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PAYING DIVIDENDS
Although still in progress, Korea's reform program is already showing benefits, as the national economy looks set to register steady growth this year

Korean gross domestic product (GDP) contracted by 6.6 percent in 1998 as the financial crisis took hold. However, the economy underwent a rapid "V-type" recovery over the following two years, registering GDP increases of 10.7 percent and 9 percent in 1999 and 2000, respectively. Most of the nation's macroeconomic indicators returned to pre-crisis levels last year, the balance of payments running a surplus of $12.1 billion, foreign investment achieving a record $15.6 billion and foreign reserves soaring to $96.2 billion.

Against this backdrop, the Bank of Korea has recently announced it will completely pay off $5.8 billion in stand-by loans borrowed from the International Monetary Fund (IMF) by August this year, ahead of the originally scheduled date of 2004. In making this decision, the central bank judged the country would face no particular problem in regard to foreign currency as Korea is expected to record a trade surplus this year and make further gains in attracting foreign investment. All told, Korea is positioned to graduate completely from the IMF's standby assistance program.

The steady progress in efforts toward corporate restructuring in the four major sectors including banking, business, government and labor plus the steady rise in exports have enabled the nation to effectively comply with the terms of the IMF program. For the past three years, the corporate reform effort has focused on liquidating nonviable financial companies, enhancing corporate financial health, maintaining industrial peace while boosting the flexibility of the labor market and expediting administrative deregulation.

Some 480 nonviable financial companies were exited from the market while major conglomerates like Hanbo and Daewoo were forced into collapse. In addition, the need for market trust as a prerequisite for corporate survival has gained further significance while the rise of joblessness to massive proportions has emerged as new social problem. Overall, the general consensus throughout Korean society is that the changes that have taken place over the past three years have been more significant and far-reaching than any that have occurred over the last 30.

Despite the outstanding economic performance over the past three years, the outlook of the Korean economy for 2001 is not particularly bright. For instance, growth in consumption, investment and exports since the fourth quarter of last year have slowed, heralding a possible economic downturn.

In regard to external factors, the United States economy has shown signs of heading towards a hard landing and the steady fall in prices of semiconductors has dampened export prospects. Uncertainty surrounding domestic corporations has intensified, resulting in a bearish stock market and a virtual drying up of the financial market as banks have become increasingly less willing to extend loans to corporate customers. This has raised the growing prospect of a credit crunch throughout the corporate sector while domestic consumption has remained essentially frozen.

In consequence, some observers predict that the nation may face another crisis. Most analysts, though, are of the notion that a crisis of the type that hit the nation in December 1997 is unlikely, given the level of foreign reserves, the growing current account surplus, and the steady rise in foreign investment.

Further, they point to such negative developments as an indication to strengthen the Korean economy by completing the process of restructuring in the corporate and financial sectors. Korea thus stands at a crossroads and decisions taken this year will be critical as to whether sustained growth will be possible.

A Commitment to Reform

President Kim Dae-jung during a New Year press conference Jan. 12th announced his government's commitment to pursuing reform in the corporate, financial, public and labor sectors. He said the successful execution of reform would be the only way to guarantee a second economic recovery. Complete and far-reaching reform, said the president, would eradicate the uncertainty in financial markets and thus win the trust of investors, domestic and foreign, although it would require the public and business to "bite the bullet."

The Korea Stock Exchange index rallied on the president's comments, rising to 583.6 points, up 15.6 percent on the 504.6-point level at the end of last year. This was largely due to  an inrush of orders from foreign investors wanting to "buy Korean" with the expectation of gains resulting from greater efficiencies through enterprise and financial sector restructuring.

The Korean government plans to set up a basic framework for reform in the four major sectors by the end of February this year. A feature of the reform program will be the ability to exit nonviable companies from the market at any time in accordance with market principles.

In fact, indications are that reform in the financial sector is already bringing market pressure to bear  on marginal enterprises. Through cuts in new loans, 52 enterprises in 2000 were excluded from the market including Woobang and Dong-Ah Engineering and Construction, while 12 subsidiaries of the Daewoo Group were put under court receivership. Daewoo Motor is mapping out a self-rescue program in consultation with its union with the aim of registering profits next year, while negotiations are continuing with potential purchaser, General Motors. Daewoo Corporation and Daewoo Heavy Industries were spun-off while the TDX and the electronic parts  divisions of Daewoo Telecom were sold off. Disposal plans for seven other affiliates including Daewoo Electronics were also completed.

In order to prevent corporate insolvencies and their attendant fallout, the government plans to set up a preventive supervisory and "permanent expulsion system." Under these new systems, enterprises with symptoms of insolvency may be forced out of the market as soon as their difficulties begin to manifest themselves at an early stage. The initiatives are expected to advance the process of corporate restructuring as they would avoid impacting  seriously upon the financial sector in contrast to the existing system under which a large number of firms are exited at once.

The government has also enforced measures to enhance managerial transparency and improve the ownership structure as a means of effectively curbing unilateral management action by chaebol owners. Toward that end, the rights of outside directors and minor shareholders will be strengthened by making it easier to launch a class action suit and enhancing the class voting system. With the aim of improving overall financial transparency, outside accountants will be selected through a committee composed of independent auditors.

As mentioned, a growing number of financial institutions are refusing loans to corporate customers and to purchase their bonds since they are opting for security over the promise of quick and huge profits. The result has been that the normal operation of the financial market has been hindered and facility investment has slowed. The major goal of Korean financial sector corporate restructuring has been to enhance the soundness of the financial institutions and normalize their intermediary roles. To that end, the Korean government gained approval in December last year from the National Assembly for an additional 40 trillion won to fund the restructuring process in the financial sector.

Six ailing commercial banks Hanvit, Pyunghwa, Kwangju, Cheju, Kyongnam and Seoul had their entire stock scrapped and received financial injections to the sum of 4.1 trillion won. Five of them are to be amalgamated into a financial holding firm that will come into being during the first quarter of this year. Seoul Bank will be included in the financial holding company should efforts to sell it to a foreign buyer during the first half of this year end in failure.

The government is also encouraging healthy banks to pursue voluntary mergers and acquisitions and integrate their separate business divisions in order to gain competitiveness. Last December, Kookmin Bank and Housing & Commercial Bank signed a memorandum of understanding (MOU) and are proceeding with negotiations to merge, a harbinger of the rise of a gigantic bank with 150 trillion won in assets.

The government is also considering publicizing various bank indices such as self-equity and asset profit ratios every quarter so that the public at large can judge individual bank's soundness and profitability. Through the Korea Development Bank (KDB), it is pursuing a program to purchase bonds of certain companies to help them more easily raise capital.

In the public sector, the government reduced the workforce by 130,000, 18.7 percent of the total over the past three years and is  planning to cut another 12,000 jobs this year. The privatization of six public enterprises including Korea Heavy Industries and Construction (Hanjung) and Pohang Iron & Steel Co. (POSCO) was completed last year. The government is also pressing ahead with plans to wrap up the privatization of other public companies this year. This will include spinning off the power generating division of Korea Electric Power Corp. (KEPCO) within the first half of this year and expanding the foreign stock ownership ceiling in Korea Telecom to 49 percent from the current 33 percent. The government will also cooperate with economic organizations and foreign investing companies on a permanent basis with the aim of furthering regulatory reform to promote competitiveness.

In the labor sector, the government  is seeking to maintain industrial peace while enhancing flexibility in the labor market. The labor disputes that occurred in KEPCO and Korea Telecom and the financial sector involving Kookmin Bank and H&CB came to  an end without serious consequences.

2001, a Growth Year

A number of research institutes, foreign and domestic, are bullish  on Korea for 2001. They include  the Organization for Economic Cooperation and Development (OECD), Wharton Econometric Forecast Associates (WEFA), the Bank of Korea, Samsung Economic Research Institute (SERI) and LG Economic Research Institute. They predict the Korean economy will grow by 5 to 6 percent this year with a trade surplus ranging from $4.5 billion to $10.7 billion should the ongoing corporate and financial sector restructuring program be successfully accomplished. They estimate the inflation rate would be 3.5 percent while unemployment would hover between 3.7 and 4.3 percent.

Growth of 5 percent to 6 percent means less expansion than the 9 percent experienced last year, but the figure also represents a more "natural" growth rate. Given this background, the national economy is expected to undergo a soft landing after the technical rebound in the wake of the financial crisis.

Overall, the Korean economy is expected to experience a downturn in the first half and begin a recovery during the latter half. The expansion of consumption, investment and exports, which led economic growth last year, have slowed as of the fourth quarter of last year. These economic indicators are expected to remain sluggish until the first half of this year.

In the corporate area, intensifying uncertainty has prompted the banks to avoid providing new loans to corporate borrowers, so resulting in contracted facility investment. Domestic consumption has remained frozen amid growing anxiety over unemployment and the so-called "negative wealth effect" on account of the bearish stock market. Exports have also remained lackluster, buffeted by the steady rise in oil prices, the  sluggish U.S. economy and the fall in semiconductor prices. Overall, sluggish aggregate demand has acted as a brake on the Korean economy.

However, the national economy is expected to recover during the second half of 2001, should oil price hikes be curbed, chip prices stabilize and a soft landing be in store for the U.S. economy. Investment confidence is also expected to return in the event that the government's stimulation package begins to take effect in the second half, and the credit crunch is eased through successful corporate and financial sector restructuring.

An Export-led Recovery

Exports rather than domestic demand are expected to prompt national economic growth this year. The world economy is likely to experience lower growth this year than last, due mainly to the cooling of the U.S. economy. Nonetheless, growth is expected to be in the region of 4.2 percent, buoyed by economic recovery in Japan, the European Union and the less-developed nations. Further, global trade is expected to grow at a relatively high 7.8 percent, so brightening Korea's export prospects.

Exports to the U.S. were initially expected to remain sluggish because of economic slowdown in the U.S. However, with the lowering of the call interest rate by the Federal Reserve Board (FRB), plus President George W. Bush's possible tax cut, the U.S. economy's slide was curbed to some extent, improving the prospects for Korean exports to the U.S.

Also, recovery in the EU and Japan is expected to spur Korean exports to these regions.

By item, exports of information and telecommunication products such as computers, wireless communications devices and LCDs, are expected to maintain steady increases. Meanwhile, semiconductor prices are likely to stabilize in the latter half of 2001, due to a rise in demand for personal computers in the Asian market and the introduction by domestic makers of the 128MD chip.

The growth of imports is forecast to slow, impacted by the economic downturn and a likely easing in oil prices. The nation is expected to end the year with a surplus of anywhere between $4.5 billion and $10.7 billion, maintaining the trend of positive trade balances established in 1998.

PRICES STABILIZATION,
THE KEY TO AN ENHANCED BUSINESS ENVIRONMENT

The expected stabilization of wages, interest rates and commodity prices is likely to ameliorate the business environment.

While wages hiked by 8 percent last year, a rise of only 4 percent is projected for 2001 since the steady rise in the number of jobless in the wake of the corporate restructuring drive has dampened the upward pressure on wages. Further, business is limited in its capacity to pay excessive wages. Also, housing prices have eased, lowering living costs; their hitherto steady rise had been the backdrop of the demand for wage hikes prior to the financial crisis.

Structural changes in the labor market have also contributed to stabilizing wages. In the past, the lack of available human resources had intensified wage hike demands. As a surplus in qualified workers has begun to appear, such demands have ebbed. Due to the increasingly competitive labor market, it has become almost impossible to demand wage hikes that surpass rises in productivity.

Interest rates are likely to decrease to the 6 to 7 percent level as investment dwindles in the face of the economic slowdown. Helping the trend is the fact that banks are opting for low-risk bonds at concomitantly lower rates of interest. They are also offering lower deposit interest rates to offset their drop in profits occasioned by their current preference of lending solely to low-risk clients.

Despite the envisioned low level of interest rates, domestic business with low credit ratings are expected to have difficulties in obtaining bank financing as the latter have been increasingly reluctant to extend loans to them. Accordingly, the foreign enterprises in Korea, which generally have more stable financial resources at their disposal are expected to maintain the upper hand in competition with their domestic competitors.

Commodity price inflation is forecast to stabilize at close to 3.5 percent, amid the fall in aggregate demand and slowing wage increases, despite possible upward pressure from costs. All told, inflation is not envisaged as a major problem in 2001.

Appliances, IT,
Telecoms Set to Boom

 The electronic home appliance, computer, communication device and communication service industries are likely to boom in 2001. Conversely, the petrochemical, automobile and construction industries are projected to still be in the grip of the economic downturn.

The electronic home appliance industry is expected to maintain a steady growth of 9.9 percent due mainly to brisk sales of digital home appliances. Domestic sales are likely to remain weak because of the  economic slowdown and market saturation. On the other hand, sales of high-functional multi-purpose goods and digital products are forecast to lead the industry and record growth of 11.5 percent. Overseas shipments are forecast to increase by 9.1 percent from a year earlier, boosted by exports of digital television sets, set-top boxes, DVD players and MP3 players. Sales to industrialized markets are forecast to remain brisk.

The computer industry is forecast to grow by 13 percent despite a  torpid domestic market and reduced demand for personal computers in the United States, while domestic consumption is likely to be up 12 percent from a year earlier. Exports are likely to surge 23 percent, boosted by aggressive marketing  of computer main bodies, LCD monitors and DVD drives.

The telecommunications service industry is expected to grow by 20 percent to 30 trillion won in 2001, due to the rapid adoption of ultra-high speed Internet and wireless Internet services. In the fixed telecommunications area, the share of the ultra-high speed Internet service market will continue to increase. In the wireless market, wireless Internet services are expected to undergo an upsurge with the launch of IS-95C mobile telecommunications services this year. When the IMT-2000 service also comes on stream in 2001, the telecommunications device market is forecast to grow by 14 percent.

Domestic demand for fixed devices is likely to soar phenomenally with the spread of high-speed Internet services. At 11 percent, growth in this area is projected to be the strongest in the sector of telecommunications devices. Exports are estimated to increase 19 percent thanks to booming sales of CDMA and GSM mobile phone sets and CDMA-related equipment.

The semiconductor industry is expected to grow by 8 percent. The DRAM market except flash memory and SRAM chips will remain slack while non-memory chips are forecast to perform outstandingly. The flattening PC market will likely worsen the situation facing DRAMs makers. Memory chips like flash memory and SRAMs, though, are projected to record growth of 22 and 13 percent, respectively, as sales of communication equipment and digital home appliances boom.

Petrochemical output is forecast to grow by only 1 percent because of weak domestic and overseas sales. Domestic consumption is expected to be 9.40 million tons this year, almost the same as in 1999, due to poor business conditions in major client industries such as automobiles and construction. Synthetic material sales are expected to remain sluggish, while those of synthetic resin and synthetic rubber will undergo a slight increase.

Automobile production will increase slightly by 2.6 percent from a year earlier, due to the economic downturn and poor domestic consumption. Domestic sales are likely to be off 2 percent as purchasing power ebbs, while exports will likely increase 4 percent due to aggressive marketing tactics.

The domestic construction industry is forecast to sustain growth of a mere 2 percent, as orders for public projects slow and demand for housing and non-residential buildings contracts. Public sector demand is expected to be off 1 percent, due to the limited budgets of the central and provincial governments. Private sector orders are likely to be up 3 percent year-on-year as housing construction and facility investment falls, despite the expansion of social overhead capital projects. Bearish conditions are forecast for the distribution sector due mainly to weak retail sales. Department stores sales are expected to sink by 8 percent due to aggressive sales strategies employed by the discount stores. The discount chains are likely to achieve growth of 15 percent from a year earlier, as they expand their store-building programs into the provinces and consumers increasingly appreciate their low-price marketing strategies.

Updated January 3rd 2001, By Jang-Hee Lee ( asia@kotra.or.kr)