Does Korea's Recovery Have Legs?

The key to growth is reining in the chaebol

Is it this easy? Last year, South Korea's crippled economy contracted 5.8%, labor strife abounded, and soup kitchens dotted Seoul. Years of economic pain seemed a certainty as the chaebol, or family-owned conglomerates, sank under huge debts. But look again. The stock market is up 25% so far this year. Unemployment has fallen back to 7.2% from a scary 8.7% as recently as February. The first quarter's annual growth rate of 4.6%, announced on May 21, has confounded the skeptics. Is South Korea launched upon a V-shaped recovery?

The short answer is yes, but.... There's no denying that a recovery is under way. That's the best news out of Seoul since the economic collapse in late 1997. But too much of the growth relies on stimulus spending. Since the onset of the crisis, Seoul has pumped some $36 billion into the wobbly banking sector, helping to restore confidence as well as stability. An additional $27.5 billion will pour into projects such as an airport for the port city of Inchon and a high-speed rail link between Seoul and Pusan.

Now the question is: How swiftly can Korea switch to sustainable economic expansion? Domestic demand is growing. But President Kim Dae Jung can't afford many more handouts as the budget deficit already is about 5% of gross domestic product. Healthy growth depends mainly on whether Kim can force discipline on the overdiversified chaebol.

FLAWED SYSTEM. Small wonder that International Monetary Fund Managing Director Michel Camdessus and U.S. Treasury Secretary-designate Lawrence H. Summers continue to hector Seoul about bringing the chaebol to heel. The biggest industrial sprawls--Hyundai, Daewoo, Samsung, SK, and LG Group--have pledged to sell noncore assets and reduce their debt-to-equity ratios from 525%, in Daewoo's case, to a more manageable 200% by year-end. Alarmingly, two of the top five chaebol increased their debt loads last year by aggressive spending. Unless that trend is reversed, small and medium-size companies will be starved of the credit they need if they are to create more jobs.

Despite some headline-grabbing talk, the chaebol won't give up their borrow-and-build ways without a fight--not after the decades their owners spent growing them. Government-brokered asset swaps haven't eased Korea's massive overcapacity in autos, memory chips, or petrochemicals. And instead of selling assets, many chaebol are raising cash simply by flooding the stock market with rights offerings. One worry is that the defiant giants could trigger a market crash that way. Worse, the recovery could prove illusory if the same flawed system is left essentially intact.

Consider Hyundai, which has been on a spending spree since the country's crisis hit. Its purchase of Kia Motors Corp. for $1.1 billion last March made it Korea's No. 1 carmaker. By then it had already taken over Hannam Investment Trust Co. Hyundai's Asan Corp. paid nearly $1 billion last year for the rights to develop a North Korean tourist resort. In May, the group absorbed a near-bankrupt oil refiner, Hanwha Energy Co., by assuming its $2.5 billion in debt. Later this year, when it forks over $2.2 billion to buy LG Semicon Co., Hyundai will rank among the world's largest memory-chip makers.

Hyundai may be the worst case, but it is hardly alone. The other elite chaebol have wriggled furiously to avoid trimming back too far. In April, Daewoo pledged to sell some $6 billion worth of assets, including a cement plant and a bus division, and hinted that it may have found a Japanese buyer willing to pay $4 billion for one of its shipyards. The second-ranked chaebol also announced that it would sell such profitable assets as the Seoul Hilton Hotel and its commercial-vehicle division to pay down about $24 billion in debt before yearend.

But analysts are dubious, particularly about the shipyard sale. "That deal has all the earmarks of being worked out on the back of an envelope," says Henry G. Morris, a director at Industrial Research & Consulting, a Seoul-based advisory. The only chaebol that has inspired confidence among reformers is Samsung. It sold its construction-equipment division to Sweden's Volvo last year and has cut groupwide debt by $6 billion. Still, Samsung's insistence on continuing to build its money-losing car, the SM5, has raised questions about its willingness to acknowledge bad investments.

CRASH DIET. Kim's determination to clean up the chaebol is clear in the makeup of his new Cabinet. Finance & Economy Minister Kang Bong Kyun is a strong proponent of chaebol reform. In his former job as Kim's chief economic adviser, Kang, 56, a U.S.-educated economist, played a key role in shaping Kim's initial policies toward the chaebol. Kang's brief now: Place them on a crash diet of asset sales to meet debt targets. Kang might have to invoke Seoul's longstanding threat to order the banks to cut off lending to the chaebol, push the biggest of them into debt workouts, and force them to replace top management.

Kim's other appointments send the same message. Chung Duck Koo, the new Commerce, Industry & Energy Minister, is a Kim loyalist as committed to reform as Kang. Jin Nyum, the new Planning & Budget Minister, is expected to concentrate on bureaucratic reform and privatizing state-run monopolies. Clearly, Kim and the chaebol are still on a collision course. Who's left standing after Kim's new team gets to work will speak volumes about the staying power of South Korea's turnaround.

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