Korean financial crisis during 1997-98

The Korean financial crisis in 1997-98 started because of government failure in two significant policy areas: exchange rate policy and industry policy. The Korean financial crisis hit Korea’s economy and had a devastating impact on Korean companies, especially chaebols (family-owned big business conglomerates).

The real GDP growth fell from levels which had been running in the positive 5 to 10% range before the crisis to a negative 5.8% rate in 1998. The crisis was rooted in its chaebols, which had their fingers in many pies, often spent money wastefully and had accrued massive debts. At the end off 1997, South Korea companies were unable to pay off their loans, the stock market crashed and the Korean currency lost half of its value.

The unemployment rose from 2 or 3 percent to 8.7 percent. At end of December 1997, the stock market had declined by 49 percent and the currency had depreciated by 65.9 percent. A black market for dollars opened in Myongdong in Seoul. The growth of DGP in 1998 was -7.8 percent from about 10% growth.

Due to crisis, everybody forced to austerity measures, expense accounts were curbed; street lamps were turned off; commuters stopped driving; and teachers encouraged student to use their pencils until they were stubs. Public holidays were canceled. Weddings and trips were postponed. Elevators were programmed not to stop at every other floor to save energy. Hospitals — which imported 90 percent of their supplies — delayed nonemergency surgeries.

The 1997-1998 Asian financial crisis was a blow to South Korea’s pride. The crisis took hold just months after the country reached the $10,000 per capita income level for the first. The collapse of the won (the South Korean currency) quickly reduced it to $6,600 and the world's 11th largest economy was suddenly the 17th largest economy behind Russia, Mexico and the Netherlands.

Overseas investors began taking a hard look at South Korea and they were not happy with what they saw: namely inefficient local companies with massive debt burdens. They began taking their money out of South Korea and tightening credit.

By October, foreign reserves were dwindling dangerously low. Without a supply of credit, Korean companies found themselves unable to pay back their loans and faced defaulting. The entire South Korean economy came close to collapsing.

Chaebol waste was closely tied to corruption and cronyism between the chaebols and the South Korean government. In addition, concessions to labor created higher wages and made it more difficult to lay off workers. Companies were vastly overstaffed.

Much of South Korea’s debt was owed by the chaebols. Chaebols get easier bank credit than medium and small industries. The chaebols-maintained debt burdens three times that of businesses in the West. Their debt-to-equity ratio was an astonishing 400 to 1,000 per cent.

The Korean government pegged the Won (Korean currency) to the U.S. dollar, which induced the failure of the exchange rate policy. As a result of pegging, the Won appreciated as much as the U.S. dollar, which diminished the Korean export potential. In 1997 financial markets and investors considered Won as overvalued currency.

Therefore, Chaebols manufactured Korean products were unable to compete with the other international companies due to the relatively expensive product prices. Thus, the Korean government then devalued the Korean Won and guaranteed the Chaebols and other businesses that foreign exchange risk did not exist. However, the devaluation of the Korean Won caused many financial issues. The problem was that Korean banks and companies (mostly Chaebols) were up to their ears in foreign debts. So, that wrong political decision dragged Korea’s export-oriented economy into a mega economic crisis. During that financial crisis, many Chaebols either went bankrupt or obtained bank protection.

For example, Daewoo, one of the giant conglomerates, and 25 chaebols went bankrupt due to credit debt. The Reason for the Korean Financial Crisis The reason for the Korean financial crisis is that the Korean government let the chaebols access loans with the low-interest rate for more than 30 years, which created weaknesses. Besides, chaebols had close ties with politicians who provided cheap loans that the backbone of the Chaebol’s growth. Korean government in the 1980s decided to rapidly open the Korean domestic market to international competition without taking any careful precautions in the Korean local market.

Another issue that caused the Korean financial crisis is that the Korean education system does not provide skilled labor forces. As the Korean economy developed quickly and moved toward the level of developed countries, its products became more complex and more deeply integrated into the world economy.

However, the Korean education system was not modernized, did not involve the changing needs, and still retained its repetitive memory-oriented methods that proved successful in earlier periods. So it did not cater to the Korean economy’s urgent needs of creative and highly skilled labor force such as entrepreneurs, workers, bankers, and the like.

Finally, Korean financial crisis was triggered by the exchange rate and the foreign debt of Chaebols. That financial crisis bankrupted fourteen big and eleven small chaebols, including Daewoo. Therefore, the Korean government had to invoke the IMF to get a bailout package, which was worth $60 billion. During the crisis, many middle-class people lost their jobs and saving.

That economic crisis and the news that the IMF’s bailout caused panic among Koreans. Many patriotic and nationalist people started thinking that South Korea would lose its economic sovereignty. In this setting, Samsung and Daewoo initiated gold collection drives between workers, and this campaign spread countrywide before the end of the year. The Korea Herald reported that 225 tons of gold had been collected, and South Korea did not need to use the whole amount of $60 billion bailouts.

The Korean government reformed its financial system by switching its exchange rate system and reconstituting the structure of financial institutions and chaebols firms.

With the IMF’s advice, some chaebols switched their ownership structure from a circular shareholding system to a holding company system. Some chaebols still have a strong relationship with politicians and control a big part of South Korea’s economy. That might cause a new financial crisis in South Korea in the future because some chaebols, such as Samsung, Hyundai, L.G., Kia, and Lotte, are much greater than ever and have been controlling a much bigger portion of Korea’s economy than they had been in 1997.

In the context of Ukraine war, Bangladesh and other countries may take the experiences of Korea and other ASEAN countries and take corrective steps to address the exchange rate policy and industry policy, education policy and tackle the ever emerging big business conglomerates and cronyism.

The writer is Non-Government Adviser, Bangladesh Competition Commission. He can be contacted at [email protected]