Plenty Of Land Mines Ahead For Seoul

The IMF rescue will almost surely spark a political melee

For nearly a week, South Korean Finance Minister Lim Chang Yuel shuttled day and night between the Blue House--Seoul's presidential palace--and the posh Hilton Hotel to negotiate with two intransigents as he attempted to defuse the country's biggest financial crisis in decades. On one side: a team from the International Monetary Fund insisting that Seoul immediately shut down shaky financial institutions as a condition for a $55 billion bailout. On the other: Korean officials facing the threat of a nationwide strike if it caves in to IMF demands.

The compromise that was reached on Dec. 3 won't satisfy hardliners in either camp. And it's likely to lead to months of economic turmoil and political infighting. In return for a package of emergency loans, Seoul agreed to slash public spending and reduce its economic growth target from 6% to 3% in 1998. But rather than immediately shutter a dozen virtually insolvent merchant banks, as the IMF insisted, Korea promised to close just one and give the rest another three months to sort things out. It also flatly ruled out, for now, closing any of its 25 commercial banks.

To Western critics of the deal, that seems to leave the door open for Korean politicians to postpone meaningful financial reform. Indeed, with presidential elections just two weeks off, opposition leader Kim Dae Jung, who is running neck-and-neck with ruling party candidate Lee Hoi Chang, has threatened to renegotiate the IMF deal if it leads to mass layoffs. Nor are there ironclad guarantees that Korea's overstretched conglomerates, or chaebol, will rein in their torrid expansion in everything from cars to computer chips.

Regardless of the deal's face-saving veneer, however, Korea Inc. clearly is in for a transformation. Foreigners, who have largely been shut out of playing a major role in the economy, will for the first time be able to buy a majority of shares in public companies and own stakes in banks. Despite a hue and cry from labor, which has organized Korean banks, failures of financial institutions seem inevitable. Lee Jeong Ja, head of research at hsbc James Capel in Seoul, predicts that four more merchant banks, in addition to the eight already "suspended," will close--as could up to four commercial banks.

weak position. This, in turn, "will send shock waves to the manufacturing sector," Lee says, as lenders are forced to call in credit lines from the chaebol and their suppliers. The slowing economy is expected to add up to 1 million workers to the unemployment rolls.

Foreign agencies should be able to enforce this discipline because Seoul's bargaining position is weak. Its banking system is on the brink of collapse, with an estimated $50 billion in bad loans. After a futile defense of the won, which has plunged by 23%, to around 1,250 to the U.S. dollar in the past month, foreign reserves are believed to be enough to cover less than two months of imports. Foreign banks have refused to roll over some $70 billion in short-term loans that come due within a year.

To close the deal, the IMF did agree to give Seoul more time before shutting down any institution that doesn't meet capital reserve requirements of 8%. The government doesn't want to push too fast because it fears sparking a cascade of more chaebol collapses. But to the IMF, egregious fiscal mismanagement can't go unpunished. Many new merchant banks, for example, lent heavily to conglomerates that already were leveraged to the hilt without demanding collateral. They also made huge, highly leveraged bets on risky bonds from Latin America and Russia, often using funds raised from short-term borrowings abroad. These moves were disastrous as chaebol started defaulting and the won melted down.

Forcing the IMF's terms down the throats of chaebol and the unions will still be tough. Representatives of 30 chaebol have stated they will oppose attempts to break them up. While the $93 billion Samsung Group grabbed headlines recently by announcing it will exit dozens of businesses, executives say that none of its biggest sectors--such as autos, chemicals, and semiconductors--will be involved.

Labor also is bracing for battle. If economic restructuring leads to a wave of layoffs and pay cuts, warns Korean Confederation of Trade Unions spokesman Chung Sung Hee, "we will launch a strong struggle against the government and the IMF." Such bluster is unlikely to move the IMF. But it could make South Korea's fiscal recovery a long and painful ordeal.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE