Seoul Is Still Teetering On The Edge

The crisis has eased for now, but without radical reform, default still looms

The first stage of Korea's crisis is over. But the second is about to begin--and it could be even worse.

True, as Koreans voted for a new President on Dec. 18, they had some good news. By cobbling together its last foreign currency reserves with a few billion in initial loans from the International Monetary Fund and other agencies, the government came up with the funds to cover some $20 billion in short-term debt due by yearend. November brought a modest monthly current account surplus, the first since 1993. And traders saw a decision to let the won float as a sign that policymakers are at last getting serious about reform. By election eve, the currency had rallied 28% from its Dec. 12 low.

The euphoria, however, could be short-lived. Over the next few months, either a policy gridlock will prevail or a new industrial order will start to take shape--an order based on a restructured corporate sector that stresses focus and profits over debt-fueled, runaway expansion. If the new President cannot convince the world that he's committed to such changes, foreign banks may not roll over the huge debt that's coming due. Since the government has guaranteed the debt of the financial sector, a liquidity crunch could turn Korea's private debt problem into a de facto sovereign debt problem--leading to a moratorium on payments. In a similar situation, Mexico had to reschedule its debt in 1982--and lenders shunned it for years, costing the country half a decade of lost growth.

It's a scary combination of political and financial unknowns. The best guess now is that Korea owes foreign lenders some $150 billion. A huge chunk of that--some $30 billion--is up for repayment during the first quarter of 1998. That's because foreign bankers gladly offered short-term loans at attractive rates to Korean banks and chaebol for much of 1996 and early 1997. Institutions such as Korea First Bank borrowed liberally abroad, then in turn lent money to pay for the reckless expansion of such groups as Kia and Hanbo, which are now bankrupt.

Now, much of that debt is coming due. Banking analysts say the top Korean banks each must roll over or repay anywhere from $100 million to $1 billion every month for the next few months. If the banks cannot meet their commitments, the financial crisis will be back with a roar.

Adding to the uncertainty is an untested government that must deal with Korea's worst crisis since the assassination of President Park Chung Hee in 1979. Default is "a real risk, given the foreign-exchange position of the government at the moment," says Koyo Ozeki, director of bank rating agency Fitch-IBCA Ltd. Japan, noting that foreign banks are calling loans.

QUICK WORK. Though the new President won't take office until Feb. 25, his team must quickly link up with outgoing policymakers to push ahead with changes that would give foreign lenders the confidence to roll over loans. The National Assembly will convene on Dec. 23 to vote on a controversial financial reform package to give greater independence to the central bank, create a unified financial watchdog, and require transparency in business activities. "The next month will be critical for the country's economic fate," says Park Kyung Suh, research fellow at the Korea Institute of Finance, an economic think tank funded by nearly 40 South Korean banks. According to Washington analysts, officials from the U.S., the IMF, and Asian governments are pressing the Koreans to speed up the handover of power.

The longer-term issue is whether the incoming administration pushes through radical reform or tries to limp by with half-measures. A new agency, similar to the Resolution Trust Corp. in the U.S., needs to move quickly to unload the $14 billion in bad assets it is seizing from banks--steel mills, real estate, machinery, and factories. Encouraging foreigners to buy these distressed assets and acquire ailing companies would mark a welcome change, given Korea's traditional paranoia about giving up control of the economy. Selling a big bank to a foreign buyer would also underscore a commitment to reform. Securitizing and selling dud assets would boost confidence.

Watching all this closely will be the giant banks of Japan, the U.S., and Europe, which by last year had some $60 billion at stake in exposure to Korea. Many also have large domestic loans (table). According to filings from the past year, Bank of America, Chase Manhattan, and Citibank each have more than $2 billion in Korean loans, and Japan's Sanwa Bank is on the hook for $2 billion. No one thinks the fundamental soundness of these banks is threatened by this exposure, and many of them have been reducing their position in Korean debt. Japanese banks have scaled back their exposure to Korea, which totaled $24 billion at the end of last year, by more than one-third.

The foreign banks are not about to cut off credit to the biggest chaebol, which have been clients for years. But the pressure on Korean companies, especially on those below the top tier, will remain intense. Goldman, Sachs & Co. says that the 49 largest business groups had total profits of just $32 million on combined sales of $274 billion last year, a return of just over 0.01%. This year is certain to be worse. Goldman says higher rates will cost 600 manufacturing companies $8 billion in additional interest payments. The firm also expects at least 10 more of the 50 largest chaebol, plus half of all small and medium-sized companies, to go under. In 1997, 11 chaebol collapsed. "The name of the game is survival," says Samsung Group executive Um Joo Hyuk.

BEGGING. Mid-December saw Hanwha Group, Korea's ninth-largest chaebol, begging its banks for $140 million in emergency loans. The Hyundai Group is smarting from $700 million in loans and guarantees it provided to the bankrupt Halla Group, which was started by the brother of Hyundai's founder. Other chaebol with large short-term debt burdens include Kohap, Doosan, Dong Ah, and Kumho. "All these chaebol have poor short-term solvency ratings similar to those of the 11 that have already collapsed," says Kevin Ohn, corporate analyst at KEB Smith Barney Securities. Rumors abound that some of the bigger chaebol have their problems too. Market sources say recently some Samsung companies defaulted for a few hours on promissory notes. Samsung denies the incident occurred.

The barrage of bad news coming out of Korea makes it hard to be optimistic. But the $600 million current account surplus in November is a reminder that Korea remains a manufacturing powerhouse. Because Korea hasn't had a big corporate shakeup for more than 15 years, this crisis is a chance to make some overdue changes. "This is a big opportunity for Korea to open itself up," says Robert F. Gould Jr., a consultant for Korean and Japanese businesses and banks at Coopers & Lybrand.

The choice has never been starker. Korea can hang on to business as usual. Or it can embrace a more open economy and trust that it will see a payoff in higher growth and more efficient companies. Both ways will hurt. But one promises long-term benefits, while the other leads to a dead end. Koreans can only hope their new leader has the courage to pick the right path.

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