Korea's Crisis

Edging perilously near to meltdown, Seoul needs to get serious about reform. So far, it's balking

In 1989, two years after I moved to South Korea to write about its booming economy, I had a revealing conversation with a senior executive at Hyundai Motor Co. His fledgling auto company, he reckoned, would one day overtake General Motors Corp. in size, just as his country's economy would grow to rival that of the U.S.

Astounding claims--yet for a time, such hubris seemed almost believable. Korea's 46 million people, with a combination of gritty industriousness and fierce pride, achieved an economic miracle. Pulling themselves out of the debris of war, they managed 8.2% annual growth over three decades and raised annual incomes from $80 in 1960 to over $10,000 today. I was lucky to witness one of the most extraordinary episodes in economic history, where a poor farming country situated next to a threatening Communist dictatorship transformed itself into an industrial powerhouse in a generation.

Yet today, a more troubling side of that amazing story is coming out. Korea's conglomerates, the chaebol, have grown to astonishing size. But they have borrowed recklessly to reach their goals, at the expense of profits and economic prudence.

SIGNS OF GROWTH. As a result, Korea is now in the grip of a crisis. Seven of the chaebol have collapsed or gone bankrupt. The banks that lent to all these companies now hold at least $52 billion in bad debts--17% of their portfolios. Sensing blood, traders have attacked the currency, driving the won from 844 to the dollar in January to almost 1,000 in recent days. The central bank has spent precious hard currency to keep the won under the psychologically important 1,000 mark. Layoffs are on the way, including 5,000 through attrition at mighty Hyundai Motor. And rumors are flying that the world's 11th-largest economy may well be the next International Monetary Fund bailout case. Says a Korean 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."

Even if the IMF doesn't intervene, Korea is entering a perilous period. Incredibly, the economy is still growing at about 6% annually--down from the 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. Korea doesn't have much time to find the right track. Growth could shrink as the debt crisis worsens. Banks have huge foreign loans, about $65 billion of which come due within the next year. As the won keeps slipping, the loans get more expensive to repay. While Korean financial officials are confident foreign lenders will roll over loans, that is far from certain. Korea could get shut out of overseas capital markets just when it needs more foreign capital than ever.

To correct the problem, banks, chaebol, government policymakers, and labor unions will all have to adjust to these realities. Banks will probably have to recapitalize and merge with each other. The survivors will need to say no to chaebol hungry for more loans, while extending more credit to smaller entrepreneurs. The chaebol should 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 to help their companies out. They also have to accept layoffs. Bureaucrats need to encourage mergers and let foreign companies buy Korean assets more easily as a way of recapitalizing the economy. And the government must back off from its micromanagement of the economy.

None of this is easy, and it will take sacrifice. Ordinary Koreans know that 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."

Yet the government is not yet tackling the issues with sufficient might. Policymakers are still hoping that the falling won will reignite exports and spark a recovery. But that's just a short-term solution. Because of global deflation, prices for many of Korea's products are dropping. As a result, exports are growing 20% annually by volume, but revenue generated by exports is only growing 8%. The chaebol "cannot survive with this kind of growth," says Pohang Iron & Steel Co. (POSCO) Chairman Kim Mahn Je.

BACKFIRED. Alarmingly, the government's instinct to intervene remains strong. It's almost as if Korea is turning back the clock, reverting to the early days of state capitalism, rather than continuing with liberalization. As debt-heavy Kia Motors Corp. was heading inexorably to bankruptcy, the government stepped in. It replaced the chairman and told Korea Development Bank Ltd., Kia's main creditor, to forgive its loans to the carmaker and accept equity instead. The intervention backfired in the financial markets, spooking investors who had wanted Kia's assets sold off. Now, analysts think the government will try to arrange similar debt-equity swaps between beleaguered chaebol and their Korean lenders. One possible candidate: Ssangyong, which may not succeed in selling its troubled auto venture.

To be fair, the government is trying to change. It is setting up an agency that will buy bad loans from banks and give banks cash instead. The agency aims to buy up to $20 billion of loans in the next five years and then resell them to investors. Seoul soon plans to take moderate steps to spark mergers, allow foreigners to buy bigger stakes in Korean companies, and relieve loan pressure. A financial reform bill that toughens regulations and gives more independence to the central bank may also be voted in--but various ministries are quarreling over the provisions.

Yet no real moves have been taken to break the problematic alliance between the chaebol and the government or to tell workers that the iron rice bowl guarantee of lifetime employment is financially untenable. Instead, the country's elite is consumed with the runup to the Dec. 18 presidential election, producing a vacuum in leadership. President Kim Young Sam is getting less than a 10% approval rating from the Korean people, and his administration has largely stopped governing. The new president won't take office until Feb. 25.

Polls show that the public is interested in the economy, but presidential candidates aren't staking out policy. Rather, they seem go out of their way to avoid talking about the kind of austerity Korea will need to pull out of the crisis. Says 39-year-old housewife Kim Yie Kyung: "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."

PRODUCTIVITY BOOST. Some companies are not waiting for changes in government policy and are restructuring on their own. Since 1993, POSCO Chairman Kim has relied on attrition to cut 5,000 jobs, or 20% of his workforce, even while increasing capacity. "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 to report a record $1.1 billion in net profits this year. The company is rewarding workers for the boost in productivity by handing out hefty bonuses.

Anam is another group with a bright future. It is the world's largest independent semiconductor packaging house. For the most part it has resisted the temptation to stray into new businesses. It's cutting its exposure to consumer electronics and redoubling commitment to industrial electronics with a joint venture with Texas Instruments to produce specialty chips. Another group to watch is LG. After lagging during the late 1980s, it has embarked on a wide-ranging restructuring and for the past several years has been paying more attention to profitability.

It would be wonderful to hear more such examples from Korea Inc. But it's clear that many companies still seem slow to learn. Even in the midst of the crisis, they are plunging into new businesses rather than concentrating on their core ones--and planning to borrow billions to do it. Over the years, the chaebol have spawned countless new companies without paying enough attention to the profitability of their existing ones. Decisions are quick, bets are bold. But they are often wrong--and they rarely cut their losses.

Hyundai, for example, has a rough road ahead as it tries to join the ranks of the world's top auto makers. Yet it plans to spend $5.6 billion on a pair of steel mills--even though similar moves drove three of its competitors into bankruptcy. One of those companies was Kia, which plunged into the steel business even before it had firmly established itself in cars. And Samsung Co., with a brutally competitive core business producing DRAMs, is going far afield into the auto making business with a $10 billion investment.

Such examples abound. Haitai group was doing fine making cookies and candies, but it decided to get into electronics and heavy industry. Last year its electronics unit had $626 million in debt but only $6 million in profits. Haitai sought bankruptcy protection on Nov. 1. And Ssang Bang Wool Ltd. figured that making underwear wasn't enough, so it set up a posh Austrian-style ski resort in southwestern Korea. Ssang Bang collapsed on Oct. 15, $909 million in debt.

The saga of computer-parts maker Taeil Media epitomizes the problem best. It was one of Korea's highfliers in the glory days of the late 1980s. Policymakers extolled the computer parts maker as one of a new breed of Korean companies--a focused, high-tech startup independent from the top-heavy business groups that dominate the economy. Its initial stock offering in 1989 was one of Korea's hottest ever. But its obsession with getting bigger instead of making a better disk drive led to its downfall. On Nov. 10, Taeil Media collapsed, brought down by its $100 million investment in a merchant bank.

PAPER CHASE. 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 next year on packaging alone. Ssangyong has sold a paper-making business to Procter & Gamble Co., and it's trying to unload its troubled auto unit on Daimler Benz, which has a small stake in the venture.

These deals also reveal how inflated the official value of many chaebol assets are. POSCO is offering only 30 cents on the dollar for the assets of bankrupt Hanbo Steel & General Construction Co., after being asked by the government to step in. Coke is finding that it must write off 25% to 40% of assets on the books of three bottlers bought recently. They had kept trucks that don't run and broken-down coolers on the books as collateral for loans.

Another problem is corruption inside corporate Korea. Hanbo Group, whose spectacular disintegration in January revealed nearly $6 billion in debt and virtually no equity, had long been a disaster in the making. Its chairman, Chung Tae Soo, was convicted on a corruption charge in 1991 after he used his political connections to rezone land for real estate: He wanted some quick profits from apartment sales to finance his ill-fated steel mill. Yet despite his legal troubles, the banks continued to finance his empire, propelling it to the 14th-largest company in the country by the time it fell apart. Chung was convicted of corruption again in 1996.

To limit further corporate collapses, Korea's credit system needs a dose of modernity. Korean banks are just starting to think about the most basic banking functions such as setting up 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 presidential Blue House--was enough. Over the years, the Blue House used credit as a tool to keep political control over the chaebol--and make sure campaign contributions kept rolling in. Just as farmers chose which rice paddies to irrigate, a former central bank governor once said, so the government had to decide which businesses to provide with credit.

Korean officials are telling the international financial community simply to trust them to make the necessary changes. But investors aren't in a patient mood. Cash-strapped countries such as Korea are now considered guilty until proven innocent. Foreign investors and lenders want strong political or technocratic leadership, a sense that policymakers have things under control.

NORTHERN NEIGHBOR. If Korea doesn't act decisively, the mighty chaebol could be 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 at marginal prices rather than the high-tech powerhouse it has long dreamed of becoming.

It's even more imperative that Seoul shore up its economy given the ominous signs of trouble in North Korea. With that country's famine and potential for instability, it is likely that South Korea will have to bear the cost of absorbing its destitute northern neighbor within the next decade.

Unfortunately for its people, Korea's economic problems will get worse before they get better. There's a tendency among its authorities these days to blame foreigners for the troubles and clamp down on information. Yet behind the blame game, the question is whether com- panies, workers, and government can embrace reform. Painful though it will be, a radical shakeup is Korea's best hope.

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