Can Korea Battle Back?

Seoul needs to get serious about reform. So far, it's balking

Back in 1989, a senior executive at Hyundai Motor Co. had an astonishing vision. His fledgling auto company, he reckoned, would overtake General Motors Corp. in size, and his country's economy would grow to rival that of the U.S.

For a time, such hubris seemed almost believable. The Korean people, with a combination of gritty industriousness and fierce pride, achieved an economic miracle. They managed 8.2% annual growth over three decades and raised annual incomes from $80 in 1960 to over $10,000 today. A poor farming country transformed itself into an industrial powerhouse in a generation. Yet today, the dark side of that amazing story is coming out. Korea's conglomerates, or chaebol, have grown to astonishing size. But they have borrowed recklessly to reach their goals, and did it at the expense of profits.

CURRENCY WOES. As a result, Korea is in the grip of crisis. Seven chaebol have collapsed or gone bankrupt. Banks that lent wantonly to all these companies hold at least $52 billion in bad debts--17% of their total loans. Sensing blood, traders have attacked the currency, driving the won from 844 to the dollar in January to almost 1,000 in recent days. Layoffs are pending, including 5,000 through attrition at mighty Hyundai Motor. And rumors are flying that the world's 11th-largest economy may be the next International Monetary Fund basket case. Says an economist at a state-financed think tank: "There are only two paths South Korea can take--rapidly carrying out financial reforms by itself [or] seeking help from the IMF."

Incredibly, the economy is still growing at 6%--down from its previously blistering pace but high by international standards. Yet 6% is too slow for the lumbering chaebol, which need double-digit sales increases to cover their debts. The banks have huge foreign loans, about $65 billion of which come due within a year. As the won slips, the loans get more expensive to repay.

To keep Korea growing, banks, chaebol, government policymakers, and labor unions will all have to change. Banks have to recapitalize and merge with each other. The surviving banks must stop feeding loans to the hungry chaebol and extend more credit to smaller entrepreneurs. The chaebol must focus on core businesses and profitable returns, not aggressive expansion. Labor unions, which have pushed up wages fivefold in the past 12 years, have to improve productivity and accept layoffs. Bureaucrats need to encourage mergers and acquisitions and let foreign companies buy Korean assets more easily. And the government has to back off from economic micromanagement.

Ordinary Koreans know something has to give. "The hardship is just beginning," says Song Hae Myung, a 43-year-old real estate agent in Seoul. "The government will have to open markets and introduce reforms to improve our competitiveness."

Seoul soon plans to take moderate steps to do that. It intends to create a Resolution Trust Corp.-style agency to buy up to $20 billion of dud bank loans in the next five years. It may also adopt a financial reform bill that toughens regulations and gives more independence to the central bank. Yet policymakers still hope the falling won will reignite exports and spark a recovery--a short-term solution at best. Because of global deflation, prices for Korean products are dropping. As a result, exports are growing 20% annually by volume, but export revenues are only growing 8%. The chaebol "cannot survive with this kind of growth," says Pohang Iron & Steel Co. (POSCO) Chairman Kim Mahn Je.

DEBT-EQUITY SWAPS. Alarmingly, the government's instinct to intervene remains strong. It's almost as if Korea is turning back the clock, reverting to the days of state capitalism rather than continuing with liberalization. The government nationalized Kia Motors Corp., whose debts were driving it inexorably to bankruptcy. The government put in its own chairman and told Korea Development Bank Ltd., Kia's main creditor, to forgive its loans to the carmaker and accept equity instead. Analysts think the government will try to arrange similar debt-equity swaps between beleaguered chaebol and their Korean lenders.

No real moves have been taken to break the corrupt alliance between the chaebol and the government or to tell workers that the iron rice bowl guarantee of lifetime employment is untenable. Instead, the country's elite is consumed with the runup to the Dec. 18 presidential election, producing a leadership vacuum. President Kim Young Sam is getting less than a 10% approval rating from the Korean people, and his administration has largely stopped governing. Rather than stating their economic policies, the presidential candidates are avoiding talk of the crisis. Says housewife Kim Yie Kyung, 39: "I'm worried that if the trend continues, the whole country will go under. The government should put aside political differences and concentrate on reviving the economy."

In one sign of hope, some companies are restructuring on their own. Since 1993, POSCO Chairman Kim has cut 20% of his workforce through attrition, even while increasing capacity. POSCO is rewarding staff with bonuses for their productivity. "It wouldn't sound like much in America or Hong Kong, but in Korea we are unique," says Kim. Partly as a result, POSCO expects a record $1.1 billion in net profits this year.

But many other Korean companies still seem slow to learn. Even in the midst of crisis, they are plunging into new businesses--and planning to borrow billions to do it. Hyundai has a rough road ahead to join the ranks of the world's top auto makers. Yet it plans to spend $5.6 billion on two steel mills--even though such moves drove three of its competitors into bankruptcy.

CREDIT CHECKS. To limit further corporate collapses, Korea's credit system needs a dose of modernity. Banks are just starting to think about basic functions like credit committees to approve loans. Previously they didn't bother, figuring that lending to well-known companies based on collateral--or a nod from the top--was enough. Over the years, the presidential Blue House used credit as a tool to control the chaebol, and make sure generous campaign contributions kept rolling in.

With their backs to the wall, companies are selling assets--and creating opportunities for foreign companies. Doosan, a beverage company that makes OB Beer, said on Nov. 10 it was selling its bottling operation to Coca-Cola Co. for $432 million--one of Korea's largest sales ever to a foreign investor. That allows Coke to bust up domestic supplier cartels and develop new sources for everything from aluminum cans to plastic bottles. Coke expects to save tens of millions of dollars on packaging alone.

Given the ominous signs of trouble in North Korea, it's imperative that Seoul shape up its economy. With the North's famine and potential for instability, it is likely that South Korea will have to bear the cost of absorbing its northern neighbor within a decade.

Korean officials want the international financial community simply to trust them to make the necessary changes. But investors aren't in a patient mood. If Korea doesn't act, the mighty chaebol could be starved of foreign capital--and reduced to little more than low-priced suppliers of commodity products. That would leave Korea a downmarket version of Japan, a supplier of middling goods rather than a high-tech powerhouse. Painful though it will be, a radical shakeup is Korea's best hope.

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