Korea’s rapid growth since the early 1960s has indeed been a wonder. Over three decades until the mid-1990s, annual real income growth in Korea averaged over 8 percent. If a country grows by 8 percent each year, its national income will double every decade; if that growth trend continues for thirty years, national income will record a stunning tenfold increase. The small city-state economies of Hong Kong SAR and Singapore also enjoyed rapid growth comparable to Korea’s over the same period. But it was a much bigger accomplishment for a country of almost 50 million people to sustain such high growth for more than three decades.
The Asian financial crisis began with the floating of the Thai baht in July 1997. The crisis then spread rapidly to the Philippine peso and the Malaysian ringgit. In August, the Indonesian rupiah devalued, ultimately by more than any other Asian currency. Relatively small depreciations occurred in the Singaporean dollar, starting in August, and the New Taiwan dollar, starting in October. The South Korean won depreciated substantially starting in November. Japan also had a moderate devaluation between July 1997 and January 1998. No significant devaluations took place in China, which has remained relatively insulated from world financial markets, and Hong Kong, which maintained a currency board linked to the U.S. dollar.
Over the three years since the crisis broke out in 1997, the five Asian countries—Indonesia, Korea, Thailand, Malaysia, and Philippines—managed impressive recoveries. The recoveries were faster than expected by anyone. The economies started to bottom out in the second half of 1998. The rebound of growth in 1999 was no less drastic than its free-fall. In Korea, for example, the growth rates showed a turnaround from −6.7 percent in 1998 to 10.7 percent in 1999.
This paper provides detailed accounts of the Korean banks’ debt restructuring process in the first half of 1998. This event deserves our attention not only because it significantly relieved the Korean economy of its immediate shortages of foreign exchange, but also because it provided a turning point from which the Korean economy started to regain foreign investors’ confidence, and thus to overcome the crisis. Reflection upon this event also has a special meaning at the time of writing as Korean banks have recently repaid in full the debts that had been extended up to three years in early 1998.
This paper assesses measures taken or under consideration to reform the international monetary and financial system.1 The analysis of efforts to strengthen the international financial architecture, as these initiatives are colloquially known, has grown into a considerable industry.2 The literature is now so large and unruly as to all but elude systematic assessment. I therefore organize my analysis around a pair of questions. First, how meaningful are the changes to the international financial architecture currently underway—are they merely cosmetic or do they constitute a significant attempt to modify the structure and management of the international financial system? Second, do the initiatives under consideration address Asia’s concerns with, inter alia, the volatility of financial markets, the structure of policy conditionality, and the operation of the exchange rate system?
The monetary policy and exchange rate regime that served Korea well for many years ended in crisis in 1997. The regime that collapsed was characterized by a tightly managed nominal exchange rate and domestic financial markets that were controlled by the government and largely closed to international transactions. The practical question for authorities over the next few years is what monetary and exchange rate regime will best promote the objectives of maintaining economic and financial stability as financial markets are liberalized.
Korea’s three-year stand-by arrangement with the IMF expired on December 3, 2000. Looking back, a tremendous amount was accomplished during the IMF-supported program. First, macroeconomic fundamentals have improved and vulnerability to a balance of payments crisis has been sharply reduced. The economy recovered very rapidly from the deep recession in the immediate aftermath of the 1997 crisis; unemployment has been reduced; inflation has been contained; exports have been strong (although they have softened recently with the global slowdown); foreign direct investment and portfolio inflows have increased markedly; and foreign reserves have been built to record levels. Second, a wide range of structural reforms have made Korea’s economy more open, competitive, and market driven. Significant progress has been made in stabilizing the financial system; addressing corporate distress; strengthening the institutional framework for corporate governance and financial sector supervision; liberalizing capital markets and foreign investment; enhancing transparency; and creating an environment where market discipline plays an increasingly important role.
The Korean economy faced a severe financial and currency crisis in November 1997 and started an IMF program in early December 1997. It fell into a deep recession, with real GDP contracting 6.7 percent in 1998. The economy started a rapid recovery in late 1998, with growth rates of 10.7 percent in 1999 and 8.8 percent in 2000 (Table 1). But the economy started to slow in late 2000, and by mid-2001 a recession appeared likely. Thus, the Korean economy has gone through a full cycle since the 1997 crisis.
When Korea was hit hard by the financial crisis in 1997, the IMF rescue program included a high interest rate policy for more than three months to stabilize the won/dollar exchange rate. The short-term inter-bank interest rate was raised to 30 percent on December 26, 1997 in response to the exchange rate plummeting from 900 to 2,000 Korean won against the U.S. dollar. As the exchange rate stabilized, the short-term interest rate started to ease following an agreement between the Korean government and the IMF on February 7, 1998. Thereafter the interest rate was gradually lowered as the situation in the foreign exchange market improved. The interest rate fell below its precrisis level in the middle of 1998, and has remained low since then.
Despite the similarities among the countries hit by the Asian financial crisis of 1997, there were some differences. Among them, there were allegations that Korean chaebol had misallocated resources and become overindebted; by contrast, the role of “crony capitalism,” in which friends and relatives of the politically powerful received loans that they were not expected to repay, was a focal point.