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The Outbreak of the 1997 Financial Crisis and Its Recovery

The Outbreak of the 1997 Financial Crisis and Its Recovery. Doowon Lee Professor of Economics Yonsei University, Seoul, Korea. I. Outbreak: Causes of Crisis. Doowon Lee, School of Economics, Yonsei University. I. Outbreak: International Comparison of Debt-Equity Ratios of Mfg Industry.

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The Outbreak of the 1997 Financial Crisis and Its Recovery

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  1. The Outbreak of the 1997 Financial Crisis and Its Recovery Doowon Lee Professor of Economics Yonsei University, Seoul, Korea

  2. I. Outbreak: Causes of Crisis Doowon Lee, School of Economics, Yonsei University

  3. I. Outbreak: International Comparison of Debt-Equity Ratios of Mfg Industry * Sources : Krueger and Yoo (2001). Bank of Korea, Bank of Korea Information (June, 2001, p.66) Doowon Lee, School of Economics, Yonsei University

  4. I. Outbreak: Debt Service Burden of Manufacture Company * source: The Bank of Korea website (www.bok.or.kr) Doowon Lee, School of Economics, Yonsei University

  5. I. Outbreak: International Comparison of NPL (unit: %) • Sources : Korea Financial Supervisory Service (www.fss.or.kr) ; The Banker (July 2000, July 2001), recited From www.seri.org (2001.6) and www.bok.or.kr • Note : * Average of all the commercial banks’ NPL. Korea has changed its criteria of NPL in 1999 according to international standard. The ratio of NPL to total loans increased after the adoption.Thus ‘13.6’ is value derived from new criteria and ‘8.3’ is based on previous criteria. ** Average of ten biggest commercial banks’ NPL. *** Average of five biggest commercial banks’ NPL. Doowon Lee, School of Economics, Yonsei University

  6. II. Crisis Recovery • Corporate and financial sector restructured • Three party agreement between labor, manager, and government • Export led recovery -> current account surplus • Exchange rate stabilized Doowon Lee, School of Economics, Yonsei University

  7. II. Recovery: General Review • Financial Sector Restructuring • M&A or Liquidation (Applying BIS criteria) • Liberalization • Removing Bad Loans • Corporate Sector Restructuring • Lower Debt/Equity Ratio • Improving Corporate Governance • M&A Support by Government Budget Domestic Economy • Establishment of Social Safety Net • Calm Labor Dispute • Create Jobs • Help the Unemployed Recovery of Korean Economy • Attracting Foreign Capital • FDI • Portfolio Investment External Economy • Increase Foreign Exchange Reserve • Decrease Foreign Debt Current Account Surplus Doowon Lee, School of Economics, Yonsei University

  8. II. Recovery: Summary of Reforms in Four Major Areas • Note : * BIS(bank of International Settlements) ratio measures the ratio of bank’s equity over a weighted average of • risky assets. The higher this ratio is, the more financially sound is the bank. • sources : Bank of Korea website (www.bok.or.kr); Korea Financial Supervisory Commision website (www.fss.or.kr); • Korea National Statistical Office website (www.nso.go.kr); Korea Development Institute website • (www.kdi.re.kr); Fair Trade Commission website (www.ftc.go.kr) Doowon Lee, School of Economics, Yonsei University

  9. II. Recovery: The Number of Financial Institutions • Note : * The number of security firms increased due to the establishment of foreigners-owned security firms. • Also, some merchant banks are transformed into security firms. • Sources : Recited from Figure 5 of Jones (2002), Financial Supervisory Service of Korea Doowon Lee, School of Economics, Yonsei University

  10. BIS ratio of Commercial Banks in Korea * Sources : Bank Management Statistics of Financial Supervisory Service of Korea Doowon Lee, School of Economics, Yonsei University

  11. ROE ratio of Commercial Banks in Korea * Sources : Bank Management Statistics of Financial Supervisory Service of Korea Doowon Lee, School of Economics, Yonsei University

  12. ROA ratio of Commercial Banks in Korea * Sources : Bank Management Statistics of Financial Supervisory Service of Korea Doowon Lee, School of Economics, Yonsei University

  13. II. Recovery: Summary of Reforms in Four Major Areas • sources : Bank of Korea website (www.bok.or.kr); Korea Financial Supervisory Commision website (www.fss.or.kr); • Korea National Statistical Office website (www.nso.go.kr); Korea Development Institute website • (www.kdi.re.kr); Fair Trade Commission website (www.ftc.go.kr) Doowon Lee, School of Economics, Yonsei University

  14. II. Recovery: International Comparison of Debt-Equity Ratios of Mfg Industry * Sources : Krueger and Yoo (2001). Bank of Korea, Bank of Korea Information (June 2001, Sep 2005) Bank of Korea, Principal Economic Indicators (May 2007) Doowon Lee, School of Economics, Yonsei University

  15. The Volume and Composition of Corporate Finance (Unit : bn Kr\, %) * Note : Numbers in parentheses are % ratios.* Source : A periodical, “경제포커스 (in Korean)” No.112, Samsung Economic Research Institute Doowon Lee, School of Economics, Yonsei University

  16. Proportion of Direct Finance Out of External Sources • Source : Hahm, Joon-Ho(2007), “금융시스템의 변화와 평가” presented at『A Decade after Financial Crisis : Process and Problem』, 2007 Seminar of Korean Economic Association (June 11th, 2007) Doowon Lee, School of Economics, Yonsei University

  17. II. Recovery: Summary of Reforms in Four Major Areas • sources : Bank of Korea website (www.bok.or.kr); Korea Financial Supervisory Commision website (www.fss.or.kr); • Korea National Statistical Office website (www.nso.go.kr); Korea Development Institute website • (www.kdi.re.kr); Fair Trade Commission website (www.ftc.go.kr) Doowon Lee, School of Economics, Yonsei University

  18. Painful Process of Laying-Off * Sources : Recited figure 3 of An article on East Asian Economies “Gold from the Storm”, Economist, June 28th 2007 Doowon Lee, School of Economics, Yonsei University

  19. II. Recovery: Unemployment Rate * source : Bank of Korea (http://www.bok.or.kr) Doowon Lee, School of Economics, Yonsei University

  20. II. Recovery: Summary of Reforms in Four Major Areas • sources : Bank of Korea website (www.bok.or.kr); Korea Financial Supervisory Commision website (www.fss.or.kr); • Korea National Statistical Office website (www.nso.go.kr); Korea Development Institute website • (www.kdi.re.kr); Fair Trade Commission website (www.ftc.go.kr) Doowon Lee, School of Economics, Yonsei University

  21. The Total Number of Public Officials (unit : persons) 6th “Civilian” “A People” “Participation” 5th Administration The Number of Public Officials by Successive Administrations * Sources : Maeil Business Newspaper, July 11th 2007. Doowon Lee, School of Economics, Yonsei University

  22. II. Recovery: Growth Rates of Macroeconomic Indices • Note : * The growth rates are compared to the same quarter of the previous year. • ** Figures for 2000 and 2001 are annual figures. • sources : Major Indicators of Korean Economy, Korea Development Institute, 2002. 3. 9., p.41 • Bank of Korea website (www.bok.or.kr) Doowon Lee, School of Economics, Yonsei University

  23. II. Recovery: Exports Have Been the Main Driver for Growth 45 45 Merchandise Exports (Percent change, y/y, 40 40 two-month average) 35 35 30 30 25 25 20 20 15 15 10 10 Sep- Dec- Mar- Jun- Sep- Dec- Mar- Jun- Sep- 02 02 03 03 03 03 04 04 04 Doowon Lee, School of Economics, Yonsei University

  24. II. Recovery: Exchange Rate Fluctuation (monthly)

  25. II. Recovery: Exchange Rate Movement (annual) * source : Bank of Korea (http://www.bok.or.kr) Doowon Lee, School of Economics, Yonsei University

  26. II. Recovery: Movement of KOSPI after the Crisis

  27. III-1. Role of Foreign Capital in the Outbreak of Crisis • Withdrawal of foreign capital, but in what channel? - Little FDI before 1997 - Stock market partially opened - Borrowing from foreign banks - Especially the loan from the Japanese banks Doowon Lee, School of Economics, Yonsei University

  28. Inflow & Outflow of Portfolio Investment * Source : Economic Statistic System, Bank of Korea Doowon Lee, School of Economics, Yonsei University

  29. Total Foreign LiabilitiesGovernmentMonetary AuthorityCommercial BanksExcetra (NBFI) Composition of Foreign Liabilities (mn, US$) * Source : Economic Statistic System, Bank of Korea Doowon Lee, School of Economics, Yonsei University

  30. III-1. Role of Foreign Capital in the Outbreak of Crisis • Were there no crisis if capital market was not liberalized? • Even before capital market liberalization, there existed insatiable demand for capital by conglomerates. • Excessive investment caused chronic trade deficit and increasing NPLs • Foreign exchange crisis could have been avoided if e was allowed to depreciate, which was politically difficult • Even if capital market was not liberalized, mounting NPLs would have caused domestic financial crisis. Doowon Lee, School of Economics, Yonsei University

  31. III-2. Role of Foreign Capital in the Recovery: Positive Aspect • Initially, it provided much-needed liquidities. • It boosted stock market, and partially eliminated the so-called ‘Korea Discount’ • Structural reforms and improved profitability • Protection of minority shareholders’ right • Improved transparency (case of SK) Doowon Lee, School of Economics, Yonsei University

  32. Inflow of Foreign Capital * Source : Economic Statistic System, Bank of Korea Doowon Lee, School of Economics, Yonsei University

  33. MSCI World Average PER (left scale) MSCI Korea PER (left scale) ( times) Korea PER / World PER (right scale) year Price Earning Ratio (PER) * source : Maeil Business Newspaper (June the 4th, 2007)

  34. (%) Institutes Corporate Individuals Foreigners Proportion of Foreign Possession in Stock Market * Sources : A Periodical “Securities & Futures, the May 2007 issue, Korea Exchange Doowon Lee, School of Economics, Yonsei University

  35. III-3. Role of Foreign Capital in the Recovery: Negative Aspect 1 • Consumer loans increased, and HH debt (fueled by the government policy of easy credit) accumulated that dampened consumption Doowon Lee, School of Economics, Yonsei University

  36. Corporate Loan Household Loan Proportion of Corporate Loan and Household Loan Out of Commercial Bank Credit • Source : Hahm, Joon-Ho(2007), “금융시스템의 변화와 평가” presented at『A Decade after Financial Crisis : Process and Problem』, 2007 Seminar of Korean Economic Association (June 11th, 2007) Doowon Lee, School of Economics, Yonsei University

  37. HH Debt Suppress Consumption * source : ecos.bok.or.kr Doowon Lee, School of Economics, Yonsei University

  38. III-3. Role of Foreign Capital in the Recovery: Negative Aspect 2 • Growth potential deteriorated • Less investment as banks are reluctant to lend • Threat of hostile take-over has prevented big companies from making large-scale and long-term investment: cash-hoarding, increased divident payment, buying its own shares. But, it is difficult to generalize. • Increased regulation, rapidly aging population, and instable labor relation are also responsible for deterioration of growth potential Doowon Lee, School of Economics, Yonsei University

  39. Falling Growth Rate

  40. Falling Growth Rate

  41. Five Asian Economies’ Investment ratio & Growth rate * Sources : Recited figure 1 of An article on East Asian Economies “Gold from the Storm”, Economist, June 28th 2007 Doowon Lee, School of Economics, Yonsei University

  42. III-3. Role of Foreign Capital in the Recovery: Negative Aspect 3 • PEF: Short-term speculative gains that were non-taxable: Case of Lone Star’s take over of Foreign Exchange Bank of Korea in 2003 • As part of the banking sector is under foreign ownership, public good nature of banking industry is under threat. Also, it is difficult to carry out the old-style industrial policy (case of The First Bank w.r.t. Hynix), which is not always a bad thing. • Some myths about foreign capital: herd behavior? Increased volatility? Increased divident/profit? Doowon Lee, School of Economics, Yonsei University

  43. Invasion of Private Equity Fund * source : Maeil Business Newspaper (June the 23rd, 2007) Doowon Lee, School of Economics, Yonsei University

  44. IV. Lessons of the Korean Crisis • Fixed e with capital market liberalization is difficult to maintain • After all, it was sound fundamentals of the Korean economy that enabled the recovery • Foreign capital is a two-edged sword. Also, it is difficult to define ‘foreign capital’ in one word as they are not homogeneous. • Sequential liberalization of capital market is necessary • Too much foreign exchange reserve can also be a problem Doowon Lee, School of Economics, Yonsei University

  45. V. Side Effects and Remaining Agenda • Low investment growth rate • Credit bubble and household debt -> weak consumption growth • Government owned financial institutions • Ballooning government debt: public fund and budget deficit • Worsened income distribution and poverty problem • Bi-polarization of the economy • Set back of reforms in labor market and government Doowon Lee, School of Economics, Yonsei University

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