Crisis and Recovery: What We Have Learned from the South Korean Experience?*

Jong‐Wha Lee,Changyong Rhee

doi:10.1111/j.1748-3131.2007.00061.x

Abstract

This paper analyzes the process of recovery from the 1997 financial crisis in South Korea, and draws some lessons from it. The fast restoration of financial stability due to early closure of non‐viable financial institutions and quick resolution of non‐performing loans was critical for the speedy recovery of the South Korean economy. The swift adjustment in fiscal and monetary policies in addition to the large depreciation of real exchange rates also supported the fast recovery. Corporate and government bond markets played an important role in the financial restructuring and macroeconomic adjustment process. Structural reforms helped to alleviate the weaknesses in the corporate sector, particularly in chaebol groups. However, the fast recovery also generated unwelcome side‐effects. Because of aggressive fiscal expansion through government‐guaranteed bonds and public credit guarantee programs, sovereign liabilities increased greatly and transparency of the official fiscal stance deteriorated. Thanks to structural reform, corporate and financial sectors began to recognize the importance of micro risk management, but increased risk aversion contributed to the slowdown of corporate investment and, therefore, reduced long‐run growth perspective in South Korea. How to revive long‐term growth rates remains an important question in South Korea despite fast recovery from the crisis.

Highlights

The sudden financial crisis was a devastating shock to the South Korean economy
With the external environments given, the government-led financial restructuring programs and macroeconomic adjustment policies played an important role in the fast recovery of the South Korean economy
If we look at the winning bidders of Korea Asset Management Corporation (KAMCO)’s activity such as auctions, establishment of joint asset management corporation, corporate restructuring corporations (CRC), and asset backed securities (ABS) issuance, they are overwhelmingly dominated by larger foreign players

Summary

Introduction

The sudden financial crisis was a devastating shock to the South Korean economy. The real gross domestic product (GDP) growth rate plunged to –6.7% in 1998 from the pre-crisis average of 7–8%. The V-shaped recovery in real GDP growth in South Korea follows the stylized pattern observed from the previous crisis episodes (Lee & Rhee, 2002; De Gregorio & Lee, 2004) as well as from the adjustment patterns in the other Asian crisis-hit economies (see Ito, 2007, figure 1). The purpose of this paper is to assess the role of macroeconomic polices and structural reforms in the recovery process of the South Korean economy and draw appropriate lessons.. With the external environments given, the government-led financial restructuring programs and macroeconomic adjustment policies played an important role in the fast recovery of the South Korean economy. Corporate and financial sectors began to recognize the importance of micro risk management, but their risk aversion contributed to the slowdown of corporate investment and thereby reduced long-run growth perspective in South Korea.

The Role of Macroeconomic Policies in the Recovery Process

The Role of Financial Market Development and Structural Reforms

Findings

Conclusion