South Korea North Korea€¦ · All information in this report is verified to the best of the...

COUNTRY REPORT

South Korea

North Korea

1st quarter 1999

The Economist Intelligence Unit15 Regent Street, London SW1Y 4LRUnited Kingdom

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Contents

3 Summary

5 Inter-Korean relations

South Korea9 Political structure

10 Economic structure11 Outlook for 1999-200016 Review16 The political scene18 Economic policy20 Production and demand23 Employment, wages and prices25 Money and finance29 Foreign trade and payments32 Business news

North Korea36 Political structure37 Economic structure38 Outlook for 1999-200039 Review39 The political scene41 The economy, trade and investment

45 Quarterly indicators and trade data

List of tables12 South Korea: forecast summary13 South Korea: global assumptions15 South Korea: economic results and forecasts19 South Korea: budgets21 South Korea: expenditure on gross domestic product21 South Korea: gross domestic product by industry22 South Korea: construction indicators, 199823 South Korea: seasonally adjusted manufacturing production24 South Korea: unemployment rate, 199824 South Korea: wages in manufacturing industry25 South Korea: consumer, producer, export and import prices, 199825 South Korea: money supply trends, 199826 South Korea: interest rates

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EIU Country Report 1st quarter 1999 © The Economist Intelligence Unit Limited 1999

26 South Korea: fund raising by the business sector, flow basis27 South Korea: net share purchase position on the KOSPI by investor type, 199829 South Korea: external liabilities30 South Korea: exports of selected commodities31 South Korea: imports of selected commodities32 South Korea: current- and capital-account balances45 South Korea: quarterly indicators of economic activity46 South Korea: foreign trade48 South Korea: structure of trade49 South Korea: direction of trade49 North Korea: direction of trade

List of figures16 South Korea: gross domestic product16 South Korea: won real exchange rates20 South Korea: real estate prices27 South Korea: KOSPI, 199831 South Korea: number of South Koreans travelling abroad

2


January 20th 1999 Summary

1st quarter 1999

Inter-Korean relations: The success or failure of Kim Dae-jung’s “sunshine”policy will be key in shaping inter-Korean relations. The first South Koreantourists have visited the north. Hyundai plans to build an industrial estate inthe north to produce goods for export. South Korea’s navy has sunk a NorthKorean semi-submersible found in its waters.

South Korea Outlook for 1999-2000: Political reform will continue to lag behind eco-nomic reform. The NCNP-ULD ruling coalition will step up its efforts to splitthe opposition GNP party. Real GDP will grow by 0.3% in 1999 and by 4.8% in2000. Domestic demand will, however, remain weak in both years. Exportgrowth will also be slow by recent standards. The won will appreciate againstthe dollar, albeit gradually. Inflationary pressures will be largely absent. Largebut diminishing current-account surpluses will be recorded.

The political scene: Relations between the NCNP-ULD ruling coalition andthe opposition GNP remain tense. The GNP has accused the government ofspying on it. The government continues to charge the GNP’s leader, Lee Hoi-chang,of corruption, partly to force a split in the party. Relations with China haveimproved, but there are differences with the US on policy towards North Korea.

Economic policy: Monetary policy remains loose, but the finance ministryand the central bank differ on how fast interest rates should be lowered. The1999 budget has been passed; more than 50% of spending will be front-loaded.Financial-sector reform is progressing, but the bad loan problem remains.KAMCO has not been as successful as the government had hoped in selling onthe bad assets it has acquired.

Production and demand: Real GDP contracted by 6.8% year on year in thethird quarter, as private consumption and gross fixed investment continued tofall. Growth in exports of goods and services slowed. The domestic construc-tion sector remains in deep depression. Industrial production fell year on yearbut rose slightly quarter on quarter in the third quarter.

Employment, wages and prices: Unemployment rose in November to7.3%. Nominal wages in manufacturing fell by 10.1% in the third quarter.Weak domestic demand, low world commodity prices and the appreciation ofthe won against the dollar have moderated consumer price rises.

Money and finance: M2 growth has accelerated as savers move funds intotime deposits. Nominal interest rates have fallen to below pre-crisis levels, butsmaller companies may not be feeling the benefits. The won continues toappreciate. The stockmarket is buoyant, partly owing to strong foreign interest.The domestic bond market remains active, but the government has introducedmeasures to curb the dominance of the largest chaebol. The level of externaldebt is stable.

3


Foreign trade and payments: Preliminary data show that the merchandisetrade surplus (fob-cif) reached $39.9bn in 1998. This was mainly owing to asharp contraction in merchandise imports in both volume and value terms.The current-account surplus continued to grow, driven by merchandise tradesurpluses, reaching $31.2bn in January-September.

Business news: The government has stepped up chaebol reform, forcing LG togive up its semiconductor operations to Hyundai. The so-called Big Deals maynot be entirely beneficial. The government appears to be favouring Hyundai,giving it an unfair advantage over other chaebol. The government has sold partof its stakes in POSCO and Korea Telecom. Korea First Bank will be bought bya consortium led by Newbridge Capital and GE Capital.

North Korea Outlook for 1999-2000: North Korea’s new government may initiate eco-nomic reforms. These could, however, be challenged by the military. The US’sengagement policy towards North Korea could change as nuclear concernsmake Congress harden its attitude.

The political scene: Relations with the US have worsened. Japan and Russiawant to join the four-way talks. North Korea could conclude a treaty withRussia. Taiwan may want to acquire North Korean military technology.

The economy, trade and investment: Merchandise trade is estimated tohave fallen by 30% in value in 1998. A better harvest is expected in 1998, butthe US is still seeking fresh aid for North Korea. Hyundai and Samsung planinvestments in North Korea.

Editor: Robert WardAll queries: Tel: (44.171) 830 1007 Fax: (44.171) 830 1023

4


Inter-Korean relations

The outlook is mixed The outlook for inter-Korean relations over the next two years is, as ever,uncertain. Two contradictory trends are in evidence: one promises a break-through, at least in business and civilian co-operation, while the other threat-ens a rise in tension, perhaps back to the levels of 1993-94 when concernsabout North Korea’s possible nuclear capabilities were at their height.

South Korea ismaintaining its

“sunshine” policy—

The positive trend is South Korea’s “sunshine” policy, which South Korea’spresident, Kim Dae-jung, is adhering to despite continued military provocationby the north (see below) and some opposition at home. While neither easingmilitary deterrence nor expecting an early political breakthrough, this activelyencourages non-governmental contacts of all kinds. North Korea seems amena-ble to this, as witness the start of regular trips by South Korean tourists to thenorth in November last year under the auspices of one of South Korea’s largestchaebol (conglomerates), Hyundai (see below).

—which may encouragecloser economic

co-operation—

The success or failure of the sunshine policy will be a key factor shapinginter-Korean relations more broadly. Substantial inter-Korean economic co-operation will augur well not only for warmer political ties in the mediumterm, but will also act as a counterweight for the north to the harder US line,caused by concerns about North Korea’s missile programmes and new allegedlynuclear-related construction. (See North Korea: Outlook for 1999-2000.)

—provided the north iswilling to change

If engagement policies are not to be jeopardised, both South Korea and, moreparticularly, the US need to see clear signs of a more positive approach by thenorth. On the economic front, there must be swift movement beyond theheavily quarantined and essentially tribute-bearing tourism project (for whichHyundai is paying almost $1bn over six years) to sustainable, reciprocal andprofitable business deals. It is not yet clear, however, whether North Korea’sleader, Kim Jong-il, has the courage to embrace this. Likewise, and more ur-gently, North Korea must do enough to satisfy US concerns on the nuclear andmissile issues.

Chung Ju-yung meetsKim Jong-il—

The high point in inter-Korean relations in the latter part of 1998 came onOctober 30th when Hyundai’s founder, Chung Ju-yung, on the second of histhree crossings of the demilitarised zone (DMZ) in 1998, had the rare treat of ameeting with Kim Jong-il. That public seal of approval from the top of the NorthKorean leadership provides some grounds to hope that inter-Korean businesswill progress from gifts and gestures to substantial projects. As on his earlier visitin June 1998, Mr Chung brought some 500 cattle as a gift. Crossing again inDecember, he took cars rather than cows. Mr Chung plans to go north yet againin February this year. His main interlocutor in the north, the influential partysecretary, Kim Yong-sun, is said to have replied positively to an invitation toreciprocate by visiting Seoul at some point. That may not be very soon.

Inter-Korean relations 5


—and Hyundai’s touristboats start sailing north—

The flagship of Hyundai’s northern ambitions (which also include plans tobuild an industrial estate in the north to produce goods for export), namelyregular boat tours to Mt Kumgang on the east coast just north of the DMZ,finally started on November 18th, two months later than originally planned(for details on Hyundai’s cruise plan see 4th quarter 1998, page 6). There wasalso grumbling in South Korea’s press at the quarantine imposed to minimiseany contacts with ordinary North Koreans. North Korea refused at first to letjournalists from the conservative—and often critical—South Korean dailynewspaper, Chosun Ilbo, go ashore, relenting only on the final day. Overall,however, the trip was judged a success, by the many elderly northerners-by-birth especially in the 980-strong group, who were just glad to set foot in thenorth after half a century away.

—but a row over moneycould jeopardise

the project

Hopes that the project will run smoothly may be jeopardised, however, by arow over money. Despite the sunshine policy’s supposed delinking of businessfrom politics, South Korea’s unification ministry has delayed Hyundai’s firstmonthly payment to the north on the grounds that the duration of the rights



to tourism has not been clarified. A 30-year period had been mooted, but NorthKorea is taking the perverse line that so long a timeframe implies a permanentpartition of the peninsula. This may be an excuse to backtrack, and it remainsto be seen if South Korea will yield.

South Korea sinks a NorthKorean submersible

A further threat to improving inter-Korean relations comes from North Korea’srepeated military incursions into South Korea’s territory. On November 20th asuspected North Korean spy boat escaped its southern pursuers, giving rise tofurther criticism in South Korea of its armed forces’ incompetence—the earlierintruders were detected by civilians, not the military. Then, on December 18th,after a seven-hour night chase along the south coast of South Korea, SouthKorea’s navy sunk a North Korean semi-submersible and recovered the body ofone suspected North Korean agent. A larger mother ship is thought to have gotaway. Needless to say, each such incident undermines public support in SouthKorea for Kim Dae-jung’s sunshine policy. If this continues, and especially ifthere were a serious incursion or terrorism causing casualties, Kim Dae-jungwould no doubt be forced to revert to a traditional hardline stance and rein inbusiness co-operation with North Korea.

More southerners thanever go north—

The publicity given to Hyundai’s cows and ships may obscure no less impor-tant wider trends. Chosun Ilbo reported on December 4th that already moreSouth Koreans had visited the north in 1998 than in all the 45 years since theend of the Korean war. South Korea banned such travel altogether until June1989, and even thereafter it was not made easy until Kim Dae-jung came topower. The actual numbers remain modest, however: around 2,650 in 1998(January-November), compared with 2,450 between 1989 and 1997. (This ex-cludes the 2,957 tourists who travelled on Hyundai’s cruises in the first fort-night alone.)

—but not all are tourists Their aims were diverse. The majority (1,356) were tourists, but travelling ontheir own account and not with Hyundai; most will probably have been meet-ing relatives. The next largest group, numbering 721, were workers of theKorean Peninsula Development Organisation (KEDO) at its light-water reactorproject at Kumho; 238 went for social and cultural exchange: these includedjournalists and sports officials. There were 203 business visitors, and 125 aidworkers from southern non-governmental organisations, who are allowed tooperate in the north independently of the government in Seoul.

The two Koreas couldshare the 2002 World Cup

Looking ahead, there is talk of letting North Korea host two games in the 2002football World Cup, already being shared by South Korea and Japan. ChungMong-joon (the head of Seoul’s football association, and a Hyundai scion—heis Chung Ju-yung’s son), revealed this idea in December last year after visitingPyongyang. Facilities are not lacking: the 150,000-seat Rungnado stadium inPyongyang is larger than any in Seoul. The fact that this showpiece was built inthe hope, in the event unfulfilled, of staging part of the Seoul Olympics in 1988is a reminder that the two Koreas may still not find it easy to share.

Inter-Korean relations 7


The number of defectorsfrom the northremains small

The trickle of defectors from North Korea is still amazingly small—the cumula-tive total since 1953 has yet to top 1,000. The flow is, however, increasing.Recent defectors included a Korean People’s Army (KPA) captain and his ser-geant mistress. In January this year it was revealed that a leading northern filmactress, Kim Hye-young, had been secretly living in Seoul with several membersof her family since last August. South Korea has an unknown number of suchunannounced high-ranking defectors, whose presence is kept secret either fortheir own security or to avoid antagonising the north unduly.



South Korea

Political structure

Official name Republic of Korea

Form of state Presidential system; president and National Assembly directly elected, both on afirst-past-the-post system

The executive The president (elected for a single term of five years) appoints the State Council(cabinet) composed of the president, prime minister and between 15 and 30 ministers.The State Council includes appointees from outside the National Assembly

Head of state Elected president

Legislature Unicameral Kuk Hoe (National Assembly) of no fewer than 200 members (currently299) elected for four-year terms; currently 253 seats are filled by direct election; theremaining 46 are distributed between parties in proportion to their share of the vote

National elections April 1996 (National Assembly) and December 1997 (presidential); next elections dueby April 2000 (National Assembly) and December 2002 (presidential)

National government Coalition of the National Congress for New Politics (NCNP) led by the president, KimDae-jung, and the United Liberal Democrats (ULD) led by the prime minister, KimJong-pil. Until September 1998 the National Assembly was controlled by the GrandNational Party (GNP), the former ruling party, but after opposition defections thegovernment now has a slim majority. As of January 20th 1999 the NCNP had 101seats, the ULD 52 seats, and the GNP 140 seats; there were six independents. Thecoming months may see further fluidity, including the possible collapse of the GNP

Main political organisations Government: National Congress for New Politics (NCNP) in alliance with UnitedLiberal Democrats (ULD). Opposition: Grand National Party (GNP), formed by mergerof the former New Korea Party (NKP) and the small Democratic Party (DP) towards theend of 1997. The former New Party by the People (NPP) has been absorbed into theNCNP

Main members ofState Council

President Kim Dae-jung Prime minister Kim Jong-pil

Key ministers Construction & transportation Lee Jung-mooDefence Cheon Yong-taekEducation Lee Hai-chanEnvironment Choi Jae-wookFinance & economy Lee Kyu-songForeign affairs & trade Hong Soon-youngGovernment administration Kim Jung-kilHealth & welfare Joo Yang-jaIndustry & energy Park Tae-youngInformation & communications Namgoong SuekJustice Park Sang-cheonLabour affairs Lee Ki-hoNational unification Kang In-duckScience & technology Kang Chang-hee

Central bank governor Chon Chol-hwan

South Korea 9


Economic structure

Latest available figures

Economic indicators 1994 1995 1996 1997 1998

GDP at market prices (W trn) 306.0 352.0 389.8 416.8 428.7a

Real GDP growth (%) 8.6 8.7 7.3 5.5 –7.0a

Consumer price inflation (%) 6.2 4.5 4.9 4.5 7.5

Population (m) 44.5 45.1 45.5 45.9 46.4a

Exports fob ($ bn) 95.0 124.6 130.0 138.6 127.9a

Imports fob ($ bn) 97.8 129.1 144.9 141.8 91.6a

Current-account balance ($ bn) –3.9 –8.5 –23.0 –8.2 35.7a

Reserves excl gold ($ bn) 25.6 32.7 34.0 21.1 52.0

Total external debt ($ bn) 81.5 100.3a 123.4a 145.6a 153.5a

Debt-service ratio, paid (%) 6.9 7.3a 8.7a 10.9a 13.7a

Exchange rate (av; W:$) 803.5 771.3 804.5 951.3 1,396.3

January 19th 1999 W1,175.3:$1

Origins of gross domestic product 1997 % of total Components of gross domestic product 1997 % of total

Agriculture, forestry & fishing 5.7 Private consumption 53.6

Mining & quarrying 0.3 Government consumption 11.1

Manufacturing 25.7 Fixed capital formation 35.0

Electricity, gas & water 2.3 Change in stocks 0.0

Construction 14.6 Exports of goods & services 38.1

Trade, restaurants & hotels 11.3 Imports of goods & services –38.8

Transport, storage & communications 7.3 Statistical discrepancy 1.0

Financial & business services 17.6 GDP at market prices 100.0

Government services 8.3

GDP at market prices incl others 100.0

Principal exports 1997b $ m Principal imports 1997b $ m

Transistors, semiconductors etc 19,663 Machinery & transport equipment 48,722

Textiles, fabrics & yarn 10,617 Mineral fuels & lubricants 27,381

Passenger cars 9,264 Chemicals 13,110

Ships & floating structures 6,520 Raw materials 10,424

Refined petroleum products 5,099 Food & live animals 6,517

Total incl others 136,164 Total incl others 144,616

Main destinations of exports 1997 % of total Main origins of imports 1997 % of total

US 15.9 US 20.7

Japan 10.8 Japan 19.2

China 10.0 China 7.0

Hong Kong 8.6 Saudi Arabia 4.9

Singapore 4.3 Australia 4.1

a EIU estimate. b Customs basis.

10 South Korea


Outlook for 1999-2000

Kim Dae-jung makes agood start—

It is hard to believe that Kim Dae-jung has been president for less than a year.(Although elected on December 18th 1997, his formal inauguration was notuntil February 25th 1998.) Having won the presidency at his fourth attempt,late in life and in the middle of economic crisis, Mr Kim has taken chargewith vigour—a welcome change after the vacillations of his predecessor, KimYoung-sam.

—but the chaebol areresisting reform

Concern continues, however, that some chaebol (conglomerates), above all thebiggest, are still either resisting real change or implementing only superficialreforms. Bringing down their absolute debt burdens and debt-equity ratios tothe tight targets nominally set will be tough, not least because a still weakbanking system dare not risk letting major creditors go to the wall and takethem with it. This stark reality will underpin the shadow-boxing between thelargest chaebol and the government, which will no doubt continue in 1999 andmaybe beyond.

Political reform lagsbehind economic reform—

Back in the days of growth and dictatorship, South Koreans commented rue-fully that their country’s political development had failed to keep up witheconomic progress. In today’s very different climate, this in some ways remainstrue. While economic reform has made considerable strides, the political arena,although now firmly democratic, at least in its institutions, in practice remainsa great disappointment to many ordinary South Koreans. Factional strife andinternecine party battles are still the order of the day, despite the lack of anyclear policy or ideological differences between most of those involved.

—and this will continueover the forecast period—

It is doubtful whether Kim Dae-jung will do much about this in the next twoyears. His main concern is to win the parliamentary election due in April 2000,so avoiding uncomfortable cohabitation with an opposition-controlled Nat-ional Assembly (parliament) as in the first half-year of his presidency. To thisend, he will continue to seek to split the main opposition party, the GrandNational Party, in order to form a new reforming grand coalition transcendingregional and party affiliations. A related goal is to enable his National Congressfor New Politics to end its alliance with its conservative ally, the United LiberalDemocrats—led by Kim Dae-jung’s former political foe, the prime minister,Kim Jong-pil—in order not to have to keep a promise of changing the constit-ution to give more power to the prime minister. All in all, party politics willcontinue to be both unstable and tough in 1999-2000.

—with emphasis onpolitical theatre

and revenge

Another negative side of Korean political culture likely to be in evidence overthe forecast period is a quest for scapegoats. Parliamentary hearings to investig-ate the causes of the economic crisis, already postponed once, were due tobegin in January, amid controversy over whether Kim Young-sam would testifyor should be forced to. On the precedent of the trial and brief jailing by KimYoung-sam of his own two military predecessors, Chun Doo-hwan and RohTae-woo, for coup-making and corruption, the likely outcome will be politicaltheatre rather than a serious enquiry.

South Korea 11


Kim Dae-jung may visitMoscow—

Internationally, Kim Dae-jung may slow down a little after the hectic diplo-matic pace of his inaugural year, when he made state visits to the US, Japan andChina, as well as attending the Asia-Europe Meeting (ASEM) in London, theAsia-Pacific Economic Co-operation forum (APEC) in Kuala Lumpur and theAssociation of South-East Asian Nations (ASEAN) meeting in Hanoi. His firstport of call in 1999 should be Moscow, Russia being the only one of the fourpowers adjoining or involved with Korea (both north and south) which he hasyet to visit as president.

—and perhaps even theMiddle East and

North Korea

Beyond that, Mr Kim may well choose to spend time in Europe. Seeing himselfas a regional and even a global figure, he will also travel further in Asia andmight become the first South Korean president to visit the Middle East(although the choice of hosts could prove delicate). Where he would really liketo go to is, of course, Pyongyang, but this is unlikely in 1999—although notimpossible in 2000.

South Korea: forecast summary($ bn unless otherwise indicated)

1997a 1998b 1999c 2000c

Real GDP (%) 5.5 –7.0 0.3 4.8

Consumer prices (av; %) 4.4 7.5a 1.2 2.0

Unemployment rate 2.9 7.0 8.5 8.4

Merchandise exports fob 138.6 127.9 114.1 111.8

Merchandise imports fob 141.8 91.6 89.3 97.3

Trade balance –3.2 36.4 24.8 14.5

Current-account balance –8.2 35.7 19.5 7.2

Exchange rate (av; W:$) 951.3 1,396.3a 1,182.5 1,140.0

a Actual. b EIU estimates. c EIU forecasts.

Growth will resumein 1999—

The EIU estimates that South Korea’s real GDP contracted by 7% in 1998. Thiswould have been the worst annual contraction in the country’s real outputsince the Bank of Korea (BOK, the central bank) began compiling data in 1953.We expect growth to resume in 1999, however, with real GDP expanding by amodest 0.3%. Underlying this forecast are two assumptions. The first is that thegovernment is broadly successful in reconstructing the financial sector—although progress on this has been made, questions remain as to how thegovernment will fund bank recapitalisation, particularly as there appears to belittle consensus on the level of non-performing loans. The second is that thecurrent financial crisis in Brazil will not have a significant impact on USgrowth—and, by extension, on South Korea’s export prospects.

—but consumer sentimentwill remain weak—

Although the worst of South Korea’s economic crisis will be over, domesticdemand will remain very weak throughout 1999. Unemployment will con-tinue to rise over the year, averaging 8.5%, as corporate restructuring acceler-ates. The worsening labour market and continuing harsh earningsenvironment will also mean that wages in both nominal and real terms will fallagain for many workers, further undermining consumer sentiment. Workers atthe larger companies, who have hitherto fared better than their compatriots insmaller companies, will also not be immune from staff and wage downsizing: arecent survey by the Korea Employers’ Federation, for example, found that

12 South Korea


63.4% of the country’s top 50 companies planned to lay off more workers in1999, and that 58.6% of these companies planned wage freezes while 19.5%planned further wage cuts. We therefore expect a further contraction in privateconsumption in 1999 of 4.6%, although the pace of contraction in year-on-year terms will ease as the year progresses.

—and continuing cuts inbusiness investment—

Credit conditions will not ease appreciably for many of South Korea’s com-panies in 1999. This will be owing both to the continuing pressures on thebanks to improve their Bank for International Settlements capital adequacyratios and to lingering distortions in the domestic financial markets which willimpede direct financing for smaller companies. Although none of the chaebolinvolved in the so-called Big Deal business swaps has yet produced details ofhow overlapping capacity will be trimmed, the government may pressure themto do so in the near future. Capacity reduction would have a direct impact onmany of the small subcontractors currently serving the larger chaebol, presum-ably putting many out of business and further reducing the prospects for evena modest rally in business investment in the short term.

—will not be offset byincreased government

spending

In its 1999 budget the government envisages increased spending on publicworks to alleviate unemployment (see Economic policy for details on thisyear’s budget). We do not believe, however, that this will be enough to offsetthe continued projected decline in business investment and we therefore ex-pect gross fixed investment to contract by 18.7% in 1999. Once again, how-ever, the pace of contraction in year-on-year terms will moderate over the year.

South Korea: global assumptions(% change unless otherwise indicated)

1997a 1998b 1999c 2000c

Real GDP growthUS 3.9 3.7 2.1 1.8 Japan 1.4 –3.0 –0.6 0.8 EU 2.6 2.8 1.6 2.1 World trade growth 10.3 4.4 4.1 5.7

Oil price –6.8 –32.7 –33.5 16.4

Consumer prices, OECD average 2.1 1.5 1.6 1.8

Average exchange rate (¥:$) 121 131 125 125

a Actual. b EIU estimates. c EIU forecasts.

Source: EIU.

Export volume growthwill slow—

Growth in South Korea’s exports of goods of services will slow to 4.3% in 1999from an estimated 13.9% in 1998. This relatively poor performance will belargely because of the projected sharp slowdown in US import growth andanother year of economic contraction in Japan, which will help slow worldtrade growth to 4.1% from an estimated 4.4% in 1998. (The US and Japantogether took nearly 30% of South Korea’s exports in 1997.) South Korea’sexports are also likely to become less competitive in 1999 than they were in1998, owing to forecast won appreciation against the dollar.

South Korea 13


—but the foreign balancewill make a positive

contribution to growth

The foreign balance will make a 1.8 percentage point contribution to growth in1999, well down on the estimated 16.9 percentage point contribution in 1998.This will reflect both the slowdown in growth of exports of goods and servicesand the modest rise in imports of goods and services of 2.4%.

Growth will acceleratein 2000

Growth will accelerate to 4.8% in 2000. This will be considerably below pre-crisis levels—real GDP grew by an annual average of 7.2% in 1993-97—and willpartly reflect the lingering weaknesses in the banking sector, which will im-pede the flow of bank-intermediated lending. Although an improvement incorporate sentiment is likely by 2000, those firms that have survived the eco-nomic downturn of 1998-99 will maintain a cautious stance with regard toinvestment, limiting growth of gross fixed investment to 2% for the year.Private consumption will continue to contract, albeit by a modest 0.5%. Thiswill be largely because of stubbornly high levels of unemployment, which,being structural rather than cyclical, will be difficult for the government toeradicate over the short term. Although there will be increasing job opportun-ities in the currently underdeveloped services sector, this is unlikely to happenon a significant scale within the forecast period. Growth in exports of goodsand services will accelerate, albeit modestly, to 5.5%, as a resumption of growthin Japan helps lifts world trade growth.

Monetary and fiscal policywill remain expansionary

Given the current very tight credit conditions for most companies and thelikelihood that the won will remain stable, there is little reason to expect thegovernment to tighten monetary policy significantly in the short term, pro-vided domestic inflationary pressures remain under control. Fiscal policy willalso remain loose over the forecast period, as the government increases spend-ing on unemployment programmes and financial-sector restructuring. Thegovernment’s revised budget for 1999 projects a deficit equivalent to 5.1% ofits forecast for 1999 current-price GDP. This assumes, however, real GDPgrowth of 2% in 1999, rather faster than we are forecasting. The actual level ofthe budget deficit in 1999 is therefore likely to be higher than the govern-ment’s projection, possibly in excess of 6%. Continuing public spending de-mands are likely to keep the deficit above 5% in 2000. The government will usethe domestic bond market to finance much of its extra spending. This couldmean that nominal interest rates will not fall as far into single figures as thegovernment would like.

The won will appreciate The won will appreciate against the dollar over the forecast period, averagingW1,182.5:$1 in 1999 and W1,140:$1 in 2000. This will reflect the continuingprojected current-account surpluses, steadily rising foreign direct investmentand portfolio investment inflows, and large and increasing foreign-exchangereserves, which we forecast will reach nearly $70bn by the end of 2000. Fasterappreciation will, however, be hindered by occasional intervention—or threatsof intervention—by the government, which will remain concerned about de-clining export competitiveness, and by increasing outflows of interest pay-ments on the large stock of dollar-denominated debt and of profits anddividends from the steady accumulation of assets by foreign investors.

14 South Korea


Inflationary pressuresshould remain muted—

Our forecasts for weak continuing weak domestic demand, exchange-rate sta-bility and very soft world oil and non-oil commodity prices suggest that dom-estic inflation will be muted in 1999-2000. The continuation, which weassume, of the credit contraction for much of the forecast period will furtherreduce inflationary pressures. We therefore expect consumer price inflation tomoderate to an average of 1.2% in 1999, after 7.5% in 1998, and to pick uponly slightly to an average of 2% in 2000.

—although there are risks There are, however, two main risks to this forecast. First, increases in water,electricity, some transport and medical insurance fees are planned for 1999,which could, in turn, put pressure on parts of the private sector to raise pricesand cause inflation to rise more quickly than our forecast. Second, the govern-ment’s loose monetary policy could prove more inflationary in the mediumterm than we have assumed.

South Korea: economic results and forecasts(W bn at constant 1990 prices; % change year on year in brackets)

1997a 1998b 1999c 2000c

Private consumption 152,480 135,097 128,883 128,175 (3.1) (–11.4) (–4.6) (–0.5)

Public consumption 26,249 23,335 22,355 21,908 (5.7) (–11.1) (–4.2) (–2.0)

Gross fixed capital formation 100,947 74,196 60,321 61,528 (–3.5) (–26.5) (–18.7) (2.0)

Final domestic demand 279,676 232,628 211,559 211,611 (0.8) (–16.8) (–9.1) (0.0)

Change in stocks –6,922 –31,319 –12,000 –3,500 (–3.7)d (–8.4)d (7.1)d (3.1)d

Total domestic demand 272,753 201,309 199,559 208,111 (–2.8) (–26.2) (–0.9) (4.3)

Foreign balance 20,320 69,603 74,498 79,082 (8.6)d (16.9)d (1.8)d (1.7)d

Statistical discrepancy –2,186 –500 –2,800 –2,800

GDP 290,888 270,412 271,258 284,392 (5.5) (–7.0) (0.3) (4.8)

Exports of goods & non-factor services 149,014 169,727 177,025 186,673

(23.6) (13.9) (4.3) (5.5)

Imports of goods & non-factor services 128,694 100,124 102,527 107,592

(3.8) (–22.2) (2.4) (4.9)

a Actual. b EIU estimates. c EIU forecasts. d Contribution to GDP growth.

Large but fallingcurrent-account surpluses

will be recorded

We estimate that the current-account surplus reached $35.7bn in 1998, equiva-lent to 11.7% of GDP. A forecast continued contraction in the value andvolume of merchandise imports in 1999 and an only modest recovery in bothin 2000 will ensure continuing, albeit declining, trade and current-accountsurpluses in 1999 and 2000. The services deficit will start to widen in 1999,after narrowing sharply in 1998, and will reach $1.4bn in 2000. This will be theresult of an increase in trade-related services as the economy starts to recoverand of a rebound in foreign travel by South Koreans. The income deficit,

South Korea 15


meanwhile, will continue rising, reaching $6.9bn in 2000, because of increas-ing outflows of interest payments as South Korean borrowers service their largestock of foreign debt.

Review

The political scene

Parliament remainsfractious—

Domestic politics over the past months are hardly worth dwelling on, beingneither significant nor edifying. The atmosphere in the National Assembly(parliament)—which, because of in-fighting between the ruling NationalCongress for New Politics-United Liberal Democrats (NCNP-ULD) coalitionand the opposition Grand National Party (GNP), has a large legislative backlog,including important reform bills—can be judged by two recent events. OnJanuary 6th MPs of the ruling coalition sneaked in by a side door to avoid asit-in and blockade by members of the opposition (who had also locked thespeaker in his office, but his deputy was free), and passed 60 bills in 15 minutes.

—and the GNP claims thegovernment is spying on it

One of the new laws changes the name of the Agency for National SecurityPlanning (NSP, the successor of the feared Korea Central Intelligence Agency) tothe softer-sounding National Intelligence Service (NIS). The GNP, however,suspects that the NSP/NIS is being used by the government to spy on them, andon December 31st a number of GNP MPs broke into a room in the NationalAssembly building, which they claim was being used for this purpose. Documentswhich they seized suggest, rather, that the NSP/NIS has been watching boththe ruling and opposition camps, with particular reference to legislation andattitudes which may bear on its own future. The break-in’s ring-leaders werepromptly barred from leaving the country and may face charges.

Bad blood all round— These incidents illustrate, and will further prolong, the continuing feudbetween ruling and opposition parties. This does nothing to improve the imageof politicians in the minds of either their own electors or foreign observers.

70

80

90

100

110

1990 91 92 93 94 95 96 97 98 99 2000

South Korea: won real exchange rates (c)1990=100

W:$W:$W:$W:$W:$W:$W:$W:$W:$W:$W:$W:$W:$W:$W:$W:$W:$W:$W:$

W:¥

W:$

W:¥W:¥

W:DMW:DMW:DM

W:$

W:¥

W:$

W:¥W:¥

W:DMW:DMW:DM

97 98(a) 99(b) 2000(b)

W:$

W:¥

W:$

W:¥

W:$

W:¥

W:$

W:¥

W:$

W:¥

W:$

W:¥

W:$

W:¥

W:$

W:¥

W:$

W:¥

W:$

W:¥

W:DM

97 98(a) 99(b) 2000(b)97 98(a) 99(b) 2000(b)97 98(a) 99(b) 2000(b)

-8

-6

-4

-2

0

2

4

6

8

1996 97 98(a) 99(b) 2000(b)

South Korea

Asia (excl Japan)

South Korea: gross domestic product% change, year on year

(a) EIU estimates. (b) EIU forecasts. (c) Nominal exchange ratesadjusted for changes in relative consumer prices.Sources: EIU; IMF, International Financial Statistics.

16 South Korea


Blame for this negative trait must go to both sides. The GNP, having broughtthe country to the brink of sovereign default by the end of 1997, was from thestart irresponsibly unco-operative with Kim Dae-jung’s administration—witness, for example, the GNP’s use of its (then) majority in the NationalAssembly to block confirmation of Mr Kim’s coalition partner, Kim Jong-pil, asprime minister. The GNP can scarcely be surprised, therefore, that the rulingcoalition has responded by trying to break it up, chiefly by seeking to lure itsMPs to cross the floor to join the government’s ranks.

—does credit toneither side

Kim Dae-jung’s NCNP also seems to be resorting increasingly to the familiarold politics of personal vendettas and double standards. The NCNP seemsdetermined to try to destroy the GNP’s leader, Lee Hoi-chang, and charges ofcorruption have been overwhelmingly targeted at the opposition—unless anMP crosses the floor, in which case they are mysteriously dropped. It is dismay-ing that a committed democrat and reformer like Kim Dae-jung tolerates,whether or not he directs, this kind of politics. It also seems a strange way topursue his apparent goal of forcing a split in the GNP and creating a grandcoalition for reform: it can only reinforce old animosities between his ownCholla region in the south-west, now enjoying its first-ever taste of power inSeoul, and Kyongsang in the south-east, from which most of South Korea’sprevious presidents have come.

The police storm aBuddhist temple

The peaceful image of Buddhism took a rude jolt in Seoul in December: not somuch the sound of one hand clapping as the sight of many fists punching.Over several years, a factional feud in the Chogye order—the largest in Korea,with 8m adherents—has regularly erupted into violence. This came to a headon December 23rd, when riot police stormed the Chogye temple to evict some100 dissident monks, who 40 days earlier drove out their rivals and had sat inever since. Twenty police and monks were injured, some seriously, includingtwo police who fell from a mobile assault ladder. Like the antics of politicians,the unseemly spectacle of holy men fighting tooth and nail has angered theSouth Korean public, further diminishing respect for supposed elites.

Relations with Chinaimprove—

Fortunately, South Korea’s international politics are more serious and less taw-dry than at home. Kim Dae-jung concluded a year of vigorous and successfuldiplomacy, during which he had already visited the US and Japan, with trips toChina (taking in Beijing, Shanghai and Hong Kong) and two regional meetings,the Asia-Pacific Economic Co-operation forum summit in Kuala Lumpur, andthat of the Association of South-East Asian Nations in Vietnam. He also wel-comed the US president, Bill Clinton, in November. All these meetings werebroadly successful. While Kim Dae-jung has no illusions about China, he ac-cepts the need both to strengthen Seoul-Beijing ties and to try to influenceChina’s handling of North Korea. In Vietnam he became the first South Koreanpresident ever to express public regret for the past: that is, the 300,000-oddSouth Korean troops who fought for the south in the Vietnam war. (His hosts inHanoi made it clear they had not asked for any apology: an interesting contrastto the way Koreans north and south endlessly harry Japan to say sorry.)

South Korea 17


—but there are differenceswith the US on North

Korea policy

President Clinton’s short visit, while amicable enough, barely concealed differ-ences which have recently emerged over how to handle North Korea. The USreaffirmed its commitment to an engagement strategy, while South Koreaagreed that North Korea must allow inspections of its “big hole” at Kumchangriin North Korea’s north-west. Yet behind this unity it was clear that South Koreais worried that its ally’s new harder line may undermine its sunshine policy,before the latter has time to work its hoped-for healing.

Trilateral security istightening

Sunshine does not, however, mean any lessening of vigilance and deterrence.One of the several own goals scored by North Korea’s recent recklessness is tohave spurred South Korea, the US and Japan into ever tighter military co-operation. This was clear from the visit of the (then) head of Japan’s defenceagency, Fukushiro Nugaka, to Seoul in December last year, and the visit inmid-January by the US defence secretary, William Cohen, for the regular an-nual security meetings with South Korea. (This latter meeting had been post-poned from November last year because of the crisis over Iraq. South Korea, likeJapan, was quick to offer support for the US bombing of Iraq, an act which mayyet lose South Korean firms in Libya billions of dollars in business.)

Economic policy

The governmentcontinues to loosenmonetary policy—

The government continues to loosen monetary policy in order to stimulatedomestic demand and to ease credit conditions for those smaller firms withinsufficient creditworthiness to raise funds on the domestic capital markets.Importantly, this policy easing still has the agreement of the IMF. As part of itsprogramme for lowering interest rates the Ministry of Finance and Economy(MOFE) indicated that nominal interest rates might be lowered to 4-5% thisyear. One way of achieving this would be to lower the rate of interest onrepurchase agreements to below 5% from the current level of around 7%.

—but MOFE and the BOKdiffer on the speed

of easing

Although both MOFE and the Bank of Korea (BOK, the central bank) agree onthe need for monetary easing, the two entities appear to differ on the speed atwhich interest rates should be lowered. While MOFE favours aggressive ratecuts, the BOK appears to favour a more gradual programme of reductions.Reasons for the BOK’s caution include concerns about the inflationary impactof radical cuts as well as the negative impact such action would have on theprofitability of the country’s hard-pressed financial institutions. This publicdisagreement between the two organisations, almost unthinkable before theend-1997 financial crisis, suggests that the BOK is trying to assert its new-foundindependence by attempting to wrest the initiative in monetary policy form-ation from MOFE.

The 1999 budgetis passed—

The budget for 1999 was finally passed on December 9th, more than a week afterthe expiration of the legal deadline. Several amendments were made to theproposed budget (4th quarter 1998, page 19), including a 12% reduction in thefinancial-sector restructuring allocation and a 6.1% reduction in the proposedspending on unemployment programmes. Even with the reductions, however,spending on both these categories will still far exceed 1998 levels. The revisedbudget also projected a 0.5% reduction in revenue, partly owing to lower—but

18 South Korea


still optimistic—projections for tax receipts for the year. The net result of theseamendments was a slightly higher projected budget deficit of W22.7trn ($12bnat an exchange rate of W1,182.5:$1) for 1999 than in the proposed budget,equivalent to 5.1% of projected current-price GDP for the year.

—and more than 50% ofallocations will be

front-loaded

The government has made much of its decision to spend more than 50% of theproposed allocations in the first half of this year to maximise the stimulatoryimpact. Bringing forward already-planned spending in this way is, however,unlikely to give a significant boost to overall growth, as spending for thesecond half of the year will probably shrink by an equivalent amount. Thegovernment may well therefore have to introduce supplementary budgets dur-ing the year to maintain the momentum of the fiscal stimulus.

South Korea: budgets(W trn unless otherwise indicated)

% change over 1998

1997a 1998b 1999b estimatec

RevenueGeneral account 64.15 75.58 80.14 6.0 Tax 60.91 59.26 61.94 4.5 Other revenue 3.24 4.64 4.70 1.1 Bond issuance – 11.68 13.50 15.6 Special account (public-sector loans) 4.45 5.18 4.80 –7.3 Total 68.60 80.76 84.94d 5.2

Expenditure by main categoryFinancial-sector restructuring – 3.60 6.85 90.3 Unemployment programmes 2.61 5.66 7.73 36.4 Support for small and medium-sized companies & export promotion 2.79 3.91 4.05 3.5 Social overhead capital investment 10.13 11.50 12.19 6.0 Art & culture 0.31 0.36 0.48 34.1 Environment 1.77 1.78 1.83 2.5 Law & order 0.74 0.78 0.86 10.2 Science & technology 3.48 3.57 3.75 5.1 Civil service salaries 14.99 14.45 13.62 –5.7 Defence 13.79 13.80 13.75 –0.4 Education 18.17 17.49 17.46 –0.2 Support for rural areas 8.67 8.53 8.10 –5.1 Total 77.44 85.42 90.65d 6.1

Budget balance 0.1 –21.3 –22.7d – % of GDP 0.0 –5.5 –5.1 –

Tax burden as proportion of GDP 21.0 19.8 19.6 –

a Actual. b Government estimates. c Percentage changes calculated on unrounded figures. d Although the overall projected budget deficit for1999 has been estimated at W22.7trn, information on total public-sector revenue and expenditure is not yet available from the government.

Source: Planning and Budget Commission.

Financial-sector reformhas been bold—

The government will be keen to press on with restructuring of the financialsector in 1999. Although considerable progress was made in 1998 in closingnon-viable financial institutions and encouraging stronger banks to mergewith weaker ones (4th quarter 1998, page 20), significant problems remain.Prominent among these is the problem of non-performing loans, which may

South Korea 19


rise further in the near future as the economic slowdown in general and creditcontraction in particular increases the level of corporate bankruptcies.

—but KAMCO fails toperform—

In November 1997 the government set up the Korea Asset Management Corpor-ation (KAMCO) to buy non-performing loans from South Korean financial insti-tutions. The intention was that these would then be repackaged as securities andsold to—presumably foreign—investors. As of September 1998, the latest datefor which we have data, KAMCO had bought non-performing loans with a bookvalue of W36trn ($26bn at an exchange rate of W1,396.3:$1) at a purchase priceof W16.5bn. Of this total, however, also as of September last year, it had man-aged to dispose of just W250bn. Reasons for the lacklustre performance are hardto pinpoint, but presumably include uncertainties regarding South Korea’s eco-nomic outlook, the country’s opaque accounting practices and overpricing. Thegovernment plans to make further purchases of non-performing loans with abook value of some W50trn between October 1998 and June this year (at adiscount of W16trn) and will therefore be hoping for a sharp improvement inKAMCO’s loan-disposal performance in the near future.

—which could delay fullfinancial-sector

rehabilitation

The so-called put-back option granted to those five healthy banks which ac-quired five weaker banks in the middle of 1998 (3rd quarter 1998, page 28),under which the acquiring banks can sell problem assets from the acquiredinstitutions to KAMCO up to a year after the acquisition if they subsequentlyturn bad, could also put pressure on KAMCO’s finances. This option is also tobe granted to the purchasers of Korea First Bank, the consortium led by New-bridge Capital of the US. Failure by KAMCO to act fully as a means for resolvingthe bad-loan problem is likely to strain government finances further—that is,taxpayers will have to foot more of the bill—and possibly delay the full reha-bilitation of the financial sector.

Production and demand

Real GDP contracts by6.8% in the third quarter—

Real GDP contracted by 6.8% year on year in the third quarter of 1998. This,and the 0.2 percentage point downward revision in the second quarter year-on-year GDP data, took the total year-on-year contraction for the first ninemonths of 1998 to 5.9%.

On the demand side, rising unemployment, sharply lower real incomes andfalling asset prices undermined consumer confidence, prompting a year-on-year contraction of 12% in private consumption during the quarter. Just howfar South Korean consumers have retrenched was revealed in the 1998 dom-estic sales data from the country’s carmakers: Hyundai Motor, the largest car-maker, saw sales fall 52.3% below the 1997 level, while sales at Daewoo Motorand Kia Motors fell by 44.4% and 53.3% respectively. In an attempt to boost carsales in 1999, the government lowered excise taxes on cars and reduced interestrates on car loans by five percentage points to 13%.

The severe credit contraction and the poor outlook for profits hit businessinvestment over the quarter, prompting a 28.3% year-on-year shrinkage ingross fixed investment. Within this component the steepest decline was inmachinery and equipment investment, which contracted by 46.3% compared

-10

-8

-6

-4

-2

0

2

4

Q1 Q2 Q3 Q4 Q1 Q2 Q3

Housing prices

Land prices

South Korea: real estate prices% change, quarter on quarter

Source: Bank of Korea, Quarterly Economic Review,December 1998.

1997199719971997199719971997199719971997199719971997199719971997199719971997199719971997 989898981997 981997 989898981997 981997 981997 981997 981997 981997 981997 981997 981997 981997 981997199719971997 989898981997 98

20 South Korea


with the same period in 1997; this was the third consecutive quarter in whichthis subcomponent had declined by more than 40% year on year. The weak-ness of domestic demand during the quarter prompted a large year-on-year fallin imports of goods and services of 20.9%.

—and export growth slows Year-on-year growth in exports of goods and services slowed to 8.9% from14.4% in the second quarter. This was partly a natural fall-back from theparticularly brisk performance in the third quarter of 1997, when exports ofgoods and services grew by 33.2%. Stocks have decreased sharply since thebeginning of 1998, falling in each quarter of the year so far by more than thetotal for 1997 in real won terms. This suggests that some export demand hasbeen met through destocking rather than increased production.

South Korea: expenditure on gross domestic product(% change, year on year; constant 1990 prices)

1997 19982 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr

Private consumption 4.8 4.8 –1.0 –10.6 –13.0 –12.0

Government consumption 6.9 7.2 4.0 –4.3 –12.1 –11.1

Gross fixed capital formation 0.2 –3.7 –9.6 –23.0 –29.8 –28.3

Exports of goods & non-factor services 27.2 33.2 20.8 26.4 14.4 8.9 of which: merchandise exports 29.2 36.8 19.9 30.1 18.8 11.1

Imports of goods & non-factor services 7.3 4.7 –4.0 –25.3 –23.1 –20.9 of which: merchandise imports 6.9 3.7 –4.5 –27.6 –25.6 –25.0

GDP 6.6 6.1 3.9 –3.9 –6.8 –6.8Sources: Bank of Korea, Monthly Statistical Bulletin; press release.

The decline inmanufacturing eases—

In terms of supply, agriculture, construction and services fell more steeply yearon year in the third quarter than in the second quarter. The decline in manu-facturing output was, however, less marked in the third quarter than in thesecond quarter. This was largely owing to an upturn in the output of electricaland electronic goods as overseas demand for semiconductors rose. Most othermanufacturing sectors continued to decline, however. Electricity, gas and watercontinued to grow in the third quarter, albeit more slowly than in previousquarters, partly as a result of the increase in gas-fired electricity generation.

South Korea: gross domestic product by industry(% change, year on year; constant 1990 prices)

1997 19982 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr

Agriculture, forestry & fishing 2.1 1.0 3.0 4.6 –0.9 –5.6

Manufacturing 7.2 7.5 4.6 –6.4 –10.0 –7.9

Electricity, gas & water 10.0 10.9 12.0 9.6 7.4 2.8

Construction 2.5 4.8 3.6 –7.3 –12.1 –12.9

Services 8.2 6.6 3.7 –3.5 –5.7 –6.0Source: Bank of Korea, Monthly Statistical Bulletin.

South Korea 21


—but the slump in thedomestic construction

industry continues

As the table below shows, the construction sector remains in deep recession,with permits for construction orders and the value of construction orders re-ceived both contracting by large amounts in year-on-year terms. As might beexpected given the current very tight credit conditions and depressed con-sumer demand, orders from the private sector are declining most steeply: in thefirst nine months of 1998 (latest available data), private-sector orders were61.5% down year on year, while orders from manufacturers alone were 78%down year on year (both in value terms). Public-sector orders contracted by amore modest 14% year on year in the same period. This suggests, however, thatdespite promises of higher public spending to counter rising unemployment,existing projects are being cancelled or deferred at a faster rate than newprojects are being initiated.

South Korea: construction indicators, 1998

May Jun Jul Aug Sep Oct

Permits for building construction m sq metres 4.16 4.51 3.34 2.36 3.22 2.05 % change, year on year –65.2 –54.3 –64.0 –70.1 –57.6 –79.9

Domestic construction orders received W trn 16.50 38.66 22.53 21.63 24.59 27.41 % change, year on year –62.3 –45.6 –41.0 –41.8 –50.3 –51.9Source: Bank of Korea, Monthly Statistical Bulletin.

Manufacturing outputslides again year on year

Seasonally adjusted manufacturing output fell by 9.5% year on year in the thirdquarter. In quarter-on-quarter terms, however, industrial production grew by4.6%, suggesting that the worst of the declines in this indicator may nowbe over.

Motor vehicles register thesteepest decline—

Most industrial categories recorded year-on-year declines in output in July-September. As in the second quarter, production of motor vehicles and trailersposted the steepest year-on-year contraction—of 42.5%—partly reflecting thestrikes at Hyundai Motor, which stopped production in the firm’s factories inJune-August (4th quarter 1998, page 17). Production of textiles and clothing—so-called sunset industries—continued their now well-established pattern ofdecline in the quarter, contracting by 14.8% and by 36.9% respectively year onyear. As well as being hit by falling export demand, firms in these sectors haveincreasingly moved production offshore in recent years to cut costs.

—but production oftelevisions and ships

remains robust

Only two categories posted year-on-year production growth in the thirdquarter: radio, televisions and communications equipment (up by 37.6%) andother transport equipment including ships (up by 32.8%). South Korean com-panies in these sectors have benefited from the appreciation of the yen againstthe dollar. (South Korea and Japan compete in third markets in both thesecategories.)

22 South Korea


South Korea: seasonally adjusted manufacturing production(1995=100; period averages)

1997 1998 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr % changea

Food & beverages 102.6 101.4 93.7 91.0 91.3 –11.0

Textiles 84.8 82.9 79.5 75.8 72.2 –14.8

Clothing 79.6 77.0 61.7 55.7 50.3 –36.9

Chemicals & products 124.4 125.2 118.5 114.1 115.5 –7.1

Rubber & plastics products 110.3 104.9 87.5 81.9 81.7 –26.0

Basic metals 112.0 114.6 96.0 97.3 97.3 –13.1

Fabricated metal products 101.6 96.8 78.5 73.6 74.0 –27.1

Non-electrical machinery 104.7 97.1 78.3 69.4 68.3 –34.8

Radio, TV & communications equipment 175.0 178.7 186.8 195.7 240.8 37.6

Office, accounting & computing machinery 150.5 164.6 161.5 132.0 135.9 –9.7

Electrical machinery 106.2 102.0 80.2 70.3 74.0 –30.3

Motor vehicles & trailers 111.2 102.5 69.0 67.9 64.0 –42.5

Other transport equipment 146.2 157.8 167.3 193.7 194.1 32.8

Manufacturing 116.2 115.5 102.4 100.5 105.1 –9.5

a 3 Qtr 1998/3 Qtr 1997.

Source: Bank of Korea, Monthly Statistical Bulletin.

Employment, wages and prices

Unemployment goeson rising—

The unemployment rate rose to 7.3% in November 1998 and then to 7.9% inDecember (seasonally unadjusted measure), reversing the declining trend ofAugust-October. As well as reflecting lay-offs from corporate restructuring andbankruptcies, this rise was also the result of a seasonal drop in employment inthe agricultural and construction sectors and increased numbers of universitystudents looking for work in the run-up to graduation in February.

—particularly among the40- to 60-year-olds

Particularly hard hit by the current tightening of the labour market have beenthose between 40 and 60 years old. In November, for example, the number ofunemployed in this age group stood at 495,000, a fourfold increase on the samemonth in 1997. This is a reversal of the situation before the end-1997 financialcrisis, when unemployment in this age group had been both low and stable.

The outlook forunemploymentremains bleak

The unemployment rate is certain to rise in the coming months as the fivelargest chaebol begin rationalising under the Big Deal programme of businessswaps (4th quarter 1998, pages 32-34): the Korea Employers’ Federation, forexample, estimates that more than 100,000 jobs will be lost from the chaebolthemselves as well as from affiliated subcontractors. The government has alsoannounced plans to cut 30% of local government workers and 11% of centralgovernment workers during 1999—altogether 100,000 civil servants maybe affected.

South Korea 23


South Korea: unemployment rate, 1998(% of total labour force)

Jun Jul Aug Sep Oct Nov Dec

Unemployment rate 7.0 7.6 7.4 7.3 7.1 7.3 7.9Source: Bank of Korea, Principal Economic Indicators.

The government attemptsto maintain employment

levels

Aware of the potentially socially destabilising effect of a further rapid rise inunemployment, the government is to raise the subsidies it pays to firms whichkeep workers, who otherwise would have been sacked, on their payrolls. Forlarge companies this subsidy will be the equivalent of just under 70% of suchworkers’ salaries, while for smaller companies it will be equivalent to 75%. Thiscompares with the existing level of 50% of pay for larger firms and 60% of payfor smaller firms. The Ministry of Labour estimates that these and a furthermeasures subsidising companies for taking on laid-off workers will keep around640,000 in the labour force and cost the government some W690bn ($584m atan exchange rate of W1,182.5:$1). The impact of these measures will, however,only be temporary, and it is likely that most of those affected will sooner orlater become unemployed once the subsidies are reduced or withdrawn.

Manufacturing wages arestill falling

The table below shows that nominal monthly wages in manufacturing havebeen falling year on year since the fourth quarter of 1997. As well as theslackening labour market, these steep falls reflect the increasing willingness ofSouth Koreans in employment to accept wage cuts in return for keeping theirjobs. As well as wage freezes, however, a growing number of workers are alsobeing paid late or not being paid at all. According to labour ministry data, inNovember 1998 wage arrears totalled W1.1trn ($800m at an exchange rate ofW1,396.3:$1). This was the first time at wage arrears had exceeded W1trn.

South Korea: wages in manufacturing industry(won per month; period averages)

% change,Earnings year on year

1996 1,261,168 12.2

1997 1,326,241 5.21 Qtr 1,287,076 9.92 Qtr 1,295,054 9.33 Qtr 1,405,427 5.44 Qtr 1,319,762 –2.9

19981 Qtr 1,252,690 –2.72 Qtr 1,244,597 –3.93 Qtr 1,263,479 –10.1Sources: Bank of Korea, Monthly Statistical Bulletin; Quarterly Economic Review, December 1998.

Consumer pricesmoderate—

Consumer price inflation, responding to a combination of weak domestic de-mand, falling world commodity prices and improving terms of trade as thewon has strengthened, moderated during the second half of 1998, and there isnow very little inflationary pressure in the economy. Consumer price inflationfor the whole of 1998 was 7.5%, a moderate rate of increase in light of the verysteep decline in the won at the end of 1997 and the beginning of 1998.

24 South Korea


—as do producer, exportand import prices

The import-intensity of South Korean manufactured goods is high—in 1997,for example, imports for use in exports accounted for 35% of the total. As aresult, relative won weakness during 1998 has had a considerable impact onproducer prices, which rose by 12.2% for the full year, compared with just 6.6%in 1997. This was the fastest increase since that in 1981 following the secondoil shock, when producer prices rose by 20.4%. Despite the steep increase inannual average terms, however, the year-on-year rate of increase in producerprices slowed steadily throughout the year from a peak of 15.3% in February tojust 3.6% in December, owing mainly to the gradual appreciation of the wonagainst the dollar. Won-based export and import prices also showed broadlythe same pattern for the same reason.

South Korea: consumer, producer, export and import prices, 1998(% change, year on year)

Aug Sep Oct Nov Dec Year

Consumer prices 6.9 6.9 7.2 6.8 4.0 7.5

Producer prices 11.8 11.4 11.7 11.0 3.6 12.2

Export prices (won terms) 20.5 25.2 26.8 16.4 –17.8 31.3

Import prices (won terms) 20.3 24.0 25.6 15.3 –14.5 28.2Source: Bank of Korea, Principal Economic Indicators.

Money and finance

M1 growth continues tocontract—

The Bank of Korea (BOK, the central bank) started loosening monetary policyfrom mid-1998 largely to ease tight credit conditions for the corporate sector.Although this has helped bring interest rates down to below pre-crisis levels(see below), the narrow measure of money supply, M1, continues to contract inyear-on-year terms, reflecting the decline in economic activity.

—while M2 growthaccelerates

The broader money-supply measure, M2, has, however, remained robust, grow-ing in year-on-year terms by more than 20% each month from July to November.This partly reflects savers moving their funds out of short-term instruments intohigher-yielding time deposits: in August (latest available data) for example, timedeposits at South Korean deposit money banks stood at W103.9trn ($74bn at anexchange rate of W1,396.3:$1), an increase of 155.9% year on year.

South Korea: money supply trends, 1998(W trn unless otherwise indicated; end-period)

Jun Jul Aug Sep Oct Nov

M1 286.70 292.27 285.59 331.49 320.08 317.35 % change, year on year –23.0 –13.9 –17.6 –6.2 –11.9 –8.6

M2 2,183.42 2,288.38 2,361.39 2,475.01 2,520.80 2,562.55 % change, year on year 16.3 20.9 20.7 25.3 26.1 25.3Source: Bank of Korea, Principal Economic Indicators.

Interest rates are nowbelow pre-crisis levels—

The stabilisation of the exchange rate, the generally depressed state of theeconomy and increasing liquidity have contributed to successive falls in inter-est rates since early 1998. By mid-January this year the nominal yields onovernight won and on the benchmark three-year corporate bond stood at 6.4%and 7.8% respectively, both well below pre-crisis levels. The BOK has indicatedthat it may guide interest rates even lower in the near future, both to relieve

South Korea 25


upwards pressure on the won and to help maintain the solvency of SouthKorea’s large number of highly leveraged companies.

South Korea: interest rates(%; end-period)

1998 1999Aug Sep Oct Nov Dec Year Jana

Overnight won rate 8.5 7.0 7.3 7.0 6.5 14.8 6.4

3- year corporate bond yield 11.8 11.9 9.8 9.1 7.8 15.0 7.8

a January 15th 1998.

Source: Bloomberg.

—but many companiesmay not be feeling

the benefits

Given the current reluctance of banks to lend to all but the most creditworthycompanies—essentially the top five chaebol—this fall in rates will in itself havemade little difference to smaller companies, which are traditionally more de-pendent on bank-intermediated borrowing. The sharp fall in overall bank lend-ing, at least in the first half of 1998, is confirmed in the BOK’s latest flow offunds data, which show indirect financing falling by 108.9% during the periodyear on year.

South Korea: fund raising by the business sector, flow basis(W bn)

1997 1998 Jan-Jun Jul-Dec Jan-Jun % changea

Indirect finance 29,472 14,890 –2,626 –108.9 of which: bank borrowings 14,829 288 8,142 –45.1 non-bank borrowings 14,643 13,756 –10,002 –168.3

Direct finance 19,160 24,232 18,321 –4.4 of which: commercial paper 5,277 –504 –1,617 –130.6 stocks 3,605 5,369 4,964 37.7 domestic corporate bonds 9,111 17,734 13,958 53.2

Borrowings from abroadb 5,732 1,430 –9,571 –267.0

Othersc 9,050 13,076 8,830 –2.4

Total 63,414 53,628 14,954 –76.4

a Jan-Jun 1998/Jan-Jun 1997. b Includes external bonds. c Includes trade credits and borrowing fromthe government.

Source: Bank of Korea, Quarterly Economic Review, December 1998.

The won appreciatesfurther—

Continuing low demand for imports, steady foreign direct investment (FDI)inflows, sharply higher portfolio inflows and healthy foreign-exchange re-serves all helped maintain the appreciation of the won against the dollar in thelatter part of 1998 and into the early part of this year. By mid-January this yearit was trading in a stable range of W1,170-1,190:$1, compared with nearlyW2,000:$1 at the height of the end-1997 financial crisis.

—upsetting exporters Although the won’s rise against the dollar has been mitigated to an extent bythe recent sharp rise of the yen against the dollar—between the beginning ofOctober last year and mid-January the yen and the won appreciated by some20% and 17% respectively in nominal terms against the currency—South

26 South Korea


Korea’s exporters are increasingly pressing the government to take steps toweaken the won. As well as lowering interest rates further, measures currentlybeing mulled over include purchase by the BOK of dollars and putting a tem-porary curb on overseas short-term borrowing by South Korean entities.

The stockmarket hasbeen buoyant—

The stability of the South Korea’s financial markets, a belief that reform isproceeding, that economic recovery is at least approaching and the recentstrength of the yen against the dollar have lifted the benchmark Korea CompositeStock Price Index (KOSPI). Although the KOSPI averaged only 406.1 points in1998, compared with an average of 654.5 points in 1997, it finished the yearstrongly at 562.5 points; this was well up on the low for the year of 280 pointsrecorded in June, when share prices were depressed by strikes at Hyundai Motorand apparently receding prospects for economic reform.

—partly owing toforeign interest

Foreign investors played an important part in the KOSPI’s rise towards the endof 1998, and out of all the investor categories, only foreigners were net buyersof shares for the year as a whole. This took total foreign ownership of SouthKorean shares outstanding in 1998 up to nearly 20%, compared with just over9% in 1997.

South Korea: net share purchase position on the KOSPI by investor type,1998a

(W m)

Securities companies –764,065

Insurance companies –799,283

Investment companies –689,707

Banks –3,064,634

Other financial companies –160,742

Funds –21,586

Others –53,076

Individuals –170,295

Foreigners 5,723,387

a Total purchases minus total sales.

Source: Korea Stock Exchange.

0

100

200

300

400

500

600

700

800

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Manufacturing industry

KOSPI (overall)

Financial institutions

Wholesale trade

Construction

South Korea: KOSPI, 19981980=100

Source: Korea Stock Exchange.

South Korea 27


The domestic bondmarket is active—

The large financing needs of the government and the reluctance of banks toundertake new lending has resulted in a surge of public and corporate bondissues. According to Korea Stock Exchange data, at the end of 1998 public bondsoutstanding totalled W214.6trn ($154bn at an exchange rate of W1,396.3:$1)and corporate bonds outstanding stood at W119.4trn, year-on-year increases of55.4% and 38.8% respectively. (See also flow of funds table above.)

—but distortions remain The government has stepped up its efforts to break the dominance of the fivelargest chaebol over the domestic bond market. In arguably the most importantmove to this end yet, at the end of October last year the Financial SupervisoryCommission introduced a requirement that commercial banks and investmenttrusts limit their holdings of bonds issued by the five largest chaebol to 10% and15%, respectively, of their total corporate bond holdings. In addition, excessholdings of bonds issued by these chaebol must be disposed of by the end of2000. Although these measures have made it easier for smaller companies toissue bonds, the dearth of new issues from the largest chaebol has pushed yieldson bonds issued by these groups down further than they might otherwise havefallen. One market distortion may therefore unwittingly have been replacedby another.

Government bonds willbecome the benchmark

South Korea’s bond market is the second largest in Asia after Japan. Unlikemost important debt markets, however, in South Korea for a variety of reasonsno government-issued debt instrument has yet established itself as a bench-mark issue. (To date the three-year corporate bond has functioned as a proxyfor a benchmark government bond.) As part of its attempt to reorganise thedomestic bond market, the government aims to change this, establishing itsthree-year bonds as the new benchmark, initially alongside the three-year cor-porate bond, but in place of it once the daily turnover of the government bondreaches W400bn-500bn.

Usable reserves haverisen again—

Usable foreign-exchange reserves—as opposed to total stated reserves—havecontinued to rise, reaching $48.8bn at the middle of December 1998, from$43.4bn in September and only $8.9bn in December 1997. As well as by strongnet inflows of foreign currency, the reserves have been swollen by repaymentsto the BOK by domestic banks of funds lent to them to support their foreign-exchange needs during the end-1997 financial crisis. The goal is to raise usablereserves to $55bn by the end of 1999, indicating perhaps a continuing concernon the part of the authorities about possible liquidity problems in the future.

—and foreign debt is stable Such anxieties are not immediately pressing, however. Total foreign debt wasreported at $153.6bn at the end of October last year, the same level as theprevious month. Of October’s total, the public sector’s share was 24.4%, whilethe share of domestic financial institutions, where the liquidity crisis hit thehardest, had fallen to 39.4%. Short-term debt was $31bn, 20.2% of the total,down from $68.4bn, or 44.3% of the total, in December 1997.

Repayment of IMFbail-out money begins

Partly to increase its creditworthiness on international markets—and, by exten-sion, to make it easier for corporate borrowers to tap international financialmarkets—the government made prompt repayment of $2.8bn of supplemental

28 South Korea


reserve facility resources owed to the IMF and disbursed as part of the end-1997IMF-led bail-out package at the end of 1998. Provided reserves remain stable,the government has indicated it may try to make early repayments of furtherIMF borrowings during 1999.

South Korea: external liabilities(end-period; $ bn)

1997 1998 Dec May Jun Jul Aug Sep Oct

Public sector 22.3 30.1 30.7 30.7 35.1 36.0 37.4

Domestic financial institutions 75.2 70.9 69.6 68.1 61.9 60.8 60.6 Long-term 46.3 59.2 59.1 57.3 50.7 50.0 50.0 Short-term 28.9 11.7 10.5 10.8 11.2 10.8 10.6

Branches of foreign banks 18.9 16.1 15.0 14.7 13.9 14.1 13.2 Long-term 4.0 5.7 5.3 5.9 5.8 5.8 5.9 Short-term 14.9 10.4 9.7 8.8 8.1 8.3 7.3

Domestic corporations 42.2 37.9 38.5 38.8 42.7 42.7 42.4 Long-term 17.6 19.6 19.7 20.0 29.9 29.7 29.3 Short-term 24.6 18.3 18.8 18.8 12.8 13.0 13.1

Total 158.6 155.0 153.8 152.3 153.6 153.6 153.6Source: Ministry of Finance and Economy.

FDI inflows are rising, butare still modest

President Kim Dae-jung’s government is anxious to attract FDI inflows and hasset an ambitious target of $15bn in FDI for 1999. Although the first ten monthsof 1998 (latest available data) showed a 83.6% increase year on year in actualFDI inflows, the absolute amounts are still modest—$4bn in January-October1998 against $2.2bn in the same period in 1997. South Korea evidently still hasto overcome its reputation for being a high-cost and difficult environment forforeign investors. It is hoped that the new Foreign Investment Promotion Act,which came into force in November 1998, will help to make investment inSouth Korea a more attractive prospect.

Foreign trade and payments

A record trade surplus isrecorded in 1998

Preliminary reports from the Ministry of Commerce, Industry and Energy indi-cate that South Korea recorded a merchandise trade surplus (fob-cif) of $39.9bnin 1998. This compares with a merchandise trade deficit (fob-cif) of $8.5bn in1997. According to the ministry, in 1998 merchandise exports slipped by 2.2%year on year to $133.3bn, while merchandise imports plummeted by 35.4%year on year to $93.4bn.

Merchandise exports slipslightly in

January-September—

Detailed customs data for January-September 1998 show that merchandise ex-ports fell by 1.7% year on year, to $97.8bn. This reflects slowing growth ofmerchandise export volumes during the same period, because of slumping de-mand in key Asian markets, and reduced unit export values as South Koreanexporters lowered dollar prices to maintain price competitiveness against Japaneseand other competitors.

—as car and electronicsexports fall—

Partly responsible for the slip in the dollar value of South Korea’s exports in thefirst nine months of 1998 was the poor performance of two of its most impor-tant products, motor vehicles and semiconductors, which fell by 20% and by

South Korea 29


14.3% respectively year on year. Car exports were hit hard by the mid-yearstrikes at the country’s largest carmaker, Hyundai Motor. Semiconductor priceson world markets, meanwhile, have remained soft, owing to oversupply, al-though they appeared to firm towards the end of 1998.

—but metal and shipexports remain robust

Exports of metal goods and ships, however, continued to be robust in valueterms, rising 18.4% and 32.9% respectively year on year in January-September.Iron and steel exports have benefited from the won’s competitiveness and fromrobust demand in the US. Indeed, so brisk has US demand been that SouthKorea’s largest steelmaker, Pohang Iron and Steel, has indicated that it will cutexports in 1999 by around 5% to avoid possible trade friction with the US.Similarly, South Korea’s shipbuilders have also reaped the rewards of currencymovements, particularly the yen’s strengthening against the dollar. Japan isSouth Korea’s main competitor in exports of ships.

South Korea: exports of selected commodities($ m unless otherwise indicated)

Jan-Sep 1996 1997 % change 1997 1998 % change

Food 3,082 3,013 –2.2 2,155 1,940 –10.0

Crude materials & fuels 6,335 7,949 25.5 5,870 5,903 0.6 of which: petroleum & derivatives 3,859 5,337 38.3 3,923 3,498 –10.8

Textiles 16,896 17,455 3.3 13,120 12,253 –6.6 of which: clothing 4,929 4,897 –0.7 3,618 4,038 11.6 fabric 10,505 10,827 3.1 8,188 7,045 –14.0 yarn 1,461 1,731 18.5 1,315 1,171 –11.0

Rubber tyres & tubes 1,549 1,437 –7.2 1,072 1,177 9.9

Footwear 864 588 –32.0 472 358 –24.2

Chemicals & chemical products 7,069 8,508 20.4 6,277 6,207 –1.1

Metal goods 7,301 8,678 18.9 6,275 7,433 18.4

Machinery & equipment 15,365 16,668 8.5 12,054 10,935 –9.3

Electronic products 24,425 26,392 8.1 19,223 16,572 –13.8 of which: semiconductors 17,843 17,424 –2.3 12,742 10,926 –14.3

Motor vehicles 11,462 12,107 5.6 9,548 7,638 –20.0

Ships 7,127 6,520 –8.5 3,920 5,210 32.9

Total incl others 129,715 136,164 5.0 99,437 97,790 –1.7Source: Bank of Korea, Monthly Statistical Bulletin.

Merchandise importcontraction continues

Merchandise imports (cif) contracted by 37.3% year on year in January-September,reflecting weak consumer and private-sector investment demand—forexample, consumer durables fell by 48.8% and machinery and equipment fellby 54%. Interestingly, however, while merchandise imports for domestic usecontracted by nearly 50% year on year in January-September, those for use asinputs in exports contracted by 14.1%, also year on year. This suggests that thegovernment’s programmes of funding for exporters may have had at least someimpact. The large contractions in food and fuel imports during the period werepartly the result of continuing weak world prices for these products.

30 South Korea


South Korea: imports of selected commodities($ m unless otherwise indicated)

Jan-Sep 1996 1997 % change 1997 1998 % change

Food & consumer goods 16,942 15,603 –7.9 12,056 6,827 –43.4 of which: cereals 3,362 2,587 –23.1 1,968 1,688 –14.2 consumer non-durables 3,231 3,044 –5.8 2,379 889 –62.6 consumer durables 5,616 5,183 –7.7 4,063 2,079 –48.8

Industrial materials & fuels 74,501 76,230 2.3 57,800 37,341 –35.4 of which: crude petroleum 14,432 17,772 23.1 13,047 8,387 –35.7 metallic ore 3,658 4,014 9.7 2,969 2,416 –18.6 light industry inputs 6,107 5,377 –12.0 4,143 2,577 –37.8 chemicals & chemical compounds 8,603 8,575 –0.3 6,536 4,573 –30.0 iron & steel products 6,762 5,827 –13.8 4,360 2,337 –46.4 non-ferrous metals 4,211 4,494 6.7 3,480 2,423 –30.4

Capital goods 58,896 52,784 –10.4 40,244 24,845 –38.3 of which: machinery & equipment 24,826 19,542 –21.3 15,215 7,004 –54.0 electric & electronic machinery 21,392 23,966 12.0 17,738 13,584 –23.4 of which: semiconductors 10,544 12,888 22.2 9,465 4,795 –49.3 precision instruments 4,676 4,253 –9.0 3,188 1,942 –39.1 transport equipment 5,417 2,934 –45.8 2,456 1,463 –40.5

Total incl others 150,339 144,616 –3.8 110,100 69,012 –37.3 of which: for domestic use 101,709 94,020 –7.6 72,012 36,294 –49.6 for export 48,631 50,597 4.0 38,087 32,719 –14.1Source: Bank of Korea, Monthly Statistical Bulletin.

The current-accountsurplus increases

Largely owing to the sharp contraction in merchandise imports in both volumeand value terms, which has kept the merchandise trade balance strongly insurplus, South Korea’s current-account surplus continues to grow, reaching$31.2bn in the first nine months of 1998. Thanks to a decline in the level oftrade and a sharp fall in outward tourism, the services balance recorded a$246.4m surplus in January-September, compared with a deficit of $3.9bn inthe same period in 1997. The income deficit, meanwhile, widened to nearly

200

250

300

350

400

450

500

550

Mar . May . Jul . Sep . Nov . Jan . Mar . May . Jul . Sep . Nov . Jan . Mar . May . Jul . Sep . Nov

South Korea: number of South Koreans travelling abroad'000

Source: National Statistical Office, Monthly Statistics of Korea.

1996199619961996199619961996199619961996199619961996199619961996199619961996199619961996 979797971996 971996 97979797 98981996 971996 971996 971996 971996 971996 971996 971996 971996 971996 971996199619961996 97 9898989897 989797 981996 971996 97 98

South Korea 31


$3bn from $1.8bn in January-September 1997 as a result of higher outflows ofinterest payments on the country’s large stock of foreign debt. Sharply higherremittances from South Koreans living abroad pushed current transfers into asurplus of $2.5bn in January-September 1998 after a deficit of $232.1m in thesame period of 1997.

South Korea: current- and capital-account balances($ m unless otherwise indicated)

Year Jan-Sep 1996 1997 1997 1998

Merchandise exports 129,968.0 138,619.1 101,880.6 98,494.6

Merchandise imports 144,932.7 141,798.2 108,115.2 67,035.6

Trade balance –14,964.7 –3,179.1 –6,234.6 31,459.0

Services balance –6,179.4 –3,200.3 –3,883.4 246.4

Income balance –1,814.5 –2,454.3 –1,778.2 –3,078.5

Current transfers –46.1 667.0 –232.1 2,538.1

Current-account balance –23,004.7 –8,166.7 –12,128.3 31,165.0

Capital- & financial-account balance 23,326.8 1,314.4 11,227.4 –1,186.8Source: Bank of Korea, Monthly Statistical Bulletin.

Business news

The government instructsthe largest chaebol to

reform—

The main business story of recent months has been the battle between thegovernment and the five largest chaebol: Hyundai, Samsung, Daewoo, LG andSK. Whereas lesser chaebol, through choice or dire necessity, are for the mostpart now actively restructuring their activities, the five largest groups are widelyseen as having dragged their feet or adopted merely cosmetic changes. As 1998wore on, the government lost patience. On December 7th the chairmen of thebig five were summoned to President Kim Dae-jung’s residence, where theysigned a detailed pledge of “self-reform”—a misnomer, arguably, since the11-page document was drawn up by the Financial Supervisory Commission(FSC), which instructed each chaebol on how many subsidiaries it must cut andin which fields it would henceforth specialise.

—and sets a deadline forsubmission of

restructuring plans

So pressured, the five dutifully promised to halve the number of their affiliatesfrom 261 to 136 by 2000; reduce their debt-equity ratios to 200% by the end of1999; end mutual debt guarantees among their subsidiaries by March 2000;and to draw up consolidated group financial accounts, beginning with their1999 results. This time, however, the government was taking no chances,insisting that each chaebol must draw up a detailed “corporate structure im-provement plan” by the end of the month with its creditor banks. This theyduly did by December 20th.

The planned “Big Deals”— These arrangements include two momentous asset swaps, the so-called BigDeals. At long last Samsung is to give up its foolish foray into making cars,swapping this for Daewoo’s established consumer electronics operations. Simi-larly, LG and Hyundai are to merge their semiconductor businesses into asingle giant firm (with giant debts to match). Coming soon after HyundaiMotor’s takeover of Kia Motors, which will leave South Korea with just twocarmakers as against five little over a year ago, it seems the government wants

32 South Korea


there to be just two national champions in each sector: enough to maintaincompetition, but not so many as to perpetuate overcapacity.

—meet resistance fromthe unions

Needless to say, such important changes have not been and will not be pain-less. Both Samsung’s and Daewoo’s unions predictably staged demonstrationsand strikes, which no doubt will flare up again as and when the mergersactually bite. Not even the government was united. The only businessman inthe cabinet, the information and communications minister, Bae Soon-hoon,was formerly a head of Daewoo Electronics; he criticised its absorption intoSamsung and was promptly sacked. As of early January, many practical detailsabout this swap remained unclear.

LG also resists at first— Merging the chipmakers has proved even more contentious. Both Hyundai andLG see semiconductors as a core area, and with each having 12-13% of theworld market, it is not self-evident that they should be forced to merge. (Thesuspicion is that the government needed this for its symbolic symmetry, tomatch the much more defensible Samsung-Daewoo swap.) LG, in particular,resisted all along, including on the choice of an independent arbitrator to settlewhich party should manage the new joint venture, it being agreed that thisshould be on a clearcut 70:30 split. LG was reportedly less than co-operativewith the eventual arbitrator, Arthur D Little (ADL), and when ADL ruled forHyundai, LG’s fury knew no bounds. At first it refused to yield, and the ulti-mate sanction—often threatened, but never before used—was rolled out. Fromthe end of December, LG’s creditor banks—many of them now formally or ineffect under government control, conveniently, as part of their own financialrescue programmes—began to cut off new credit and threatened to call in thegroup’s outstanding loans.

—but then gives way topresidential pressure

Even then it looked as if LG would continue to resist. It was thought to haveamassed a war-chest for this purpose and to be exploring alternative market-based solutions, such as a foreign joint venture, which an avowedly pro-marketgovernment could hardly oppose. In the event, however, LG’s chairman, KooBon-moo, was summoned to the presidential Blue House on January 6th forfurther arm-twisting and gave in. Indeed, LG now wants no part of the newcompany. While this will no doubt create future arguments about the price tobe paid, at least it forestalls the worse prospect of endemic rows between tworeluctant and warring sets of owners. A clean break thus makes more sense.

The Big Deals may not beentirely beneficial

Yet the whole episode leaves some uncomfortable questions. At one level thelarge chaebol have only themselves to blame: for getting their own—and so theircountry’s—finances into a near-disastrous mess and then stubbornly resistingreform. Even so, a self-righteously reforming and interventionist governmentcan also make mistakes. It is not clear that this merger is beneficial. LG andHyundai use different technologies, so any synergy will only come over time, bypooling research and development on the next generation of chips. Against thismust be set the more immediate negative energies that have arisen from thehostilities and bruised feelings all around.

South Korea 33


The government appearsto favour Hyundai—

The charge-sheet against the pre-crisis administrations was not just that theyfavoured chaebol in general, but that some chaebol were always more equal thanothers. Under the previous president, Kim Young-sam, for example, Samsungwas favoured, being allowed to make cars in Mr Kim’s power base, Pusan; whileHyundai found itself out of favour, starved of loans and contracts because ofChung Ju-yung’s temerity in running for president in 1992 against Kim Young-sam.

—giving it an unfairadvantage

It is especially important for an avowedly reforming president to be scrupu-lously free of such favouritism. Lately, Kim Dae-jung is not universally seen asthus neutral: both LG and Samsung mutter that they are out of favour onregional grounds, based as they are (or were) in Kyongsang. Conversely, onegroup seems to very much in favour. Hyundai won the auction for Kia Motors;it also won control of the merged chipmaker with LG; and it is pioneeringbusiness with North Korea. Taken together, all this adds up to a formidable andperhaps unfair advantage, seen as stealing a march by its rivals. Yet each ofthese ventures also saddles an already highly geared conglomerate with billionsof dollars in additional debt. Both the political and financial aspects of all thiswill want watching.

The larger chaebol maywant to buy banks

The wider struggle between government and chaebol is by no means over. Twonew battlefields are only just emerging. The government needs to sell off thebanks it nationalised to stop them going under; and it also wants to sell offstate-invested companies, both on principle and to raise revenue. In eithercase, the chaebol will be eager buyers, and it may prove hard to stop them. Onceagain Hyundai is in the vanguard. Its merchant bank is merging with twoothers, Cho Hung and Kangwon (the latter a regional bank in the eponymousmountainous eastern province, straddling the demilitarised zone, which ishome to Chung Ju-yung). On December 20th Lee Hun-jai, who, as chairman ofthe FSC, heads the government’s push for reform, reiterated that chaebol wouldnot be permitted to own banks—and specifically that Hyundai would not beallowed to become the largest shareholder in the above merger, which is due tobe completed by March. The merged entity will have assets of W62trn ($52bnat an exchange rate of W1,182.5:$1), including W2.2trn in fresh equity to beinjected by the government.

The government sells partof POSCO—

Pohand Iron and Steel (POSCO), the world’s second largest steelmaker, haslong been highly regarded as one of South Korea’s best managed and focusedand most profitable companies. As of early January, however, it was underinvestigation for alleged past corruption in its procurement processes. Somecritics claim this is yet more anti-Kyongsang bias, aimed particularly atPOSCO’s past chairman, Kim Mahn-je, a close colleague of Kim Young-sam.This notwithstanding, the sale of a 5.1% $300m stake to foreign investors onDecember 9th reduced the government’s holding to under 20%, which is to besold off over the next two years. POSCO noted on December 16th that it is nowmore than 38% foreign-owned, and may be vulnerable to takeover bids.

—and lists shares inKorea Telecom

Also on the privatisation front, on December 23rd the government for the firsttime listed shares in Korea Telecom. By early January they had risen by 53%.This is just one step in a lengthy and complex process. At present foreign

34 South Korea


investors are limited to just 5% ownership, while most of the 29% not ownedby the government is not tradeable but must be held for a fixed period.

A foreign consortiumwants to buy Korea

First Bank

On the last day of 1998 the government announced an agreement to sell acontrolling stake in Korea First Bank (KFB), which had been nationalised 15months earlier to save it from collapse. The buyer is a consortium headed bytwo US firms: GE Capital, the world’s largest non-bank financial services com-pany, and Newbridge Capital. This result surprised some, since gossip hadtipped the main rival suitor, HSBC Holdings. HSBC Holdings had, however,apparently sought an 80% stake, whereas the winners were happy with 51%.Presumably the government expects the bank’s share price to rise, so by hold-ing on it may recoup some of the W1.5trn ($1.1bn at an exchange rate ofW1,396.3:$1) it has spent recapitalising KFB. The purchase price was not dis-closed, and along with other details has not even been finalised, so this is notyet a done deal. The government had reportedly been seeking at least $2bn tolet go the majority of its 93.8% stake. HSBC Holdings may not be out of thepicture, however; it is thought to be in the running to buy Seoul Bank, nat-ionalised at the same time and due to be sold by January 31st.

South Korea 35


North Korea

Political structure

Official name Democratic People’s Republic of Korea

Form of government One-party rule, based on the ideology of juche (self-reliance)

The executive Constitutional revisions in September 1998 abolished the Central People’s Committee,renamed the State Administration Council as the cabinet, and reaffirmed the NationalDefence Commission (NDC) as the highest state body, albeit nominally under theSupreme People’s Assembly (SPA)

Head of state As of September 1998 Kim Il-sung (who died in 1994) is dubbed “eternal president”.The SPA Presidium president performs the formal duties of the head of state, but theultimate executive power holder is the chairman of the NDC

National legislature Unicameral 687-member SPA directly elected for five-year terms. Its Presidium,formally the Standing Committee, substitutes when the SPA is not in session

Regional legislatures Each province, city, county or district elects people’s assemblies or committees. Thesecommittees elect local officials to carry out centrally decided policies

National elections The tenth SPA was elected on July 26th 1998, more than three years late. The next SPAelection is due by 2003. These are communist-style elections, with a single list ofcandidates and claimed turnout and yes votes approaching 100%

National government The Korean Workers’ Party (KWP) controls all arms of the state. Since the death of KimIl-sung, military figures have had a growing influence

Main political parties Government: The KWP is nominally in coalition with the Social Democratic Party andthe Chondoist Chongu Party

Key holders of state &party positions

National Defence Commission Chairman Kim Jong-ilFirst vice-chairman Jo Myong-rokVice-chairmen Kim Il-chol; Ri Yong-muSPA PresidiumPresident Kim Yong-namVice-presidents Yang Hyong-sop; Kim Yong-daePrime minister Hong Song-namVice-premiers Jo Chang-dok; Kwak Bom-kiKey politburo members Kye Ung-tae; Chon Byong-ho

Key ministers Agriculture Ri Ha-sopCommerce Ri Yong-sonDefence Kim Il-cholFinance Rim Kyong-sukForeign affairs Paek Nam-sunForeign trade Kang Jong-moLight industry Ri Yon-su Metals & machine building Jon Sung-hunPublic security Paek Hak-nimRailways Kim Yong-sam

Chairman of the StatePlanning Commission Pak Nam-gi

36 North Korea


Economic structure

Latest available figures

Economic indicators 1994 1995 1996 1997 1998

Real GDP growth (%)a –1.8 –4.6 –3.7 –6.8 n/a

Rice productionb (’000 tonnes) n/a n/a 1,340 n/a n/a

Population (m) 23.1b 23.5b 23.6a 23.9a n/a

Exportsa ($ m) 840 740 730 910 n/a

Importsa ($ m) 1,270 1,310 1,250 1,270 n/a

Trade balancea ($ m) –430 –570 –520 –360 n/a

External debtc ($ m) 9.8 n/a n/a n/a n/a

Exchange rate (av; Won:$) 2.17 2.15 2.15 2.20 2.20d

January 18th 1999 Won 2.20:$1

Origins of gross domestic product 1994a % of total

Agriculture, forestry & fishing 29.5

Mining 7.8

Manufacturing 23.6

Electricity, gas & water 4.8

Construction 6.3

Services 27.9

Total 100.0

Main destinations of exports 1995e % of total Main origins of imports 1995e % of total

Japan 27.9 China 32.6

South Korea 20.8 Japan 17.2

China 5.2 Russia 4.7

Germany 4.0 South Korea 4.3

Russia 1.2 Germany 2.9

a Bank of Korea (Seoul) estimates. b UN Food and Agriculture Organisation (FAO) figures. c Including rouble-zone debt, at pre-1990 values. d EIUestimate. e Cited in a book by Marcus Noland: The North Korean Economy, Institute for International Economics, Washington DC, 1995.

North Korea 37


Outlook for 1999-2000

North Korea is aremarkable survivor—

In many ways it is astonishing, on the eve of a new millennium, that NorthKorea still has an outlook at all. The world’s last Stalinist regime has enduredfor almost a decade after communism elsewhere either collapsed or, as inChina and Vietnam, mutated into de facto variants of capitalism. Such survivalis all the more remarkable in the face of three crises, each of which might havebrought down the North Korean regime and state. Economically, the abruptend of Soviet aid on top of sclerotic planning caused GDP to fall throughoutthe 1990s. Politically, the death of the omnipotent founding leader, Kim Il-sung, in 1994 posed a serious challenge of succession and authority. Socially,the famine of the past three years—which may have killed as many as 3mpeople, or nearly 13% of the population—might have been expected to weakenstability and provoke popular protest.

—yet risks remain unlessthe economy is reformed—

Despite all this North Korea is still there, apparently carrying on as it alwayshas, militantly defiant. Nonetheless, the fact that predictions of an early col-lapse were ill-founded does not mean that the current state of affairs canendure indefinitely. All three crises are very serious, and none is as yet resolved.

—and market forces areembraced

It is to be hoped that the new cabinet appointed last September (4th quarter1998, page 40) will make efforts to reverse North Korea’s economic decline. Atthe very least, the Supreme People’s Assembly (parliament) may resume itspractice, suspended since 1994, of convening in April to consider the budget.Much more than this is needed, however. Although infusions of South Koreaninvestment will help, they are no substitute for the explicit embrace of marketreforms which North Korea has been resisting for 20 years. There is still no signof this happening, except in the sole free zone at Rajin-Sonbong in the north-east. Despite hints in last September’s constitutional changes of slightly moreroom for private property and profits (4th quarter 1998, page 41), the tenor ofmost official discourse is still to equate reform with treachery.

The military mayresist reform

This simply has to change—and quickly. Whether it will or not depends onwhether North Korea’s leader, Kim Jong-il, has the vision, courage, and powerto see what must be done and to do it. Mr Kim may still be playing a waitinggame, but if so he is opposed by a powerful military who have much to losefrom any shift towards peace and reform. Meanwhile, the rise of a kind ofmarket economy and the continuation of famine both threaten to erode faithin socialism and Mr Kim alike, even if, for now, many people still buy theofficial line that the real culprits are bad weather, fickle comrades and theimperialist blockade.

The US’s engagementpolicy is in jeopardy—

North Korea now, in early 1999, also faces a new external threat, for which—asusual—it is itself mostly to blame. The US engagement policy of the past fouryears, epitomised by the Geneva Agreed Framework of October 1994, is now injeopardy. North Korea’s reckless rocket launch across Japan on August 31st lastyear (4th quarter 1998, page 37)—Korea claims it was a satellite—focused atten-tion on its missile development and proliferation. Satellite pictures of a largesuspect underground construction site (the so-called “big hole”) at Kumchangri

38 North Korea


in the north-west, not far from the supposedly mothballed Yongbyon facility,have fuelled fears in the US of covert efforts to resume nuclear weaponsdevelopment.

—as the nuclear issueresurfaces—

The big hole issue has perhaps been assiduously stoked for reasons that gobeyond any proven fresh danger from North Korea. A former head of the NorthKorea desk at the US State Department, Kenneth Quinones, who has visitedPyongyang 13 times during the past five years on government service, hasopenly accused elements in the US intelligence services, who oppose the en-gagement approach, of deliberately leaking pictures of the hole and then put-ting an unwarranted spin on its interpretation. If that is so, it has certainlysucceeded. The big hole has now taken centre stage in US policy, with demandsto inspect it being countered by a brazen demand (later dropped) by NorthKorea for a $300m fee for the privilege.

—and Congress hardensits attitude

Meanwhile, against the background of the Lewinsky affair, the Republican-dominated US Congress—where Korea is not often an important issue, butwhich never liked the Agreed Framework and has often held up funding forheavy oil deliveries to Pyongyang under the framework—seized on the chargeof being soft on Kim Jong-il and appeasing a rogue state as further proof ofPresident Bill Clinton’s unsuitability for office. As a consequence, fresh fundingfor the Korean Peninsula Energy Development Organisation, set up under theAgreed Framework, is now subject to convincing Congress that North Korea isnot developing nuclear weapons and is not selling missiles—propositionswhich will be difficult to prove.

US policy towards NorthKorea will be reviewed—

Congress also insisted that a senior figure be appointed to review overall USpolicy on North Korea. In November a former defence secretary , William Perry,was given this task. Mr Perry visited Seoul, Tokyo and Beijing in December andmay return in January, when his itinerary may include Pyongyang, and perhapseven a meeting with Kim Jong-il. He is due to report in March, and much hingeson how he concludes. If Congress remains hawkish, then a return to the ten-sions of 1993-94 cannot be ruled out; which in turn would undermine KimDae-jung’s hopes of progress through political and business co-operation.

—which could undercutKim Dae-jung’s

“sunshine” policy

Hopefully the US will not thus undercut its own Korean ally’s bold and prom-ising new approach before giving it time to bear fruit. What would help morethan anything is some gesture or olive branch from Pyongyang, as opposed tolurid threats to “blow up” the US. Whether Kim Jong-il has the sense or courageto concede is as moot a point as his propensity or otherwise for reform.

Review

The political scene

Relations with the UShave worsened

The last four months of 1998 saw a worsening in relations with the US, in thewake of North Korea’s rocket launch over Japan at the end of August as well as

North Korea 39


suspicions of covert nuclear-related digging at Kumchangri in the north-west ofthe country. The latter has suddenly become the central concern of US policy,for reasons which those without access to intelligence clearance can only guessat. In November last year Charles Kartman, the deputy assistant secretary foreast Asian and Pacific affairs who doubles as the US’s roving ambassador fordealing with North Korea, visited Pyongyang to discuss Kumchangri but madeno progress. Negotiations resumed in mid-January, albeit without success, justbefore the next round of four-party talks between the two Koreas, the US andChina, which were scheduled to begin in Geneva on January 18th.

Japan and Russia want tojoin the four-way talks

On past form, the four-party talks were not expected to produce rapid progress.The last session, held in October, took a whole week merely to agree to set uptwo subcommittees: one to discuss replacing the 1953 armistice which endedthe Korean war with a proper peace treaty, while the other considers moreimmediate practical steps to reduce tension. This time much depends onwhether North Korea is prepared to join the other three in adopting a business-like approach, or alternatively persists with maximalist demands, including atreaty with the US alone and immediate withdrawal of US troops. If nothingelse, it is good that all concerned are still meeting and talking, although afurther problem is that Russia and latterly Japan want to join them. Since bittermemories of Japan’s harsh colonial rule over the Korean peninsula at thebeginning of the 20th century make it unlikely that either Korea would readilygrant Japan a formal role in settling the peninsula’s future, this could becomea tricky issue in future if it is pressed.

North Korea couldconclude a treaty with

Russia

Recent reports suggest that the protracted process of concluding a treaty withRussia may be nearing an end. This would replace the 1961 friendship agree-ment with the Soviet Union, which included a clause of automatic mutualmilitary support (not just in case of attack by others) which is clearly out-moded. Neither party has seemed in a hurry to produce a new document,however. The latest hold-up is said to involve Russia’s resistance to any formalsupport of the three principles endorsed by the two Koreas in their 1972 jointdeclaration, which North Korea has subsequently interpreted as saying thatKoreans alone should determine the peninsula’s future.

Deng Xiaoping urged KimIl-sung to reform

Documents published in China late last year confirm what had long been sup-posed: that Deng Xiaoping, the architect of China’s economic reforms, repeat-edly urged the late president, Kim Il-sung, to follow his example. Transcripts ofsix informal meetings between the two leaders, at various dates between 1978and 1991, show Deng hammering away at two themes: to develop the economyand to avoid war. At least in Japanese newspaper reports, Kim Il-sung’s replieswere not recorded, but evidently he was not convinced. At one of his last foreigninterviews, in 1994, Kim Il-sung testily riposted to a question on opening byclaiming “We opened, already”, referring to the Rajin-Sonbong free zone, whichhe evidently thought was enough.

Taiwan may want NorthKorean military

technology—

The new year has brought speculation that North Korea and Taiwan are on thebrink of closer co-operation. According to a Hong Kong magazine, YazhouZhoukan, on January 4th, Taiwan is keen to acquire North Korean military

40 North Korea


technologies: submarine, missile, and even nuclear. Whether or not the desireexists, and granted Pyongyang will do anything for money, in this case pres-sure from China will surely suffice to prevent this from happening. Moreplausible was the suggestion on the same day in a Taipei newspaper, Chung-KuoShih-Pao, that tourism may be developed, including direct flights on acharter basis.

—but North Korea owesTaiwan money—

There is, however, one small, if all too familiar, problem. Since 1993 Yu Tai, abusiness associated with Taiwan’s ruling Kuomintang (KMT, or NationalistParty), has supplied consumer goods and other items worth a total of $67magainst letters of credit issued by Pyongyang—and has not been paid. The KMTis luckier or more resourceful than most of North Korea’s numerous creditors.It is said to be buying an (unnamed) tourist hotel in Pyongyang, and to havelinked up with a prominent Hong Kong-based businessman, Stanley Ho, tooperate a casino on a 50-year licence. None of this is confirmed, but othercreditors, such as Western banks, have in the past been offered assets such asmines—on condition that they put in yet more investment cash, before theysee any money back. This was an offer they felt they could refuse.

—and may sue Taiwan forbreach of contract

Less amicably, earlier reports suggested that North Korea is threatening to sueTaiwan over its failure to fulfil a controversial contract made in January 1997.Taiwan Power was due to pay $75m to store 60,000 barrels of low-grade nuclearwaste in a disused coal mine at Pyongsan in North Korea’s south-west. The planhad drawn fire from both China and South Korea, and no shipments have beenmade. On another front, in October Taiwan offered to contribute funds for theKorean Peninsula Development Project, but China, although not itself a mem-ber of the consortium, made clear its opposition.

The economy, trade and investment

Merchandise trade mayhave fallen 30% in value

in 1998—

There are as yet no figures for North Korean economic performance in 1998,and no doubt there will be no official ones in any case. However, South Korea’strade promotion body, KOTRA, estimates that North Korea’s total trade, whichreached $2.2bn in 1997, will have plunged 30% in 1998 to around $1.5bn.Worse, merchandise exports are reckoned to have fallen by 42.5% from $904mto $520m, while merchandise imports are estimated to have fallen by 23%from $1.3bn to $980m. This seems to be an extrapolation from the knownfigures for the first half of last year, when North Korea’s trade totalled $750m,a fall of 13% on the same period the previous year. Differences between thesefigures and those given in our economic structure data for North Korea abovearise in part because South Korean bodies such as KOTRA exclude inter-Koreantrade. This, too, is reckoned to have fallen in 1998, however, reflecting eco-nomic setbacks on both sides of the demilitarised zone.

—but could improvein 1999

While 1997 merchandise trade data may have been affected by one-off goldsales, 1999 might just see the start of a real and sustained improvement. Thesefigures are so low—South Korea, by contrast, even now, exports $10bn worthof goods per month, 20 times what the north manages in a whole year—that itwould take only a few small South Korean or other investments, let alone

North Korea 41


something as massive as Hyundai’s proposed industrial estate (see below), tomake a huge and palpable difference.

The harvest apparentlyimproved in 1998—

Last year looks to have been the first year since 1993 when North Korea’sagriculture was largely spared weather damage. There was localised flooding—much worse in South Korea—but nothing to match the floods of 1995 and 1996,the hail and cold of 1994, or the drought and tidal waves of 1997. Hence a betterharvest is expected. As usual there are competing figures, but South Korea’sunification ministry reckons it at around 4m tonnes of grain in total: up by 13%over 1997, but still leaving a shortfall of some 1.3m-1.5m tonnes.

—but the UN still seeks$376m in aid—

A single improved harvest does not, however, resolve North Korea’s food crisis.On December 16th the UN issued a consolidated inter-agency appeal, callingfor a total of $376m in fresh aid for North Korea in 1999. This sum is to covernot only food aid but also related farm rehabilitation and public-health meas-ures. How much of this will be forthcoming is another matter. Donor fatigue issetting in, fuelled by continued concerns over access, diversion and NorthKorea’s priorities and trustworthiness more generally.

The WFP confirmsmalnutrition is

widespread

The plight of North Korea’s children was confirmed by the publication inNovember of the first comprehensive random survey of child nutrition that theWorld Food Programme (WFP), after much pressure, was finally allowed toconduct earlier in the year. This revealed acute malnutrition in some 16% ofchildren under seven: a worse figure than in Cambodia, Laos and most ofAfrica. Moderate or acute malnutrition afflicts 60% of all children, and almost65% are small for their age.

The south’s foreignministry encourages

economic co-operation—

Despite the official sunshine policy, various arms of the South Korean govern-ment send conflicting signals—no doubt reflecting both turf wars and internaldebate—on the prospects for economic co-operation with the north. One sucharm, the Ministry of Foreign Affairs and Trade, called in a report published inDecember last year for greater efforts to conclude a free-trade agreement withNorth Korea, to “pave the way for a national (north-south) economic commu-nity through enhanced trade, processing on commission and direct invest-ment”. South Korea should also back any bids by North Korea to joinmultilateral bodies such as the World Trade Organisation and the Asia-PacificEconomic Co-operation forum. The policy of delinking economic co-operationfrom political and security issues should be maintained.

—but KOTRA councilscaution

By contrast, in a report published on November 23rd, KOTRA warned SouthKorean companies against an overhasty northward plunge and listed a range ofways in which conditions are unfavourable or ambiguous. These includewages—a fairly high monthly minimum of Won220 ($100 at the official ex-change rate), or Won160 in free zones—plus an inability to hire and fire freelyor impose overtime. Areas of permitted investment are unclear, as is whetherSouth Korean companies count as foreign or not. Investors must submit annualprocurement plans, which is tiresome and gives Pyongyang scope to meddle.On the sales front, goods from North Korea are excluded from preferentialtariffs in Japan and Europe, and banned altogether by the US under trade

42 North Korea


sanctions. Remittances are problematic: the theoretical right to remit all profitsfree of tax clashes with laws forbidding conversion of the won into foreigncurrency. Dispute-settlement mechanisms are unclear. Finally, if and when aproject ceases, investors must demolish and clear all buildings and plant attheir own expense.

Hyundai plans anindustrial estate in

the north—

As already mentioned, the Hyundai group has ambitious plans in North Korea.While its tour cruises are already up and running, other ventures, such as a16,500-acre industrial estate near Haeju in North Korea’s south-west, will takemuch longer to set up. Still others seem frankly speculative. Thus eyebrowswere raised in Seoul when Hyundai’s founder, Chung Ju-yung, returned fromhis second northern trip enthusing about oil, a sector not raised on his earliervisit. Allegedly Hyundai will be allowed to pipe oil to the south. Despite variousrumours over the years, there is, however, no evidence that North Korea has oilin quantities worth exploiting; and even if it did, it would surely use it to meetits own pressing needs before selling any.

—and Samsung plans a$1bn investment

Not to be outdone, Samsung, Hyundai’s rival to be the biggest chaebol (con-glomerate), has also announced grandiose plans to invest $1bn in North Korea.This drew a rebuke from the south’s unification ministry, which commentedthat Samsung had yet to clear its proposals with either Pyongyang or Seoul. Thesouth’s unification ministry, however, warned against stoking up expectations.It would also be salutary to look at the one big chaebol already operating in thenorth. Daewoo’s export factory near Nampo near Pyongyang, which producesjackets and bags for export, has been plagued by problems and has yet tonormalise production, much less turn a profit.

Farmers’ markets areincreasing

A report published in January by the south’s unification ministry estimates thatthe number of farmers’ markets in North Korea is now 300-350, with one or twoin each county and between three and five in cities. This figure has shot up inthe past few years, as a direct result of the famine. Before that, farmers’ marketsled a marginal existence, operating about one day per week. Now they are opendaily, and the unification ministry reckons that North Koreans use them to get60% of their grain and 70% of other daily necessities—this despite the fact thata kilo of rice sells for Won80, a whole month’s earnings. If true, this confirmswhat aid workers have also claimed: that Pyongyang’s state-run public distrib-ution system, which in principle guarantees a basic minimum of food for eachcitizen, has for all practical purposes ceased to operate across wide swathes of thecountry, being replaced variously by markets and international aid.

A new motorway willbe built

North Korea is to have its first true motorway, running 40 km from the port ofNampo to Magyongdae on the edge of Pyongyang. “Tens of bridges, flyoversand main roads will be built”, according to North Korea’s official news agency,the Korean Central News Agency (KCNA) on November 18th. Most construc-tion will, as usual, be done by the Korean People’s Army. This will be at least astart at modern infrastructure—as opposed to other “motorways” built in re-cent years, which are no more than wide but bumpy ribbons of concrete. Aweek earlier, KCNA announced the opening of a new 90-km coastal road in thenorth-east, between Yombunjin and scenic Mt Chilbo. Much as visitors will, no

North Korea 43


doubt, appreciate the “scores of animal sculptures along the road”, it is notclear how far this goes towards providing a proper east coast highway—withoutwhich, inter alia, the Rajin-Sonbong free zone will remain more readily accessi-ble via Russia or China than from its own hinterland.

The south alleges thenorth is counterfeiting

dollars—

Reports too diverse and frequent to be discounted suggest that Pyongyangcontinues to augment its funds by underhand means. South Korea’s Agency forNational Security Planning (NSP) claimed in a report in November that NorthKorea is printing counterfeit $100 bills to an annual face value of $15m, andthat North Korea’s involvement had been found in no fewer than 13 separateseizures in Asia of fake notes “worth” $4.6m.

—and a North Korean isarrested in Russia for

selling opium

However, the NSP’s view that North Korea had moved away from the drugstrade does not square with an article in a Russian newspaper, Izvestia, onOctober 30th. This noted that the recent arrest of a cook at the North Koreanconsulate in Khabarovsk for trying to sell 5 kg of opium was the 14th such caseinvolving employees of that office. A total of no less than 40 kg of industriallymanufactured heroin and opium has been confiscated in Russia. The samearticle described at length how nearly North Korea succeeded in illicitly buyingfive Mi-8T combat helicopters, describing this as “a vivid example ... of howcrudely and primitively the rascals act”; and accused Pyongyang’s agents offorging close ties with Russia’s mafia.

Elsewhere, Japanese police were reported on January 7th as confirming that upto 300 kg of (unspecified) drugs seized last August were of North Korean origin,and had been transferred from a North Korean to a Japanese boat at sea. InApril a North Korean ship in port in Japan was raided and found to containamphetamines worth $80m. It seems odd that, among all the various pressuresbeing put on North Korea to behave better in various ways, these shadyactivities rarely rate a mention.

North Korea gives aidto Uganda

For all its woes, North Korea remains a giver as well as a receiver of aid. OnOctober 2nd a foundry built with help from Pyongyang was opened at Kilembein Uganda. No technical or output details were given. This kind of assistance inAfrica was once widespread, in everything from agriculture and building stadi-ums and statues to both military and civilian training (the latter for massdisplays).

44 North Korea


Quarterly indicators and trade data

South Korea: quarterly indicators of economic activity

1996 1997 1998

3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr

Industrial production Monthly av

General, seasonally adj 1990=100 164 168 170 173 175 175 155 152 159 n/a

Construction

Permits issueda ’000 sq metres 9,721 10,047 7,618 10,659 8,251 11,263 5,871 4,309 2,987 n/a

Employment

Employed ’000 21,093 21,060 20,466 21,319 21,336 21,070 19,710 20,179 19,971 n/a

Unemployed “ 391 439 645 550 470 561 1,182 1,485 1,600 n/a

Wages & prices

Monthly earnings 1990=100 225.7 230.1 217.9 219.2 237.9 223.4 212.0 210.7 209.0b n/a

Consumer prices: “ 142.9 143.4 145.6 147.1 148.5 150.7 158.6 159.1 159.0 159.9c

change year on year % 5.1 5.1 4.7 4.0 3.9 5.1 8.9 8.2 7.1 n/a

Producer prices 1990=100 120.5 121.2 123.1 123.8 124.7 128.0 141.6 141.6 139.7 139.5d

Share prices ” 108.0 99.9 90.3 96.9 96.8 65.5 68.0 49.7 42.9b n/a

Retail sales

Value 1995=100 107 119 114 116 113 119 102 102 97 n/a

Money End-Qtr

M1, seasonally adj: W bn 38,447 36,783 35,929 36,614 35,697 32,592 28,688 28,147 29,780e n/a

change year on year % 21.5 1.8 2.7 4.8 –7.2 –11.4 –20.2 –23.1 n/a n/a

Foreign trade Qtrly totals

Exports fob $ m 29,576 35,468 29,724 35,532 34,182 36,727 32,240 34,840 30,626 22,845f

Imports cif “ 37,092 40,503 37,050 37,362 35,688 34,517 23,891 23,645 21,474 15,998f

Exchange holdings End-Qtr

Goldg $ m 99.2 92.3 86.1 84.1 79.4 77.0 96.0 97.2 93.5 95.9h

Foreign exchange:

Bank of Korea “ 32,038 33,237 29,146 33,316 29,654 19,710 29,677 40,764 46,904 49,931i

other banks ” 31,029 33,136 32,882 33,793 34,912 32,749 41,925 38,478 36,995e n/a

Exchange rate

Market rate W:$ 821.2 844.2 897.1 888.1 914.8 1,695.0 1,383.0 1,373.0 1,391.0 1,246.0i

Note. Annual figures of most of the series shown above will be found in the Country Profile.a 32 cities and 90 towns. b Average for July-August. c Average for October-November. d October only. e End-August. f Total for October-November.g End-quarter holdings at quarter’s average of London daily price less 25%. h End-October. i End-November.

Sources: Bank of Korea, Monthly Statistical Bulletin; IMF, International Financial Statistics.

Quarterly indicators and trade data 45


South Korea: foreign trade($ m)

Total US Japan China Germany

Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec

Imports cif 1995 1996 1995 1996 1995 1996 1995 1996 1995 1996

Food 5,928 7,265 2,472 2,883 114 120 424 624 82 117

of which:

cereals & preparations 1,949 2,654 1,564 1,862 2 2 32 69 58 89

Hides & skins, raw 1,189 1,175 830 802 9 7 0 0 4 4

Rubber, crude 729 703 33 52 97 92 5 1 10 10

Wood, unmanufactured 1,694 1,695 300 291 2 3 82 93 2 3

Pulp 1,858 1,473 837 675 11 17 9 1 3 1

Textile fibres & waste 1,551 1,367 483 378 117 94 125 137 13 9

Metal ores & scrap 3,238 2,981 882 699 133 218 63 32 65 39

Coal 2,081 2,337 218 216 12 15 353 411 1 1

Petroleum & products 14,760 19,049 558 688 623 522 507 762 24 28

Chemicals 13,156 13,257 3,116 3,252 4,244 4,047 616 611 939 989

Textile yarn, cloth & mnfrs 3,959 3,878 198 232 627 576 1,345 1,150 64 56

Iron & steel 6,539 6,549 345 265 2,398 2,379 1,243 1,134 173 178

Non-ferrous metals 4,617 4,126 408 354 630 473 234 224 118 92

Metal manufactures 1,555 1,744 359 451 539 552 95 128 178 197

Machinery & transport eqpt 49,436 54,701 14,706 16,516 17,932 17,522 782 1,316 4,086 4,597

of which:

power-generating eqpt 3,891 3,666 1,515 1,429 931 772 83 118 471 403

office machinery 3,570 3,998 1,271 1,445 1,015 885 108 201 28 47

telecommunications eqpt 3,057 3,505 1,122 1,522 951 783 249 362 44 59

transistors, valves etc 9,838 11,460 3,185 3,681 3,740 3,864 58 124 211 223

road vehicles 1,910 2,068 449 484 778 641 14 22 362 491

aircraft 2,479 2,766 2,185 2,360 1 68 0 0 1 3

ships 1,556 1,934 8 12 233 250 1 19 3 5

Scientific instruments etc 6,370 6,706 1,601 1,916 3,179 2,981 73 107 447 507

Total incl others 135,113 150,334 30,419 33,320 32,604 31,448 7,401 8,538 6,584 7,292

Saudi Arabia Australia Indonesia Italy Malaysia

Imports from other Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec

suppliers 1995 1996 1995 1996 1995 1996 1995 1996 1995 1996

Total 5,432 6,667 4,897 6,272 3,325 4,013 2,425 3,070 2,515 3,007

continued



Total US Japan China Hong Kong

Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec

Exports fob 1995 1996 1995 1996 1995 1996 1995 1996 1995 1996

Food 2,656 2,724 155 153 1,680 1,680 90 91 157 150

of which:

fish & products 1,551 1,494 88 76 1,143 1,111 63 67 15 6

Crude materials, inedible 1,790 1,608 154 142 322 259 526 532 183 170

of which:

textile fibres & waste 1,061 927 119 100 9 10 457 458 106 92

Mineral fuels 2,472 3,866 115 96 930 1,728 480 822 280 328

Chemicals 8,944 9,149 430 517 910 866 2,181 2,221 1,141 953

Rubber manufactures 1,513 1,754 256 247 63 49 16 13 44 51

Paper & manufactures 1,170 1,228 82 64 49 54 268 345 388 399

Textile yarn, cloth & mnfrs 12,313 12,718 653 734 629 574 1,359 1,819 2,845 2,696

Non-metallic mineral mnfrs 676 633 59 50 251 209 23 38 36 30

Iron & steel 5,411 5,229 599 603 1,792 1,451 576 765 373 386

Metal manufactures 3,721 2,629 626 584 517 475 234 197 68 59

Machinery & transport eqpt 65,646 67,584 16,891 15,030 5,600 4,714 2,064 2,854 3,327 3,299

of which:

power-generating eqpt 1,212 693 473 169 121 136 36 72 30 30

office machinery 4,967 5,673 2,016 2,259 350 260 84 173 132 151

radio & television receivers 2,810 2,736 328 192 329 238 66 92 58 127

sound & video recorders 1,824 1,747 555 342 144 132 97 61 218 294

other telecommunications eqpt 4,244 4,404 908 720 380 331 190 260 250 296

transistors, valves etc 19,373 17,305 6,596 5,526 2,956 2,268 151 217 1,667 1,651

road vehicles 10,122 12,351 2,240 2,403 153 133 229 177 138 105

ships 5,533 7,127 259 42 21 44 2 18 273 91

Clothing 4,957 4,221 1,825 1,526 1,849 1,398 61 88 57 51

Footwear 1,506 1,235 474 328 370 336 92 152 63 46

Scientific instruments etc 1,708 1,677 476 388 268 266 58 80 101 105

Total incl others 125,056 129,715 24,344 21,926 17,049 15,767 9,144 11,377 10,682 11,131

Singapore Germany Malaysia Taiwan UK

Exports to other Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec

main markets 1995 1996 1995 1996 1995 1996 1995 1996 1995 1996

Total 6,689 6,439 5,965 4,705 2,951 4,333 3,882 4,005 2,874 3,222

Source: UN, External Trade Statistics, series D.



South Korea: structure of trade($ m)

Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Sep Jan-Sep1994 1995 1996 1997 1997 1998

Imports cifFood, beverages & tobacco 5,110 6,460 7,929 7,178 5,453 3,676 of which: cereals 1,904 2,451 3,362 2,587 1,968 1,688Crude materials, inedible 9,405 11,713 10,965 10,424 7,920 5,400 of which: metal ores 3,167 3,913 3,658 4,014 2,969 2,416Mineral fuels 15,415 19,013 24,284 27,381 20,124 13,605 of which: crude petroleum 8,878 10,809 14,432 17,772 13,047 8,387Chemicals 9,763 13,156 13,231 13,110 10,057 6,964Manufactured goods 15,936 21,270 20,947 19,249 14,698 8,398 of which: iron & steel products 4,711 6,732 6,762 5,827 4,360 2,337 non-ferrous metals 3,140 4,703 4,211 4,494 3,480 2,423Machinery & transport eqpt 37,408 49,437 54,675 48,722 37,319 23,027 of which: electric & electronic mach 14,391 19,516 21,392 23,966 17,738 13,584 transport equipment 4,083 4,729 5,417 2,934 2,456 1,463Miscellaneous manufacturesa 8,165 10,803 12,062 11,561 8,774 4,734 of which: precision instruments 3,059 3,890 4,676 4,253 3,188 1,942Total incl others 102,348 135,119 150,339 144,616 110,100 69,012

Exports fobFood, beverages & tobacco 2,396 2,803 2,918 2,841 2,023 1,810Crude materials, inedible 1,430 1,790 1,608 1,780 1,321 1,169Mineral fuels 1,746 2,472 3,866 5,349 3,935 3,516Chemicals 6,339 8,944 9,148 10,666 7,878 7,725Manufactured goods 22,949 27,568 26,959 29,097 21,696 22,092 of which: textiles 9,018 10,261 10,505 10,827 8,188 7,045 metal goods 7,783 9,972 7,301 8,678 6,275 7,433Machinery & transport eqpt 47,068 65,546 67,584 68,110 48,454 46,419 of which: electronic products 18,170 26,217 24,425 26,392 19,223 18,435 motor vehicles 5,758 9,069 11,462 12,107 8,548 7,438 ships 4,945 5,533 7,127 6,520 3,920 5,210Miscellaneous manufacturesa 8,165 10,803 12,062 11,561 8,941 9,248 of which: clothing 6,269 5,668 4,929 4,897 3,618 4,038Total incl others 96,013 125,058 129,715 136,164 99,437 97,790

a Including clothing and scientific instruments.

Source: National Statistical Office, Monthly Statistics of Korea, Bank of Korea, Monthly Statistical Bulletin.



South Korea: direction of trade($ m)

Jan-Dec Jan-Dec Jan-Sep Jan-Sep Jan-Dec Jan-Dec Jan-Sep Jan-Sep

Exports fob 1996 1997 1997 1998 Imports cif 1996 1997 1997 1998

US 21,671 21,625 15,850 16,758 US 33,305 29,981 23,340 15,044

China 11,377 13,573 9,795 8,891 Japan 31,449 27,836 21,237 12,291

Japan 15,767 14,771 11,044 8,875 China 8,538 10,117 7,530 4,874

Hong Kong 11,131 11,725 8,701 7,192 Australia 6,272 5,892 4,531 3,433

Taiwan 4,005 4,613 3,322 3,331 Saudi Arabia 6,667 7,153 5,334 3,397

Singapore 6,439 5,797 4,633 3,007 Germany 7,239 5,815 4,470 2,517

UK 3,222 3,984 2,864 2,962 Indonesia 4,013 4,099 3,016 2,281

Germany 4,705 4,753 3,477 2,817 UAE 2,259 3,085 2,242 1,608

Malaysia 4,333 4,356 3,240 2,516 Malaysia 3,007 3,275 2,367 1,566

Panama 3,195 1,918 1,346 1,597 UK 2,994 3,356 2,645 1,304

Indonesia 3,198 3,541 2,799 1,335 Canada 2,724 2,599 2,033 1,259

Total incl others 129,715 136,164 99,437 97,790 Total incl others 150,339 144,616 110,100 69,012

Source: Bank of Korea, Monthly Statistical Bulletin.

North Korea: direction of trade(%)

Jan-Dec Jan-DecExports 1995 Imports 1995

Japan 27.9 China 32.6South Korea 20.8 Japan 17.2China 5.2 Russia 4.7Germany 4.0 South Korea 4.3Russia 1.2 Germany 2.9Source: Institute for International Economics, Washington DC, The North Korean Economy.



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