NBER Reporter: Spring 2000

The Korean Currency Crisis:

The Third Country Meeting of the NBER Project on Exchange Rate Crises in Emerging Market Countries

The third in a sequence of country-specific meetings of the NBER Project on Exchange Rate Crises in Emerging Market Countries, directed by NBER Research Associate Jeffrey Frankel, was held in Cambridge on February 2, 2000. Following successful meetings on Mexico and Thailand, this gathering focused on Korea. Jeffrey Frankel, NBER and Harvard University, and Jong-Wha Lee and Yung Chul Park, Korea University, organized the meeting. In addition to academic researchers, the participant list included high-level past and current officials of the Korean and U.S. governments, as well as key personnel from the IMF, World Bank, and financial community. As outlined in introductory remarks by National Bureau President Martin Feldstein, a key purpose of the meeting was to discuss different perceptions of what happened in Korea, and, hopefully, to leave with a better understanding of the crisis

The day's proceedings were divided into four chronologically organized sessions. Each session followed a format of short presentations by various experts and a free flowing general discussion.

A full report on the conference -- including an outline of the main themes of the general discussion -- is available on the NBER's web site. The program was:

Session 1: Build-up to the Crisis in 1997
Chair: Martin Feldstein
Bohn Young Koo, Chairman of the Board, Korean Center for International Finance
Nouriel Roubini, U.S. Department of Treasury (formerly Chief Staff Economist at CEA)
Jeffrey Shafer, Saloman, Smith, Barney (formerly Assistant Secretary of the Treasury for International Affairs)
Wanda Tseng, Deputy Director, Asia and Pacific Department, IMF

Session 2: Crisis and Macroeconomic Adjustments
Chair: Yung Chul Park
Kang-Nam Lee, Assistant Governor, Bank of Korea
David Lipton, Moore Capital Strategy Group (formerly Under Secretary of the Treasury for International Affairs)
Timothy Lane, Chief of Policy Review Division, IMF

David Pflug, Senior Credit Executive and Managing Director of Chase Manhattan's Global Bank

Session 3: Restructuring and Economic Recovery
Chair: Jong-Wha Lee
Ajai Chopra, Division Chief of the Korea Desk, Asia and Pacific Department, IMF
Kap-Soo Oh, Assistant Governor, Financial Supervisory Service
Zia Qureshi, Lead Economist and Country Program Coordinator, East Asia and Pacific Region, The World Bank
Caroline Atkinson, U. S. Department of Treasury

Session 4: Lessons and Prospects for the Future
Chair: Jeffrey Frankel
Martin Feldstein
Paul Krugman, MIT and NBER
Rak-Yong Uhm, Vice Minister, Ministry of Finance and Economy
Richard Cooper, Harvard University
Lael Brainard, Deputy Director of the National Economic Council, Assistant to the President

In the first session, there was an evident split on the panel between those who see the crisis as the product of severe structural weaknesses in the economy and those who see it mainly as a liquidity crisis. To those who hold the first view, the crisis was an almost inevitable punishment for the sins of "crony capitalism." Those who hold the second view typically admit that there were mistakes in economic management, but they also point to such factors as contagion effects from other countries and the herding behavior of foreign investors. Roubini was the clearest exponent of the structural weakness view, highlighting twelve vulnerabilities -- ranging from the bankruptcy of a number of the chaebol to significant political uncertainty -- already apparent in early 1997. Offering the perspective of the former government official, Koo argued for the liquidity crisis view. He contended that the essence of the crisis was that foreign banks refused to roll over short-term debt, and he offered various reasons for their unwillingness. Shafer agreed that the crisis was fundamentally a liquidity crisis, but concentrated his remarks on understanding the timing of the crisis. Among the factors he emphasized was the evasiveness of Korean government officials even after the IMF program of December 1997. This led to a loss of confidence and an acceleration of bank outflows. Tseng drew attention to the differences between the Korean case and previous crisis situations that the IMF had faced. She stressed that while it is true that Korea did experience a liquidity crisis -- the debt had to be extended -- major fundamental weaknesses underlay the loss of investor confidence. The policy content of the IMF programs was aimed at the structural weaknesses.

In the second session the panelists considered how the creditor panic of late 1997 and early 1998 was resolved. Among the questions considered: How did the late-December 1997 program differ from the earlier December 4 program? What was the effect of the initial IMF programs? Would some combination of devaluation and expansionary monetary policy have avoided the recession?

K. N. Lee started with a Korean central banker's perspective on the turnaround. He stressed the importance of international funds in overcoming the crisis, and the importance of getting the private sector on board. Echoing themes from the first session, he said that the crisis was caused by a sort of herd behavior. To regain investor confidence it was necessary to push for wide ranging economic reforms. Lipton then offered the perspective of a former Assistant Secretary of the U.S. Treasury who had dealt with the Korean crisis. As the Treasury saw it, it was crucial to put in place policies that would restore currency stability and prevent an internal run. He also offered various lessons for similarly crisis-affected countries, including the need for a firm monetary stance to lean against the pressures on the currency and the advantages of starting deep structural reforms to restore market confidence. Lane offered the perspective of the IMF. He added that he has been part of an ex post assessment of what the IMF was trying to do, and why it did not turn out as well as expected. He stressed that given the financial and corporate sector weaknesses, Korea was hugely vulnerable -- including vulnerability to domestic residents moving their money out -- unless credible commitments could be made to reform. He also addressed issues related to fiscal policy, the "iron logic of the reserve position," and the difficulty of bailing private creditors in. Finally, Pflug added the viewpoint of a private sector participant in the debt maturity restructuring. He raised various issues, including the role of the Basle requirements on the behavior of the international banks, the impact of the rating agencies (initially overrating Korea and then dropping the rating three times), and the conflicted role of the creditor banks in being asked to restructure debt.

In the third session the focus moved to the actual progress in financial and corporate sector reform. Session chairman J. W. Lee also posed two important questions for consideration in the session. First, referring to Korea's famous V-shaped recovery, he asked, "How did Korea recover so fast?" And second, "Do the reforms mean sustainable growth in the future?"

Chopra opened by stressing the IMF's heavy emphasis on promoting recovery. In charting the Korean recovery, he then used Sweden, Finland and Mexico as standards of comparison. Next Oh offered the perspective of a Korean financial supervisor. He pointed to the improved condition of the financial sector, noting such outcomes as the reduced number of banks and investment companies and the enhanced use of forward looking criteria for judging the credit worthiness of borrowers. He also listed various improvements that had been made in the financial structure of the corporate sector. Qureshi continued the emphasis on financial and corporate sector reforms. On the depth of reforms, Qureshi believes that Korea compares favorably with other crisis affected East Asian economies and with post-crisis Mexico. In the corporate sector major progress has been made in reducing debt-equity ratios. Yet further progress is needed for the current recovery to be translated into sustained growth. He listed a number of areas that needed further effort, including the problem of "reprivatizing" the financial sector and the dangers of "regulatory arbitrage" associated with the increase in assets of non-bank financial institutions. Atkinson followed Qureshi by asking if the recovery was a surprise. She offered the example of Mexico as a country that had a sharp turnaround in its current account and a recession, yet also had a fast turnaround in economic activity. Echoing Lipton and Shafer from earlier sessions, she stressed the importance of tight money in turning confidence around.

Feldstein opened the final session by questioning the wisdom of the IMF and World Bank's drive to reform the economy along multiple dimensions. He asked if they would have done that for any other OECD country. Arguing that there was a need to go back to an older, more narrowly focused approach, he said that the focus should have been on getting the private sector obligations rolled over, paying down the debt and building reserves. The focus also should have been on crisis prevention and management -- but not on long-term growth -- in a country that had been as successful as Korea. Krugman started off his presentation by restating a disagreement that he felt had lurked in the discussion all day: Does the recovery show that the policy response to the crisis was correct? Or, since the economy recovered so quickly, was there a need to have the crisis in the first place? He thinks it is difficult to tell. He also argued that the structural versus liquidity distinction is not very useful. A better distinction is between the bursting of a bubble and a bank run. Krugman addressed various other issues ranging from the role of structural reforms in the recovery, to the impact of high interest rates on the exchange rate and the possible advantage that Korea's underdeveloped financial system gave it in organizing private sector creditor involvement in debt restructuring. Uhm argued that there is a need to deal with the vulnerabilities that led to the crisis: both issues related to short-term liabilities and structural weaknesses. Among other points, he stressed the value of social cohesion (noting that it was not a coincidence that the crisis broke out during a political transition), and the need for reforms to the international financial architecture to protect small open economies. In a wide-ranging presentation, Cooper made a number of observations on the Korean crisis including: the inherent instability of financial systems; the fact that Korea had committed the standard error of borrowing short and lending extremely long; and the large contribution of the exchange rate depreciation to the economic recovery. Brainard, Assistant to the U.S. President during the crisis period, made the final presentation of the day. She began by asking why it is possible to see such a rapid decline in a country, and why financial variables are capable of turning around so quickly. She also dealt with the importance of psychological factors in the response of the financial system, which led her to the role of politics. In the case of Korea, the ability of President Kim to take difficult steps did turn confidence around, with the structural reforms seen as putting Korea on a sustainable long-run growth path.

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