Korea, facing a severe currency and financial crisis in late 1997, was forced to turn to the IMF for emergency funds. As part of the bailout conditions, the IMF required the Korean government to pursue macroeconomic stabilization and major structural reforms. The Korean government implemented drastic reforms in the corporate, financial and labor sectors in order to promote transparency, efficiency and flexibility. As the economic reforms were successfully implemented, the foreign exchange market began showing signs of improvement, resulting in the stabilization of the exchange rate and interest rates. The Korean economy began to show considerable improvement in the industrial activity indicators in early 1999.

A deepening contraction of private consumption, shrinking investment and sluggish export growth caused GDP in the first quarter of 1998 to contract by 3.9%. GDP continued its fall in the second and third quarters and 1998 posted a record low decline of 6.8%. However, events have dramatically changed as a faster-than-expected recovery is now underway. The economy grew 4.6 % in the first quarter of 1999, is expected to grow more than 6% in the first half of 1999 and is forecast to grow as much as 7% for the entire year, though official 1999 growth estimates remain at 4.3%. This upward trend is to continue in 2000 with the expected growth rate set at around 5%. The growth of the economy will occur largely due to the recovery of consumption helped by expansionary fiscal and monetary policies and improvements.

Private consumption, that had contracted 11.7% in the first half of 1998 due to the massive unemployment caused by the economic downturn, has continually improved since the beginning of this year. Private consumption recorded a 6.3% increase during the first quarter of 1999 compared to a 9.9% decrease recorded in the first quarter of 1998.

Facility investment recorded a 46.5% decrease over the first three quarters of 1998 due to the fall in domestic demand and economic restructuring. However, in May 1999, facility investment advanced a record 43.4% on a year-on-year basis, along with the economic recovery. Construction orders also increased, by 89.6%. Economic recovery has tended to be driven by consumption in the past months, but from May rising investment also began playing a significantly positive role.

After a sharp rise in the first quarter of 1998, prices showed remarkable stability for the rest of the same year, due to the stable exchange rate of the Korean won against the US dollar, the sharp contraction in domestic demand and the decline in international raw material prices. In November 1998, the year-on-year rates of increase of producer prices and consumer prices eased to 11% and 6.8%, respectively.

Thanks to the steady won/dollar exchange rate and a continued fall in the prices of raw materials, consumer prices remained stable in the first half of 1999, with only a 0.7% increase from January to May 1999. Meanwhile, producer prices declined an average of 3.4% in the first half from the same period of a year earlier.

By December 1998, the number of employed workers fell by 5.6%. The number of employees in the agriculture, forestry and fishery sectors fell by 1.8%, while the number of employees in the manufacturing and services sectors fell by 12.5% and 4.0%, respectively. The overall unemployment rate increased to 7.8% (seasonally adjusted 7.9%) by the end of 1998 as a consequence of the economic recession and restructuring in the public and private sectors that effectively blocked the hiring of new workers.

However, thanks to the improving economic conditions, by May 1999, the unemployment rate decreased to 6.5%, after peaking at 8.7% in February. Despite the recent improvements, comprehensive efforts are needed to ensure an adequate social safety net to meet the social challenges of unemployment, an inevitable by-product of the restructuring process.

The current account balance was reversed from an US$6.2 billion deficit in 1997 to a US$40.05 billion surplus in 1998. The unprecedentedly large surplus was almost entirely due to a sharp decline in imports. Exports decreased by 2.8%, while imports plummeted 35.5% in 1998. The service balance was also in surplus due to a surplus in the travel balance. With the increase in remittances by foreign residents of Korea, the current transfers balance also recorded a significant surplus.

However, from January to June 1999, the current account surplus was reduced to US$13.6 billion from US$21.0 billion recorded in the same period of the previous year due to the recovery of the domestic economy and an increase in imports. Also, the service account balance reversed, becoming a deficit due to the increasing number of Koreans travelling overseas and increasing freight costs caused by increasing imports.

Korea’s total external liabilities, defined as long term debt plus short term debt including both public and private sectors, were diminished for the first half of 1999. As of end of January 1999, Korean external liabilities posted US$147.03 billion, down by US$2.32 billion from December 1998. In line with the downturn in January, external liabilities reached US$145.43 billion in February, US$142.7 billion in the end of April 1999. In March 1999, there showed a slight increase in external liabilities that amounted to US$145.52 billion. This was mainly due to the rise of short-term debt, which was up 0.9% from February. In March, short-term debt occupied 21.9% in total external liabilities.

Following its huge depreciation in the end of 1997, the won quickly recovered to the won/dollar rate of 1300-1400 by the second quarter of 1998 and continued to slowly appreciate to a won/dollar rate of 1,200s in June 1999. The continued strength occurred despite the strong dollar and weak yen. The won has been strengthening mainly due to the continuous current account surplus and the rise in foreign capital inflow coming from FDI.

From January to December 1998, total FDI in Korea amounted to US$8.9 billion, a 21.25% increase over a year earlier. As the restructuring process in every field of Korean economy has been going well, FDI flowed into main industries such as the electronics, telecommunications, petrochemical and financial services.

In the first quarter of 1999, there were 389 committed foreign direct investments that provided a total investment of US$2.0 billion. This is a 26.3% increase in the total number of cases and a 250.3% increase in the total amount of FDI in comparison to the first quarter of 1998. In addition FDI amounted to US$811 million in April 1999, a 10.36% increase over the previous month. During the first quarter of 1999, foreign investment through acquiring newly issued stocks and participation in capital increase, amounted to 321 committed cases of FDI that equaled a total amount of US$1,512 million and accounted for 75.4% of the total foreign investment.

In order to bring the economy out of recession and to accelerate the restructuring process, the Korean government has redirected its policy focus to one of expansionary fiscal measures. The second supplementary budget passed in September increased the deficit target for 1998 to 5% of GDP. Fiscal policy in 1999 will be mainly focused on stimulating the real economy. The government had previously projected a budget deficit of 5% of GDP in 1999 but thanks to rising tax revenues, that projection has been revised to 4% of GDP. Revenues are expected to surpass previous estimates by 5 trillion won (US$4.29 billion).

The increased tax revenue will be used to reduce the budget deficit and support wage earners and the poor. The government had earlier expected the government budget to strike a balance in 2006, but it expects to achieve a balanced budget two to three years earlier than expected if the economy continues along its path to recovery.

Monetary policy has been eased substantially with rates now well below their pre-crisis levels. Interest rate policy has continued to be conducted in a flexible manner with upward and downward adjustments being implemented based on existing situations. Interest rates have been reduced significantly to support the recovery from the currency crisis. One-day call interest rates recorded 6.35%, 5.55%, 4.98% and 4.78% respectively from the months of January to April 1999. This is in striking contrast with interest rates of 25.34% in January and 25.2% in February 1998. In line with the decline in interest rates, the 91-day CD yield rate and the 3-year corporate bond yield have been on a similar trend for the first half of 1999. M2 money supply has grown steadily for the first half of 1999. In detail, M2 increased 26.3% in January, 29.9% in February, 33.6% in March and 34.5% in April.

Low interest rates are expected to continue for the last half of 1999. The central bank will pay greater attention to the stable management of the money supply in light of a recent surge in liquidity at non-bank financial firms and a jump in the inflow of foreign stock investment funds. The sharp rise in liquidity could increase the total money supply, spark a rise in asset prices and thus fuel inflationary expectations. In order to keep any inflationary pressures from materializing, the central bank will closely monitor the movement of funds among financial markets, wages, stock prices and real estate prices.

Despite the slowing growth of the world economy, the Korean economy is expected to enjoy positive growth of 7% in 1999. As stated earlier, this is largely the result of the government’s expansionary fiscal and monetary policies. In particular, due to the expansionary policies that have been activated recently, private and government expenditure will increase slightly. With steady recovery from the crisis, the Korean economy is estimated to grow by nearly 5% in 2000. However, the strength and speed of recovery and the resumption of sustainable growth will greatly depend on both domestic confidence in the restructuring programs and the international economic environment

Korea’s current account surplus will fall to around US$7 billion in the second half of 1999, and the economy is expected to attain its current account surplus target of US$20 billion for 1999. Helped by the rapid economic recovery, private consumption is expected to surge by 6.4% in 1999, compared with a decline of 9.6% a year earlier. Annual consumer price inflation is forecast to be 1.8% in 1999, much lower than the 3% set in the latest consultation with the IMF, and 2.0% in 2000. Unemployment is targeted to be reduced to 6.0% in 1999 and to stay at around 6.0% during 2000.

Through furthering the reach of the market mechanism in its economy, Korea will strive to maximize its growth potential. By 1999, the Korean economy will restore full economic stability and the year 2000 will mark the beginning of a new phase of sustainable growth with increased productivity and global competitiveness.

The Korean government continues its efforts to consolidate and recapitalize the banking sector. As of January 1999, five commercial banks have had their operations suspended and 99 other financial institutions have been closed. The government has mobilized fiscal resources totaling 64 trillion won to support viable financial institutions for recapitalization and the disposal of non-performing loans. Meanwhile, the banks have intensified their own rehabilitation efforts, including mergers and acquisitions. Most significantly, Korea First Bank was auctioned off to a U.S.-based consortium, and a similar deal for Seoul Bank is near conclusion. The integration and coordination of the supervision and prudential regulation of the financial sector have been furthered by the formation of the Financial Supervisory Service on 1 January 1999.

A number of non-viable firms have been forced to close, while the process of corporate workouts with creditor banks has begun for viable firms. The top five chaebol and their creditor banks have formulated capital structure investment plans that focus on reducing debt-equity ratios and the swap of affiliates between groups. Important progress has been also made in restructuring the 58 other top chaebol under the debt workout framework established in collaboration with the World Bank. Institutional standards for corporate governance, transparency and accountability have been greatly improved.

Public sector reform and labor market flexibility

Public sector reform has been advanced by the downsizing of government bodies. Labor market flexibility has been enhanced through the Tripartite Accord between labor, business, and government.

The government completely removed the foreign equity ownership ceiling in May 1998; allowed complete freedom for foreign investors to make hostile mergers and acquisitions from May 1998; rendered complete freedom for foreigners to invest in local bonds and short-term money market instruments, and liberalized foreign exchange transactions from April 1999.

Source: Data are as submitted by member economies, unless otherwise specified.

Table 2. Forecasting Summary (% change from previous year)

Note: The IMF forecast is from the World Economic Outlook (IMF, April 1999). The ADB forecast is from the Asian Development Outlook (1999). The OECD forecast is from the OECD Economic Outlook (OECD, June 1999).