Decade Brings South Korea to the Brink and Back

After 1997 Crisis, Nation Sharpened Oversight and Exports Tripled; Now, Debt Collection Is Becoming a Liability

SEOUL -- South Korea in recent weeks has been perceived as the Asian country most vulnerable to the unfolding global financial crisis. It got that way not by doing things wrong -- the way it did in the Asian financial crisis a decade ago -- but because of unexpected effects from things that were going right.

Reuters

South Korea is playing down talk of a currency crisis similar to one that nearly broke the economy 10 years ago. Above, a foreign-exchange center.

Some big contributors to South Korea's recent economic vibrancy -- such as a bull run in the country's stocks and rocket-like growth of its shipbuilding industry -- turned out also to influence a jump in bank borrowings and a rise in the country's foreign debt.

After the mid-September collapse of Lehman Brothers raised risk aversion to new levels, many investors and analysts felt South Korea's debts no longer looked reasonable, particularly since they were larger than those of most Asian countries.

Government officials have stressed that the debts pose little challenge, noting that the country's central bank sits on the world's sixth-largest pile of foreign currency -- $240 billion. But the global liquidity crunch has roiled South Korea anyway. And the likely onset of recession in the U.S. and Europe, which together consume more than one-fourth of South Korea's exports, is quickly putting the brakes on the country's growth. That double whammy has fueled a selloff of South Korean stocks and devaluation of its currency, the won.

It is a surprising turn for a country that made many changes after the 1997-98 Asian financial crisis brought it to the brink of insolvency. South Korea's turnaround saw exports triple and China become its biggest customer. Regulators and lawmakers, whose inaction contributed to the last crisis, sharpened rules and oversight, and officials and executives sought not to rack up big debts in any part of the economy.

In particular, South Korean banks built up strong capital-solvency ratios and fended off bad assets. Loan-to-value ratios on property loans are extremely low at 47%, and the delinquency ratio of business loans is 1.5%.

But in 2006 and 2007, South Korean consumers began withdrawing savings to invest in brokerage accounts tied to the country's booming stock market -- some for the first time. Banks also aggressively expanded lending to small businesses last year, which boosted profits. At Shinhan Bank, the nation's third-largest, loans to small and midsize businesses grew 47% from the start of last year through the middle of this year, compared with 36% growth in the bank's loan portfolio.

The moves raised banks' loan-to-deposit ratio, a figure watched closely as an indicator of bank safety. After Lehman's collapse, some investors became nervous. Now, banks are reining in loan growth, which is squeezing their profits. That, in turn, is sending South Korean bank shares down even more sharply than the broader Korean market.

The tighter lending is starting to be felt around the country. Kim Young-ho, president of a Seoul company that sells machinery components to factories in south Asia, said he has been unable to increase the firm's bank credit line to take advantage of sales opportunities that grew as the won fell. "I mortgaged nearly everything I could, including my brother's house, so I tried to raise the limit on personal credit, but the bank rejected it," Mr. Kim said. "I think banks would have expanded the limit if there were no crisis."

Meanwhile, South Korea's $420 billion in foreign debt as of June, which also alarmed global investors, was built up in large part by the success of the country's shipbuilders.

Because shipbuilders take orders for ships that will be built in three or four years, they hedge most of their orders to guarantee that they get present value for them. About 36% of the country's debt is backed up by export payments to be received when ships are delivered. An additional 19% is owned by foreign banks in Korea, and analysts debate whether this should be considered part of the country's liability.

Before the global financial crisis spread, analysts expected South Korea's economy to grow about 4.5% for the year. Now, the consensus of estimates is just below 4% -- and for next year, forecasts range from 2.5% to 3.5%.

On Monday, the Bank of Korea lowered its main interest rate by three-quarters of a point to 4.25% in hopes of easing borrowing costs to the nation's businesses. BOK leaders said more cuts are on the way.

On Thursday, the National Assembly is to vote on a bill to guarantee the foreign-currency borrowings of the nation's banks, aiming to shore up liquidity of dollars and euros. And the Financial Services Commission on Wednesday eased liquidity requirements on the won, relieving pressure on banks to issue bonds.