The 1997 Asian financial crisis was a period of economic and financial turmoil that gripped much of Asia, starting with the collapse of the Thai baht in July of that year. As the crisis spread, many Asian countries saw slumping currencies, stock market declines, and other economic reverberations. South Korea was among the countries hardest hit by the crisis. By late 1997, the South Korean won had lost more than half its value. The country was on the verge of defaulting on its foreign loans as foreign capital fled the country.
To avoid an economic meltdown, South Korea turned to the International Monetary Fund (IMF) for emergency funds. After initial resistance, the South Korean government agreed to an IMF bailout package worth $57 billion – at the time the largest IMF rescue program ever. However, the bailout came with strict conditions aimed at financial and economic reforms.
The IMF agreement marked a pivotal moment in South Korea’s modern economic history. This article will provide an in-depth look at the background, terms, and outcomes of South Korea’s IMF bailout and reform program. It will analyze the origins of the crisis, the negotiations with the IMF, the reform requirements, and the long-term impacts on the economy.
Background to the Crisis
South Korea’s Rapid Growth
To understand the genesis of the 1997 crisis, it is important to consider South Korea’s rapid industrialization and growth in the preceding decades. Starting in the 1960s, the country embarked on an export-oriented model backed by strong state planning and subsidies for large family-run conglomerates known as chaebol. This drove decades of GDP growth averaging 8-10% annually.
Emergence of Chaebol Dominance
The chaebol, such as Samsung, Hyundai and LG, became dominant players across many industries. While successful at first, this model led to an economy overly dependent on debt financing and risky overexpansion by the chaebols. It also created moral hazard issues where the chaebol expected implicit government bailouts if needed.
Weak Regulatory Environment
Limited financial oversight and regulation allowed reckless borrowing by banks and companies. By 1996, South Korea’s short-term foreign debt was $120 billion, quadruple the amount in 1990. The debt-to-equity ratios of major chaebol skyrocketed.
Currency Decline and Corporate Collapses
This mountain of foreign currency debt became unsustainable as the US dollar strengthened through 1996, making loan repayment in dollars more expensive. Meanwhile, several major South Korean conglomerates went bankrupt. This sparked capital flight out of the won, leaving the currency vulnerable.
Contagion from Southeast Asia
The final spark was the crash of the Thai baht in July 1997. As the crisis spread across Southeast Asia, international investors grew wary of risk in emerging markets like South Korea. This triggered further won selling and a full-blown currency collapse. By late 1997, the won had fallen from 800/$1 to almost 2000/$1.
Negotiating an IMF Bailout
Initial Resistance to the IMF
As the currency plunged, the South Korean government hesitated to go to the IMF, fearing the loss of economic sovereignty. After borrowing from Japan, Taiwan and the U.S. failed to stop the won’s decline, President Kim Young-sam had no choice but to reluctantly apply to the IMF in November 1997.
Tough Bargaining by the IMF
At first, the IMF negotiated harsh terms, demanding wide chaebol reforms and greater opening of South Korean markets. Kim pushed back against the initial demands. But with currency reserves down to $6 billion in December, South Korea had to accept IMF terms to get the vital funds.
The $57 Billion Bailout Deal
On December 3, 1997, South Korea formally signed a $57 billion emergency bailout deal – then the largest rescue in IMF history. The package included $35 billion in IMF loans, plus funding from the World Bank, Asia Development Bank, and creditor countries like the U.S. and Japan. The IMF provided an immediate disbursement of $5.6 billion.
Public Anger Over Loss of Sovereignty
The IMF deal was met with anger among the South Korean public, who saw it as a humiliating loss of economic sovereignty to a foreign organization. But the country was in no position to refuse if it wanted to avoid default. President-elect Kim Dae-jung took office amid the IMF negotiations, inheriting the reforms mandated by the deal.
Reform Requirements of the IMF Program
The IMF bailout was conditional on South Korea enacting major financial and economic reforms under IMF supervision:
Tight Monetary Policy
To stabilize the won, the IMF demanded high interest rates and other tight money policies. The Bank of Korea benchmark rate hit 30% in early 1998. This tightened credit access and slowed the economy, but did bolster the won.
Chaebol Restructuring
The deal forced large conglomerates to reduce debt, end cross-subsidies among affiliates, and bring accounting standards up to international norms. Many chaebol sold off assets, culminating in Hyundai’s breakup in 2000. Government-directed credit also declined.
Financial Sector Reform
Under the deal, financial supervision was strengthened, prudential regulations were enhanced, and policies were improved to manage capital flows and external debt. Struggling banks were forced to recapitalize. Two dozen financial institutions were closed or merged.
Improving Corporate Governance
The IMF program compelled public companies to reform governance, adopt international accounting standards, and improve transparency. This was aimed at better oversight and ending cozy government-business ties.
Trade and Investment Liberalization
The IMF required South Korea to accelerate planned reductions in trade barriers, open financial markets wider to foreign firms, privatize state-owned enterprises, and relax foreign investment restrictions.
Labor Market Reform
The deal also sought to introduce more labor market flexibility, seen as essential to corporate restructuring. But the Kim government resisted pursuing this due to expected social pushback.
The Aftermath and Impact on South Korea
The tough IMF reforms succeeded in stabilizing South Korea’s financial situation. But they also plunged the country into a sharp recession. By 1998, the economy had contracted by 5.8%. Unemployment hit 8.6% in February 1999 – the highest on record at the time. The congruent impact was severe.
Short-Term Pain
In the first half of 1998, business bankruptcies soared and investment and consumption plummeted. Small businesses and the urban poor were especially hard hit. Public anger peaked in early 1998 over the economic pain and loss of national control.
Long-Term Transformation
Over the longer run, though, the crisis prompted major changes that strengthened South Korea’s economy. Corporations deleveraged and improved efficiency and profitability. The financial sector grew sounder and supervision stronger. Economic policymaking became more transparent and responsive.
Greater Trade Orientation
Export competitiveness increased due to reforms and the weaker won. South Korea’s trade-to-GDP ratio rose from 65% in 1996 to 99.9% in 2008. Exports expanded in key industries like electronics, autos, and ships. FDI inflows accelerated post-crisis too.
Return to Growth
By 1999, South Korea returned to 6.3% GDP growth as corporate balance sheets healed, export competitiveness improved, and domestic demand rebounded. Growth averaged 4-5% in the 2000s, slower than pre-crisis but more balanced and stable.
Shift in Public Attitudes
The crisis caused a major shift in public attitudes. After an initial backlash, Koreans increasingly accepted the need for change and supported greater transparency and competition. Successive governments continued liberalization in finance, corporate governance and trade.
Lasting Policy Changes
The crisis triggered lasting policy improvements, including more exchange rate flexibility, better debt management, tighter financial supervision, and reforms for chaebol corporate governance. These helped Korea weather later crises.
Conclusion
The 1997-98 IMF crisis was a watershed moment for South Korea, forcing rapid transformation at high social cost. The reforms mandated by the deal brought short-term economic pain but fundamentally strengthened South Korea’s economy for the 21st century.
Two decades later, South Korea stands as a more resilient economy less prone to financial volatility and with world-class companies and financial institutions. The crisis taught South Korea the dangers of moral hazard and weak oversight. It also shifted public attitudes to support greater transparency and competition. The reforms launched under the IMF program laid the foundations to restore South Korea’s rapid growth and emergence as a developed economy.
