In early 1983, the Korean authorities stepped up their efforts to reduce the external imbalance by formulating an adjustment program which was supported by a stand-by arrangement with the Fund.8 The program sought to reduce gradually the current account deficit during 1983–84 to 2.5 percent of GNP, while raising the growth of output to 7.5 percent a year and containing inflation to 5 percent. The program envisaged a sharp deceleration of the growth of external debt and a substantial improvement in its maturity structure. These objectives represented a significant departure from the development strategy pursued in the 1960s and 1970s, which had aimed at maximizing growth through substantial recourse to inflationary finance and external borrowing.

In early 1983, the Korean authorities stepped up their efforts to reduce the external imbalance by formulating an adjustment program which was supported by a stand-by arrangement with the Fund.8 The program sought to reduce gradually the current account deficit during 1983–84 to 2.5 percent of GNP, while raising the growth of output to 7.5 percent a year and containing inflation to 5 percent. The program envisaged a sharp deceleration of the growth of external debt and a substantial improvement in its maturity structure. These objectives represented a significant departure from the development strategy pursued in the 1960s and 1970s, which had aimed at maximizing growth through substantial recourse to inflationary finance and external borrowing.

The actual performance of the economy during 1983–84 surpassed initial targets: the current account deficit fell to below 2 percent of GNP, while output rose by an annual average of over 8 percent and inflation was held to about 2 percent. With the improvement in the external position, foreign borrowing decelerated sharply and the maturity structure of external debt was lengthened significantly. Although a recovery in export markets and stable foreign prices contributed to this favorable outcome, the authorities deserve much of the credit. They implemented a strong adjustment program consisting of strict financial discipline, which sharply reduced the public sector deficit and the rate of monetary expansion, and a flexible exchange rate policy, which improved external competitiveness.


The major elements of the adjustment program for 1983–84 were a sharp reduction in both the public sector deficit and the rate of credit expansion and a real depreciation of the currency. The public sector deficit declined from about 4.5 percent of GNP during 1981–82 to 1.5 percent during 1983–84, while the rate of credit expansion was cut by more than half to about 13 percent. The effective exchange rate depreciated by about 7 percent in real terms during 1983 and remained stable subsequently. Structural policies continued to focus on trade liberalization and financial sector reform.

Fiscal Policy

Fiscal policy was tightened considerably in 1983. The public sector deficit declined from 4.3 percent of GNP in 1982 to 1.6 percent in 1983, a level markedly below the initial target.9 While cyclical factors contributed to the improvement in the fiscal position, particularly on the revenue side, the major portion of fiscal adjustment was associated with discretionary measures. Higher indirect taxes were supplemented with a newly imposed 5 percent tariff on imported oil, resulting in an increase of 1.3 percentage points in the ratio of revenues to GNP. Expenditure measures accounted for slightly more than half of the fiscal adjustment. The ratio of central government expenditures to GNP declined by 0.7 percentage point, mainly because of a cut in capital outlays. Current expenditures on health, education, and public services rose broadly in line with GNP. The resulting shift in the composition of expenditure was in accordance with the fifth Five-Year Plan’s objective of concentrating the development effort during 1982–86 on social infrastructure. The Government’s decision to freeze the support prices of rice and barley halved the deficit of the Grain Management Fund to 0.4 percent of GNP, thereby significantly increasing public sector savings. The improved fiscal position in 1983 reduced the Government’s recourse to all sources of financing. The public sector made net repayments to the banking system for the first time since 1979, while borrowings from both domestic nonbank and external sources were cut substantially.

With the substantial improvement in the public sector position in 1983, there was limited scope for further fiscal adjustment. Accordingly, the fiscal policy stance remained broadly unchanged in 1984: the ratio of the public sector deficit to GNP declined only slightly to 1.4 percent. The share of total revenues in GNP rose marginally to 20 percent. Higher sales by the tobacco and ginseng monopolies more than offset a decline in the ratio of central government revenues to GNP. Aggregate expenditures rose in line with nominal GNP. The rise in current outlays of the Central Government was constrained, in part, by a freeze on wages and salaries of the public sector. The increase in government expenditure also was modest, although expenditure on public housing was stepped up somewhat in the face of an easing of private construction demand. The expenditure of the Grain Management Fund rose in 1984 primarily because of a record rice crop that necessitated high volumes of procurement and because of the government decision to raise both buying and selling prices by equal amounts (3 percent). Consequently, in contrast to the previous year, the financial position of the Grain Management Fund deteriorated. The pattern of financing of the public sector deficit remained broadly unchanged, with the Government continuing to record a small surplus with the banking system and to rely on domestic nonbank and external sources of finance.

Monetary Policy

Monetary policy was tightened substantially during 1983–84. The implementation of monetary policy was hindered by two financial incidents, in 1983, which forced the Bank of Korea to step in as lender of last resort and rescue the affected banks. The authorities successfully sterilized the monetary impact of these rescue operations by tightening rediscount policy and issuing additional stabilization bonds. The growth of domestic credit decelerated from 25 percent in 1982, to 16 percent in 1983, and 13 percent in 1984. With the lower level of domestic inflation, the deceleration in real credit was less pronounced (from 19 percent in 1982, to 14 percent in 1983, and 10 percent in 1984). Because the public sector recorded a surplus with the banking system in both years, there was adequate room for extending credit to the private sector to support growth without jeopardizing external or inflation objectives. Pressures on bank credit were also eased by measures designed to encourage firms to liquidate their speculative holdings of real estate and to increase their direct financing from the nonbank private sector.

Monetary expansion, which had hovered around 26 percent throughout the previous three years, was reduced to 15 percent in 1983 and 11 percent in 1984. In real terms, broad money rose by 13 percent in 1983 and 8 percent in 1984. As a result, the velocity of broad money fell by about 6 percent in 1983 and subsequently remained relatively stable. The 1983 decline was associated with the continued progress made on the price front which further reduced the public’s inflationary expectations.

With the abolishment of credit ceilings in 1982, the authorities relied mainly on the control of reserve money for monetary management during 1983–84. The reserve requirement was not used actively. It was adjusted only once (from 5.5 percent to 4.5 percent) in September 1984. The monetary stabilization account and monetary stabilization bonds were used to sterilize the liquidity impact of commercial banks’ external borrowings that were undertaken to bolster official international reserves. The authorities also used the rediscount window to influence the allocation of credit by adjusting the discountable proportion of various loans.

As a result of the above operations, the expansion of reserve money moderated from 36 percent in 1982, to 7 percent in 1983, and 4 percent in 1984. The impact of the slowdown of reserve money on monetary aggregates was mitigated by increases in the deposit-reserve ratio that raised the money multiplier. The short-term fluctuations of the deposit-reserve ratio and the deposit-currency ratio created some difficulty for monetary management, but the money multiplier was sufficiently stable to allow the authorities to keep the growth of monetary aggregates on track by adjusting monetary stabilization accounts and bonds.

In order to enhance the role of market forces in the determination of interest rates, the authorities introduced, in January 1984, a narrow band for bank lending rates (10–10.5 percent), which permitted banks to charge different rates according to borrowers’ credit worthiness. Also, a new term structure for deposit rates was established (ranging up to 9 percent for one-year deposits) to encourage a shift of financial savings into longer-term deposits. Long-term deposit rates and the upper limit of the bank on lending rates were further increased by 1 percentage point in November. Notwithstanding the rise in bank interest rates, the gap between these rates and those prevailing in the nonbank financial sector remained large. The high level of interest rates in the nonbank sector was partly attributable to inflationary expectations; after 20 years of relatively high inflation, the public was understandably slow in adjusting its expectations downward. With continued price stability, inflationary expectations gradually dissipated and interest rates in the nonbank sector began to decline.

The Government took advantage of the favorable economic developments and, in April 1985, further widened the band on bank lending rates by increasing the maximum rate on term lending by 2 percentage points to 13.5 percent. In addition, two new deposit schemes were introduced which offer attractive interest rates (12–13 percent) to household savers.10 Interest rates during this period were significantly higher than the rate of inflation. They remained below the rates prevailing in the nonbank financial sector, but the differential narrowed.

External Policies

External policies during 1983–84 were designed to further reduce reliance on foreign debt as well as to lengthen the maturity structure of such debt. The exchange rate policy was managed flexibly so as to improve external competitiveness and facilitate the recovery of exports. Both the nominal and real effective exchange rates depreciated by about 7 percent during 1983 and remained stable during 1984. There was a substantial divergence, however, between movements in competitiveness vis-à-vis the United States and the other industrial countries, reflecting the sharp appreciation of the U.S. dollar against other major currencies.

An important element of the adjustment program during 1983–84 was the improvement in the maturity structure of external debt. While the overall level of Korea’s debt had remained consistent with its debt-servicing capacity, the increase in short-term debt during 1979–82 had become a source of increasing concern. A large portion of short-term debt was trade related, but its sharp increases since 1979 in relation to both total debt and to international reserves had rendered Korea vulnerable to shifts in market sentiment.

To correct the situation, the authorities restricted their external borrowings during 1983–84 to only medium- and long-term maturities and took a number of measures to reduce short-term borrowing by the private sector. First, regulations affecting the use of trade credits, which had been available for all imports, were tightened in several steps. In May 1983, eligibility for short-term trade credits was restricted to imports with maximum tariff rates of 30 percent, and the maturity period was shortened to 150 days from 180 days. The maturity period was further shortened to 120 days in December 1983, and to 90 days, except for oil imports, in July 1984. Second, the provisions for foreign currency loans to finance equipment imports were also tightened. Beginning in November 1983, domestic banks were permitted to finance such loans with a maximum of 30 percent in short-term funds, instead of the previous 50 percent. In March 1985, the maximum foreign currency funding for equipment imports was reduced from 100 percent to 80 percent, with consequent reductions in the short-term component.

Structural Policies

During 1983–84, the authorities accelerated their efforts to liberalize the trade system and introduced a number of important measures to reform the financial system. Trade liberalization efforts took place despite an adverse trade climate in export markets. During 1983, the automatic approval list for imports was expanded by 305 items, raising the import liberalization ratio to 80 percent. Early in 1984, the Government announced its intention of following a five-year plan of import liberalization. Under this plan, the import liberalization ratio was raised to 85 percent in 1984, and it is expected to rise, by 1988, to 95 percent—the level presently prevailing in the industrial countries. The list of 540 items to be freed during 1985–86 was announced in May 1984. The areas targeted for liberalization include machinery, electronics and textile industries, petrochemicals, chemicals and their raw materials, steel, and metal products. To smooth out the adjustment process, tariffs on certain liberalized items were raised temporarily, but these tariffs are anticipated to be reduced over a period of three years.

The Government has also announced a five-year program of tariff reform. Under this program, the average (unweighted) tariff rate was reduced from 22 percent in 1984 to 21 percent in 1985, and it is expected to decline further to 18 percent by 1988. In addition to the reduction in the average tariff rate, the dispersion in the rates is also to be substantially narrowed—from a range of 0–100 percent to a uniform rate of 20 percent for finished products and 5–10 percent for raw materials.

In the area of financial sector reform, the Government initiated a long-term program of liberalization, an essential element of which was the gradual relaxation of interest rate ceilings. In addition, important institutional reforms were implemented to enhance competition within the financial sector and reduce the role of the Government in credit allocation. In early 1983, the Government divested itself of all nationwide commercial banks. Also, certain amendments to the General Banking Act were made so as to promote the managerial autonomy of banks and to increase their public accountability. Commercial banks were also authorized to undertake new activities to improve their profitability and their competitive position with the nonbank sector. Among the new permissible activities were the sale of commercial paper and government securities, acceptance of trust business, factoring, and operation of investment trust companies. To spur competition, two new nationwide banks, which are joint ventures with foreign banks, and numerous nonbank financial institutions were established. In addition, large security companies were allowed to participate in some money market activities that had previously been limited to commercial banks.

During 1984 and early 1985 the Government took the initiative to promote domestic savings by encouraging the introduction of a number of financial instruments. Domestic commercial banks were allowed to issue negotiable certificates of deposit (CDs) with an annual yield of 12 percent. The interest rate on CD generated loans was also higher than most lending rates. A new financial instrument, cash management accounts, was introduced by investment and finance companies with an attractive annual yield. Also, commercial banks were permitted to engage in trust business by issuing cash trust accounts.

Consistent with the government policy of easing restrictions on foreign banks, these banks were granted access to the rediscount window of the Bank of Korea on the same terms available to local banks. Effective July 1985, the branches of foreign banks were also given permission to engage in trust business.

A number of measures were also taken during this period to improve the allocation of credit by the banking system. Reflecting the Government’s desire to promote banks’ autonomy, the share of policy loans in total was further reduced by 2 percentage points to 14 percent in 1984. Moreover, in line with the policy of discouraging bank borrowing by large corporations, measures were adopted to promote direct financing so as to develop the capital markets. The commercial paper market was liberalized, and regulations on corporate financing were eased.

Economic Developments

By any conventional standard, Korea’s economic performance during 1983–84 was outstanding. In 1983, output expanded by 9.5 percent, reminiscent of the growth experienced during the 1960s and 1970s. Economic growth decelerated in 1984, but the recorded rate of 7.6 percent was still unmatched by all except a few countries. Consumer prices rose by a mere 2 percent in both 1983 and 1984, while the current account deficit fell from 3.7 percent of GNP in 1982, to 2.1 percent in 1983, and 1.7 percent in 1984.

The rapid growth in 1983 was propelled by a rebound in manufacturing and the continued construction boom. Real gross investment increased by 14 percent, or nearly triple the pace of 1982, while the growth in real consumption nearly doubled to 7 percent. Real exports of goods and services increased by 14 percent, or more than twice as fast as in 1982 (Table 11). While both external and domestic demand contributed to the economic recovery in 1983, a comparison of developments in the first and second half of the year reveals a striking shift in the pattern of growth: the stimulus provided by domestic demand, which was the main expansionary force during 1982 and early 1983, gradually diminished as a result of tight financial policies and was replaced by foreign demand. The dampening of domestic demand and the recovery of foreign demand returned the Korean economy to its traditional pattern of export-led growth. Export growth in 1983 was led by ships, electronic products, and footwear. Exports to the North American market were particularly buoyant because of both the strength of the recovery in the United States and Canada and improvement of Korea’s competitiveness vis-à-vis those countries. Import growth was also very high (13 percent in volume terms), reflecting the rapid expansion of exports, investment, and economic activity in general.

The strong, albeit slower, growth of output in 1984 was supported by a buoyant manufacturing sector. Manufacturing output rose by 15 percent and the real investment in machinery and equipment rose by 12 percent. Consequently, the growth of real gross investment decelerated only slightly (12 percent) despite a weakening in private construction that resulted from tight financial policies and measures to discourage speculation in real estate. The growth of domestic consumption also slowed slightly but, with a concomitant slowdown in imports, the contribution of domestic demand (for domestic products) to GNP growth remained high (about 4.7 percentage points). The contribution of real exports, on the other hand, fell, as export growth decelerated to 8 percent in real terms.

The rate of domestic inflation dropped further to 2 percent in 1983 and remained at this level during 1984. Appropriate demand management, stable prices of traded goods, plentiful supply of agricultural products, and moderate wage increases contributed to this favorable price development. Nominal wages rose by 11 percent in 1983 and 9 percent in 1984. Real wages rose by 6–7 percent in each year, well below the productivity gains of over 10 percent a year. These wage and price developments contributed to a gradual decline in the unemployment rate from 4.4 percent in 1982 to 3.8 percent in 1984.

The current account deficit declined from $2.6 billion (3.7 percent of GNP) in 1982 to $1.6 billion (2.1 percent) in 1983, and $1.4 billion (1.7 percent) in 1984. With the recovery of export markets and improved external competitiveness, exports resumed their rapid growth, although at a lower pace than that observed during the 1970s. The volume of exports rose by 17 percent in 1983 and 15 percent in 1984. The slowdown of exports in 1984 reflected both the weak oil market that adversely affected exports to the Middle East and the rising protectionism against Korean exports in several markets. The composition of export markets during this period shifted in favor of the North American market, reflecting the strength of the recovery in the United States and Canada and the improvement in Korea’s competitiveness vis-à-vis those countries. Imports also grew rapidly during this period because of the rapid expansion of exports, investment, and economic activity in general. Foreign prices declined in 1983 but regained some of the lost ground in 1984; the external terms of trade improved by about 3 percent during 1983–84. Service receipts from overseas construction fell sharply in 1983 and remained relatively low, owing to a retrenchment of investment by Middle Eastern countries.

The improvement in the current account position during 1983–84 was associated with higher domestic savings—the ratio of national savings to GNP rose by 5 percentage points to over 28 percent while the ratio of domestic investment to GNP rose by 3 percentage points to nearly 30 percent. The rise in the savings rate was attributable to both cyclical and more permanent factors. Following the recession of 1980, the savings rate plummeted from over 28 percent to below 22 percent as the public apparently regarded the decline in its income as a transitory phenomenon and did not adjust its standard of living. During the subsequent economic recovery, the savings rate rose gradually and, by 1984, returned to the level prevailing in 1979. A contributing factor to the recovery of the savings rate was the reduction in domestic inflation and the emergence of high positive interest rates. The ratio of gross domestic investment to GNP also rose during 1983–84, but remained well below the peak levels of the late 1970s.

With the reduced current account deficit, Korea’s external financing requirements fell sharply during 1983–84. The overall payments position strengthened. Gross international reserves rose by $0.5 billion and at the end of 1982 stood at $8.2 billion, or equivalent to 2.8 months of imports. The growth of external debt, which had decelerated continuously from 36 percent during 1979–80 to 16 percent during 1981–82, slowed further to 8 percent during 1983–84. Outstanding debt stood at $43.1 billion at the end of 1984. Notwithstanding the relatively high level of debt relative to GNP (53 percent), the debt service ratio remained moderate (20 percent).

In line with the Government’s policy of restructuring the maturity profile of external debt, the level of short-term debt, which had increased by $9 billion during 1979–82, declined by $1 billion during 1983–84. Consequently, the ratio of short-term debt to total debt declined from over 34 percent at the end of 1982 to 26 percent at the end of 1984. With the concomitant increase in international reserves during this period, the ratio of reserves to short-term debt rose from 58 percent to 72 percent. These developments improved significantly the maturity structure of Korea’s debt and bolstered its position in international capital markets.