More nationwide strike action would be a severe blow to government's economic recovery plans.
Few would dispute that the South Korean economy is in trouble. Last year, rising foreign debt and shrinking export growth fuelled a massive current-account deficit; steep interest rates and high labour and component costs battered industry; while the stock market sank to a three-year low. And with the new year kicking off with major industrial unrest, a feeling of doom should be widespread.
But until recently, South Koreans seemed unphased by their problems, believing they were just temporary setbacks. Indeed, the nation's tycoons have earned a reputation as the world's 'big spenders', while imports of luxury electronics and cars are increasing - a sign of strong consumer confidence.
The contradictions run deep. Last year, an average of 45 companies went to the wall every day. But at least 37 a day set up information or telecoms software businesses, many of which proved highly successful.
According to the state-owned Korea Development Bank, big enterprises are instructing their managers to cut back on labour to 'gain 10% competitiveness', while many smaller factories have been unable to operate at all due to staff shortages. Manufacturers have no cash to keep their production lines running, yet money is flooding into the consumer-goods market. And corporate investment in the manufacturing sector is shrinking by 6% annually, although the non-manufacturing sector is expanding by 16.7%.
'Our economy can be best described as fuzzy,' admits Yoo Han-soo, head of POSCO Research Institute, an affiliate of the steel giant Pohang Iron & Steel Corp. 'At a time when the economy is on the verge of being crippled by a rising deficit and foreign borrowing, it appears to be thriving more than ever.'
Last year, the economy enjoyed robust economic growth of 6.9%, stable inflation of 4.5%, and a low unemployment rate of 2% - an enviable record by Western standards. But it also sat on a highly burdensome current-account deficit of $23 billion - 4.5% of gross national product (GNP), which is forecast at $486 billion. The large deficit has in turn fuelled the rise of total outstanding foreign debt, which surpassed US$100 billion in 1996.
A steep rise in short-term foreign debt is particularly worrying for South Korea because it will shrink foreign-exchange reserves, making foreign investors doubt the country's ability to repay its debts and thereby reluctant to roll over maturing loans.
And this year's forecast is bleak. Gross domestic product growth is expected to drop to 6.4% in 1997 amid higher inflation - projected at 4.7% - and higher unemployment of 2.2%. This might sound an idle worry considering South Korea now holds US$70 billion worth of property overseas, and once survived foreign debts that topped 40% to 50% of GDP in the 1970s and early 1980s. But with elections looming and an investment drive into North Korea on the cards, these difficulties are heading the political agenda.
'The problem [of rising foreign debt] lies not so much with its current high level as with the fact that the foreign debt level will inevitably shoot up when South Korean companies start investing in North Korea - perhaps within the next two or five years,' says professor Koo Hyong-gun of the general education department at Pohang University of Science & Technology. 'Nobody thinks [companies] can internally finance their investments in North Korea. They will need massive foreign capital. Then, it will be a matter of time before that more than doubles the nation's trade balance deficit.'
The urgency is already apparent. Last month, Seoul granted approval to seven South Korean companies to invest in the North, including trading firm LG International Corp, garment maker Shin Won Corp and drug maker Korea Green Cross Corp, and many more are likely to follow.
A poor economic performance could also wreck president Kim Young Sam's bid for re-election in December 1997. Alarmed, Kim has ordered his government to halve the current-account deficit. This has left it with the seemingly impossible task of slashing the deficit, while maintaining economic growth and keeping prices under control.
Conservative central bankers say the nation must make it a priority to cut back the current-account deficit, even if it means lower economic growth. But this would leave Seoul with the politically contentious task of cutting jobs and production. 'If we are to slow the real growth rate by 1%, this will mean getting rid of 500,000 jobs and 9.8 trillion won (US$ US$1.17 billion) in lost production,' said Kim June Il, a senior analyst at the Korea Development Institute.
According to Lee Kang Nam, general manager at the Bank of Korea, there are two choices: if the current account deficit is brought down to US$13 billion, GDP growth would fall to 5.5%, and unemployment would rise to 2.6%. But if growth of about 7% is maintained, the deficit would hover around US$19.5 billion and prices would rise 5.2%. The central Bank of Korea projects the deficit is more likely to be US$18 billion.
The government-initiated mammoth social overhead capital (SOC) projects are widely blamed for the huge current-account deficit. They triggered a massive inflow of foreign capital by allowing private builders to borrow US$50 million for each project annually, making the nation dangerously dependent on 'cheap' foreign money.
Threat of more labour unrest
The poor state of labour relations may frustrate the government's efforts to overcome the downturn. The introduction of a labour reform bill led to nationwide demonstrations in January. The government says the bill is essential to bolster national competitiveness, because it will ease the burden of high labour costs. But the unions argue it will destroy the union movement. The bill allows employers to refuse to pay full-time union officers, rescind union membership of dismissed workers, and stop all wages during strike action. Unionists fear that it will also jeopardise job security, because it allows employers to make pay cuts when they believe their company is in difficulty.
Threatened nationwide strike action would be a a severe blow to the government's economic recovery plans. Daewoo Economic Research Institute believes strikes would slow economic growth to only 5.6%, and cause a loss of US$1.09 billion in industrial output.
A combination of a steep cut in the export price of semiconductors, rising imports of consumer goods, and dwindling exports of shoes, textiles and leather goods resulted in an estimated US$19 billion trade-balance deficit in 1996 - falling from US$10.6 billion in 1995 - according to the Korea Foreign Traders' Association. Exports of five strategic export items - semiconductors, steel, chemicals, machinery and cars, which account for 47.5% of total exports - are declining. Most of these are exported to the European Union, the US and Japan. Nevertheless, US demand for South Korean telecommunications equipment and cars is mounting.
Analysts predict that, despite the imminent recovery of the world economy, which will boost the flow of international trade, South Korea's car, shipbuilding, steel and petrochemicals industries will have another bad year - hit by Japan's expected economic revival, which will reduce South Korea's competitiveness.
Meanwhile, the rapidly depreciating value of the won against the US dollar is both welcomed and feared. 'The fall of the won was a matter of course, because it had been overvalued, making Korean products artificially more expensive,' says one analyst.
A cheaper won is a good sign for traders. 'We will need a further depreciation of the won if we are to narrow the trade deficit and make our exports more competitive,' says professor Park Won Um of Hong Ik University.
But conservative planners, such as the central Bank of Korea, and domestic companies fear that a sharp fall in the won's value will encourage foreign money to leave the South Korean stock market, reminiscent of the Mexican peso crisis in December 1994.
The black market has been a key beneficiary of the poor performance of the won. The Small Business Federation estimates W12 trillion worth of private loans were made last year. But a tax research institute says the figure could be nearer W34 trillion, or 10% of GNP. Much of the money - part of a reported 20% increase in money supply - is sneaking into consumption rather than into the manufacturing sector, at a time when small firms are hampered by cash-flow problems.
To discourage the speculators, the government plans to issue public bonds - with an interest rate of less than 5% - which it will absorb as SOC funds. This year, the government will issue 12- to 15-year maturity SOC bonds, with tax incentives, while easing restrictions on cash loans for SOC builders of roads, ports, railways and airports. An estimated US$3 billion cash in foreign borrowing is forecast to flow into SOC projects during the next four years, up from the initially planned US$2 billion.
Rise in direct investment
More South Korean companies are investing abroad than foreign firms are investing in South Korea. According to the Bank of Korea, South Korean companies were granted US$4.14 billion worth of foreign direct investment (FDI) contracts from January to September 1996, up 53.9% from 1995. Meanwhile, South Korea approved 873 FDI projects, valued at US$2.3 billion, in the first 11 months of 1996. This represents an increase of 32.6% in value and 10.6% in the number of projects, according to an interim report by the Ministry of Finance and Economics.
'The South Korean government's tight regulation of corporate activities is driving us out, whether we like it or not,' says an official of one conglomerate. 'As a global business, we must maintain our operational base where our markets are, and secure our human as well as material resources there.'
From 1986 to 1995, South Korean conglomerates were known as big spenders, snapping up foreign firms no matter how deeply in the red they were, if they were thought to provide easy access to technology, brand and marketing power. In 1995, the chaebols bought 51 foreign firms, including 25 with contracts valued at a total of US$1.46 billion.
Now stories of woe are beginning to emerge. By the third quarter of 1996, Hyundai had incurred debts of US$122 million from US-based hard disk drive manufacturer Mexter, while LG was US$130 million in the red from Zenith, a US electronics giant. In 1993, Hyundai Motors, South Korea's leading car maker, closed its money-losing plant in Canada.
Samsung's move to acquire the troubled Dutch aircraft-builder Fokker was stalled by stiff opposition from Daewoo Heavy Industries, Korean Air and Hyundai Space & Aircraft. They objected to Samsung's intention of using the money-losing Fokker as an alternative to the aborted government-sponsored aircraft-building project with China (page 20).
Daewoo's attempt to buy into the troubled French organisation, Thomson Multimedia, was derailed after vehement objections from Thomson's union, which feared working conditions would suffer under Daewoo management. In retaliation, Seoul rejected French tenders for infrastructure projects.
But start-ups in the information, telecoms and software sectors are thriving, boosted by the rapidly growing interest in the Internet. Lee Hyong-suk, head of the Business Information Development Institute says there were 16,214 start-ups in six major cities between January 1 and December 21, 1996. 'Most of start-ups are in the distribution and services sector, while those in the machine and manufacturing sector are declining,' he says. 'As start-ups boom, industrial society is becoming more dynamic and fresh,' says Chae Jae-uk, president of the Small and Medium Industry Promotion Corp, a government agency.
The Personal Communication Service (PCS) - a cheap version of cellular phone - will be up and running next year. The three PCS licence winners - Hansol PCS, Korea Telecom and LG Telecom - are already jockeying for market position. The government is now mulling over how to relax the state-controlled giant Korea Telecom's cross-subsidiary equity as the provider battles to become a global 'super-carrier'.
Relaxation of M&A rules
Managements are dreading the coming wave of mergers and acquisitions. The 20% limit on foreign ownership of domestic stocks will be lifted by December 2000, which means companies will no longer be safe from hostile M&As by foreign investors. The government has eased restrictions on friendly M&As, and the number of listed companies that have changed their controlling shareholders has risen from five in 1993, 13 in 1994 and 20 in 1995, to 20 at December 2, 1996.
Falling share prices have brought down the share prices of commercial banks, increasing the chances of buying bank stocks at a bargain price. 'But any massive hunting into Korean stocks by foreign firms is unlikely, if we consider that Japan allowed hostile M&As by foreigners long ago, but cross-holding ownership of stocks by several Japanese affiliates has effectively kept foreigners off,' says Kang Chang-hee, executive director at Daewoo Economic Research Institute.
South Korea's major business groups, including LG, Daewoo and Ssangyong, are aggressively moving to take over foreign financial institutions as a means of financing their overseas investments at low cost. LG signed a contract in October 1996 to take over Petro Bank of Poland through the purchase of more than 50% of the bank's total equity for US$28 million.
'The takeover of Petro Bank will greatly help LG subsidiaries advance into the Polish and Eastern European markets in the future,' says Min Kwang-shik, director of LG Securities Co, which invested US$18 million to buy 32.14% of the Polish bank's total shares along with LG Merchant Banking Corp, which spent US$10 million to acquire 17.86%.
Meanwhile Daewoo Securities Co, the stock trading arm of the Daewoo Business Group, has been pushing ahead with takeover plans for a state-run commercial bank in France. 'At the same time, Daewoo Securities Co will soon establish a joint-venture bank in Bucharest, Romania with KorAm Bank,' says Choi Jin-sun, assistant manager of the Daewoo securities company. Daewoo has already purchased 89.99% of the joint venture, with initial paid-in capital of US$25 million, and has named it Romania Daewoo Bank.
But Kang Kwang-ha, economics professor at the National Seoul University, advises firms to take a cautious approach this year. 'This is the time our economy will slide,' he says. 'Our three decades of high growth is over. Now our economy must settle for low growth, low prices and low interest rates.'