Based in Singapore as an employee of a private equity firm, I began assessing South Korean investment opportunities from September 1998. My previous employers only had an ASEAN mandate, so I had no prior South Korean work experience. Within a few days, I learned that my firm too didn’t have prior South Korean investment experience. The reason was simple, the fund’s mandate was emerging markets and until the Asian Currency Crisis, South Korea was higher ranked and not within “emerging markets.” The Asian Currency Crisis had opened an opportunity for foreigners to take ownership in South Korean companies.
With my new director, I went to a South Korean investor fair in Singapore which showcased companies eager for foreign direct investment. By listening to the presentations and reading the investor memos, it was clear all these South Korean companies’ equity capital need was for the same underlying reason: The large loan packages given to “chaebols” (family-controlled conglomerates) pre-1997 had ballooned into non-performing loans.
“I am head of the Office of Chairman reporting directly to our chairman,” smiled the Korean executive politely as we exchanged greetings and business cards.
“So the groups that were called Strategy or Business Development, now are doing restructuring or sell offs and renamed Office of Chairman,” my director figured it out after we’d met the third executive with similar title for the third chaebol at the Singapore fair.
“I was in Stamford with GE. You were working in the region in 1997, so you got to see things as they were unfolding in South Korea,” he said.
Enter the IMF
This was before the days of “fake it till you make it” so I told him that I’ll speak to the Korean central bank economists and investment bankers here; read up on IMF publications, Wall Street Journal, Business Week, etc; and prepare a background memo for both of us. Here’s the main gist of that: In January 1997 it came out that Hanbo Group (14th ranked chaebol) had received illegal preferential treatment from South Korean president Kim Young-sam’s circle. Bribed high ranking politicians and banking executives had pressured Korean banks to give loans to Hanbo.
In March, Sammi Group declared bankruptcy, confirming weaknesses in the financial system. In June 1997, the Hanbo’s losses from corruption and bribes were estimated at $6 billion. The company's founder, his son, and eight other prominent figures, including former Home Minister and former presidents of Korea First Bank got jail sentences. The present Korean President’s son got a jail sentence.
Then in July Kia was at the brink of bankruptcy; it asked for and received an emergency loan. It came out that the government and local banks discouraged chaebol from taking long term loans as it required more disclosures. So, the chaebol were loaded with short-term loans linked to long-term government projects and government guarantees. The Korean banks in turn got US dollar and Japanese yen floating interest rate loans to support their domestic loan portfolios. After the Hanbo revelations, Japanese banks significantly restricted their South Korean lending. The combination of strong US dollar, weaker Korean exports and non-performing loans would’ve meant the won was overvalued. However, with central bank buying, the won held up fairly well over for the first half of 1997.
The Korean government took steps to get local banks to provide grace periods on loans, allow companies to raise more stock market equity and public debt, and relax the ownership percentage for foreigners.
The Bank of Korea (the central bank) had some objections to how a newly created supervision entity would weaken their independence. Meanwhile, the Thai baht debacle unfolded, perhaps an unrelated topic but a topic looming in the background. Then, on June 27, Moody’s downgraded the nation’s sovereign credit rating from stable to negative.
This is a good time for me to mention there was a presidential election planned in December 1997. Korean presidents can only serve one five-year term, and historically, the ruling president’s party candidate usually won. Opposition candidate Kim Dae-Jung had been running for the presidency since 1971 and had a checkered political career including death sentence, assassination attempt, kidnapped, exiled and visiting teaching posts on both sides of the “pond”: Harvard and Cambridge universities. When he announced his presidential candidacy for the third time, he trailed behind the ruling President Kim’s party’s candidate.
From July to September, Korean merchant banks faced credit crunch; the stock market index fell steadily; semiconductor exports surged but foreign investors sold their position in Korean stocks and called back the short-and long-term loans they were holding. Small and medium businesses were facing a liquidity crisis, local merchant banks were shutting down, and real estate prices began plunging.
The shareholders, creditors, and the government are not the only stakeholders in a company -- the workers are also stakeholders. And South Korean workers have a track record of being organized and not afraid to go on the streets to voice their discontent. The labor unions and civic groups opposed the plan that had been chalked out for Kia by the creditors, owners, and management. Therefore, on October 24, the creditors filed for court receivership and the chairman resigned. And in the same month four companies defaulted on their loans and or declared bankruptcy. Moody’s pushed Korea’s long-term sovereign rating down two notches, from A1 to A3: The last place in the “upper medium grade” category.
Mounting pressure
On November 5, Bloomberg News reported that Korea’s external debt amounted to $110bn, of which $80bn was due by the end of the year. The paper said that Korea’s foreign exchange reserves totaled about $15bn, and concluded the nation was headed for a severe financial crisis. Foreign currency trading was halted for four days, and on November 18 the National Assembly did not pass the government’s financial reform package. The involvement of President Kim Young-sam's son in the Hanbo scandal undermined his father's reforms package, and his party’s presidential candidate.
On November 19, a new finance minister announced measures aimed at financial market stability and restructuring, including mergers, and opening up the bond market to foreigners. Yet the legislative body wasn’t convinced, and the stock market reached its lowest point in 10 years. By November 20, it was clear foreign reserves were insufficient to settle even one month’s worth of imports.
The world’s 11th largest economy was on the brink of financial collapse, so it had to reach out to the IMF and on December 3, after extensive negotiation, both sides agreed to the largest bailout package to date.
The Bank of Korea surrendered the Korean won from December 16, and let the financial markets decide its value. On December 18, 1997, by a slim margin of only 1.6% votes, Kim Dae-Jung defeated the ruling party’s candidate to become the first person in opposition to win the presidential election. Outgoing President Kim made incoming President Kim take charge of major economic decisions months before the inauguration. Korean loans were effectively rated junk bond status by December 23.
Santa Claus did bring a Christmas gift for South Korea. On December 24, the Federal Reserve Bank of New York made US banks with the largest exposures to South Korean banks voluntarily commit to roll over their short-term loans, and restructure them into medium-term loans. South Korea was the symbol of the 1980s “Asian Tiger” as well as the democratic answer to communist North Korea. Hence, it made philosophical, political, and economic sense for US support. The other G-10 countries, the World Bank, and ADB followed the leader. In total, they gave $58bn assistance of which $20bn was from the IMF.
President Kim-Dae Jung got the chaebol and labour unions to agree to the plan for business transparency, corporate accountability, and corporate restructuring. In return the government agreed to provide social welfare safety nets for the downsized workers. He took on the IMF’s banking reform directives to strengthen audit and accounting, implement best practice regulations and lift many of the restrictions for foreign direct investment. The won tumbled down 40% by year-end and household income fell 17%.
“You wrote a good memo. The Japanese doldrums and strong US dollar policy were two external forces, so it wasn’t only Korea’s fault,” my director said during our car ride from Seoul airport to the hotel.
Witnessing the struggle
Over the course of late-1998 and 1999, I went to Seoul a few times to bargain shop for equity investments in Korean industrial companies. One morning before breakfast, I went to the semi-open air Namdaemun Market by the old city gate to bargain shop for myself. I once had a little break during due diligence meetings, so instead of a taxi, I took the subway. These were the only ways I could see how downtrodden folks were dealing with the contracting GDP, rising unemployment and inflationary pressures.
Foreign investment during 1998 and 1999 exceeded the cumulative total for the previous 40 years. Our fund made one investment and just before the final days of the second one, the target decided to dump us and go for an IPO. My business trips to Korea ended but my genuine interest in Korea remained.
The IMF is never popular in any country it enters on a rescue mission. South Koreans regarded this as their second biggest national challenge after the Korean war. They showed their patriotism by donating 2.27 tons of personal gold jewelry to the national reserve. By 2001 South Korea was on a growth mode and considered the best successes of the IMF, having repaid its loans. One can certainly question if generations of Koreans should now be carrying the national debt burden caused by the reckless privileged few.
President Kim is credited for enacting banking reform and restructuring, liberalizing foreign investment, as well as, allowing harsh unemployment and instituting welfare programs -- all of which exists till today. The chaebols still have complex murky structures and it is unclear how many business lines are profitable. He received the Nobel Peace Prize for his “Sunshine Policy'' with North Korea. The Nobel Peace Prize itself is controversial. Arafat, Rabin and Perez won it for Palestine-Israel peace in 1994 and there has been no peace; rather a horrific war is going on right now. The majority of Bangladeshis seriously question why Aung San Suu Kyi is still in the circle of peace prize alums. So, let’s set aside what the international or “Western free world” says about any Asian leader.
For me, the best measure of a person is how she treats her number one enemy. President Kim forgave a former Korean president and an opposition presidential candidate: both had at different times attempted to kill him. He held official meetings with them at the presidential Blue House. He refrained from seeking vengeance and opted for national unity. In 2009 when President Kim died North Korea sent a delegate to his funeral. This has yet to be repeated. President Kim was the second person in South Korea to be given a State Funeral. Perhaps plunges do open opportunities, lasting ones.
Lubna Kabir has over 25 years of experience leading US and international projects in first line of defense risk management, integrated internal audit, strategy, and financial analysis.
