab catch is no be to challenge the NLL— doubt valuable—reportedly generating potential export revenue of $20m for a KPA company—this scarcely seems worth risking a war for. A likelier reason is to call into question the NLL, which was declared unilaterally by the UN command at the end of the Korean war and which North Korea never formally agreed, although it has de facto accepted it. Unlike the clear-cut terrestrial MDL, the NLL involves an indented coastline with five islands in South Korean hands and accordingly breaches the 12-mile territorial waters which North Korea claims.

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—but it initially refuses to Even so, a state other than North Korea might have proceeded by negotiation discuss the stand-off rather than provocation. One can imagine Kim Dae-jung’s government readily agreeing to fishing rights as part of the sunshine policy—if only they were requested. Instead, North Korea refused at first to discuss the stand-off. When it finally agreed to a meeting at Panmunjom, the shooting broke out at that very moment—and the North Korean side apparently had advance knowledge of it.

The North Korean There are two possible further reasons for the provocation. First, a split in the government may be split Pyongyang regime, with the KPA deliberately seeking to undermine dialogue. Second, perverse as it sounds, there are precedents for North Korea prefacing dialogue with menaces—presumably in the hope of scaring the other side into making concessions. Whatever the aim, the outcome cannot have been com- forting for the KPA, whose ageing craft proved no match for the south’s modern high-tech fleet.

North Korean casualties The north lost at least 30 and maybe as many as 80 men and may lack the cash are high to repair its damaged vessels. Naval sources in Seoul noted that North Korea’s troops had to fire their old guns manually from exposed positions on deck, while their southern counterparts aimed at them with computerised sights from safely inside their own ships. South Korean casualties were thus limited to a few light wounds.

Hyundai’s cruises to North In an odd but perhaps hopeful compartmentalisation of inter-Korean relations, Korea continue despite this battle did not scupper other ongoing contacts. While the guns blazed, on the clash— the other side of the peninsula cruise ships of the Hyundai group—Hyundai is one of South Korea’s largest chaebol (conglomerate)—continued to ferry South Korean tourists to Mt Kumgang, a scenic area just the other side of the demili- tarised zone which divides the two Koreas. (For details on Hyundai’s cruise plan, see 4th quarter 1998, page 6.) Even stranger, South Korea maintained its deliveries of fertiliser to North Korea throughout, delaying just one boat briefly. Despite threats by North Korea to curtail visits by South Korean businesses, a trip by a 16-strong delegation from another large chaebol, Samsung, went ahead as planned on June 15th-21st.

—until a South Korean It took a separate provocation from North Korea to halt Hyundai’s cruises, at tourist is held as a spy— least temporarily. On June 20th Min Young-mi, a South Korean tourist travelling with her six-year-old son, was detained in North Korea for allegedly trying to encourage a guide to defect. Hyundai at once suspended all its tours. After being forced to write a “confession”, Ms Min was released within a week. It seems she did no more than speak unwisely, but there are suggestions that the North Korean guide initiated the line of conversation and led her on to entrap her.

—after which all tours are Despite Ms Min’s release, here again Kim Dae-jung is taking a firm line. suspended— Hyundai has been forbidden to resume its tours until it gets a guarantee from Pyongyang that such incidents will not recur. As of mid-July the cruises had yet to restart, resulting in considerable loss of revenue to both Hyundai and North Korea, which had earned $150m so far for the seven months that the tours have been running, making this one of North Korea’s most important hard-currency earners.

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—casting a shadow over So popular had these tours proved—more than 80,000 South Koreans have inter-Korean relations made the trip—that Hyundai had latterly been running three cruise ships on the route. This project is also the only concrete result so far of the sunshine policy. Any prolonged suspension will, therefore, cast a wider shadow over north-south relations. Separately, on June 17th North Korea arrested a middle- aged US-Korean woman in Rajin-Sonbong economic zone in the north-east of the country; she was still being held as of late-July.

Talks in Beijing go ahead, Despite these ructions the Beijing talks went ahead. Unsurprisingly in the but without result circumstances, they made no progress. For once it was South Korea which broke them off, after several days of on-off meetings, claiming that North Korea refused to discuss the previously agreed agenda. As well as demanding an apology for the shooting at sea, North Korea wanted the full complement of fertiliser delivered before it would start talking about family reunions.

Some in Seoul hope Nonetheless, some in Seoul remain reasonably optimistic that dialogue will dialogue will resume resume soon, once North Korea decides on a line. South Korean delegates soon— formed the distinct impression that their North Korean counterparts were confused by receiving changing instructions from Pyongyang. Signs that North Korea is preparing to celebrate national liberation day (August 15th) by staging the usual propaganda rallies at Panmunjom may, however, suggest that any resumption of serious dialogue will have to wait until later in the year.

—but others are exploiting Even if talks do resume, the question arises whether after all this the sunshine North Korea’s hostility policy has a future. With a parliamentary election due in April 2000 and the opposition already exploiting this issue, Kim Dae-jung will be under pressure to show firmness and produce results. To be fair, he has always insisted that military preparedness must not be compromised, and sinking a northern ship will have done him no harm politically. However, unless Pyongyang rapidly turns over a new leaf, Mr Kim will have little option but to be more cautious in offering olive branches, for the next few months at least.

Defectors from North Korea In comparison with similar situations elsewhere, such as the former two top 1,000, officially— Germanys, the number of North Korean defectors remains astonishingly small. As of July 6th the cumulative total to reach South Korea since 1948 was just over 1,000. Of these, 792 are still living in South Korea; the remainder have died or emigrated. Unsurprisingly, given conditions in North Korea, this trickle is picking up speed. As recently as the early 1990s there were fewer than ten arrivals each year. This rose to 52 in 1994, 41 in 1995, 56 in 1996, 86 in 1997, and 72 in 1998; 53 arrived in the first half of this year alone.

—but unofficial figures These official figures are misleading in several ways. They omit the millions may be higher who fled in 1945-53, that is, before and during the Korean war. They also exclude an unknown number of high-ranking defectors whose presence is kept secret, and they fail to mention that the numbers would be far higher if South Korean embassies in third countries (above all China) were less discouraging to those who apply for asylum. This delicate matter will become all the more so now that South Korea has been allowed (as of July) to open a consulate in Shenyang in the north-east: nearer for northern refugees to reach than Beijing.

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South Korea

Political structure

Official name Republic of Korea

Form of state Presidential system; president and National Assembly are directly elected; National Assembly members are elected in a mixed system of first-past-the-post and proportional representation

The executive The president (elected for a single term of five years) appoints the State Council (cabinet) composed of the president, prime minister and between 15 and 30 ministers. The State Council is not entirely composed of members of the National Assembly

Head of state Elected president

Legislature Unicameral Kuk Hoe (National Assembly) of no fewer than 200 members (currently 299) elected for four-year terms; currently 253 seats are filled by direct election; the remaining 46 are distributed between parties in proportion to their share of the vote

National elections April 1996 (National Assembly) and December 1997 (presidential); next elections due by April 2000 (National Assembly) and December 2002 (presidential)

National government Coalition of the National Congress for New Politics (NCNP) led by the president, Kim Dae-jung, and the United Liberal Democrats (ULD) led by the prime minister, Kim Jong- pil. Until September 1998 the National Assembly was controlled by the Grand National Party (GNP), the former ruling party, but after opposition defections the government now has a slim majority. As of July 21st 1999 the NCNP had 105 seats, the ULD 55 seats, and the GNP 135 seats; there were four independents

Main political organisations Government: National Congress for New Politics (NCNP) in alliance with United Liberal Democrats (ULD). Opposition: Grand National Party (GNP), formed by merger of the former New Korea Party (NKP) and the small Democratic Party (DP) towards the end of 1997. The former New Party by the People (NPP) has been absorbed into the NCNP

Main members of State Council President Kim Dae-jung Prime minister Kim Jong-pil

Key ministers Commerce, industry & energy Chung Duck-koo Construction & transportation Lee Kun-choon Defence Cho Seong-tae Education Kim Duck-choong Environment Kim Myung-ja Finance & economy Kang Bong-kyun Foreign affairs & trade Hong Soon-young Government administration & home affairs Kim Ki-jae Health & welfare Cha Heung-bong Information & communications Namgoong Suek Justice Kim Jung-kil Labour affairs Lee Sang-yong National unification Lim Dong-won Science & technology Seo Jung-uck

Central bank governor Chon Chol-hwan

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Economic structure

Latest available figures

Economic indicators 1994 1995 1996 1997 1998 GDP at market prices (W trn) 323.4 377.3 418.5 453.3 449.5 Real GDP growth (%) 8.3 8.9 6.8 5.0 –5.8 Consumer price inflation (av; %) 6.2 4.5 4.9 4.5 7.5 Population (m) 44.5 45.1 45.5 45.9 46.4 Exports foba ($ bn) 95.0 124.6 130.0 138.6 131.8 Imports foba ($ bn) 97.8 129.1 144.9 141.8 90.6 Current-account balance ($ bn) –3.9 –8.5 –23.0 –8.2 40.0 Reserves excl gold ($ bn) 25.6 32.7 34.0 21.1 52.0 Total external debt ($ bn) 81.5 100.3b 131.3b 161.7b 156.7b Debt-service ratio, paid (%) 6.9 7.3b 8.7b 11.1b 13.8b Exchange rate (av; W:$) 803.5 771.3 804.5 951.3 1,401.4

July 21st 1999 W1,200:$1

Origins of gross domestic product 1998 % of total Components of gross domestic product 1998 % of total Agriculture, forestry & fishing 4.9 Private consumption 55.7 Mining & quarrying 0.4 Government consumption 10.9 Manufacturing 30.7 Fixed capital formation 29.4 Electricity, gas & water 2.3 Change in stocks –8.6 Construction 10.1 Exports of goods & services 48.7 Trade, restaurants & hotels 10.6 Imports of goods & services –35.8 Transport, storage & communications 6.9 Statistical discrepancy –0.4 Financial & business services 19.6 GDP at market prices 100.0 Government services 8.0 GDP at market prices incl others 100.0

Principal exports 1998c $ m Principal imports 1998c $ m Electronic products 25,686 Electric & electronic machinery 18,939 Textiles 15,840 Crude petroleum 11,241 Machinery & equipment 14,783 Machinery & equipment 9,453 Motor vehicles 11,173 Chemicals & chemical compounds 6,117 Ships & floating structures 8,014 Light industry inputs 3,429 Total incl others 132,313 Total incl others 93,282

Main destinations of exports 1998 % of total Main origins of imports 1998 % of total US 17.2 US 21.9 Japan 9.2 Japan 18.1 China 9.0 China 7.0 Hong Kong 7.0 Australia 5.0 Taiwan 3.9 Saudi Arabia 4.7 a Balance-of-payments basis. b EIU estimate. c Customs basis.

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Outlook for 1999-2000

The National Assembly The political scene in South Korea will increasingly be dominated by the next election looms election to the National Assembly (parliament), which is due in April 2000. President Kim Dae-jung will be seeking to retain and ideally increase his working majority in order to avoid the risk of becoming a lame duck president for the last three years of his presidential term (which ends in February 2003). Given that in the past parliamentary elections have often functioned as a mid- term protest vote against an incumbent president, and that Mr Kim’s political honeymoon appears to have ended (see Review: The political scene), these are by no means abstract concerns.

The issue of constitutional The first question is whether the existing ruling coalition will hold. This allies reform— Kim Dae-jung’s centre-left National Congress for New Politics (NCNP) with the conservative United Liberal Democrats (ULD), led by the prime minister, Kim Jong-pil. The two have worked surprisingly well together, but could split over the NCNP’s reluctance to deliver the condition which was the price of the ULD’s support in the end-1997 presidential election, namely, changing the constitution to give more power to the prime minister and less to the president before end-1999.

—will be postponed Hitherto the economic crisis was a convenient pretext for postponing this, but until 2000— that will no longer wash, particularly given the recent stream of strong economic data. In mid-July press reports suggested that Kim Dae-jung and Kim Jong-pil had agreed to defer the issue until after next year’s National Assembly election. If so, Kim Dae-jung may be hoping that his party will perform sufficiently strongly in the election for him to consider ending the coalition and, by extension, abandon the idea of constitutional reform altogether.

—but the ULD will not Although posturing and brinkmanship can be expected, ultimately the ULD is leave government unlikely to want to leave the government over the issue. Its frankly oppor- tunist alliance with the NCNP has given it a taste of power which, as a small regionally based party (centred on the Chungchong provinces south of Seoul) it could not have enjoyed otherwise, and which it will be reluctant to give up. Conceivably it could retain this if it joined the opposition Grand National Party (GNP) in a new conservative grand alliance, looking towards the next presidential election in December 2002.

Kim Dae-jung will seek to The other key question is whether Kim Dae-jung can persuade part of the GNP recruit members of to cross the floor and join him in a grand coalition—possibly involving the the GNP— creation of a new political party—that would be assured of victory next April. Beyond mere lust for power, such a shift could be portrayed as having an underlying nobler cause, representing a healing of the regional antagonisms which disfigure South Korea’s politics. The GNP is rooted in the Kyongsang provinces in the south-east, which furnished all the country’s presidents from 1961 to 1997.

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Kim Dae-jung may slacken From a business point of view such factional intrigues matter less than— the pace of reform although unfortunately they are inseparable from—the question of whether Kim Dae-jung will maintain the momentum behind the current economic reforms. Here the signals are beginning to look mixed. The combination of political setbacks, economic recovery and an impending national election cannot but be a temptation to ease up on restructuring and go in for populist gestures. It will be a test of the president’s political skill and statesmanship alike to see how far he can resist this.

South Korea: forecast summary ($ bn unless otherwise indicated) 1997a 1998a 1999b 2000b Real GDP (%) 5.0 –5.8 6.1 5.3 Unemployment (%) 2.6 6.8 7.0 6.1 Consumer prices (av; %) 4.5 7.5 1.3 2.2 Goods: exports fob 138.6 131.8 136.1 152.7 Goods: imports fob 141.8 90.6 110.8 139.2 Trade balance –3.2 41.2 25.3 13.5 Current-account balance –8.2 40.0 19.4 6.0 Exchange rate (av; W:$) 951.3 1,401.4 1,186.0 1,141.0

a Actual. b EIU forecasts.

Real GDP growth will Thanks both to the positive impact of relaxed fiscal and monetary policies and rebound— the continued buoyancy of its most important export market, the US, South Korea’s economic prospects have improved sharply since our second-quarter report. The EIU has, therefore, revised its economic forecast for South Korea and now expects real GDP to grow by 6.1% in 1999 and by 5.3% in 2000. Although we expect domestic demand to recover slowly over the forecast period (see below), to a large extent growth in 1999 will be driven by the technical impact from changes in stockbuilding. We expect this component of GDP to contribute 5.3 percentage points to overall growth in the year.

—as consumer sentiment The outlook for private consumption has improved over the past quarter. This firms— reflects a number of factors, including falling unemployment (thanks partly to increased government spending on job creation programmes) and rising wages in the manufacturing sector. More recently consumer sentiment may also have been helped by the wealth effect from the rising stockmarket as well as the growing perception that, with the worst of the post-1997 crisis clearly over, the worst of corporate restructuring may now also be past. We expect private consumption to rebound in 1999 on the strength of improving consumer sentiment, growing by 6.2% for the year. Private consumption growth will, however, slow slightly in 2000—to 5%—as the impact of pent-up demand for consumer goods apparent in 1999 diminishes.

—and gross fixed Firming consumer sentiment will encourage some firms to start investing again investment picks up in new plant and equipment, particularly those larger ones which can easily raise funds on the domestic capital markets. The pace of recovery in business investment will, however, be held back by the continuing poor financial position of a large number of companies, the excess capacity that exists in

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many industries, and the banks’ restrictive lending attitude. Although foreign direct investment (FDI) is expected to rise steadily over the forecast period, FDI funds are unlikely to boost business investment in the short term, as they will mostly be used by the receiving firms to pay off debts and help in the restructuring process. Public investment, meanwhile, will run at relatively high levels in both 1999 and 2000, as the government seeks to support the recovery in private-sector demand. As a result of these movements we expect gross fixed investment to contract by just 2% in 1999 and to grow by 5.6% in 2000.

South Korea: global assumptions (% change year on year unless otherwise indicated) 1997a 1998a 1999b 2000b Real GDP US 3.9 3.9 3.9 2.3 Japan 1.4 –2.9 0.0 0.1 EU 2.6 2.8 1.8 2.2 World trade growth 10.6 3.0 3.4 5.3 Oil price –6.8 –34.6 12.0 10.7 OECD consumer prices (av) 2.1 1.5 1.4 1.8 Exchange rate (av; ¥:$) 121 131 121 125

a Actual. b EIU forecasts. Source: EIU.

The foreign balance will be Growth in exports of goods and services (real national accounts terms) will a drag on growth slow from 13.3% in 1998 to 10% in 1999 and 8.5% in 2000. Although continued strong growth in the US together with accelerating growth in the EU and key Asian markets will help export volumes over the forecast period, this will be partially offset by the expected appreciation of the won against the dollar in nominal and real effective terms. Imports of goods and services, meanwhile, will grow rapidly in 1999—by 21.6%—in line with the expected upturn in domestic demand and inventory rebuilding. Import growth will fall back in 2000 to 15.2% as inventory rebuilding slows. As a result of faster growth in imports of goods and services, the foreign balance is expected to exert a slight drag on overall GDP growth in both years of the forecast period.

Growth in fiscal spending Although mindful of the need to use fiscal policy to support economic growth, will slow— the government may start to slow spending increases in 2000 in order to achieve its stated medium-term target of balancing the budget by 2006. It will, however, need to tread carefully if it is not to derail the fragile economic recovery. In view of this it is likely to continue to favour cutting spending in areas such as defence and support for rural areas—both of which were cut in the initial 1999 budget—rather than raising taxes; the current low levels of taxation in South Korea mean, however, that there is ample scope to do so in the medium term. It is, however, unlikely to be able to cut outlays for financial sector restructuring in the short term. This is because the cost to the government of reforming the financial sector is likely to rise further over the forecast period, particularly if it has to inject more public funds into financial institutions it wants sold to foreigners.

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—but monetary policy will The trend towards a tighter fiscal policy will put a premium on the remain flexible government maintaining a flexible monetary policy in order to prevent another downturn in private-sector demand growth. Although the Bank of Korea (BOK, the central bank) is likely to raise short-term interest rates over the forecast period, any increases are likely to be modest owing to the need to support restructuring in the financial and corporate sectors and to relieve upward pressure on the won. In view of the large amount of excess industrial capacity, the relatively slack labour market and the forecast strengthening of the won against the dollar, this continued loose monetary policy stance is unlikely to prove inflationary—indeed, we expect consumer price inflation to average just 1.3% in 1999, well below the government’s own target for the year of 3%, and 2.2% in 2000.

The won will continue to We have revised upwards our forecast for the won:dollar exchange rate from appreciate— our second-quarter report and now expect the won to average W1,186:$1 in 1999 and W1,141:$1 in 2000. We have assumed that steady inflows of portfolio and foreign direct investment together with steadily increasing foreign-exchange reserves—which we forecast will reach nearly $80bn by end- 2000—and continuing current-account surpluses will continue to exert upwards pressure on the won against the dollar. The won will also receive an additional boost if the BOK decides to guide interest rates higher.

—despite government The government will continue to worry about the impact of the strengthening attempts to weaken it won on exporters. It can, therefore, be expected to continue pressing state companies not to borrow overseas and to maintain its heavy programme of IMF credit repayments. Commercial banks will also be encouraged to pay back some of their loans early. These and similar measures will, however, only slow rather than reverse the won’s rise against the dollar.

South Korea: current-account balance ($ bn unless otherwise indicated) 1997a 1998a 1999b 2000b Goods: exports fob 138.6 131.8 136.1 152.7 Goods: imports fob –141.8 –90.6 –110.8 –139.2 Trade balance –3.2 41.2 25.3 13.5 Services: credit 26.3 24.6 25.2 25.7 Services: debit –29.5 –24.2 –26.0 –27.0 Services balance –3.2 0.4 –0.8 –1.3 Income: credit 3.9 3.7 3.8 4.0 Income: debit –6.3 –8.5 –9.8 –11.5 Income balance –2.5 –4.8 –6.0 –7.5 Current transfers: credit 5.3 6.8 5.8 6.1 Current transfers: debit –4.6 –3.5 –4.9 –5.0 Current transfers: balance 0.7 3.3 0.9 1.1 Current-account balance –8.2 40.0 19.4 6.0 % of GDP –1.7 12.5 4.8 1.4

a Actual. b EIU forecasts.

EIU Country Report 3rd quarter 1999 © The Economist Intelligence Unit Limited 1999 14 South Korea

Shrinking merchandise Although merchandise export growth will hold up well in national accounts trade surpluses— terms, it will be outpaced by merchandise import growth in both years of the forecast period, as investment growth recovers and inventories are rebuilt. The impact of these trends on the merchandise trade account will be reinforced by a mild deterioration of the dollar terms of trade over the forecast period, driving the merchandise trade surplus down to $25.3bn in 1999 and $13.5bn in 2000.

—will reduce the current- The effects of the declining merchandise trade surplus on the current account account surpluses will be reinforced by movements on the services and income balances. Services will return to deficit in 1999 as import flows and outward tourism both accelerate. The income deficit, meanwhile, will widen under the influence of rising debt-service payments and larger outflows of profits and dividends on the growing stock of foreign-owned assets. The current-account surplus will fall to 1.4% of GDP in 2000, after a high of 12.5% in 1998.

South Korea: economic results and forecasts (W bn at constant 1995 prices; % change year on year in brackets unless otherwise indicated) 1997a 1998a 1999b 2000b Private consumption 228,738 206,766 219,585 230,564 (3.5) (–9.6) (6.2) (5.0) Public consumption 39,984 39,938 39,179 39,571 (1.5) (–0.1) (–1.9) (1.0) Gross fixed capital formation 145,295 114,618 112,325 118,616 (–2.2) (–21.1) (–2.0) (5.6) Final domestic demand 414,017 361,321 371,089 388,751 (1.2) (–12.7) (2.7) (4.8) Change in stocks –4,218 –27,983 –6,900 2,000 (–2.0)c (–5.6)c (5.3)c (2.1)c Total domestic demand 409,799 333,338 364,189 390,751 (–0.8) (–18.7) (9.3) (7.3) Foreign balance 13,026 64,540 58,246 54,244 (5.7)c (12.2)c (–1.6)c (–0.9)c Statistical discrepancy 182 435 0 0 GDP 423,007 398,313 422,436 444,995 (5.0) (–5.8) (6.1) (5.3) Exports of goods & non-factor services 153,931 174,432 191,875 208,184 (21.4) (13.3) (10.0) (8.5) Imports of goods & non-factor services 140,905 109,892 133,629 153,940 (3.2) (–22.0) (21.6) (15.2) a Actual. b EIU forecasts. c Contribution to GDP growth.

EIU Country Report 3rd quarter 1999 © The Economist Intelligence Unit Limited 1999 South Korea 15

South Korea: gross domestic product South Korea: won real exchange rates (b) % change, year on year 1990=100 South Korea 110 8 Asia (excl Japan) W:$

6 100 4 W:DM

2 90 0

-2 80

-4 W:¥ 70 -6 1996 97 98 99(a) 2000(a)

(a) EIU forecasts. (b) Nominal exchange rates adjusted for changes in relative consumer prices. (c) EIU estimates. Sources: EIU; IMF, International Financial Statistics. 1990 91 92 93 94 95 9697 97 98 98 99(a) 99 2000(a) 2000

. .

The political scene

Kim Dae-jung runs into The past quarter has not been a happy one for South Korea’s president, Kim difficulties— Dae-jung. While nothing disastrous has happened, his reforming image has been tarnished by a series of minor scandals. These have raised questions about the probity of some of his associates and appointees and, by extension, his own judgment in appointing them—or failing to sack them promptly enough. In a rare but effective gesture, Mr Kim went on television in June and apolo- gised to the public. As of mid-July, relations between the two ruling coalition partners—Mr Kim’s National Congress for New Politics (NCNP) and Kim Jong- pil’s United Liberal Democrats (ULD)—as well as between government and opposition, were also proving difficult.

—as a scandal involving the The first problem to surface was the allegation that the wife of Kim Tae-joung, justice minister— newly appointed as justice minister on May 24th in Kim Dae-jung’s first large- scale cabinet reshuffle, had been plied with expensive designer clothing by the wife of Choi Soon-yong—the chairman of the Shindongah group, who is in jail facing charges of corruption—in an attempt to procure leniency for her husband. (The case became known as the “boutique scandal”.)

—leads to losses in two June Although Mrs Kim was not charged with any crime (she said she sent back the by-elections— gifts), public opinion took umbrage at the picture revealed of extravagant life- styles within a government preaching austerity to the voters. This was thought to be part of the reason why the opposition Grand National Party (GNP) convincingly won two by-elections on June 3rd (see below), whereas in the last round of by-elections, on March 30th, it had lost two seats to the ruling coalition. Kim Dae-jung was criticised for not moving promptly to sack the minister: an error of judgment put down variously to his preoccupation with visits to Moscow and Mongolia, or being kept in the dark as to the true depth of public feeling by a “human curtain” of aides in the presidential Blue House.

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—and to the sacking of the In the event the justice minister was fired on June 8th for something else more justice minister serious, but again nothing he himself had done. This time a prosecutor boasted to journalists of having deliberately fomented a strike at the national mint last year as an excuse to crack down on trade union militants. As chief prosecutor at the time, Kim Tae-joung took responsibility, by Confucian precept, for the misdeeds of his subordinate, who was also sacked.

The new environment It was not long before a second new minister was forced to resign. The minister also resigns— appointment as environment minister of Son Sook, described by Korea News Review as “a theatre actress close to the president”, drew immediate fire as being lightweight and tokenist—hers was the only female face in the new line-up. Then came revelations that while performing in Moscow during Kim Dae-jung’s visit there, shortly after her appointment, she had accepted gifts of $20,000 from South Korean businessmen. This time the government was taking no chances: Ms Son resigned on June 24th. Her replacement is another woman, Kim Myung-ja, a university professor with a PhD in chemical engineering.

—as does a presidential Meanwhile, on June 2nd You Jong-keun, governor of North Cholla province, economic adviser lost his other job as a presidential economic adviser. Long resident in the US, Mr You, a former economics professor, was seen as one of the most foreigner- friendly and reform-minded voices in the government. Although outwardly all was amicable, Mr You’s retreat from the national to the local stage is presumably connected to an odd case, where a thief claims to have stolen $120,000 in cash from his house. Although the facts are murky, once again a hint of untoward wealth among ostensible reformers has sufficed to sink—or at least stall—a political career.

“Frugalitarianism” strikes To an outsider, the attitudes revealed in these various cases are puzzling—if again— quintessentially Korean. In few other cultures would the discovery that those in power also have money be deemed odd, let alone reprehensible. In a country whose industries include the world’s largest maker of fur coats and several manufacturers of limousines, the propensity of those who have money to spend it should arguably be praised as economic virtue—by helping demand to recover—rather than condemned as cultural vice.

—and the government By contrast, revelations of a regular lunchtime drinking culture of beer laced introduces new codes for with whiskey by public prosecutors should be more shocking, if unsurprising civil servants to those familiar with Korea. The government responded by rushing in a new ten-point code of conduct for civil servants, including such illiberal and unenforceable absurdities as a ban on their spouses visiting expensive clothes shops. Cash gifts at weddings and funerals, a universal practice in South Korea, are also now forbidden.

Relations between the Just as Kim Dae-jung came back from Moscow to face the “boutique scandal”, NCNP and the ULD so his return from the US and Canada in July was marred by the worst deteriorate outbreak yet of in-fighting within the ruling coalition. The good working relationship between president and prime minister does not extend to their respective MPs or party machines. The latest row involved NCNP charges that the ULD seemed slyly supportive of the opposition GNP’s attempts to set up a

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wide-ranging enquiry into allegations of corruption in the government. A furious Kim Jong-pil demanded and got the resignation of the NCNP’s acting president and a close confidant of Kim Dae-jung, Kim Young-bae. This sacrifice in turn angered many in the NCNP.

Parallels with Kim The past quarter might give observers of South Korean politics a sense of Young-sam— déjà vu. It is not so long since Kim Dae-jung’s predecessor as president, Kim Young-sam, began strongly as a popular crusader for reform, only to flounder in a fateful mix of incompetence and corruption. This line of thought was reinforced by a tragic fire on June 30th, which killed 19 children at a summer camp near Seoul, evoking memories of the collapse of a department store and a bridge in Seoul a few years ago. Now, as then, there are accusations of safety regulations having been bypassed and permits obtained by bribery.

—may be overplayed Yet it is much too soon to draw overall parallels between Kim Dae-jung and Kim Young-sam. The alleged wrongdoings that have surfaced so far under this administration are small compared to the gigantic scale of graft during past regimes, be it the huge slush funds of ex-presidents Chun Doo-hwan and Roh Tae-woo or the $6bn loans obtained corruptly by what was then one of South Korea’s largest chaebol, Hanbo, under Kim Young-sam. Meanwhile on the policy front, even if there is some slacking in the pace of reform, as far as vigour and competence are concerned, this government remains far ahead of its predecessor. As of mid-June, Kim Dae-jung’s personal popularity rating still stood at a healthy 65%, albeit down from 83% in February.

Lee Hoi-chang wins a The GNP’s by-election wins on June 3rd were a personal triumph for its leader, parliamentary seat Lee Hoi-chang, who stood himself for a seat in Seoul and won a convincing 61% of the vote, albeit on a 46% turnout. Mr Lee thus returns to the National Assembly (parliament) 18 months after his narrow defeat in the presidential race by Kim Dae-jung. This will help his efforts to keep on top of his often fractious party, in which he has no strong base of support, because as a career judge he came late to politics. With 135 seats (after a recent defection to the ULD) the GNP remains the largest single party in the 299-member National Assembly, although it has fewer seats than the combined forces of the ruling NCNP-ULD coalition.

Kim Dae-jung reshuffles his On May 24th, just before all the various scandals broke, Kim Dae-jung cabinet— conducted the first large-scale cabinet reshuffle of his 15-month-old administration, replacing 11 out of 17 ministers. The main details are as follows.

• The new finance and economy minister is Kang Bong-kyun, previously the senior presidential secretary for economics and a noted reformer (unlike the man he replaced, Lee Kyu-song).

• In a parallel move, Lim Dong-won, formerly the top Blue House adviser on security issues and foreign affairs, replaced Kang In-duck as national unification minister. Mr Lim is seen as more heartfelt in pursuit of sunshine than his predecessor.

EIU Country Report 3rd quarter 1999 © The Economist Intelligence Unit Limited 1999 18 South Korea

• Other changes in economic portfolios include the replacement of Park Tae- young as the commerce, industry and energy minister by Chung Duck-koo, formerly vice-minister at the finance and economy ministry.

• What was the Planning and Budget Commission now becomes a ministry; its head remains Jin Nyum, another leading reform figure.

• In the sphere of security, defence minister Chun Yong-taek moves sideways to head the National Intelligence Service (NIS).

• The new defence minister is Cho Seong-tae, hitherto 2nd Army commander. There are fears that efforts to reform the NIS may now slow, as Mr Chun is a military man of the old school.

• The new education minister, Kim Duck-choong, was a university president. He is also the brother of Kim Woo-choong, who is chairman of the Daewoo group and the Federation of Korean Industries (FKI, the chaebol lobby group).

• Park Jie-won, hitherto chief presidential spokesman, becomes minister of culture and tourism.

• Other new incumbents, drawn from the usual variety of walks of life, now grace the ministries of health and welfare, labour affairs, construction and transportation, and the Central Personnel Committee. (As discussed above, two further new appointees—Kim Tae-joong at justice and Ms Son Sook at environment—did not last long.)

• Ministers retaining their posts include the premier, Kim Jong-pil; Hong Soon-young at foreign affairs and trade; the ministers of government administration and home affairs, agriculture and forestry, maritime affairs and fisheries, information and communication, and science and technology; plus the chairman of the Board of Audit and Inspection.

—leaving the ULD with Although the new cabinet leaves the ULD with far fewer posts, this is because fewer posts several ULD heavyweights—plus some from the NCNP—wanted to return to parliamentary politics, which in Seoul is seen as incompatible with holding ministerial office. Such returnees to the fray include the outgoing NIS chief, Lee Jong-chan. As ever, regional balance is a concern. The new cabinet includes five ministers from Kyongsang, as against four each from greater Seoul, Cholla and Chungchong.

Power over economic The proliferation under Kim Dae-jung of new government economic agencies policy may be moving back raises several questions. As well as invoking the risk of bureaucratic turf wars, it to MOFE— is unclear where ultimate power now lies and whether the impetus for reform may be waning. Hitherto most of the running on restructuring—and therefore on policy in general—had been made by the new Financial Supervisory Commission (FSC) and its high-profile chairman, Lee Hun-jai.

—at the FSC’s expense This may be changing, however, with the appointment of Kang Bong-kyun, formerly economic adviser to the president, as finance and economy minister. Henceforth, the policy agenda will be set at a monthly Economic Policy Co-ordination Meeting, to be chaired by Mr Kang. While Mr Kang’s own

EIU Country Report 3rd quarter 1999 © The Economist Intelligence Unit Limited 1999 South Korea 19

credentials as a reformer are not in doubt, the prospect of the conservative Ministry of Finance and Economy (MOFE) displacing the FSC as the main hand on the economic policy tiller may be ominous, and will want watching.

Kim Dae-jung visits In a fairly dismal quarter at home Kim Dae-jung found some consolation Moscow— through playing the statesman on a wider stage. In May he completed his tour of the four important powers involved in the Korean peninsula with his first visit to Russia as president. The Moscow-Seoul relationship, even before it was damaged by a spy row last year (3rd quarter 1998, page 19), has tended to disappoint both parties. Russia is frustrated at its virtual exclusion from forums where the peninsula is discussed, while South Korea has found Russia (in contrast to China) a difficult place to do business.

—but few substantial issues The problem is symbolised by the $1.7bn debt, much of it overdue, owed by are resolved Russia—this having been a loan extended in 1990 by Roh Tae-woo as a reward to the then USSR for daring to open diplomatic relations with Seoul. While Mr Kim’s visit went smoothly enough, it is not clear how far any substantial issues were resolved. One of these is Russia’s wish to discharge its debt in the form of submarines. The South Korean navy does not want these, but MOFE is keen to close the books.

Mr Kim also visits On his way back from Moscow, Mr Kim became the first South Korean Mongolia— president to visit Mongolia. Genghis Khan’s depredations have been forgiven, and today’s post-communist Mongols are viewed with curiosity and sympathy—and as racial kinsfolk—by South Korea. As is becoming something of a ritual, the Mongolian president expressed support for the sunshine policy and pledged to do his bit to intercede with North Korea. (In a small coup for foreign business, BMW flew a bullet-proof limousine into Ulan Bator for Kim Dae-jung’s use, pre-empting to their fury the likes of Hyundai, who assume this is their prerogative.)

—followed by the US and In July Mr Kim made his second visit as president to the US and his first to Canada Canada. While the pretext for this was private—to accept a liberty medal awarded by Philadelphia on July 4th—it turned out to be timely, given concerns about North Korean acts and intentions. Publicly, Mr Clinton and Mr Kim reaffirmed their commitment to engagement, while warning North Korea not to do anything rash. Behind the scenes, Kim Dae-jung is believed to have urged his hosts to speed up publication of the long-delayed Perry report on US policy towards North Korea.

South Korea wants to Even between two old allies who broadly see eye to eye, co-ordinating policy is develop longer-range not always smooth. One bone of contention which surfaced during this visit missiles— concerned missiles—South Korean rather than North. South Korea has long chafed at a US restriction forbidding it to develop missiles with a range longer than 180 km (not quite far enough to reach Pyongyang), and had asked to be allowed at least to enjoy the 300-km range stipulated by the global Missile Technology Control Regime (MTCR). The US was ready to accept this, whereupon South Korea unexpectedly increased its demand to 500 km.

EIU Country Report 3rd quarter 1999 © The Economist Intelligence Unit Limited 1999 20 South Korea

—and is unenthusiastic There are a number of issues here. South Korea’s stance is fuelled variously by about the TMD system— nationalism, by commercial concern that the existing limit inhibits its aerospace industry, especially rockets for satellites, and most immediately and recently by a perceived need for parity with whatever North Korea has under development. In a further twist, however, South Korea is notably cool towards US pressure to enrol it in any wider Theatre Missile Defence (TMD) system, seeing this as expensive, unreliable, but above all irrelevant, given that South Korea is within North Korean artillery range, never mind missiles.

—but the US wants to limit For its part, the US fears that giving South Korea a free hand on missiles would South Korean missile make it harder to rein in North Korea on this score. It is also concerned that development yielding here might encourage those in South Korea who would like to pursue a more autonomous security policy with less dependence on the US, which in turn could cause concern in China and Japan. It remains to be seen if South Korea will tow the line.

Economic policy

A supplementary budget is Since our second-quarter report the government has continued to pursue an passed in April— expansionary fiscal policy in order to support economic recovery. In early April the National Assembly passed a supplementary budget—the first so far in 1999—worth W2.8trn ($2.3bn at an exchange rate of W1,186:$1). The main purpose of the extra budget was to reduce unemployment by boosting spending on infrastructure and on short-term job creation programmes; nearly 80% of the planned spending was set aside for this purpose.

Supplementary budget, Apr 1999 (W bn)

Job creation 1,215.2 of which: infrastructure investment 887.4 Short-term jobs (public works, internships) 972.6 Vocational training 95.0 Social welfare 272.2 Support for fishing industry (to help industry adjust to recent fishing quota agreement with Japan) 200.0 Other 2.5 Total 2,757.5 Source: Budget and Planning Commission.

—but the impact may be Although this kind of government-sponsored job creation will provide short-lived welcome relief for many South Korean workers in the short term, doubts remain over how durable jobs created under the scheme will be in the long term. Japan provides a useful lesson in this regard. Although a succession of fiscal stimulus packages in Japan in recent years has helped to keep recorded unemployment there at low levels by the standards of other developed countries, the jobs created thereby have largely proved short-lived, with

EIU Country Report 3rd quarter 1999 © The Economist Intelligence Unit Limited 1999 South Korea 21

workers—particularly those in the construction industry—being laid off again once the impact of the fiscal stimulus wears off. This may not, however, worry the government too much for the moment. With the next National Assembly election due in April 2000, its main priority will be to use fiscal policy to provide the maximum boost to the economy in the shortest time in order improve its electoral chances.

Another stimulus package Also with an eye on the parliamentary election next year, the government has is planned proposed a further stimulus package of tax cuts and subsidies worth W2.5trn for those on low and middle incomes worth. Of the total package, just over W1trn would be funded from a second supplementary budget, with the remainder coming from tax revenue. Press reports have indicated that some 7m may benefit from the reduced taxes. The GNP, perhaps not without justi- fication, sees the tax cuts and subsidies as politically motivated, and as a result has refused to co-operate in passing the second supplementary budget bill.

Monetary policy remains The government has continued to pursue a loose monetary policy stance, loose driven by the need both to support the nascent recovery in private-sector demand to reduce upward pressure on the won (see Money and finance) and to help highly leveraged companies to restructure. Its primary tool of monetary loosening continues to be maintaining sufficient liquidity in the system to keep nominal short-term rates at low levels.

The BOK, however, is reported to be concerned about the wisdom of maintaining downward pressure on interest rates, given both the speculative boom this is fuelling in the stockmarket (see Money and finance) and the fact that such low rates are delaying the shake-out of the corporate sector by allowing non-viable companies to continue functioning. Pressure from the Ministry of Finance and Economy, which believes that private-sector demand is still too weak to be able to absorb higher interest rates, seems likely to ensure, however, that the current policy stance is maintained over the coming months.

Chaebol restructuring runs The progress of corporate restructuring in South Korea continues to be both into problems— slow and fitful. Two recent events indicate how far the government has fallen short of its own—optimistic—targets for corporate reform. First, one of the key platforms of the government’s corporate reform programme, the Big Deals (in which the five largest chaebol swap or merge non-core business lines), appears to have faltered. Although some deals were struck, notably that between Hyundai Electronics and LG Semicon (see Business news for details), others have come to nothing or have seen very slow progress.

—as the Samsung-Daewoo The most important failure to date was the deal in which Samsung and Big Deal collapses— Daewoo agreed to swap their vehicle and electronics businesses. Notwith- standing government threats to impose credit sanctions if the two sides failed to resolve their differences, Samsung announced at the end of June that it was placing its vehicle-making subsidiary, Samsung Motors, in the hands of the receivers. Although the government officially welcomed Samsung’s decision, the collapse of the Samsung-Daewoo deal effectively signals the end of its Big Deals policy. The fate of Samsung Motors, meanwhile, remains unclear. Indeed,

EIU Country Report 3rd quarter 1999 © The Economist Intelligence Unit Limited 1999 22 South Korea

the company may continue to produce cars for a long time before its future is decided—as did Kia Motor—which will do nothing to reduce overcapacity on the domestic vehicle market. (See Business news for further details of the bankruptcy of Samsung Motors.)

—and Daewoo’s continued Second, and perhaps more serious, despite government pressure to rationalise, expansion— the two largest chaebol, Hyundai and Daewoo, have continued to expand their operations; most recently, for example, Daewoo was rumoured to be interested in acquiring the bankrupt Samsung Motors. (In Hyundai’s case, this may have the tacit agreement of the government; the group’s founder and honorary chairman, Chung Ju-yung, is known to be close to the government and indeed has been in the vanguard of Kim Dae-jung’s North Korean sunshine policy.)

—leads it to the verge of The dangers associated with such unchecked expansion were thrown into vivid bankruptcy relief when Daewoo, apparently unable to meet maturing short-term obli- gations, nearly went bankrupt in mid-July; it only avoided this fate by pledging around W10trn ($8.5bn) of assets as a condition for creditors to agree to a rescue package. Daewoo’s near-failure not only underlines how much needs to be done in the area of corporate reform, but it also provides a timely reminder of how vulnerable South Korea’s financial system remains to the risk of large chaebol bankruptcies, despite very real progress in financial sector reform.

The domestic economy

Production and demand

Real GDP returns Data from the BOK show that real GDP grew by a robust 4.6% year on year in to growth— the first quarter of 1999. On the demand side private consumption rebounded, growing by 6.3% year on year, as increased government spending reduced unemployment and wages began rising again in most sectors, and the rate of decline in gross fixed capital formation slowed markedly, to just 4.3% from 17.9% in the previous quarter. Government consumption fell by 2.2% year on year, a steep drop relative to the contractions recorded in the last three quarters of 1998. This suggests that the government may be getting more serious about fulfilling its promises made repeatedly during 1998 to cut its spending.

—as external demand holds Exports of goods and services continued to perform strongly in the first quarter up well of 1999, growing by 12.4% year on year. To a large extent this was thanks to continued strong demand for South Korea’s products in the US, South Korea’s most important merchandise export market. Imports of goods and services, meanwhile, staged a dramatic recovery, growing by 27.6% year on year during the quarter. Although this sharp turnaround lends weight to the view that companies are beginning to rebuild stocks run down during 1998, it was also partly a reflection of the very low base of comparison in the first quarter of 1998, immediately after the financial crisis.

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Investment is beginning to Notwithstanding the overall decline in gross fixed capital formation in the first recover quarter of 1999, there are some encouraging signs that private-sector companies may at last be more willing to start investing again. According to the National Statistical Office (NSO), facility investment—that is investment in extending or upgrading industrial production facilities—rose in March, April and May by 26%, 29.5 % and 43.4% respectively year on year. Domestic machinery orders, a leading indicator of business investment, also posted strong gains: excluding ships, which tend to be volatile, NSO data show that total orders for machinery rose by 6.5% and 23.7% year on year in March and April respectively.

Manufacturing rebounds— On the supply side manufacturing registered the strongest performance in the first quarter of 1999, growing by 10.7% year on year. Strong growth was recorded in the electronics and transport equipment sectors, mainly owing to strong foreign demand for these products. Services also registered growth—of South Korea: machinery orders (a) 6.6% year on year—owing to growing demand in the areas of

30 communications, finance and insurance in particular. Reflecting the still depressed state of the residential and non-residential building markets, 20 construction declined by 15.1% year on year during the quarter.

10 South Korea: gross domestic product by industry 0 (% change, year on year; at constant 1995 prices)

-10 1997 1998 1999 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr -20 Agriculture, forestry & fishing 5.3 6.2 –3.5 –7.0 –9.0 –7.6 -30 Apr . . Jul . . Oct . . Jan . . Apr Manufacturing 5.6 –4.6 –10.4 –9.1 –4.7 10.7 1998 99 Electricity, gas & water 10.6 4.5 0.3 –4.1 –2.4 3.4 (a) Excluding vessels. Source: National Statistical Office, Monthly Statistics of Korea. Construction –3.5 –3.9 –6.6 –10.1 –13.3 –15.1 Services 6.6 –4.5 –7.4 –6.2 –3.4 6.6 Source: Bank of Korea, Monthly Statistical Bulletin; http://www.bok.or.kr.

—and many subsectors Data for seasonally adjusted manufacturing production from the NSO confirm perform strongly that the recovery evident in the fourth quarter of 1998 was consolidated and broadened in the first quarter of 1999. Thus, while overall manufacturing output grew by 12.6% year on year in the first quarter of 1999, the rate of decline in the “sunset” subsectors of textiles and clothing was slower than it had been the fourth quarter of 1998. Most other subsectors, notably motor vehicles and other transport equipment, either moved from contraction in the fourth quarter of 1998 to growth in the first quarter of 1999, or, in the case of radio, televisions and communications equipment, office and accounting machinery, recorded accelerated growth.

EIU Country Report 3rd quarter 1999 © The Economist Intelligence Unit Limited 1999 24 South Korea

South Korea: seasonally adjusted manufacturing production (1995=100; period averages) 1998 1999 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr % changea Food & beverages 94.3 92.1 92.2 95.6 96.3 2.2 Textiles 78.4 76.1 73.2 74.7 76.7 –2.2 Clothing 61.8 56.4 51.7 53.1 56.3 –8.8 Chemicals & products 122.2 119.8 121.0 127.4 127.2 4.1 Rubber & plastics products 87.8 83.5 81.8 87.7 90.2 2.8 Basic metals 96.4 97.7 97.1 101.3 102.3 6.1 Fabricated metal products 81.3 77.6 77.2 84.0 81.2 –0.1 Non-electrical machinery 77.6 72.0 69.5 72.0 76.3 –1.6 Radio, TV & communications equipment 184.3 181.6 213.8 258.0 253.1 37.3 Office, accounting & computing machinery 160.8 137.0 140.4 173.0 216.5 34.6 Electrical machinery 81.6 74.3 74.5 81.9 82.1 0.6 Motor vehicles & trailers 69.1 66.8 63.7 88.2 89.4 29.4 Other transport equipment 185.0 204.0 190.5 174.3 205.4 11.0 Manufacturing 103.5 100.6 100.4 114.4 116.5 12.6 a 1st Qtr 1998/1st Qtr 1999.

Source: National Statistics Office, Monthly Statistics of Korea.

The construction industry Recent data suggest that the worst of the recession in the construction industry is recovering may now be past. Government permits for new construction and expansion of factories, for example, covered 425,000 sq m in March and 487,000 sq m in April (latest available disaggregated data), increases of 36.2% and 64.5% year on year. The impact of extra spending by the government to offset weak private-sector demand also seems to be making itself felt. In April and May, for example, the value of construction orders placed by the public sector rose by 82.7% and 29.3% respectively, mainly owing to a sharp rise in orders from the central government.

South Korea: construction indicators 1998 1999 Dec Jan Feb Mar Apr May Permits for building construction (m sq metres) 5.48 2.67 2.88 3.98 4.43 6.12 % change, year on year –61.6 –56.4 –50.5 –29.6 4.1 47.1 Domestic construction orders received (W trn) 46.25 16.72 17.61 23.01 34.20 32.17 % change, year on year –45.2 –20.5 –52.0 –51.1 39.4 89.6 Sources: Bank of Korea, Monthly Statistical Bulletin; http://www.bok.or.kr.

EIU Country Report 3rd quarter 1999 © The Economist Intelligence Unit Limited 1999 South Korea 25

Real estate prices are rising Land prices and house prices are also rising, stimulated by the opening of the but the shipping boom real estate market to foreign investment, the relaxation of restrictions on land is over transactions and the increasing attractiveness of land as a speculative investment: according to the Housing and Commercial Bank (HCB), in May, for example, house prices rose by 2.1% year on year in May. Also in May the number of apartment-application accounts opened at HCB rose by 34,237 from South Korea: manufacturing April to an 11-month high of 591,188. Land transactions are also on the operation ratio index 1995=100 increase. Ministry of Construction and Transportation data show that in April

110 the number of land parcels traded rose by 24.9% year on year. Land transactions in green belt areas, where development is restricted, rose by 41.2%

100 year on year, because of expectations that the remaining restrictions will be eased soon.

90 In 1998 South Korea’s shipbuilding industry enjoyed favourable conditions as a result of competitiveness gains brought by the depreciation of the won. The 80 operating environment for South Korea’s shipbuilders has, however, deteri- orated since then, owing both to the need to restructure at home and to excess Apr. .Jul. .Oct. .Jan. .Apr. .Jul. .Oct. .Jan. .Apr capacity worldwide. Data from the Ministry of Commerce, Industry and Energy 1997 98 99 show that during the first six months of 1999 new orders—all of which were Source: Bank of Korea, Monthly Statistical Bulletin. from foreign firms—fell by 37.7% to 2.8m tonnes for 59 ships. Although actual output during the same period was robust, rising by nearly 40% year on year, this reflected the strong order volume recorded in 1998, and as such should not be taken as a sign of future prosperity for South Korea’s shipbuilders.

Employment, wages and prices

Unemployment eases but is Unemployment (not seasonally adjusted) peaked at 8.7% of the labour force in still high— February 1999. Since then it has fallen each month, reaching 6.5% in May, the latest period for which data are available. By May the number of those registered as unemployed had fallen from February’s high of 1.8m to 1.4m. This is, however, still high by comparison with the pre-recession period, when unemployment was close to 500,000.

South Korea: employment (m unless otherwise indicated)

1998 1999 Dec Jan Feb Mar Apr May Labour force 21.19 20.67 20.56 21.14 21.56 21.71 Employed 19.52 18.91 18.78 19.44 20.00 20.30 of which: manufacturing 3.86 3.82 3.78 3.86 3.89 3.91 Unemployed 1.67 1.76 1.79 1.70 1.56 1.41 Unemployment ratea (%) 7.9 8.5 8.7 8.1 7.2 6.5

a Not seasonally adjusted.

Source: National Statistical Office, Monthly Statistics of Korea.

EIU Country Report 3rd quarter 1999 © The Economist Intelligence Unit Limited 1999 26 South Korea

—as new jobs are created— One of the features that distinguish the South Korean economy from many other OECD countries is the speed with which recorded unemployment has fallen. The rate at which new jobs are being created are impressive. According to data from the National Statistical Office (NSO), between February and May 1999, for example, employment in manufacturing rose by 3.7%. Reflecting higher government spending on infrastructure projects, employment in construction rose over the same period by 21.6%.

—but more jobs will go The process of industrial and financial sector restructuring is, however, expected to keep unemployment at relatively high levels for the short term. Another addition to the ranks of unemployment will come from a further reduction in the numbers employed by central government. In May the central government announced plans to lay off another 6,290 civil servants over 1999- 2000, bringing the total number laid off by the central government to 14,790 by 2001.

South Korea: wages in manufacturing industry (won per month unless otherwise indicated) % change, Earningsa year on year 1996 1,261,168 12.2 1997 1,326,241 5.2 1 Qtr 1,287,076 9.9 2 Qtr 1,295,054 9.3 3 Qtr 1,405,427 5.4 4 Qtr 1,319,762 –2.9 1998 1,284,477 –3.1 1 Qtr 1,252,690 –2.7 2 Qtr 1,244,597 –3.9 3 Qtr 1,263,187 –10.1 4 Qtr 1,383,167 4.8 1999 1 Qtr 1,366,426 9.1 Apr 1,379,903 12.6

a Period averages.

Sources: Bank of Korea, Monthly Statistical Bulletin; http://www.bok.or.kr.

Wages in manufacturing Largely reflecting improving corporate sentiment in the wake of stronger are rising— consumer demand and robust export performance both in volume and local currency terms, manufacturing wages have been rising since February this year in year-on-year terms. Given that the majority of companies are still either freezing or cutting ordinary wages, most of the increase to date will have come from increased overtime and bonus payments.

—but falling in other Other sectors have, however, been less fortunate. In the first quarter of 1999, sectors for example, wages in the financial and construction sectors fell by around 1% year on year. Perhaps not surprisingly, given the still depressed state of the overall economy, wages at hotels and restaurants fell by 7.7% year on year during the same period.

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Consumer and producer Consumer price inflation remains subdued. According to BOK data, consumer price inflation is subdued prices (all items) rose by just 0.6% year on year in June. Most of this rise was, however, the result of increases in food prices; excluding food, consumer prices actually fell by 0.2% year on year in the same month. Although concerns are being voiced that the government’s current low interest rate policy could fuel inflationary pressures, this seems unlikely, at least in the short term, given the large amount of excess capacity still in the economy and the fragility of the expected recovery in private-sector demand. The situation is similar with producer prices, which have been falling year on year each month since January this year, thanks in part to the gradual strengthening of the won against the dollar.

South Korea: price indicators, 1999 (% change, year on year)

Jan Feb Mar Apr May Jun Consumer prices 1.5 0.2 0.5 0.4 0.8 0.6 Producer prices –1.8 –4.3 –4.3 8.2 –2.6 –3.2 Export prices (won terms) –35.6 –34.1 –28.6 –19.2 –18.8 –19.8 Import prices (won terms) –29.7 –29.9 –24.6 –15.4 –14.0 –14.3 Sources: Bank of Korea, Principal Economic Indicators; http://www.bok.or.kr.

Money and finance

Year-on-year M1 and M2 After declining sharply in the recession-hit first half of 1998, M1, the narrow growth is robust measure of money supply, has now resumed robust growth, expanding by 25.4% year on year in June, as low short- and long-term interest rates and a resumption of growth in consumer spending fuelled increased demand for cash. Year-on-year growth in the broader measure, M2, has also remained robust, despite the diversion of some funds in savings deposits for investment in the booming local stockmarket. Year-on-year growth in the broadest aggregate, M3, hovered between 12-14% in January-April, roughly in line with the government’s target for the year of 13%.

South Korea: money supply trends, 1999 (W trn unless otherwise indicated; end-period)

Jan Feb Mar Apr May Jun M1 322.88 347.45 327.33 331.17 342.88 350.00 % change, year on year –7.5 6.7 16.3 15.0 18.4 25.4 M2 2,618.08 2,731.31 2,782.62 2,768.79 2,772.59 2,777.69 % change, year on year 28.1 30.5 36.3 33.4 27.6 27.2 M3 8,122.09 8,230.66 8,207.72 8,292.67 n/a n/a % change, year on year 13.5 13.9 13.1 12.2 n/a n/a Sources: Bank of Korea, Principal Economic Indicators; http://www.bok.or.kr.

EIU Country Report 3rd quarter 1999 © The Economist Intelligence Unit Limited 1999 28 South Korea

Domestic commercial South Korea’s commercial banks sustained losses of some W14trn ($10bn at an banks turn to profit exchange rate of W1,401.4:$1) in 1998. In the first six months of this year, however, most of the commercial banks were able to record net profits thanks both to a reduction in non-performing loans (NPLs) and to restructuring. The two exceptions were Korea First Bank and Seoul Bank, both of which were nationalised in January 1998; press reports suggest that both banks recorded combined net losses of nearly W2trn ($1.7bn at an exchange rate of W1,183:$1). (See Business news for a discussion on how the government’s plans to sell both banks to foreign investors are progressing.)

Loans to small and While large companies have dominated the local stock and bond markets, medium-sized companies small and medium-sized firms (SMEs) have increased their borrowing from the rise banking sector. Demand for funds from SMEs is rising. The Bank of Korea (BOK, the central bank) announced in June that between January and April 1999 loans from domestic banks to SMEs rose by W2.6trn year on year, while those to large enterprises declined by W1.8trn. The former are obliged to borrow direct from banks as their access to the capital markets is restricted; the latter, meanwhile, are concerned to reduce their outstanding debt and replace it with equity.

Non-performing loans are In early June the Financial Supervisory Service (FSS, the executive arm of the rising Financial Supervisory Commission, or FSC) announced that NPLs at domestic financial institutions had reached W65.4trn ($55bn) by the end of March 1999, up by W5.1trn on the end-1998 level. The FSS put the rise down to the stricter loan classification standards introduced as one of the conditions of the IMF-led bailout. Under the old, looser standards, the FSS said that total non-performing loans would have come in at just under W60trn for the same period.

South Korea: non-performing loans by type of financial institution as of end-Mar 1999 % change Financial institution W trn on end-Dec 1998 Commercial banks 25.8 16.2 Special banks & development banks 11.7 1.7 Merchant banks 2.8 –50.0 Securities companies 2.4 26.3 Insurance companies 5.2 52.9 Mutual savings & loans companies 8.4 58.5 Leasing companies 6.1 –21.8 Credit unions 2.9 16.0 Total 65.4 8.5 Source: Financial Supervisory Commission.

The cost of bank In May the Korea Deposit Insurance Corporation (KDIC) made a further restructuring rises W2.3trn available to Kookmin Bank, KorAm Bank, Shinhan Bank, Hana Bank and Housing and Commercial Bank, all of which had acquired one non-viable bank as part of the government’s mid-1998 financial restructuring drive. (As part of the deal, the government had to agree to compensate the banks for losses arising from the acquired assets until October 1999 (3rd quarter 1998,

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page 28). The new release of funds brings the total made available to the banks so far to W8trn. The KDIC estimates that the total cost of this phase of financial restructuring could rise to around W10trn.

KAMCO sells some NPLs to a The Korea Asset Management Corporation (KAMCO) has had some success in US equity fund selling NPLs to foreign investors. In mid-June it managed to sell NPLs with a face value of just over W1trn to a private US equity fund, Lone Star Fund II. This was the second sale of NPLs by KAMCO to Lone Star. Although this was a welcome fillip for the government in its attempt to resolve the NPL problem, the task ahead of KAMCO remains daunting; to date it has bought NPLs with a face value of W44trn from South Korean financial institutions, of which it plans to sell W16trn worth (face value) in 1999 alone. KAMCO will doubtless be hoping that the recent rise in the local real estate market—many NPLs are backed by real estate—will sharpen foreign investor interest in its NPL sales.

Direct financing rises In early June the FSC announced that direct financing by the corporate sector in January-May 1999 rose by 72.6% year on year to W29trn. Of this, W11.3trn was in the form of rights offerings, a year-on-year increase of 209.7%. In addition, 98.9% of this total was offered by large companies trying to improve their balance sheets. SMEs were squeezed out of this bonanza and offered only W119.4bn, down by 38.1% year on year. Corporate bond issuance reached W17.5bn in January-April 1999, of which large companies accounted for W16.6trn, up by 31.1% year on year and accounting for 94.9% of the total. SMEs did, however, establish a toehold in this market, issuing W1.9trn worth of bonds over the same period, an increase of 778.6% year on year.

The KOSPI is buoyant In early July the benchmark Korea Stock Price Index (KOSPI) rose above the 1,000-point level for the first time since October 1995. This strong performance was driven by a variety of factors, including continued interest from foreign investors, as South Korea’s economic outlook improved, and a revival of interest from domestic investors looking for higher returns on investments than are currently available from bank deposits. Much of the interest was directed at manufacturing companies, the index for which continued to outperform the KOSPI as a whole by a large margin. Presumably such companies are expected to benefit from continued strong export performance as well as a revival in domestic demand. Reflecting the continued problems in the financial sector, financial institutions continued to underperform the overall index by 30-40%.

South Korea: financial market indicators, 1999 (end-period) Feb Mar Apr May Jun Jula KOSPI (1980=100) 520.1 619.0 752.6 736.0 883.0 1,024.6 Overnight won rate (%) 5.2 4.9 4.8 4.8 4.8 4.9 3-year non-guaranteed corporate bond (%) 8.6 8.1 7.5 8.4 8.0 8.8 3-year Treasury bond (%) 7.1 6.5 6.6 6.7 7.2 8.1

a July 19th. Source: Bloomberg.

EIU Country Report 3rd quarter 1999 © The Economist Intelligence Unit Limited 1999 30 South Korea

The futures market opens The Korea Futures Exchange (KOFEX) opened on April 23rd in South Korea’s second city of Pusan. Initially transactions will only involve dollar futures and options, certificate of deposit futures and gold futures. Trading started with 919 contracts on the opening day and are currently at a modest daily average of 716 contracts. At present investors can only meet their margin requirements with cash, not securities, because the computerised system has yet to be put fully in place. In 2000 KOFEX will allow the listing of foreign futures products and will let its own products be listed on foreign exchanges.

The won strengthens— The won has broadly maintained its upward trajectory against the dollar and, at the time of writing, was trading in a stable range of W1,150-1,200:$1. Partly responsible for this have been continued inflows of foreign portfolio and direct investment, which in turn have increased demand for won. As ever, South Korea’s exporters are concerned that a continued appreciation of the won against the dollar will erode export competitiveness, although some consolation has come in the form of the recent sustained strength of the yen against the dollar—Japan is one of South Korea’s most important competitors on third markets; South Korean exporters thus benefit from any appreciation of the yen against the dollar.

South Korea: external liabilities (end-period; $ bn) 1998 1999 Dec Jan Feb Mar Apr May Public sector 36.5 35.4 34.1 34.2 33.4 33.5 Domestic financial institutions 57.9 57.3 56.9 56.1 53.8 52.6 Long-term 47.3 46.3 45.7 44.4 44.5 43.1 Short-term 10.6 11.0 11.1 11.7 9.3 9.5 Branches of foreign banks 14.0 13.2 13.1 13.4 12.8 13.4 Long-term 5.7 5.6 6.0 5.9 5.2 5.1 Short-term 8.3 7.6 7.1 7.5 7.6 8.3 Domestic corporations 41.0 41.2 41.4 41.8 42.7 43.3 Long-term 29.0 29.1 29.1 29.2 29.3 29.6 Short-term 11.9 12.1 12.3 12.7 13.4 13.7 Total 149.4 147.0 145.4 145.5 142.8 142.8 Source: Ministry of Finance and Economy, http://www.mofe.go.kr.

—foreign debt falls— By the end of May this year total foreign debt had fallen by 65% year on year, to $142.8bn. The stock of foreign debt held by the public sector fell by 30% year on year, reflecting the repayment of loans taken out during the 1997-98 financial crisis. Short-term foreign debt held by domestic corporations, meanwhile, rose by 17% year on year, owing to improved access to trade finance by South Korean companies as the country’s creditworthiness has improved. Despite this rise, however, the level of foreign short-term corporate debt was still more than 30% below the end-1997 level.

—and FDI rises Foreign direct investment (FDI) committed in January-April 1999 totalled $2.8bn, 147.4% up on the same period of 1998, according to BOK data. Investment from the EU grew particularly fast, rising by 67.2%, and investment in the services sector grew faster than in manufacturing, reaching

EIU Country Report 3rd quarter 1999 © The Economist Intelligence Unit Limited 1999 South Korea 31

$1.9bn or 67.2% of the total, against 32.8% for manufacturing. Only 16.8% of the total investment took place through mergers and acquisitions, compared with 43.4% in the same period of 1998. Although the overall rise in FDI commitments is encouraging, the government’s target of $15bn for 1999 looks optimistic. Indeed, there is a real risk that FDI inflows could slow if faster than expected economic recovery makes takeover by foreign investors a much less attractive option for many South Korean companies.

Foreign trade and payments

The value of exports falls The robust rate of merchandise export growth in national accounts terms in in the first quarter— the first quarter of 1999 (see Production and demand) was not reflected in dollar-denominated merchandise export earnings (fob), which fell by 5.7% over the same period year on year. To a large extent this fall in dollar revenue reflects the continued willingness of South Korean exporters to cut their dollar prices in order to maintain their market share against competition from Japan and other Asian competitors.

—while that of imports The dollar value of merchandise imports (cif), meanwhile, rose by 8.1% year on rises year in the first quarter of 1999. Although their volume in national accounts terms rose by far more, merchandise import prices in dollar terms were subdued by the won’s steady appreciation against the dollar and the continuing softness of prices for many commodities on world markets. The net result of these developments was a merchandise trade surplus (fob-cif) of $4.8bn, a 44.4% decrease from the level in the first quarter of 1998.

Electronics exports post Detailed merchandise export data for the first quarter of 1999 show a familiar strong growth pattern: double digit year-on-year growth in sales of electronic products and machinery and precision instruments, much of which was presumably destined for the buoyant US market, and year-on-year contractions in sales of chemicals and metal goods, both of which are in over-supply on world markets. Revenue from exports of crude materials and fuels also showed a steep contraction year on year in the first quarter, largely owing to low international prices for oil.

Merchandise exports to An encouraging sign for South Korea’s merchandise exports came with a study Asia rise in June from the Korea International Trade Association, which found that exports to Indonesia, Malaysia, Singapore, Thailand and the Philippines rose by 7.8% year on year in dollar value in the first four months of 1998, having fallen by 25.9% in the year as a whole. These five countries accounted for 11.5% of total exports in the four months of the year, while the US took 17% of the total and China and Japan about 9% each.

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South Korea: exports of selected commodities, Jan-Mar

($ m unless otherwise indicated) 1998 1999 % change Food 635 596 –6.1 Crude materials & fuels 2,318 1,414 –39.0 of which: petroleum & derivatives 1,292 983 –24.0 Clothing 874.1 969 10.9 Fabric 1,924 1,610 –16.3 Yarn 458 319 –30.4 Rubber tyres & tubes 364 359 –1.3 Chemicals & chemical products 2,356 2,082 –11.6 Metal goods 2,771 2,336 –15.7 Machinery & precision instruments 2,250 2,549 13.3 Electronic products 8,485 9,754 15.0 of which: semiconductors 4,081 4,628 13.4 Passenger cars 1,489 1,571 5.5 Ships 1,219 1,240 1.8 Total incl others 32,232 30,342 –5.9 Source: Bank of Korea, Monthly Statistical Bulletin.

South Korea: imports of selected commodities, Jan-Mar ($ m unless otherwise indicated) 1998 1999 % change Food & consumer goods 2,670 3,391 27.0 of which: cereals 692 555 –19.7 consumer non-durables 298 282 –5.4 consumer durables 1,171 1,784 52.3 Industrial materials & fuels 12,392 11,871 –4.2 of which: crude petroleum 3,290 2,607 –20.7 minerals 674 869 28.8 light industry inputs 954 936 –1.9 chemicals & chemical compounds 2,074 2,158 4.1 iron & steel products 1,023 1,014 –0.9 non-ferrous metals 819 823 0.5 Capital goods 8,662 10,309 19.0 of which: machinery & equipment 2,651 2,679 1.0 electric & electronic machinery 5,132 6,860 33.7 of which: semiconductors 2,841 3,840 35.2 transport equipment 551 539 –2.2 Total 23,655 25,571 8.1 For domestic use 13,366 13,257 –0.8 For export 10,289 12,314 19.7 Source: Bank of Korea, Monthly Statistical Bulletin.

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Imports of capital goods Reflecting the inventory restocking and the recovery in manufacturing rise strongly production, imports of capital goods rose by a robust 19% year on year in the first quarter of 1999. The dependence of South Korea’s merchandise export performance on imported inputs was also evident in the first-quarter data: imports for use in export manufacture rose by 19.7% year on year and accounted for just under half of the total. Imports for domestic use, meanwhile, fell by 0.8% from the same period in 1998.

Imports from Japan are Although imports of consumer durables rose strongly—albeit partly reflecting rising fast— the very low base of 1998—they still accounted for only 7% of the total. Warnings in the press about the possibility of South Korea being flooded by foreign consumer luxuries as a result of import liberalisation have become louder with the removal of the “import source diversification scheme” at the end of 1998. This banned the import of many Japanese products, which are now gaining a market share.

—and taking top shares in A report issued by the Ministry of Commerce, Industry and Energy in early certain product categories June covering imports of 20 surveyed items found that Japanese camcorders and numerically controlled milling machines accounted for 90% of imports of those products in the first four months of 1999. While the majority of imports from Japan are of intermediate and capital goods (together 83% of the 20 items imported from Japan), newly liberalised consumer goods took 65.9% of their respective markets.

Trade friction could resume One consequence of South Korea’s economic recovery is that its main trading partners will once again start to press grievances which had been muted during the crisis period. Cars are one example where the trade imbalance is breathtaking. Between 1997 and 1998 the number of new South Korean cars sold in western Europe rose from 274,000 to 372,000 units, while those going the other way fell from an already derisory 3,971 to an all but invisible 848. Meanwhile, in July Daewoo became the first South Korean vehicle maker to enter EU markets duty-free: by shipping vehicles from its plants in Poland, it evades the usual 10% customs levy. ACEA, the association of European vehicle makers, claims that in South Korea non-tariff barriers, such as pressure on consumers to buy Korean goods, are once again emerging.

South Korea: current- and capital-account balances, Jan-Apr ($ m unless otherwise indicated) % change, 1998 1999 year on year Merchandise exports 44,575.2 43,144.8 –3.2 Merchandise imports 31,084.3 33,288.9 7.1 Trade balance 13,490.9 9,855.9 –26.9 Services balance 428.4 –251.8 –158.8 Income balance –1,089.6 –1,580.3 45.0 Current transfers 1,589.1 777.8 –51.1 Current-account balance 14,418.8 8,801.6 –39.0 Capital & financial account balance 1,527.9 1,711.0 12.0 Sources: Bank of Korea, Monthly Statistical Bulletin; National Statistical Office, Monthly Statistics of Korea.

EIU Country Report 3rd quarter 1999 © The Economist Intelligence Unit Limited 1999 34 South Korea

The current-account There was a 27% year-on-year fall in the merchandise trade surplus (fob-fob) in surplus falls the first four months of 1999. The services account moved back into deficit as import-related services and outward travel both picked up. The deficit on the income account, meanwhile, widened compared with the level in the first quarter of 1998, mainly as a result of continued large outflows of interest payments on the large stock of foreign debt. Because of these movements the current-account surplus totalled $8.8bn in the first quarter, 39% down on the same period of 1998.

Business news

Economic recovery may South Korea’s unexpectedly swift and vigorous economic recovery, while breed complacency welcome in itself, raises two concerns. One is that the push for restructuring will ease, on the ground that it is no longer needed, thus damaging competitiveness in the long run. The other is that South Korean firms, and perhaps also the government, may lose their new-found enthusiasm (never great, in the case of the chaebol) for selling assets to foreign investors. So far the evidence is mixed on both counts, but as of mid-July a number of recent developments lend credence to the view that South Korea may be backsliding, or at least becoming more insouciant towards foreign business.

The government’s Big Deals For better or worse, a centrepiece of government efforts to force the chaebol to business swap policy— rationalise their businesses has been the so-called Big Deals—the English term is used even in Korean—involving asset swaps and forced mergers. Official claims that these represent voluntary self-reform efforts by the chaebol ring hollow, as witness the fraught progress of especially the largest deals: the merger of Hyundai Electronics and LG Semicon, and the swap of Daewoo Electronics for Samsung Motors.

—forces Hyundai After much in-fighting, the first of these was concluded on May 20th, when Electronics and LG Semicon Hyundai Electronics signed a contract to take a 59% stake in LG Semicon for to merge W2.6trn ($1.8bn at an exchange rate of W1,186:$1). The formal takeover is due in mid-July this year, but the companies will continue to be run separately for several months thereafter. Hyundai Electronics had earlier promised no lay-offs for at least the next two years. Just what synergy or enhanced competitiveness this arranged marriage will generate, and how soon, remains to be seen.

LG will sell half its LCD Always the most prudently managed of the top five chaebol, LG is now proving business to Philips for the most seriously committed to restructuring. On May 18th it announced an $1.6bn— agreement to sell 50% of LG LCD to Philips for $1.6bn, in the largest single foreign investment ever made in South Korea. (Other LG affiliates are said to have already attracted a further $2.4bn in foreign investment.)

—but will share Philips is due to pay the entire amount by the end of July, and the new joint management rights venture—with shared management rights, which could be interesting—is to begin in August. LG is the world leader in liquid crystal display (LCD) manufacture, both technologically and in market share, and with Philips’

investment of an additional W1.4trn through 2001 it should be well placed to consolidate its lead in a field which promises to be as profitable now as semiconductors were in the mid-1990s.

The Samsung-Daewoo asset By contrast, the planned exchange of Samsung Motors for Daewoo Electronics swap fails— seems now to have irrevocably fallen through. On June 30th Samsung placed its vehicle manufacturer into court receivership. The problem was twofold: Samsung did not want Daewoo’s second-rate electronics business, while Daewoo, heavily leveraged as it is (see below), could not afford to buy Samsung Motors’ car factory. In a striking gesture the Samsung group’s chairman, Lee Kun-hee, whose own obsession with cars was the driving force behind the foray, pledged W2.8trn of his personal fortune to help pay off Samsung Motors’ W4.3trn debts.

—but foreigners react Interpretations of this outcome vary. The Seoul stockmarket fell on the initial favourably news, only to rise the next day after noting that most foreign comment was positive. While at one level this is a setback for the government, the whole Big Deals approach has been criticised variously as interventionist, inappropriate and doing nothing to reduce capacity. So if instead the firms concerned take their own freely chosen action, whether together or separately, so much the better, particularly if it involves the real closure of firms and reduction of capacity, neither of which has been prominent in South Korea’s restructuring thus far.

Restructuring as gesture On past precedent, however, court protection could just be another way of politics allowing Samsung Motors to linger on. Murky political factors are at work on all sides here. From the beginning Samsung Motors was political, starting with the decision to locate it near Pusan. Pusan was the power base of the then president, Kim Young-sam, whose approval of this project made a nonsense of his alleged attempts to force the chaebol to specialise. With a demagogy which does him no credit, Mr Kim now accuses his successor of pursuing a vendetta against Pusan by seeking to destroy Samsung Motors. With a parliamentary election approaching, the fear is that the government may shrink from shutting the plant for fear of antagonising the already hostile south-east.

Samsung Life and Kyobo There is also cunning in Lee Kun-hee’s apparently noble and responsible offer Life will be listed— to pay Samsung Motors’ debts from his own funds. This would involve selling his shares in Samsung Life, the country’s largest life insurance company, which at present is privately held. Accordingly, the Financial Supervisory Commission has had to agree to allow the company—along with, for fairness, the second largest company in the sector, Kyobo Life—to be listed on the stock exchange from 2000, something which Samsung had long been seeking.

—which could increase This in turn can only increase the predominance of the chaebol in the financial chaebol dominance of the sector as well as manufacturing, something which is already causing concern. financial sector Since the market value of Mr Lee’s stock will only become clear after listing, it was the government rather than he that quickly named the sum of $2.4bn— with the aim of holding him to it later, should the value of his shares fall short of expectations.

Sales of Korea First Bank The growing perception that Seoul is once again becoming less foreigner- and Seoul Bank run into friendly is fuelled, above all, by the lengthy and still not concluded sales of two difficulties— large banks to foreign investors: Korea First Bank to a US consortium headed by Newbridge Capital, and Seoul Bank to HSBC Holdings. In each case the sticking point appears to involve valuation of assets—a difficult task at the best of times, and all the more so in a rapidly changing market—and how far and on what terms the government will take responsibility for bad debts, both now and in the future.

—and may be hampered The suspicion is that economic recovery is causing the government to harden further by Daewoo’s its terms. Whatever the truth, the perception is damaging; hence it is very near-failure much in the government’s interests to conclude both sales promptly. The recent near-bankruptcy of Daewoo (see Economic policy), which numbered Korea First Bank and Seoul Bank among its main creditors, may, however, com- plicate the sale of both banks further. Although Daewoo is due to produce restructuring plans to restore its finances, doubt remains as to how effective these will be. Foreign investors are, therefore, likely to be wary of taking on either bank until Daewoo sets itself on a firmer footing.

—as do sales of insurance Another negative is the so far unsuccessful attempt to sell insurance companies companies. South Korea is the world’s sixth largest life insurance market; but as insurance companies are important holders of corporate bonds, indebtedness is a major issue. Thus two efforts to sell Korea Life, the third largest company, have failed so far. Five smaller firms are also on the market.

KOGAS rebuffs BG— Another dismaying case was the announcement in July by Korea Gas Corporation (KOGAS), the state monopoly gas importer and the world’s largest customer for liquified natural gas, that it had ended talks on selling a 15% stake to BG, a gas pipeline operator, for some $450m. Although KOGAS claims that it is still looking for new strategic partners, as BG would have been, it has also said it will now seek to raise funds on the domestic stockmarket.

—and may be hoping to The clear signal to foreign investors is that they are viewed in Seoul as a find local investors second-best option: tolerated when no Korean buyer is available, but jettisoned as soon as that changes. And yet the Planning and Budget Ministry (PBM), which handles these matters, had stipulated that the first stage of KOGAS’ privatisation should be specifically for foreigners. It looks as if the PBM should clarify both its policy and the image and impact of such decisions.

Chaebol see opportunity in Korean firms often spy openings where others see only problems. Hardly had rebuilding Yugoslavia the smoke settled over Yugoslavia than large chaebol—including Daewoo, LG, and Samsung—were setting up task forces to explore the manifold opportunities in everything from reconstruction to consumer goods. As with their long-standing operations in countries such as Iran, Iraq and Libya, South Korean companies are driven more by pragmatism than ideology. If Western firms will not rebuild the bridges destroyed by NATO’s bombs, the chaebol will.

North Korea

Political structure

Official name Democratic People’s Republic of Korea

Form of government One-party rule, based on the ideology of juche (self-reliance)

The executive Constitutional revisions in September 1998 abolished the Central People’s Committee, renamed the State Administration Council as the cabinet, and reaffirmed the National Defence Commission (NDC) as the highest state body, albeit nominally under the Supreme People’s Assembly (SPA)

Head of state As of September 1998 Kim Il-sung (who died in 1994) is dubbed “eternal president”. The president of the SPA Presidium performs the formal duties of the head of state, but the ultimate executive power holder is the chairman of the NDC

National legislature Unicameral 687-member SPA directly elected for five-year terms. Its Presidium, formally the Standing Committee, substitutes when the SPA is not in session

Regional legislatures Each province, city, county or district elects people’s assemblies or committees. These committees elect local officials to carry out centrally decided policies

National elections The tenth SPA was elected on July 26th 1998, more than three years late. The next SPA election is due by 2003. These are communist-style elections, with a single list of candidates and claimed turnout and “yes” votes approaching 100%

National government The Korean Workers’ Party (KWP) controls all arms of the state. Since the death of Kim Il-sung, military figures have had a growing influence

Main political parties Government: the KWP is nominally in coalition with the Social Democratic Party and the Chondoist Chongu Party

Key holders of state & National Defence Commission chairman Kim Jong-il party positions First vice-chairman Jo Myong-rok Vice-chairmen Kim Il-chol; Ri Yong-mu SPA Presidium President Kim Yong-nam Vice-presidents Yang Hyong-sop; Kim Yong-dae Prime minister Hong Song-nam Vice-premiers Jo Chang-dok; Kwak Bom-ki Key politburo members Kye Ung-tae; Chon Byong-ho

Key ministers Agriculture Ri Ha-sop Commerce Ri Yong-son Defence Kim Il-chol Finance Rim Kyong-suk Foreign affairs Paek Nam-sun Foreign trade Kang Jong-mo Light industry Ri Yon-su Metals & machine-building Jon Sung-hun Public security Paek Hak-nim Railways Kim Yong-sam

Chairman of the State Planning Commission Pak Nam-gi

Economic structure

Latest available figures

Economic indicators 1994 1995 1996 1997 1998 Real GDP growtha (%) –1.8 –4.6 –3.7 –6.8 n/a Rice productionb (‘000 tonnes) n/a n/a 1,340 n/a n/a Population (m) 23.1b 23.5b 23.6a 23.9a n/a Exportsa ($ m) 840 740 730 910 n/a Importsa ($ m) 1,270 1,310 1,250 1,270 n/a Trade balancea ($ m) –430 –570 –520 –360 n/a External debtc ($ m) 9.8 n/a n/a n/a n/a Exchange rate (av; Won:$) 2.17 2.15 2.15 2.20 2.20d

July 16th 1999 Won 2.20:$1

Origins of gross domestic product 1994a % of total Agriculture, forestry & fishing 29.5 Mining 7.8 Manufacturing 23.6 Electricity, gas & water 4.8 Construction 6.3 Services 27.9 Total 100.0

Main destinations of exports 1995e % of total Main origins of imports 1995e % of total Japan 27.9 China 32.6 South Korea 20.8 Japan 17.2 China 5.2 Russia 4.7 Germany 4.0 South Korea 4.3 Russia 1.2 Germany 2.9 a Bank of Korea (Seoul) estimates. b UN Food and Agriculture Organisation (FAO) figures. c Including rouble-zone debt, at pre-1990 values. d EIU estimate. e Cited in a book by Marcus Noland, The North Korean Economy, Institute for International Economics, Washington DC, 1995..

Outlook for 1999-2000

The short-term outlook North Korea’s outlook over the short term will largely depend on how it reacts will depend on the to the forthcoming review of US policy towards North Korea by William Perry, Perry report a former US defence secretary. In principle, the US appears ready to lift economic sanctions and furnish much more substantial aid than hitherto, as well as provide other incentives such as moves towards diplomatic relations. In return, however, North Korea must definitively and verifiably abandon its nuclear and missile programmes. Should it refuse, the US may well revert to what might be called malign neglect: ending aid and basically ignoring North Korea, but coming down hard on any provocation or malfeasance.

Possible plans for another US-North Korean relations appeared to be warming until June this year. In May missile launch— Mr Perry visited Pyongyang to put his plan forward, while a separate US team inspected the suspected nuclear site at Kumchang-ri north of Pyongyang and found it clean. In June, however, North Korea’s naval provocation in the Yellow Sea and its detention of a South Korean tourist cast a shadow (see Inter- Korean relations). This was further darkened by growing rumours that North Korea is planning to test-fire a rocket, possibly a Taepo-dong missile, as it did on August 31st 1998 over Japan (4th quarter 1998, page 37)—a reckless act, the effects of which continue to reverberate both in Japan and on the broader security picture in north-east Asia.

—would be a blow for the Were North Korea to launch another missile, the impact would be even more US and South Korean serious. It would be a blow for the Clinton and Kim Dae-jung administrations, governments— both of which have pursued innovative policies of seeking to engage rather than isolate Pyongyang. A missile launch now, especially with Perry about to report, would undermine the always fragile support for positive engagement towards North Korea in the US and South Korea, while boosting conservative critics who view this as useless appeasement of an incorrigible rogue state. With elections due next year in the US and South Korea, neither government can afford to stake its political future on defending what would be derided as a failed policy.

—may signal the end of Any new North Korean missile test would also be a serious and perhaps fatal KEDO— blow to the Korean Peninsula Energy Development Organisation (KEDO). KEDO, the consortium set up under the October 1994 US-North Korean Agreed Framework, has over the past five years quietly helped promote practical co- operation between North Korea and its enemies. South Korea and Japan have pledged to provide the lion’s share of the $5bn needed to build new light-water reactors, and in July those commitments were formally enacted. In mid-July Japan’s chief cabinet secretary indicated that Japan would probably freeze its contributions to KEDO if North Korea launched another missile.

—and persuade North However, last year’s North Korean rocket prompted Japan to suspend its Korea to continue its financing of KEDO, and any further firings might so affect public opinion as to nuclear programme make it politically impossible to continue this project. The same may also apply in the US and South Korea. In that case North Korea would doubtless accuse the others of reneging on the Agreed Framework, and threaten in turn

to resume its nuclear programme—thus ratcheting up tensions back to their level in mid-1994, when it is now known that the peninsula came dangerously close to a second Korean war.

North Korea may prefer to The hope must be that Kim Jong-il understands this and will not throw away remain militant— his country’s best chance of peace and progress. As ever, however, there is no solid basis for such hope. North Korea may prefer to remain militant and unpredictable, seeing this as its best weapon in dealing with far stronger yet hesitant adversaries. Or there may be splits in the central government, with the military in control, even while other parts of the regime have more sensible ideas. The latter view gains credence from the increasing visibility of policy differences on other fronts, notably economic policy.

—but the regional powers One positive factor in all this is that the major powers involved in Korea—the will seek to contain it US, Japan, China and Russia—are closer to unanimity regarding North Korea than ever before. The Cold War line-up is long gone: today both China and Russia have much closer relations with South than with North Korea. China will not be pleased at reports in early July this year that the latest North Korean missile base is being built just 20 km from the China-North Korea border. Another sign of the times is that China and South Korea—but not North Korea—are now openly consulting each other ahead of the next round of four- party talks, due to be held in Geneva in August this year.

The Kosovo crisis will While in some ways North Korean unpredictability is a constant, the war over increase North Korea’s Kosovo is one new factor which will have made an impact. Like China, North suspicions about the US Korea took the Yugoslav side and fiercely criticised NATO’s intervention—but adding, in several commentaries, that this was a dry-run for the next adventure of US imperialism: the invasion of socialist Korea. While such overblown rhetoric is staple fare, there is a risk of paranoids coming to believe their own propaganda. Certainly, the fact that NATO did in the end launch military action will be food for thought in North Korea. It is also hard to suppose that the bombing of Yugoslavia will have made North Korea any more inclined to abandon its own missile programme.

The political scene

Some former The fifth anniversary of the death of North Korea’s founding leader, Kim vice-presidents may have Il-sung, on July 8th was commemorated with the customary pomp and been purged— solemnity. As usual nature also paid its respects, with reports of pear trees blossoming out of season. The various events offered some clues on possible changes in the Pyongyang hierarchy. The main gathering on the day around Kim Il-sung’s bier, at the Kumsusan memorial palace, listed most of the top leadership, but none of the former vice-presidents—Pak Song-chol, Ri Jong-ok and Kim Yong-ju. The last is Kim Il-sung’s brother, who may now have been definitively purged by his nephew. However, Mr Pak and Mr Ri are veteran loyalists who had retained senior honorary posts, so their absence is puzzling.

—together with Another apparent absentee was Yon Hyong-muk, the pragmatic ex-premier and Yon Hyong-muk a rare civilian on the National Defence Commission, the top organ of state. Conversely, Cho Myong-nok, whose post as political head of the Korean People’s Army (KPA) belies his true role as Pyongyang’s most influential military man, was ranked third after Kim Jong-il and Kim Yong-nam. Moreover, it was vice-marshal Cho, rather than a civilian (state or party) dignitary, who gave the keynote speech—which included praising Kim Jong-il for his “unique military-first political methodology”.

A television forum suggests On July 6th a television forum—itself an apparent innovation—gave some rising stars prominence to relatively unknown figures such as the vice-premier, Kwak Bom-ki, who opened the proceedings, and Ri In-kyu, a deputy minister of foreign affairs. Another speaker was Ri Jong-hyok, regarded by those who have met him as one of North Korea’s ablest representatives (he headed its Paris mission in the early 1980s), and seemingly on the rise. Lately with the Asia- Pacific Peace Committee, he is now billed as president of the National Reunification Institute.

Implicit policy debates North Korea’s constant emphasis on yuilsasang or “ideological mono- continue— chromaticity” makes it impossible for policy differences to be openly debated. Nonetheless, the Pyongyang media are increasingly carrying articles which, taken together, add up to an implicit debate about what the policy priorities should be at this juncture. Naturally, all concerned claim the mantle of Kim Jong-il for their various ideas. The current slogan of “building a powerful socialist state” is also a usefully vague vessel, which different articles can fill with what are in fact divergent ideas.

—but the army comes first The party line was put uncompromisingly on June 16th in a joint article in the daily and monthly organs of the ruling Korean Workers’ Party (KWP), Rodong Sinmun and Kulloja. Appearing just one day after the shoot-out in the Yellow Sea (see Inter-Korean relations), this was entitled “Our Party’s Policy of Giving Priority to the Army is Invincible”. This is the most explicit defence yet of a policy which must have many critics in civilian sectors, which are corres- pondingly starved of resources in favour of the KPA. The article argues bluntly that putting military considerations first at all times, including in peace time, is “a strategic line of the Korean revolution” and the only way for a socialist state to survive in a “fierce face-off with imperialism”.

The structure of the KWP It is especially striking to find such pro-military sentiments in the leading party remains unclear publications. With the military’s visible rise in influence since the death of Kim Il-sung, and with the operation—or at least the organisation—of government having been normalised after last year’s elections and constitutional changes (4th quarter 1998, pages 38-40), the party is the last of the three realms of power in North Korea whose current structure and hierarchy remain unclear. No Central Committee meetings have been reported since the death of Kim Il-sung, nor is the current membership of the Politburo known. This article looks like an attempt by the KPA to bring the KWP to heel.

William Perry visits Two important US delegations visited Pyongyang in May, seeming at the time to Pyongyang— herald a welcome improvement in relations. A former US defence secretary, William Perry, spent four days outlining the proposals in his forthcoming review of US policy towards North Korea. No details were revealed, but comment from both sides suggests that these talks were serious and substantial. Although Mr Perry did not gain an audience with Kim Jong-il, he met most of the rest of the Pyongyang power elite, including, unusually, top military figures.

—and Kumchang-ri is The day before Mr Perry arrived, a separate 14-strong US technical team pronounced clean completed a week spent inspecting a tunnel complex at Kumchang-ri, near the mothballed nuclear site at Yongbyon, north of Pyongyang. Suspicions that this site, which was spotted by US spy satellites, might indicate a covert resumption of nuclear development had bedevilled US-North Korean relations for almost a year. Only in March did Pyongyang agree to let the US take a look, in exchange—although the US denies the linkage—for an extra 400,000 tonnes of food aid. Sceptics noted that North Korea had had many months to remove anything incriminating from the site, so, unsurprisingly, the inspectors found nothing but empty tunnels.

India detains a North Any sense of relief proved short-lived, however, as June brought the naval Korean freighter confrontations between South Korea’s and North Korea’s navies (discussed in Inter-Korean relations). Then in July, as concern grew that North Korea might be about to test-fire a long-range missile, came a timely reminder of why North Korea’s missile programme is such a worry to the US and others. On July 4th India detained a North Korean freighter, arrested its crew and claimed it was carrying missile components bound for Pakistan (its ostensible destination being Malta). The case continues, but North Korea is already known to have assisted Pakistan in developing its Ghauri missile.

Some parts for the As for where North Korea does its own purchasing, on July 8th two Japanese Taepo-dong missile may MPs charged that up to 40% of the semiconductors in the Taepo-dong missile have come from Japan came from Japan, along with other manufactures used in its construction, ranging from welding machines to gas. They also claimed that the North Korean semi-submersible sunk by the South Korean navy in December 1998 (1st quarter 1999, page 7), which they have inspected, had some 20% of its components sourced in Japan, including radar, cameras and ground positioning systems. Such items are freely available, and it would be hard to restrict their export. Most are thought to reach North Korea through third countries in any case.

A senior delegation visits One of the most striking changes of the 1990s had been the complete cessation China— of what used to be frequent and regular visits by senior North Korean and Chinese leaders to each others’ capitals. Lower-level delegations continued to go back and forth, but since China recognised South Korea in 1992, senior leaders, including China’s president, Jiang Zemin, have gone only to Seoul, while no senior North Korean has come to Beijing. Now the fences have been mended somewhat, with a visit to China on June 3rd-7th by the first high- ranking North Korean delegation since 1991.

—led by Kim Yong-nam— This was led by Kim Yong-nam, the ex-foreign minister who, as president of the SPA presidium, acts as head of state for contacts with the outside world. Other members of the high-powered team included the prime minister, Hong Song-nam; the foreign minister, Paek Nam-sun; and the defence minister, Kim Il-chol. Their itinerary took in Shanghai and Hangzhou as well as Beijing. Eternal friendship was proclaimed, with China promising an additional 150,000 tonnes of grain and 400,000 tonnes of coal.

—but the two sides differ Behind the smiles, however, there were tensions. The Chinese side was not best on the need for reform pleased that the 50-strong North Korean team contained not a single economic official—but plenty of generals; or by their guests’ refusal to be shown such symbols of market reform as special economic zones, such as Shenzhen. Jiang Zemin did not, however, lose the opportunity to impress on his visitors the need for economic development. In turn, Kim Yong-nam told China’s premier, Zhu Rongji, that Chinese economic reforms “suited China’s national conditions”—implying that they do not suit North Korea’s.

Kim Jong-il may visit China Both before and since this visit there have been frequent rumours that Kim Jong-il himself is to visit China, for what would be the first time since 1983— which remains Mr Kim’s sole confirmed overseas trip anywhere ever. Latest indications are, however, that this is unlikely in 1999. For one thing, after Kim Yong-nam’s trip it would be more normal for a senior Chinese leader to reciprocate first. (Some reports accordingly suggest that Li Peng may visit Pyongyang in October this year.) It is also said that North Korea is demanding extra aid and effusions of solidarity as a condition for such a visit, and that China is reluctant to comply.

North Korea and Australia On June 25th North Korea and Australia held their first high-level talks in over hold high-level talks 20 years. The two countries opened diplomatic relations in the mid-1970s, but these ended after just a few months, when North Korea’s diplomats in Canberra mysteriously packed up and left. Despite this recent exploratory meeting, the current Australian government is disinclined to restore ties unless North Korea is prepared to move on issues such as nuclear and missile concerns.

The ARF will discuss More eager to extend a hand of friendship is ASEAN’s Asian Regional Forum membership for (ARF), which is expected to discuss North Korea at its annual ministerial North Korea meeting in Singapore at the end of July. South Korea is a member of the ARF, but North Korea is not. It had expressed interest in joining, but became less keen on learning of the information-sharing this would entail (such as members perusing and commenting on each others’ defence white papers). However, given that the ARF exists to discuss regional security issues, a number of members feel it would be better to have North Korea inside rather than out.

The economy, trade and investment

In 1998 total merchandise South Korea’s national unification ministry has issued some estimates for trade collapses— North Korea’s merchandise trade performance in 1998. According to the ministry, during the second half of last year North Korea’s exports fell by 20% year on year to $300m, and imports plunged by 45% to $400m, also year on year. Total merchandise trade in 1998 is estimated at around $1.4bn, marking a fall of just over 30% from the estimated 1997 level. The ministry attributed this setback to the effects of the more general Asian economic crisis. By partner, the biggest fall in trade during the second half of 1998 was with China, where the total of $220m was down by 38%. With Japan, the total was $190m, a fall of 30%. By contrast, inter-Korean trade at $140m was only down by 11%. No balances were given.

—and the economy While the ministry did not venture to produce GDP figures, a spokesman contracts again claimed that 1998 was the ninth consecutive year of economic contraction. This contradicts other reports that the North Korean economy may at last be bottoming out. While the infusion of international aid has made a difference and some factories have been rehabilitated, overall there is as yet no sign of any real economic recovery—nor of the explicit market reforms which are a precondition thereof.

North Korea’s foreign debt Another South Korean government agency, the National Intelligence Service exceeds $12bn— (NIS), has been monitoring North Korea’s decades-old unpaid debts. The NIS estimates that the total as of end-1997 was $11.9bn, so with further accruals of interest it will have topped $12bn by now. Of this, $4.6bn is owed to Western nations (including Japan) and presumably comprises debts to both governments and banks.

—much of which is owed to However, the lion’s share—$7.4bn—is owed to China and former communist former communist allies allies such as Russia. The NIS has noted that not even legal action by a consortium of over 100 banks from 17 countries and judgments by the International Court of Arbitration have prompted North Korea to pay up. Unsurprisingly, this has affected the country’s ability to attract foreign investment, which the NIS totals at $200m, almost all from China or pro- Pyongyang Koreans in Japan.

This year’s harvest could There are signs that, for the fourth time in five years, North Korea’s precarious be bad harvest may be damaged by extreme weather. In 1995 and 1996 the problem was floods. This year, as in 1997, it is drought. The official news agency, Korean Central News Agency (KCNA), reported on June 29th that the noon temperature in Pyongyang that day was 35ºC, an all-time high, and that rainfall in June over much of the country was only between one-quarter and one-third of the normal average for the time of year.

The country’s water system This did not stop KCNA claiming the next day that “Korea has a large source of has been poorly water”. In a rare report on this sector, KCNA warned rather ominously that maintained “medical workers are responsible, both ethically and legally, for the sanitation

of drinking water under their charge”. Outside aid agencies report that what was once an impressive national system of piped potable water has succumbed in recent years to damage and lack of maintenance, to the point where water- borne disease is now among the miseries threatening many North Koreans. If so, it seems perverse to blame medics for the problem.

Northern-built railcars The exact business fields for which the Hyundai group—Hyundai is one of arrive in Inchon— South Korea’s largest chaebol (conglomerates)—has plans in North Korea have seemed to vary over time. As with foreign investment in South Korea, distinguishing aspiration from accomplishment is not always straightforward. On May 24th, however, 44 northern-built freight cars (for hot-coil steel) arrived at Inchon near Seoul. Like the cement wagons produced for Hyundai on a trial basis in March 1998, these were built in Wonsan (in the south-east of North Korea), where a team of Hyundai engineers has been stationed for over six months. This first production batch fulfils an order by the (south) Korean National Railroad (KNR).

—and computers and Also in June, Hyundai Asan Corporation—the division created specifically to roof-tiles will follow handle Hyundai’s North Korean ventures (2nd quarter 1999, page 6) announced two new projects. From September, Hyundai Asan will assemble personal computers in Pyongyang. The low projected volume (10,000-20,000 units per year), and the fact that the north is for once paying rather than being paid (a modest $1.5m), suggest that this facility is for the home market rather than export. North Korea is believed to be stronger in computer software than hardware. Separately, later in the year Hyundai Asan will set up a factory, also in Pyongyang, to manufacture traditional-style Korean roof tiles.

North Korea fails to appear The United Nations Development Programme (UNDP)-funded Tumen River at the Tumen Consultative Area Development Programme (TRADP) continues its efforts to achieve co- Commission operation and development in the area where North Korea, China and Russia meet. As well as these three countries, TRADP members include South Korea and Mongolia. The latter sees the Tumen delta as a potential outlet to the sea, and in June it hosted the fourth meeting of the Tumen Consultative Commission, which oversees TRADP, in Mongolia’s capital, Ulaanbaatar. At the meeting South Korea’s vice-minister of finance and economy, Uhm Rak-yong, pledged an additional $1m in funding for TRADP. North Korea, not for the first time, cancelled its attendance at the last minute and without explanation.

The future of the Rajin- If Pyongyang fails to turn up on such occasions, it can hardly be surprised if it Songbong economic zone is finds itself bypassed. On June 9th South Korea announced a new sea route uncertain linking Sokcho with the small Russian far-east port of Posyet. This is expected to expedite both trade and tourism with north-east China, including trips to Mt Paektu on the border between China and North Korea. All this is bad news for North Korea’s Rajin-Sonbong economic zone, whose main economic raison d’être is its function as an outlet to the sea and transshipment zone for Manchuria. Chinese sources complain, however, that North Korea has been slow to upgrade its road and rail links, whereas a new railway spur connects Posyet with China.

A casino is expected to open North Korea’s part of the Tumen delta is the Rajin-Sonbong economic zone, its in July— only declared special economic zone to date. Inward investment has been dis- appointing so far. By far the largest project, announced over two years ago, is a $180m hotel and casino complex being built by the Emperor Group of Hong Kong. In June a Hong Kong paper reported that the casino, North Korea’s first, will open on July 31st; the hotel is now due for completion next year.

—but the patrons will Obviously, the hoped-for high rollers will not be local. Hong Kong, Japan and be foreign even Taiwan have been mentioned, as well as China. This raises two questions: where will they stay, and how will they get there? Rajin-Sonbong has other accommodation, but whether this is sufficient, either in quantity or in quality, is another matter. Transport is a major problem: there is no nearby airport, the roads are poor, the trains slow, and a helicopter service, under discussion for some years, has yet to get off the ground. All in all, it may be some time before Macau has a serious competitor here. Conversely, if it is a huge success, one wonders what will be the wider impact on North Korea’s nominal and rather puritan socialism.

Sofia, so good? On June 16th North Korea signed a number of economic agreements with Bulgaria, including one on double taxation. It is hard to imagine that the class of transactions thus eased is large, if indeed it exists at all. Although Air Koryo’s tiny route map includes Sofia in its half-dozen ports of call, there was never much trade even in the old days of comradeship, much less now.

EIU Country Report 3rd quarter 1999 © The Economist Intelligence Unit Limited 1999 Quarterly indicators and trade data 47

Quarterly indicators and trade data

South Korea: quarterly indicators of economic activity

1997 1998 1999 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr Industrial production Monthly av General, seasonally adj 1995=100 115 117 116 103 101 104 115 117 119a Construction Permits issuedb ‘000 sq metres 10,659 8,251 11,263 5,871 4,309 2,987 3,822 3,179 4,428a Employment Employed ‘000 21,319 21,336 21,070 19,710 20,179 19,971 19,846 19,041 20,153c Unemployed “ 550 470 561 1,182 1,485 1,600 1,586 1,750 n/a Wages & prices Monthly earnings 1995=100 114.6 116.6 116.0 103.0 101.3 104.3 114.7 116.7 n/a Consumer prices: “ 108.9 110.0 111.6 117.5 117.8 117.7 118.3 118.3 118.8c change year on year % 4.0 4.0 5.1 9.0 8.2 7.0 6.0 0.7 n/a Producer prices 1995=100 106.0 106.8 109.6 121.2 121.2 119.6 119.0 117.0 117.4c Share prices ” 78.6 78.5 53.2 55.1 40.3 34.5 47.5 61.4d n/a Retail sales Constant value 1995=100 116 113 119 103 102 97 108 107 112a Money End-Qtr M1, seasonally adj: W bn 36,874 35,553 32,622 28,806 28,433 32,868 33,131 33,028e n/a change year on year % 5.0 –7.2 –11.4 –20.2 –22.9 –7.6 1.6 n/a n/a Foreign trade Qtrly totals Exports fob $ m 35,532 34,182 36,727 32,232 34,878 30,481 34,723 30,342 11,630a Imports cif “ 37,362 35,688 34,517 23,655 23,541 21,462 24,624 25,571 9,071a Exchange holdings End-Qtr Goldf $ m 84.1 79.4 77.0 96.0 97.2 93.5 95.9 93.6 91.4g Foreign exchange: Bank of Korea “ 33,316 29,654 19,710 29,677 40,764 46,904 51,963 57,089 61,051g Other banks ” 33,793 34,912 32,749 41,925 38,478 37,239 34,310 33,245e n/a Exchange rate Market rate W:$ 888.1 914.8 1,695.0 1,383.0 1,373.0 1,391.0 1,204.0 1,227.0 1,186.0g

Note. Annual figures of most of the series shown above will be found in the Country Profile. a April only. b 32 cities and 90 towns. c Average for April-May. d Average for January-February. e End-February. f End-quarter holdings at quarter’s average of London daily price less 25%. g End-May.

Sources: Bank of Korea, Monthly Statistical Bulletin; IMF, International Financial Statistics.

EIU Country Report 3rd quarter 1999 © The Economist Intelligence Unit Limited 1999 48 Quarterly indicators and trade data

South Korea: foreign trade ($ m)

Total US Japan China Australia Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Imports cif 1996 1997 1996 1997 1996 1997 1996 1997 1996 1997 Food 7,253 6,517 2,883 1,963 120 139 624 1,128 583 568 of which: cereals & preparations 2,654 1,972 1,862 970 2 1 69 522 187 149 Hides & skins, raw 1,175 1,035 802 687 7 6 0 0 6 5 Rubber, crude 702 578 52 33 92 81 1 2 0 1 Wood, unmanufactured 1,697 1,575 291 266 3 2 93 95 25 43 Pulp 1,473 1,161 675 533 17 23 1 1 1 1 Textile fibres & waste 1,367 1,141 378 309 94 82 137 112 234 234 Metal ores & scrap 2,981 3,385 699 755 218 302 32 79 641 672 Coal 2,337 2,399 216 182 15 11 411 391 993 1,082 Petroleum & products 16,294 21,434 688 590 522 268 762 844 157 199 Chemicals 13,250 13,130 3,252 3,170 4,047 4,026 611 646 118 105 Textile yarn, cloth & mnfrs 3,825 3,560 232 215 576 511 1,150 1,163 12 10 Non-metallic mineral mnfrs 1,656 1,513 272 248 683 546 164 196 15 17 Iron & steel 6,548 5,609 265 137 2,379 2,116 1,134 1,403 119 142 Non-ferrous metals 4,126 4,392 354 360 473 509 224 329 441 424 Metal manufactures 1,742 1,640 451 442 552 487 128 141 10 8 Machinery & transport eqpt 51,299 48,722 14,078 15,291 17,521 14,898 1,316 1,720 326 388 of which: power-generating eqpt 3,664 3,480 1,429 1,068 772 743 118 153 188 283 office machinery 4,006 3,736 1,447 1,272 890 789 201 265 41 22 telecommunications eqpt 3,489 3,300 1,522 1,356 783 784 362 377 5 2 road vehicles 2,067 1,685 484 448 641 485 22 31 18 17 other transport eqpt 4,026 2,519 2,381 1,534 340 205 24 28 1 3 Clothing 1,503 1,394 68 56 63 62 600 663 4 7 Scientific instruments etc 6,700 6,267 1,916 1,784 2,981 2,811 107 115 48 43 Total incl others 144,124 144,611 30,882 30,135 31,447 27,906 8,538 10,117 6,272 5,895

Saudi Arabia Germany Indonesia UK Malaysia Imports from other Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec suppliers 1996 1997 1996 1997 1996 1997 1996 1997 1996 1997 Total 3,911 7,153a 7,239 5,824 4,013 4,107 2,994 3,364 3,007 3,283 continued

EIU Country Report 3rd quarter 1999 © The Economist Intelligence Unit Limited 1999 Quarterly indicators and trade data 49

Total US Japan China Hong Kong Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Exports fob 1996 1997 1996 1997 1996 1997 1996 1997 1996 1997 Food 2,724 2,656 153 150 1,680 1,500 91 151 150 151 of which: fish & preps 1,494 1,362 76 65 1,111 920 67 112 6 4 Crude materials, inedible 1,608 1,780 143 146 259 265 532 607 170 168 of which: textile fibres & waste 927 1,078 100 95 10 10 458 524 92 97 Mineral fuels 3,843 5,349 107 140 1,728 1,709 822 1,565 328 759 Chemicals 9,149 10,668 534 605 870 1,016 2,238 2,729 955 1,039 Leather & mnfrs 1,642 1,650 9 11 24 18 748 805 450 413 Rubber manufactures 1,754 1,653 247 255 49 38 13 33 51 46 Paper & manufactures 1,228 1,455 64 109 54 52 345 428 399 428 Textile yarn, cloth & mnfrs 12,718 13,337 734 902 574 502 1,819 2,032 2,696 2,302 Iron & steel 5,229 5,708 603 686 1,451 1,463 765 870 386 438 Metal manufactures 2,629 2,965 584 619 475 443 197 178 59 68 Machinery & transport eqpt 62,439 68,109 9,886 14,336 4,714 4,426 2,854 3,025 3,299 3,263 of which: power-generating eqpt 693 791 169 242 136 93 72 81 30 23 office machinery 5,676 6,410 2,259 2,349 261 271 173 199 151 249 telecommunications eqpt 8,887 7,799 1,254 1,215 701 597 413 499 717 679 road vehicles 12,351 12,729 2,403 2,455 133 169 177 80 105 81 other transport eqpt 7,635 7,496 212 341 46 91 35 73 91 154 Clothing 4,221 4,192 1,526 1,689 1,398 914 88 106 51 79 Footwear 1,235 982 328 211 8 7 152 188 46 47 Scientific instruments etc 1,677 2,234 388 497 266 463 80 120 105 115 Total incl others 124,547 136,150 16,809 21,850 15,770 14,771 11,394 13,572 11,133 11,725

Singapore Germany Taiwan Malaysia UK Exports to other Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec main markets 1996 1997 1996 1997 1996 1997 1996 1997 1996 1997 Total 6,439 5,797 4,706 4,753 4,007 4,613 4,335 4,356 3,226 3,984 a Of which petroleum and products, $6,129m.

Source: OECD, Foreign trade.

EIU Country Report 3rd quarter 1999 © The Economist Intelligence Unit Limited 1999 50 Quarterly indicators and trade data

South Korea: structure of trade ($ m)

Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Mar Jan-Mar 1994 1995 1996 1997 1998 1998 1999 Imports cif Food, beverages & tobacco 5,110 6,460 7,929 7,178 4,904 1,215 1,342 of which: cereals 2,256 2,852 3,835 3,101 2,520 692 555 Crude materials, inedible 9,405 11,713 10,965 10,424 7,275 1,713 1,912 of which: minerals 3,081 3,801 3,536 3,861 3,146 674 869 Mineral fuels 15,415 19,013 24,284 27,381 18,195 5,375 4,369 of which: crude petroleum 8,878 10,809 14,432 17,772 11,241 3,290 2,607 Chemicals 9,763 13,156 13,231 13,110 9,240 2,422 2,515 Manufactured goods 15,936 21,270 20,947 19,249 11,112 2,920 3,101 of which: iron & steel products 5,081 7,120 7,188 6,256 3,319 1,223 1,014 non-ferrous metals 3,210 4,796 4,319 4,664 3,347 819 823 Machinery & transport eqpt 37,408 49,437 54,675 48,722 31,216 7,680 9,392 of which: electric & electronic mach 17,199 23,258 26,474 28,592 21,583 5,132 6,860 transport equipment 5,193 6,030 6,655 3,964 2,138 551 539 Miscellaneous manufacturesa 8,165 10,803 12,062 11,561 6,479 1,650 1,626 Total incl others 102,348 135,119 150,339 144,616 93,282 23,655 25,571 Exports fob Food, beverages & tobacco 2,396 2,803 2,918 2,841 2,580 595 564 Crude materials, inedible 1,430 1,790 1,608 1,780 1,541 408 331 Mineral fuels 1,746 2,472 3,866 5,349 4,595 1,292 331 Chemicals 6,339 8,944 9,148 10,666 10,235 2,637 2,377 Manufactured goods 22,949 27,568 26,959 29,097 28,584 7,079 6,108 of which: fabrics 8,109 9,203 9,330 9,580 7,850 1,924 1,610 metal goods 7,713 9,951 8,544 9,943 11,119 2,771 2,336 Machinery & transport eqpt 47,068 65,546 67,584 68,110 65,090 14,606 15,765 of which: electric & electronic products 25,189 35,017 34,021 36,745 34,284 8,485 9,754 passenger cars 3,839 6,551 8,255 8,635 8,167 1,488 1,571 ships 4,945 5,533 7,127 6,520 8,014 1,219 1,240 Miscellaneous manufacturesa 13,504 13,382 12,237 12,032 12,421 2,734 3,043 of which: clothing 5,681 4,969 4,226 4,194 4,653 874 969 Total incl others 96,013 125,058 129,715 136,164 132,313 32,232 30,342 a Including clothing and scientific instruments.

Sources: National Statistical Office, Monthly Statistics of Korea; Bank of Korea, Monthly Statistical Bulletin.

EIU Country Report 3rd quarter 1999 © The Economist Intelligence Unit Limited 1999 Quarterly indicators and trade data 51

South Korea: direction of trade ($ m)

Jan-Dec Jan-Dec Jan-Mar Jan-Mar Jan-Dec Jan-Dec Jan-Mar Jan-Mar Exports fob 1997 1998 1998 1999 Imports cif 1997 1998 1998 1999 US 21,625 22,805 5,204 5,821 US 30,122 20,403 4,831 5,839 Japan 14,771 12,238 3,096 3,256 Japan 27,907 16,840 4,202 4,878 China 13,573 11,944 2,929 2,891 Australia 5,894 4,642 985 1,219 Hong Kong 11,725 9,261 2,492 1,907 China 10,117 6,484 1,692 1,155 Taiwan 4,613 5,140 1,265 1,323 Saudi Arabia 7,153 4,384 1,210 920 Singapore 5,797 4,065 1,014 979 Indonesia 4,107 3,058 890 886 Malaysia 4,356 3,602 703 961 Germany 5,824 3,345 952 857 UK 3,984 4,179 881 922 Malaysia 3,283 2,211 599 680 Germany 4,753 4,009 875 851 Taiwan 2,421 1,671 381 602 Philippines 2,601 2,832 625 711 UK 3,365 1,763 484 541 Thailand 2,243 1,450 328 477 Singapore 2,417 1,713 417 531 Total incl others 136,164 132,313 32,232 30,342 Total incl others 144,616 93,282 23,655 25,571 Source: Bank of Korea, Monthly Statistical Bulletin.

North Korea: direction of trade (%)

Jan-Dec Jan-Dec Exports 1995 Imports 1995 Japan 27.9 China 32.6 South Korea 20.8 Japan 17.2 China 5.2 Russia 4.7 Germany 4.0 South Korea 4.3 Russia 1.2 Germany 2.9 Source: Institute for International Economics, Washington DC, The North Korean Economy.