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PolicyJuly 6 2009

What went right for South Korea

Han Seung-soo, South Korean prime ministerIn a speech at the IIF Spring Membership Meeting in Beijing in June, South Korean prime minister Han Seung-soo explained how the lessons learned from the Asian crisis of 1997 has helped his country come through the current recession in better shape than most.
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What went right for South Korea

Are the lessons of the 1997 Asian financial crisis applicable in today's broader global context? Clearly we are still grappling with the effects of a weak global economy. The credit crisis, triggered by the subprime mortgage meltdown in the US, produced devastating repercussions. However, the unprecedented crisis mandated unprecedented international collaboration. To this end, governments of major economies worked tirelessly to contain and stabilise the dramatic fluctuation in the global financial system.

 Specifically, we came together at the G-20 summit meetings. We first met in Washington, DC, last November, then in April in London and the G-20 will meet again in New York in September. These efforts resulted in several important fiscal and monetary measures. Financial commitments included $1100bn to various programmes to improve finance, credit, trade, investment and overall economic activity. Nearly 10% was allocated to assist international development banks in continuing to lend to impoverished countries. An agreement was also reached on broader global regulation of hedge funds and credit rating agencies.

Emphasising co-ordination

 As a member of the G-20 troika and the chair of the G-20 in 2010, South Korea has taken an active role in harnessing global financial cooperation and market stabilisation. The government has emphasised, on several occasions, the importance of policy co-ordination among economies of the world, including close consultations with neighbouring countries such as China and Japan. One such measure includes drawing out the Chiang-Mai Initiatives which helped to resolve the liquidity shortage of Asian countries.

 In looking at the lessons learned from the Korean experience in the global financial crisis, it was difficult for us at the outset to accurately assess and predict the impact of the US subprime mortgage crisis in Asia. For example, derivative products were less developed in Asia. As of 2008, over-the-counter derivative assets accounted for only 6% of Korean banks' total assets, much lower than the 27.7% exposure of US banks.

 We thought at the time, due to financial sector decoupling in Asia, the impact of Lehman Brothers and other investment banks would not be too significant. On the contrary, Korea, China and Japan all suffered dramatic market declines. Korea was particularly vulnerable because of its reliance on the US dollar for external payment settlements. For the first couple of months following the Lehman bankruptcy, Korea's policy priority was set on stabilising the foreign currency market. Korea at the time had sufficient foreign reserves, $243bn. Solvency was not an issue because its foreign debt structure was far healthier than it was at the time of the Asian financial crisis in 1997.

 Even with this backdrop, the 'stigma effect' from the 1997 crisis, combined with Korea's substantial dependency on foreign trade, caused grave concern among investors. Instability in the currency market was believed to be inevitable.

 To assure investors, our government launched a campaign to disseminate information on the key differences between the crises Korea faced in 1997 versus 2009. Contrary to our expectations, we did not see any immediate positive outcome of this initiative to restore confidence. The situation changed, however, when the currency swap agreement with the US was signed in October 2008. At that point, the central bank began to guarantee the foreign debt of commercial banks. We then began to see some positive signals. Korea's foreign exchange market regained stability.

 In retrospect, convincing the world that Korea had fewer domestic financial problems than in 1997 was also crucial to recovery. At the same time, the Korean government also had to act quickly and decisively to ward off global stagnation from affecting the real economy. The Bank of Korea responded boldly through drastic interest rate cuts while providing sufficient liquidity at the same time. We saw sharp reductions in loans to small and medium-sized enterprises (SMEs) and to contain further liquidity shortages the government introduced further measures.

 We extended credit guarantees on all SME loans through the public fund, Korea Credit Guarantee Fund, and this restored the primary function of Korea's commercial banks as liquidity suppliers to the real economy. Additionally, the government introduced a Won20,000bn ($16bn) bank recapitalisation fund. This endeavour was combined with a separate Won40,000bn fund to purchase non-performing loans from financial institutions. Thus, while the advanced countries simply provided liquidity and waited for it to take effect, our policy approach was more tailored, focused and proactive. This response was possible because, unlike 1997, the current crisis was created externally while Korean banks were sounder financially.

Tangible results

 The Korean government's response to the crisis has yielded tangible dividends. Our economy has contracted less than that of any other nation. Korea is the only OECD member state that registered positive growth in the first quarter of 2009 compared with the previous quarter.

 A Deutsche Bank report dated 15 April stated that "the Korean authorities' preemptive actions to limit the credit crunch at home have been strikingly effective". The report also highlighted Korea's current account surplus and expanding foreign currency reserves that alleviate concerns regarding foreign currency liquidity.

 In addition to monetary and financial policies, the Korean government leveraged fiscal policy tools to get the economy moving again. In this regard, we introduced an economic stimulus package that focused on increasing public spending and providing substantial tax cuts to boost the economy. In April, a supplementary budget of Won28,400bn was approved by the national assembly. This budget was targeted to shore up unemployment and expand the social safety net. In utilising deficit financing for the fiscal stimulus, Korea was better positioned and had more room to manoeuvre than most advanced countries. This was due in part to Korea's low national debt-to-GDP ratio which was 30% in 2008.

 As a result of these aggressive measures, the Korean economy has recently been showing signs of recovery. But we make no illusions about being out of the woods yet. Following a March surplus of $3.35bn, the current account surplus hit another record high of $6.65bn in April. Korea's GDP grew by one tenth of 1% in the first quarter of 2009 compared with the previous quarter. Since mid-March, we have also enjoyed relative stability in the foreign exchange and stock markets. Many international financial institutions and experts have been publishing relatively positive reports on the prospects of the Korean economy.

 Of course, uncertainties still remain, both at home and abroad. It will take some time and continued co-ordination across all sectors of the economy to fully stabilise and rebuild confidence in the financial markets and restore growth. Nonetheless, we need to look beyond the current crisis and search for ways to build a more resilient economy in order to make the best of such positive indicators. Green growth strategy is an example.

 We believe that a strong economy and a clean environment are not mutually exclusive and that Korea has to take an active role in the global effort to tackle the issue of climate change, on which the future of humanity so critically depends. President Lee Myung-bak, on the 60th anniversary of the founding of the Republic of Korea on 15 August last year, proclaimed "Low Carbon, Green Growth" as Korea's new national vision. In a nutshell, Low Carbon, Green Growth aims to shift the current paradigm from fossil fuel-dependent, quantity-oriented growth to a new paradigm of qualitative growth, the green growth. It will use less fossil fuel and therefore will be more compatible with environmental sustainability. The green growth strategy aims at 'three birds with one stone'. It will promote growth, increase the quality of life and help Korea play a more active role in the international negotiations of climate change within the framework of the UN Framework Convention on Climate Change.

 Specifically, in January this year, we initiated the Green new deal policy. The policy is an amalgam of a long-term policy of expanding growth potentially through 'green strategy' and a short-term policy of creating jobs and revitalising the economy through the 'new deal'. In short, it aims to create a low-carbon economy while stimulating job creation. As the green growth is our long-term policy objective, we are in the process of constructing the Green Growth five-year plan with a 10-year rolling plan. This may be the first attempt of its kind in the world. I hope that the Korean example will give rise to similar efforts in other nations as well.

A plan of action

 Let me conclude by offering four broadly based recommendations on how we may continue to stem the tide of the global financial crisis together. I hasten to add that more specific recommendations are now being worked out by the working groups of the G-20.

 First, we must prevent the current crisis from giving rise to a movement against globalisation. At the same time, we must be vigilant against an overly liberal market and seek to find a balance in between. Second, I wish to point out the need for stronger financial supervision and regulation. Third, greater international co-operation is needed in the international monetary system. We must institute reforms of the International Monetary Fund to remove the stigma effect that arises from utilising its funds. And fourth, I would like to underscore the importance for closer policy co-ordination among countries of the Asian region. We need to turn to markets within Asia to satisfy our export needs. This means that Asian economies must make efforts to expand domestic markets while also seeking trade and investment within the region.

 This is an extract from a speech given at the IIF Spring Membership Meeting in Beijing on 12 June

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