Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Onset, Turnaround, and Thereafter Thereafter and Turnaround, Onset, 1997 of Crisis Financial Korean The Kyu-Sung LEE Kyu-Sung The Korean Financial Crisis of 1997 The Korean Financial Crisis of 1997 ONSET, TURNAROUND, AND THEREAFTER Kyu-Sung LEE © 2011 The International Bank for Reconstruction and Development / The World Bank and the Korea Development Institute 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org All rights reserved 1 2 3 4 14 13 12 11 The findings, interpretations, and conclusions herein are those of the author and do not reflect the views of the World Bank, its Board of Executive Directors or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. 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All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522- 2422; e-mail: [email protected]. ISBN: 978-0-8213-8239-4 eISBN: 978-0-8213-8550-0 DOI: 10.1596/978-0-8213-8239-4 Library of Congress Cataloging-in-Publication Data Yi, Kyu-song, 1939– The Korean fi nancial crisis of 1997 : onset, turnaround, and thereafter / Kyu-Sung Lee. p. cm. Includes bibliographical references and index. ISBN 978-0-8213-8239-4 — ISBN 978-0-8213-8550-0 (electronic) 1. Financial crises—Korea (South)—History 20th century. 2. Korea (South)—Economic policy—1988– 3. Korea (South) Economic conditions—1988– I. Title. HB3817.5.Y5 2011 330.95195’044—dc22 2010047700 Cover design: Drew Fasick. This publication was made possible by the generous support of Citibank Korea Inc. and KORAMCO REITs Management and Trust Company Ltd. Contents Preface xiii About the Author xvii Abbreviations xix 1 The Unfolding of the Korean Financial Crisis 1 1996: A Year of Uncertainty 1 The Hanbo Bankruptcy and the Degradation in External Creditworthiness, January–March 1997 5 A Momentary Lull in Financial Markets, April–June 1997 8 A Looming Crisis in Financial Markets, July–September 1997 12 Onset of the Financial Crisis and the Request for an IMF Rescue, October–November 1997 21 Notes 34 2 Origin of the Crisis 35 Divergent Views of the Crisis 35 The Macroeconomy and the Financial Crisis 37 Korea’s Structural Weaknesses and Vulnerabilities 43 The Risks of Capital Liberalization 53 The International Financial Architecture and the Financial Crisis 60 Lax Crisis Management in Korea 69 Notes 71 3 Overview of Korea’s Postcrisis Responses 73 Crisis Recovery and Policy Challenges 73 The Implementation of Postcrisis Measures 82 Notes 85 vi contents 4 Initial Responses to the Crisis, December 1997 87 Actions by the IMF, December 3, 1997 87 Korea: Memorandum on the Economic Program 90 Actions Prior to the IMF Standby Arrangement 95 Banking Reforms 96 Averting National Insolvency 98 Notes 110 5 Securing Foreign Currency Liquidity and Laying the Groundwork for Reform and Restructuring, December 1997–April 1998 111 Securing Foreign Currency Liquidity 111 Capital Market Liberalization and the Expansion of Foreign Investment 116 Laying the Groundwork for Structural Reform 120 The Intensifying Credit Crunch and Mounting Unemployment 133 Notes 150 6 Restructuring Led by Business Closures and the Push for Lower Interest Rates, May–June 1998 151 The Recognition of Economic Reality 151 The Focus of Corporate and Financial Restructuring on the Closure of Failing Businesses 153 Lowering Interest Rates and Easing the Credit Crunch 164 The Contracting Real Economy and Deepening Labor Unrest 175 Notes 178 7 Completion of First-Phase Restructuring and Policies Aimed at Boosting Potential Growth, July–September 1998 179 Economic Outlook and Policy Challenges, Second Half of 1998 179 The Completion of the First Round of Restructuring 186 Expanded Unemployment Measures and Labor Union Resistance to Restructuring 208 The Russian Moratorium and the Fate of the Won 218 Policies for Robust Growth 226 Notes 235 contents vii 8 Getting the Economy Back on Track and Quickening the Pace of Restructuring, October–December 1998 237 Policy Challenges and the Shifting Economic Landscape 237 Instability in International Financial Markets and the Government Response 239 Quickening the Pace of Restructuring 248 Policies Aimed at Economic Revival 274 9 Restoring Financial Stability and Realizing Positive Economic Growth, January–June 1999 283 The Economic Policy Agenda for 1999 283 Forging Ahead with Restructuring 286 The Investment Grade Rating and the Supply of Foreign Exchange to Markets 305 Restoring Calm to Financial Markets and Resuming Positive Growth 314 10 The Settlement of the Daewoo Shock and the Expanded Economic Recovery, July–December 1999 327 Policy Challenges and Responses during the Second Half of 1999 327 Strategies for the Transition to a Knowledge- Based Economy 330 The Collapse of the Daewoo Group and Restoring Calm to Financial Markets 336 Pressing Ahead with Structural Reform 344 Economic Hardship among Low- and Middle-Income Households and the Government Response 360 Accelerating Economic Recovery and the Transition to Net Creditor Status 364 11 Korea’s Economic Renewal: Challenges and Solutions for the Transition to the Next Level 369 Questions about the Korean Economy 369 Diagnosis of the Korean Economy 370 The Challenges Ahead in Korea’s Economic Revival 389 The Reform of Korea’s Economic System 397 Note 413 viii contents References and Other Sources 415 Index 421 Figure 2.1 Trends in the Foreign Exchange Rates for Key Currencies, 1993–97 66 Tables 1.1 Interest Rates, Wages, Land Prices, and Logistics Costs, by Economy 3 1.2 Trends in Key Financial Indicators, Manufacturing, 1985–98 4 1.3 Trends in Short-Term Borrowing, Commercial Banks, First Half of 1997 7 1.4 Trends in Yields on Treasury Bonds in Major Countries 14 1.5 Nonperforming Loans of Commercial Banks, End of Period, 1997 15 1.6 Trends in Short-Term Borrowing by Commercial Banks, July–November 1997 17 1.7 Trends in Loans by Financial Companies, 1995–97 23 1.8 Trends in Securities Issues in Capital Markets, 1995–97 25 1.9 Overnight Borrowing by Commercial Banks, End of Period, 1997 27 1.10 Trends in Spreads on Global Bonds, 1997 29 1.11 Lines of Credit by Banks, 1997 30 1.12 Day-to-Day Foreign Currency Provision, November 1997 31 1.13 Trends in Foreign Currency Deposits by Residents, End of Period, 1997 32 2.1 Macroeconomic Indicators, 1993–96 38 2.2 Trends in the Real Exchange Rate, 1993–97 40 2.3 External Debt, 1992–97 41 2.4 Indicators of the Ability to Service External Debt, 1991–98 42 2.5 International Comparison of Corporate Financial Structures 45 2.6 Trends in the Balance of Payments, 1986–98 54 2.7 Ratio of Short-Term External Debt to Foreign Reserves, Crisis Countries 59 2.8 Balance of Payments, Republic of Korea and Five Asian Countries 63 contents ix 4.1 Disbursement Schedule of the IMF Credit 91 4.2 The Rollover of Short-Term External Debt among Financial Companies 100 4.3 Flow of Funds from Major International Financial Institutions, End of March, 1998 108 4.4 Short-Term Overseas Borrowing, by Region, End of Period, 1997 109 4.5 Movements in the W/US$ Exchange Rate, by Day, December 1997 110 5.1 Trends in Targeted and Actual Foreign Exchange Reserves, End of Period, 1998 115 5.2 FDI among Major Economies, 1997 118 5.3 Trends in Key Financial Market Indicators 140 5.4 Economic Trends, January–March 1998, Year-on-Year 142 5.5 Government Unemployment Measures (I) 143 5.6 Government Unemployment Measures (II) 147 5.7 Funding and Expenditures: Government Unemployment Measures, April 13, 1998 148 6.1 Forecasts of Key Economic Indicators by the Government and the IMF 152 6.2 BIS Ratio Requirements, End of Period, 1999–2000 160 6.3 Changes in Key Financial Indicators, Asian Economies and Russian Federation, April 16–June 16, 1998 164 6.4 Trends in Market Interest Rates, March–June 1998 170 6.5 Announcements of SME Credit Support by Banks 172 6.6 Key Financial Market Indicators, Second Quarter, 1998 175 6.7 Economic Trends, Second Quarter, 1998, Year-on-Year 176 6.8 Trends in Bankruptcies, Second Quarter, 1998 177 6.9 Trends in Labor Disputes, 1997 and First Half of 1998 177 7.1 Macroeconomic Forecasts by Domestic and Overseas Institutions, 1998 180 7.2 Signs of the Eroding Industrial Base, First Half of 1998 181 7.3 Comparison between the BIS Ratio and the Growth in Banking Account Loans, Year-on-Year 187 7.4 Ten Industries Targeted in the Big Deal 201 7.5 Corporate Restructuring Funds 205 7.6 Tax Support Measures, by Type of Restructuring 209 7.7