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Writing Sample: Financial Markets & Development

                                South Korea's Financial Crisis (1997-1998)

            I chose South Korea, because I have learnt a lot from how South Korea’s trajectory in growth and development has really impacted themselves and the world as well. I personally was astonished by their story when looking at their overall economic progress and advancement. South Korea in the 1950s was in such a major crisis that if I anyone said that South Korea would become the global economic superpower it is today, other people would have said that person has gone completely mad! Not a single person would’ve expected that back then, when you look at how much the Korean War (1950-1953) impacted South Korea as a country. It has left 1 million people killed and any help they had gotten, and importations and financing were lower than the yearly inflows. A downward sloping trend had begun, and no progress had been seen whatsoever. South Korea didn’t have the capacity to export and put in savings of what they had and due to that it was anticipated that they would be more dependent on other nations later on. The way South Korea has taken the world by storm is really fascinating. Their story is known as the “miracle story” for a reason. Back in 1955, the GDP per capita of South Korea was $64 and it reached over 400 times that amount to $27,000 today! Numerous scholars directed their attention to South Korea’s economic growth due to their efficiency with exporting endeavors (Rodrik 1994). This is very much correct. Park Chung-hee a military dictator who served between 1961-1979 must take a lot of the credit and praise here because he was the one that began to recruit and accomplish export-driven economic endeavors by making the Chaebol stick to his goals of taking South Korea out of this poor, dire situation and transform them into a global powerhouse. A lot of praise has to be aimed at the Chaebol as well. As the Chaebol began working with the authoritarian government, they enhanced their own reputation as these big modern-day conglomerates. In the 60s, The Park period, concentrated mainly on production and chemical manufacturing works and corporations that had been financed by Chaebol. For instance, Samsung that created Korea Fertilizer in 1967, and Hyundai managed to build South Korea’s opening highway that joined the 2 main places in South Korea: Seoul-Busan. Afterwards, the chaebol began working with many corporations from abroad by conferring with them regarding semiconductor manufacturing. What really amazed me was this fact: All of South Korea’s exports had been only $42M in 1961, but by 1977, it went over $10B (Korea Expose 2017)! This fact just stunned me and was the most unbelievable thing I learnt about of South Korea’s miracle story. The reason I chose the South Korean Financial Crisis of 1997-1998 as my main issue is because of the country’s miracle story and I wanted to learn more about how they dealt with such a situation and also because I have realized that the financial crisis in South Korea was also a very interesting read when knowing more in terms of how the country recuperated while simultaneously knowing more about how the crisis impacted other countries as well. After all, South Korea is known for producing cars, home appliances, etc… and is in business collaborations with many countries worldwide. South Korean companies like Hyundai, Samsung, LG, etc have really put South Korea on the map. South Korea’s story is valuable to development economics because I personally believe that South Korea’s story has definitely demonstrated that any developing country has the ability to turn into an economic superpower as long as they do the right things and have the drive and motivation to succeed. Another country which is similar to South Korea in terms of the speed of development is China. 20 years ago, China was nowhere near the economic superpower that they are now and in a few years it is predicted that they will surpass the US as the number one developed country in the world. This is just another example. In terms of South Korea however, their economic growth is definitely a miracle when taking into consideration how quickly they have attained and compounded their reputation as an economic superpower.

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Now coming to the financial crisis in South Korea. The core of my paper will revolve around the fundamental reason South Korean financial crisis. This reason is the unforeseen change of capital flows because of the shakiness and nervousness enclosing Thailand’s financial crisis in July 1997. The financial crisis in South Korea however began in November 1997. It’s vital to comprehend here though that due to the nation’s heavily relying on short-term foreign loans cemented with the nation’s bad corporate sector’s financial structure, it led to South Korea being increasingly more prone to a potential financial crisis. The ideology of “Financial liberalization” (No more government involvement in financial markets) is what enabled a massive entry of foreign capital back in the 1990s. From then on, South Korea managed to open commodity markets that cause an enormous entry of foreign capital. South Korea grew a lot of debt [where most had been constructed with increasingly “short-term maturities” (bonds)] and was joined by confined loaning gone into an investment boom that caused South Korea to be prone to a refutation of “short-term lines of credit” (a line of credit that offers corporations funds and can be utilized for anything and there is no pressure or necessity for them to show anything related to those funds) furthermore a “flight of portfolio capital” (this is a high wealth tax that could lead to rich people moving their savings elsewhere so that they won’t have to pay such high taxes). To understand why the corporate sector’s financial structure had been so bad, we can blame that on the high debt/equity ratios. Once these debt/equity ratios get to a very high level, they leave you in huge risk as countries get more reliant on assets from abroad to enhance or sustain their economies and that will result in raising your debt. The higher the debt/equity ratios get, the more burden and stress you will have to face in order to efficiently clear all of that debt. Of course everything has pros and cons. That goes the same for high debt/equity ratios. For example, a country will be more profitable with a high debt/equity ratio than if the country had a low debt/equity ratio. Towards the end of the 1980s, there was a form of corporate bankruptcies which happened as Korean industries’ revenue operations slowly started to deteriorate. This drove firms into acclimating to non-performing loans [(NPLs) refers to not clearing their debts] and as well no investment in the financial sector. Every one of these sabotaging pieces that are a part of the corporate and financial systems led to other nations losing interest in trying to develop their business ventures in South Korea and finally caused a huge and unforeseen foreign capital outlays and evidently the financial crisis (Kim 2004).

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Of course everything has to be backed up with evidence. What I will demonstrate in order to back my assertion that what had occurred throughout the financial crisis is true and what had caused it is true as well when mentioning the precipitous turnaround of capital flows (capital outlays), I will direct my attention on a couple of underlying components. Those components consist of interest rates, inflation rates, currency rates, GDP growth rates, GDP per capita and the GDP for the period of the financial crisis. By focusing on these components, it will demonstrate all of the capital variations in this period. The IMF (International Monetary Fund) also played a big role in helping stabilize South Korea’s economy and help them to recover. South Korea borrowed around $58M from the IMF to achieve this. The IMF also had other ideas, the main one however was the heightening of the interest rate. Before the crisis hit, the interest rate ranged between 12%-27% once 1997 came to an end, and increased to 30% by the start of 1998 (Kim 2000).

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This interest policy had been initiated in order to make the stakeholders keep their reserves in Korean Won and as well to bring in bankrolling from overseas to stabilize the Korean won’s worth. At a time of heightened interest rates it will not just cause a capital incursion, it will also obstruct aggregate demand, which will ultimately boost the trade balance in South Korea. Up to a specific point, this interest rate policy, worked really well in terms of supporting the currency market through averting “capital hemorrhage”. Capital Hemorrhage is when firms lose precious assets to other firms. Consequently however, the policy only helped the regional capitalist society when the financial crisis was happening, and it impacted the rest of the population very badly (Kim 2000). The 2nd underlying component is the inflation rate. Usually, a financial crisis will cause a decline in the inflation rate because of little or less demand and a lack of any significant economic activity. In terms of South Korea however, this didn’t happen at all. In the span of 1 year of the financial crisis the inflation rate soared radically by 3.07% (Macrotrends 2020). When this happens it is known as “stagflation”. Stagflation can be described as persistent major inflation that’s connected with major unemployment and barely any economic development (Estevez 2020). A couple of reasons that cause this scenario is because of increased wealth taxes (flight of portfolio capital) as well as the devaluation of the Korean won against the US Dollar that perfectly describes the 3rd underlying component, which is the currency rate, when the financial crisis was happening too. This was the exchange rate in 1997: 1 USD = 953.1904 Korean Won. This was the exchange rate in 1998: 1 USD = 1,400.4036 Korean Won. During the financial crisis, the Korean Won depreciated against the US Dollar by 447.2132 Korean Won (Fred: Economic Research 2020)! The 4th underlying component, which is the GDP growth rate, can be described as the speed at which a country’s economy grows at and in South Korea’s case, the graph trend shows that the GDP growth rate declined at a huge -11.3% originating at 6.17% and ending at -5.13% (Macrotrends 2020)! The 5th underlying component which is the GDP per capita which is best described as the average revenue a person makes in a region over a given year. South Korea’s GDP per capita dropped about $4,116 when the financial crisis was happening (Macrotrends 2020). The final underlying component which is the GDP and can best be described as all of the final goods & services that are supplied during a particular time frame. The total GDP of South Korea in the middle of Dec 1997 – June 1998 dropped about $52.09 as well (Macrotrends 2020).

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A couple of lessons which we can take from the South Korean financial crisis can be: First, it demonstrates the ability and capacity of rapid and immediate growth of administration and the corporate bond markets in a position where all investments initially went through banking procedures. The swing to bond market investments had a part to play as a “spare tire” that resulted in lowering magnitude of the crisis which banks had faced. “Corporate bonds” can be described as debts that are supplied by firms in order to raise their own funds and these firms will then subsequently pay back these lenders in the form of interest disbursements. Second, it has to be comprehended that in a super economy like South Korea’s that is a bank-controlled economy, it’s not a given that bond financing should be more efficient at dispensing assets than banking procedures even if bond financing has the ability and capacity to give elasticity and is like a useful tool for the rapid recuperations of nations with economies that are similar to South Korea’s. Major companies regularly just have suitable entry to bond financing like this and also that more attention was directed towards bond market backing instead of bank loaning even preceding the financial crisis, regardless of the fact that the crisis was kind of due to major businesses reaping the rewards of low-priced credit. Finally, to reform financially in the aftermath of the crisis, it’s vital to realize and grasp that everything in which South Korea had to handle evidently shows that more attention must be directed towards debt-for-equity swaps instead of debt-to-debt swaps. Debt-for-equity swaps can be described as those swaps that are taken place if a firm cannot repay their debt because of a financial crisis or downturn and this leads to firms offering its lenders dividends or firm ownership so that they don’t have any more debt. Debt-to-debt swaps can be described as a new debt scheme or even debt reorganizing which is what firms did and it was a mistake. After the start of the financial crisis during a period when banks had no desire to grant prolonged loans, firms were left with no alternative but to repay their debts by supplying bonds containing higher interest rates. And to pay off their debts to depositors, after the bonds matured and were left to be paid off, they had no choice but to supply fresh corporate bonds repay the old bonds. This explains the debt-to-debt swap that caused the total corporate debt being exactly as it is (Rhee & Lee 2007).

 

                              References

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