Focus on Trade #23, part 4 of 8 (fwd)

[Robert Weissman <rob@essential.org>]

FOCUS-ON-TRADE #23, MARCH 1998
SPECIAL ISSUE ON THE IMF

Part 4 of 8

A regular bulletin produced by Focus on the Global South, Bangkok,
Thailand

Focus-on-Trade is a regular electronic bulletin providing updates and
analysis on regional and global trade and finance.  Although initially
concerned with APEC, the scope of the bulletin now extends to include
the World Trade Organisation (WTO), the International Monetary Fund
(IMF), the ASEAN Free Trade Area (AFTA), the Multilateral Agreement on
Investment (MAI) and any other acronyms that require critical
attention. Focus-on-Trade contains updates on trends in world trade,
with an emphasis on analysis of these trends from an integrative,
interdisciplinary viewpoint that is sensitive not only to economic
issues, but also to ecological, political, gender and social issues.
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IN THIS ISSUES

Taming the Tigers: The IMF and the Asian Crisis

by Nicola Bullard, with Walden Bello and Kamal Malhotra

This paper is published jointly by Focus on the Global South in
Bangkok and CAFOD in London for the Asia Europe Meeting (ASEM)being
held in London on 2 and 3 April 1998. The paper will be officially
released on 2 April in London by the two organisations. If you would
like a hard copy, please contact Focus on the Global South at
admin@focusweb.org or CAFOD at dgreen@cafod.org.uk.


The paper is in EIGHT parts:

Part 1: Executive Summary, Introduction 
Part 2: The IMF and Thailand
Part 3: The IMF and Indonesia
Part 4: The IMF and South Korea
Part 5. The social impact of the crisis
Part 6. The social impact of the crisis/The role of the IMF
Part 7: The role of the IMF
Part 8: Conclusions and recommendations, footnotes

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Part 4 of 8

THE IMF AND SOUTH KOREA

Teaching the tiger a lesson
On 30 September 1996, South Korea, ‘blessed with one of the world’s most
vibrant economies’,  said goodbye to the developing world and joined the
elite ‘rich man’s club’ of the Organisation for Economic Cooperation and
Development (OECD). 
The statistics behind South Korea’s promotion are impressive. Korea, which
had a per capita GDP less than that of the Philippines in 1965, could by
1995 boast per capita income of $13,269, compared to the Philippines’
$2,475. This represented a 770 per cent increase in just thirty years.
Annual economic growth over the same period averaged slightly over 7 per
cent and pre-crash figures placed South Korea as the 11th largest economy in
the world.
A 1996 United National Conference on Trade and Development (UNCTAD) report
described South Korea as "the outstanding example of an ‘emerging donor’
with the potential for making a significant contribution to official
development assistance." The report went on to note that since independence
in 1945 South Korea had received aid grants totalling $4.8 billion and that
"(It) is a country that has successfully broken out of aid dependence." 
Little more than a year later, South Korea is in virtual receivership,
having agreed to a $57 billion rescue package assembled by the IMF – an
amount more than ten times the total official development assistance given
to South Korea in the previous forty years.  Ironically, membership of the
OECD forced financial and other deregulation which were contributing factors
to the financial meltdown, by increasing inflows of foreign finance and
putting pressure on locally produced goods from less expensive and better
quality imports.
What went wrong?
Unlike the Southeast Asian economies, Korea, the classical "NIC" or newly
industrialising country, had blazed a path to industrial strength that was
based principally on mobilising domestic savings, carried out partly through
equity-enhancing reforms such as land reform in the early 1950s.  Although
foreign capital had played an important part, local financial resources
extracted through a rigorous system of taxation plus profits derived from
the sale of goods to a protected domestic market and to foreign markets
opened up by an aggressive mercantilist strategy constituted the main source
of capital accumulation.
The institutional framework for high-speed industrialisation was a close
working relationship between the private sector and the state, with the
latter in a commanding role.   By picking priority strategic sectors and
industries, providing them with subsidised credit (sometimes at negative
real interest rates) through a government-directed banking system, and
protecting them from competition from foreign corporations in the domestic
market, the state nurtured industrial conglomerates (chaebol) that it later
pushed out into the international market. This strategy was immensely
successful in the 1960s and 1970s, becoming the bedrock of South Korea’s
"miracle" industrialisation and export growth.
In the early 1980s, the state-chaebol combine appeared to be unstoppable in
international markets, as the deep pockets of commercial banks that were
extremely responsive to government wishes provided the wherewithal for
Hyundai, Samsung, LG and other conglomerates to carve out market shares in
Europe, Asia, and North America.  The good years lasted from 1985 to 1990,
when profitability was roughly indicated by the surpluses that the country
racked up in its international trade account.
Yet even by the early 1980s the inefficiencies and complacency of what had
until then been an extremely successful state-led strategy were becoming
evident, as the economy grew and the corruption in the state-bank-chaebol
nexus multiplied and became evident. Despite this, no action was taken to
reform the system by either politicians, economists or government
bureaucrats -- or for that matter, any of their international backers.
The Squeeze  
In the early nineties, the tide turned against the Koreans. Three factors,
in particular, appear to be central.  The first was the failure to invest
significantly in research and development.  The second was the massive trade
blitz unleashed on Korea by the United States. The third was membership of
the OECD, which forced Korea to adopt a more liberal stance towards foreign
capital and finance. These factors exposed the government’s inability to
prevent market failure, the conscious prevention of which had underpinned
much of the country’s success during the "miracle" decades. 
Instead of pouring money into R&D to turn out high-value-added commodities
and develop more sophisticated production technologies, Korea's
conglomerates went for the quick and easy route to profits, buying up real
estate or pouring money into stock market speculation.  In the 1980s, over
$16.5 billion in chaebol funds went into buying land for speculation and
setting up luxury hotels  and golf courses and by 1996, total bank exposure
to real estate reached 25 per cent, higher than either Thailand or Indonesia.  
Most of the machines in industrial plants continue to be imported from
Japan, and Korean-assembled products from colour televisions to laptop
computers are made up mainly of Japanese components.  For all intents and
purposes, Korea has not been able to graduate from its status as a
labour-intensive assembly point for Japanese inputs using Japanese
technology.  Predictably, the result has been a massive trade deficit with
Japan, which came to over $15 billion in 1996.
As Korea's balance of trade with Japan was worsening, so was its trade
account with the United States.  Fearing the emergence of another Japan with
which it would  constantly be in deficit, Washington subjected Seoul to a
broad-front trade offensive that was much tougher than the one directed at
Japan, probably owing to Korea's lack of retaliatory capacity. This included
a Plaza Accord-style forced appreciation of the South Korean won.
Hemmed in on all fronts, Korea saw its 1987 trade surplus of $9.6 billion
with the US turn into a deficit of $159 million in 1992.  By 1996, the
deficit with the US had grown to over $10 billion, and its overall trade
deficit hit $21 billion.
In addition, competition from other East Asian countries with cheaper labour
put pressure on Korea. All of these elements, combined with over-expansion
and over-specialisation, meant that by 1996 the top 20 listed companies in
Korea were earning a mere 3 per cent on assets, while the average cost of
borrowing had risen to 8.2 per cent. 
The average debt to equity ratio was a phenomenal 220 per cent (and up to
300-400 per cent in many cases) and the return on equity a minuscule 0.8 per
cent. It is hardly surprising that many companies stopped paying their bills.
 Desperate Measures 
In a desperate attempt to regain profitability, management tried to ram
through Parliament in December 1996 a series of laws that would have given
it significantly expanded rights to fire labour and reduce the work force,
along the lines of a US-style reform of sloughing off "excess labour" and
making the remaining workforce more productive.   
When this failed owing to fierce street opposition from workers, many
chaebol had no choice but to fall back on their longstanding symbiotic
relationship with the government and the banks, this time to draw on ever
greater amounts of funds to keep money-losing operations alive. 
The relaxation of controls which had accompanied South Korea’s compliance
with the requirements of OECD membership and the pressures of globalisation
led to massive short-term borrowing abroad by the banks and private sector
to maintain their profitability by rolling over loans that could not be repaid. 
Abandoning state controls also resulted in excessive investment in capacity
in a few industries by a number of chaebols, a problem which was aggravated
by the increasing autonomy and lack of transparency as the chaebols
transformed themselves into transnational corporations. 
The domestic banking system was not able to neutralise, or even optimise,
the impact of foreign capital flows by directing the funds into productive
and safe lending and eventually the excess liquidity spilled over into risky
and speculative investments. According to Yilmaz Akyüz of UNCTAD, the
problem is not necessarily the control and supervision of the banking
system, but the absence of instruments to restrict capital inflows to
control their impact on the macro economy. As he points out "these
instruments are usually discarded with the adoption of liberalisation
designed to remove ‘financial repression’."    
By October 1997, it was estimated that non-performing loans by Korean
enterprises had escalated to over $50 billion.  As this surfaced, foreign
banks, which already had about $200 billion worth of investments and loans
in Korea, became reluctant to release new funds to Seoul.  By late November
1997 Korea, saddled with having to repay some $66 billion out of a total
foreign debt of $120 billion within one year, joined Thailand and Indonesia
in the queue for an IMF bail-out.
Washington to Seoul, direct
The IMF wasted no time in responding to Seoul’s call for assistance. A team
of economists was promptly dispatched with instructions to negotiate the
terms of a Mexico-style bailout to restore "economic health and stability".
An important precedent was being set: for the first time an advanced
industrial country would be subjected to the tough IMF conditions usually
reserved for developing countries.
According to Michel Chossudovsky of the University of Ottawa,  the bailout
conditions had been agreed by the US Treasury, the US Chamber of Commerce,
Wall Street bankers and key European banks even before the team stepped on
the plane. According to one knowledgeable Korean source, the US Chamber of
Commerce actually wrote a significant part of the final agreement. 
The IMF mission wrapped up the deal on 3 December 1997. In just one week
they had cobbled together $57 billion in stand-by credits, comprising $21
billion from the IMF, $10 billion from the World Bank, $4 billion from the
Asian Development Bank and a total of $20 billion from leading industrial
countries, including $10 billion from Japan and $5 billion from the US. 
For the first time, several European countries promised credit to an Asian
country in trouble, signalling the global nature of the crisis (see Table
1). In return, the Korean government agreed to a long list of economic,
institutional, labour and industrial reforms meant to revive the gasping
economy. 
But what a week it was: the stock market and currency continued to tumble
and twice the Korean Finance Minister announced that the deal was struck,
only to see it unravel. Newspapers reported that the IMF negotiators were
nervous about dealing with an advanced economy with notoriously tough
negotiators. 
They were also blamed for the delays, apparently agreeing to terms that had
not been approved by their boss Michel Camdessus who, in turn, was under
strict instructions from the Fund’s most powerful member, the United States,
to strike a tough deal with Seoul.   
Meanwhile Korea’s foreign currency reserves were dwindling and the
government was faced with the prospect of default unless a deal was reached
quickly. Korea’s negotiating position weakened with each passing day. 
What’s in the IMF package
The IMF nimbly invented a new kind of loan, the ‘Supplemental Reserve
Facility’ to enable it to bypass its normal ruling that financial packages
are not allowed to exceed five times the recipient country’s IMF quota. Its
$21 billion contribution to the South Korea "rescue package"  exceeds the
previous record loan of $17.8 billion to Mexico in early 1995, and is more
than 20 times the quota available to South Korea. 
The deal ensured that South Korea would avoid default on the estimated $66
billion of the total $120 billion foreign debt  which was short term. Sighs
of relief were no doubt heard in the board rooms of Japanese banks which had
lent $23.4 billion to South Korea and were in no position to handle defaults
given the precarious state of their own banking system.  European lenders
were also exposed in South Korea - Germany’s total lending to Malaysia,
South Korea, Indonesia, Philippines, Taiwan and Thailand is greater than
that of the US. 
Like all IMF agreements the details are sketchy, but published information
reveals an interesting mix of the traditional IMF formula of fiscal and
monetary tightening, combined with some nods to the special interests of
foreign bankers and business, such as labour market reform,  further opening
the financial sector to US banks and fund managers, opening product markets
to Japanese goods and clearing the way for majority foreign ownership of
Korean companies.
According to the publicly available IMF document  the objective of the
programme is to "narrow the external current account deficit to below 1 per
cent of GDP in 1998 and 1999, contain inflation at or below 5 per cent, and
– hoping for an early return of confidence – limit the deceleration in real
growth to about 3 per cent in 1998 followed by a recovery toward the
potential in 1999."  
 Table 1: Approximate contributions to IMF loans in US dollars (billions) 
SourceIndonesiaThailandSouth KoreaInternational Monetary Fund10421Asia
Development Bank3.51,24World
Bank4,51,510Australia111Canada1,25France1,25Germany1,25Great
Britain1,25ItalyJapan5410Singapore51United States65South
Korea,5Indonesia5,5Brunei,5Hong Kong1Malaysia11China1TOTAL*4117,257*The
figures on the total IMF loan and credit packages vary, and accurate figures
for individual countries were not readily available.
 The key elements of the arrangement were:
- tightening monetary policy to ‘restore and sustain calm in the markets’
- raising interest rates from 12.5 per cent to 21 per cent to reign in
liquidity (interest rates rose to 32 per cent in December)
- controlling money supply to contain inflation at or below 5 per cent
- floating the exchange rate with minimal interventions
- maintaining a balanced or slight surplus budget (including the interest
costs of financial sector restructuring)
- increasing the value added tax (VAT) and expanding corporate and income
tax bases.
In addition to these fiscal and monetary policies, the agreement includes a
long list of institutional reforms, including establishing an independent
central bank (effectively severing the feed line between the government and
the chaebol), closing ‘troubled’ financial institutions, imposing Bank for
International Settlements (BIS) debt/equity ratios, and accelerating the
approval of foreign entry into the domestic financial sector, including
allowing foreign banks to establish subsidiaries.
Other key structural reforms include trade liberalisation, capital account
liberalisation, reviewing corporate governance and structure, and labour
market reform.
Less than a month after the initial agreement, following three weeks of
market and currency turmoil fuelled by concerns that the IMF programme would
not solve the economic problems and that the government would be unable to
meet its short term debt obligations of $16.3 billion (with only $10 billion
in foreign reserves), Korea received an emergency injection of $10 billion
to forestall default.
 Although critics noted that the IMF was too slow in disbursing funds, this
was partly because the US in particular was keen to extract additional
concessions from South Korea in return for the first tranche of cash.  After
the objective was successfully achieved by the IMF and the US, the first
instalment of cash was presented as a ‘Christmas gift’ - provided the
Government agreed to speed up economic reforms by:
- closing ailing merchant banks and reducing risky assets to make them more
attractive for foreign takeover
- opening the bond market by the end of 1997 
- liberalising interest rates
- opening domestic markets to cars and other key Japanese industrial goods
by mid-1999
- allowing foreign banks and stock firms to set up wholly-owned branches
ahead of schedule. 
Far from sharing seasonal goodwill, it seemed that the creditors were using
their considerable muscle to squeeze concessions from the down-and-out
Korean government even ones unrelated to the facts of the economic crisis.
Criticism of the IMF programme for South Korea has been harsh, prompt and
from all directions. Even before the deal was done, an editorial in the
Financial Times of 27 November said:
"both the government and the IMF must exercise care. Korea faces a private
sector financial crisis, not the sort of government-inspired payments
problem to which the IMF is traditionally used. Its current account deficit
is low and falling, and there is a history of balanced budgets. Stringent
fiscal restraint would compound the impact of private sector adjustment. The
government can afford to borrow to finance its banks rescue. Insisting on
tax increases and spending cuts to meet the cost would smack of overkill."
Yet, that is precisely what the IMF prescribed: fiscal restraint, tax
increases, spending cuts, monetary tightening and more financial liberalisation.
Harvard’s Institute for International Development director Jeffrey D. Sachs
was scathing in his attack on the IMF, accusing the Fund of secrecy, noting
that the "IMF insisted that all presidential candidates immediately
‘endorse’ an agreement they had no part in drafting – and no time to
understand."   
Outlining the contradictions between the prescriptions and the desired
outcome to, in the IMF’s own words, "limit the deceleration in real GDP
growth… followed by a recovery toward potential in 1999,"  Sachs wrote:
"The won has depreciated by about 80 per cent in the past 12 months, from
around 840 to the dollar to a (then) record low of 1,565 yesterday (10
December, 1997). This currency depreciation will force up the price of
traded goods. Yet, despite that the IMF insists that Korea aim for
essentially unchanged inflation rates… to achieve unchanged low inflation in
the face of huge currency depreciation Korea will need a monetary squeeze.
And this is indeed what the Fund has ordered. Short term interest rates
jumped from 12.5 to 21 per cent on the signing of the agreement, and have
since risen further". 
These elements together make for a rapidly contracting economy through a
surprisingly simple chain reaction: money is in short supply, credit is
expensive, companies can’t afford credit, companies collapse, people lose
their jobs, consumer demand declines, and so on. 
In addition, the troubled financial institutions in their rush to meet BIS
debt/equity ratios closed their lending services, refused to roll-over
existing loans and shored up their reserves in an attempt to push down the
ratios. 
The panic that ensued - as local enterprises (even profitable ones) found
their credit drying up and overseas creditors faced the prospect of defaults
and a rapid contraction of the economy – did nothing to "restore and sustain
calm in the markets". In fact, the IMF’s efforts were equivalent to fanning
the flames and in the days following the signing of the agreement, almost
before the ink was dry, the won tumbled even further. 
Jeffrey Sachs called the IMF’s response "overkill" which made no sense for
an economy that "was (rightly) judged to be pursuing sound macroeconomic
policies just months earlier."    He went on to suggest that the IMF could
have tried a more behind-closed-doors approach, encouraging Japan, the US
and Europe to provide credit to the Bank of Korea and roll-over short term
debts.
On the other hand, it does seem that the Government in Korea was less than
forthcoming in their information disclosure, hugely overstating foreign
currency reserves when, in fact, they were close to the bottom of the barrel.
Crushing the chaebol
One of the clear objectives of the IMF package is to dismantle the chaebol –
the huge family-run conglomerates which have spearheaded Korea’s fabulous
growth and increasing global presence through household names such as
Daewoo, Hyundai and Samsung. 
As a result of the expansionary policies described above, the chaebol are
also responsible for the vast majority of Korea’s debt. While unpopular with
both the public and workers, dismantling the chaebol per se is not
necessarily the correct solution, especially when the side effects are
likely to be massive lay-offs and declining productivity – at least in the
short term. 
In South Korea, the labour market reforms have created the greatest
anti-government backlash. Recalling the protracted battle of 1996 against
government legislation to introduce a bill allowing for the sacking of
workers (supposedly to increase efficiency) it is possible that this
particular clause was introduced with the agreement of both government and
the chaebol as a way of pushing through unpopular reforms that had been
previously tossed out by the parliament and to make the acquisition of
Korean firms more tempting for foreign investors.

The Korean Confederation of Trade Unions (KCTU) international secretary puts
it simply: "It is the workers, not the government officials or corporate
leaders responsible for our economic crisis who will have to bear the brunt
of any IMF measures."  
Chaebol officials, for their part, are also angry at the IMF’s imperious
approach, claiming to "detect a conspiracy by the US and Japan to use the
IMF to weaken their international competitiveness." 
Kim Dae Jung – just days before he was elected Korea’s new president accused
the government of surrendering economic sovereignty in return for IMF rescue
funds, saying that "Bowing to pressure, the government opened up the capital
market, leaving banks and other healthy firms helpless to foreign takeovers."  
At the time, Kim promised to re-negotiate the terms of the IMF deal if
elected. Five days later it was revealed that the IMF had requested all
candidates for the upcoming election to sign a written pledge of support for
the IMF package.  All  agreed, except for Mr Kim who replied saying that he
supported the agreement "in principle but subject to further
renegotiations."    
Although Kim did not formally take office until 25 February 1998, he and his
team have been the main negotiators with the IMF since his election. While
he appears to have gone along with the IMF package, his initial caution
reflected a strong popular reaction to the IMF deal, based on anger at the
government and chaebol for reckless expansion which emptied the banks and
created a dependency on foreign capital, the perception that economic
sovereignty was being handed, on a platter, to the IMF and the US, and that
workers would, at the end of the day, bear the brunt of the crisis. 
Martin Wolf, writing in the Financial Times of 16 December 1997, commented:
The question is not only whether the IMF programme will enable the Korean
authorities to ensure short-term foreign liabilities are met. It is also
whether it should do so. It is important to remember that the western
creditors chose to lend to the chaebol, which they have suddenly noticed are
burdened by heavy debt. They chose to lend the money to banks which, they
have apparently just realised, are heavily influenced by government.’
Despite such criticisms, in late January 1998 $25 billion of South Korea’s
short-term debt was restructured into medium-term debt after an agreement
was reached with a group of commercial bank creditors in New York City, but
not before the South Korean government extended a guarantee to cover $24
billion of that amount in the case of default by the private sector debtors. 
Furthermore, despite this government guarantee, the interest rate terms on
which the debt was restructured varied between 7-9 per cent while the LIBOR
international lending rate was only 5.6 per cent, resulting in the very high
average spread of approximately 2.5 per cent. 
The fears that a rescue package which absolved foreign investors from the
consequences of their poor investment decisions would merely encourage such
behaviour (otherwise known as moral hazard) has been amply borne out in
Korea. Saved from the brink of debtor default, and following a debt
moratorium supported by the heavily exposed banks, investors are now pouring
money back into the country – more than $500 million in stocks and bonds
entered in January alone and the stock market is the best performer in the
world so far this year. Investors have a new spring in their step having
achieved labour reforms, effectively dismantled the chaebol and gained the
radical market and investment openings they have desired for so long.
Yet the recovery remains extremely fragile and further financial
liberalisation runs the risk of turning the South Korean economy into one
which exchanges its earlier reliance on domestic savings for a new found
addiction to foreign capital, especially portfolio and other short-term
capital flows. This is likely to create another crisis, similar to the Thai
one, in the near future, a scenario that is already being discussed by some
Korean and foreign commentators and economists. 

END PART 4 OF 8




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Walden Bello                W.Bello@focusweb.org
Kamal Malhotra              K.Malhotra@focusweb.org
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Nicola Bullard              N.Bullard@focusweb.org
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