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Business Commentary/Dilip Thakore

India must learn from the Korean crisis

But yesterday South Korea was the wonder economy of the world. Almost wholly literate, gifted with a hard-working population, recording annual GDP and exports growth rates of 8-9 per cent and 12 per cent respectively, and recently accepted into the OECD club of the rich industrialised nations, the Republic of Korea was widely admired and held up as a role model economy for the developing nations of the third world.

Yet, in early December, Korea's national currency, the won, whose exchange rate had been pegged to the US dollar at around 800 for over a decade, went into a tailspin plunging to 1,891 per dollar before recovering to its current (floating) exchange rate of around 1,390. Almost overnight, the wonder economy of the eastern world went into a deep coma, necessitating a massive bailout loan of $ 57 billion from the International Monetary Fund -- the largest loan give to any nation in the 50-year-history of this international multilateral term-lending institution. But for this emergency loan, foreign banks and customers would have refused all trade credit to Korean companies, driving them into bankruptcy and triggering a full-blown economic crisis around the world.

There are as many theories as to what's gone wrong with Korea's hitherto wonder economy as there are economists. Even the omniscient economists of the IMF, who were so concerned about the international ramifications of the Korean crisis that they quickly drew up the most expensive national bailout package in global history, couldn't possibly be sure what went wrong in Seoul. Because only three months ago, in the IMF annual report for 1997, the fund's directors welcomed Korea's continued impressive macroeconomic performance (and) praised the authorities for their enviable fiscal record. Expressions of alarm about Korea's weak financial system and questionable 'fundamentals' are of very recent origin.

Nevertheless, some defining characteristics of the Korean economic development model which exposed its soft underbelly to currency speculators and panicky foreign investors who triggered a run on Asia's hitherto wonder economy, were always clearly visible.

For one, while Korea has emerged from the mists of international obscurity to become one of the world's great exporter nations in record time, a not-so-well-know fact is that it is also one of the contemporary world's great importer nations. Now, with the benefit of hindsight, economists have identified Korea's large and persistent 7-8 per cent current account trade deficit as one of the prime causes of the vulnerability of the Korean economy. Korea needed a constant flow of hard currencies to sustain its export-led economic growth. If for any reason this flow of foreign short-term credit was interrupted, the wonder economy would be in trouble. And that's exactly what happened when foreign banks and institutions suddenly lost their nerve.

The second factor which IMF economists have correctly, even if belatedly, identified as a cause of Korea's unprecedented crisis is the nation's weak and carelessly administered financial system. As in India, Korea's major banks and financial institutions are nationalised and subject to politically directed lending. Not surprisingly, a quintessential crony capitalism, dominated by about a score of huge chaebols -- widely diversified conglomerates -- has taken firm root. These conglomerates, including Daewoo, Samsung and LG among others -- absorb an estimated 70 per cent of Korea's bank credit. Indeed, so easily was bank credit available to the chaebols, that the average debt-equity ratio of Korean industry is 4:1 (Indian industry's average is 1.5:1) with most of the favoured chaebols mounting up even higher ratios.

The easy availability of politically directed bank credit also had the effect of undermining the development of Korea's stock market. Despite the frugality and thrift of the general populace, they had few equity purchase options as the gigantic chaebols tend to be closely held. Given the easy availability of bank credit, entrepreneurs-promoters saw little need to lose control by offering equity to the public. Now with the chaebols finding it difficult to service their huge debts, Korean banks are in big trouble as panicky depositors are staging a run on several major banks and finance companies.

By accident rather than design (because it is a bit player in international trade), India's current account deficit is a mere 1.5-2 per cent. Moreover, Indian industry is much less leveraged than the Korean industry. But there is no doubt that because of our economic decades of politically directed lending, India's dominant nationalised banks are stuck with huge undisclosed NPAs (non-performing assets). And the more than 100 per cent depreciation of the rupee since 1991 is intimately connected with this nation's weak financial system.

The lesson to be derived from the precipitate fall in Korea's credit rating is that in this age of real-time electronic monetary transfers, when mountains of money can swiftly enter and exit national economies, a nation's banking and financial system must be above suspicion of infirmity.

At the bottom, there is nothing drastically wrong with the Korean economy. The nation's fundamentals -- high literacy, industrious population, low inflation, adequate reserves and high (8-9 per cent) annual GDP growth -- are sound. There's just been a general loss of confidence in the banking and financial system among foreign investors. But I entertain no doubt that with the help of the massive $57 billion IMF loan, the recently elected new president of this industrious and disciplined nation will set right Korea's banks and financial institutions very quickly.

Meanwhile, it is a sobering thought that the fundamentals of the Indian economy suffer in comparison to Korea's. Moreover this nation's financial system, dominated by under-capitalised and NPA-laden nationalised banks and institutions, if scutinised by foreign investors, will probably create a much worse impression.

So unless a determined effort to restructure (and privatise) India's suspiciously rigid and secretive financial system is mounted quickly, a Korea-like crisis is waiting to happen here. And when that does happen, it will take more than $57 billion to set the Indian economy right.

Dilip Thakore