SOUTH KOREA: MANAGING A LARGE FOREIGN DEBT

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP84S00928R000200060003-3
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 16
• Document Creation Date: December 21, 2016
• Document Release Date: April 6, 2009
• Sequence Number: 3
• Publication Date: December 1, 1983
• Content Type: REPORT

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Directorate of Confidential
Intelligence 25X1
South Korea: Managing a
Large Foreign Debt
Confidential
EA 83-10245
December 1983
Copy 2 9 2
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Intelligence 25X1
South Korea: Mana in g a
Large Foreign Deebt
Large Foreign
bt
Northeast Asia Division, OEA,
Office of East Asian Analysis. Comments and queries
are welcome and may be directed to the Chief,
This paper was prepared by
Confidential
EA 83-10245
December 1983
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South Korea: Mana
Large Foreign Debn a
Key Judgments South Korea, whose $37.2 billion foreign debt is the third largest among
Information available developing countries, has implemented a broad-based austerity program
as oft December 1983 that substantially reduces-but does not remove-the possibility of a debt
was used in this report.
financing crisis over the next several years. Since 1979, Seoul has
dramatically slowed the growth in government spending, the money supply,
and wages. The austerity measures have bolstered South Korea's already
strong international credit rating and held down new borrowing.
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Seoul's short-term debt, which 25X1
has increased from 25 percent o t etota in 1978 to 40 percent last year.
The United States, which holds about 40 percent of South Korea's debt,
would be under the strongest pressure to provide emergency assistance in
the event of a South Korean debt problem.
The Chun government is pressing ahead with further austerity measures
and new efforts to help curtail future borrowing needs:
? Government spending in 1984 will be held at the 1983 level and the
deficit reduced from 4 percent of GNP to 2 percent of GNP.
? Numerous industrial and infrastructure projects, including nuclear power
plants, have been delayed.
? Restrictions have been placed on the private sector's short-term borrow-
ing.
The economy has responded well to the government's policy mix and is now
on a sounder footing than it was in the late 1970s when debt was
mushrooming:
? Inflation has been reduced from 30 percent in 1980 to less than 5
percent.
? The current account deficit has been cut from more than $5 billion in
1980 to $2 billion, reducing the need for balance-of-payments financing.
? Real GNP has increased 9 percent.
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EA 83-1024.5
December 1983
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Any one of several economic events, however, could undermine banker.
confidence and Seoul's efforts to obtain financing:
? An aborted global recovery or a rapid runup in oil prices.
? The failure of South Korea's plan to push into skill-intensive industries as
a way to expand exports.
Political developments, even with solid economic fundamentals, could
precipitate a debt crisis. Signs of instability in the Chun government or a
series of terrorist acts by North Korea to disrupt the Chun regime could
cause creditors to pull back.
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South Korea: Managing a
Large Foreign Debt
Foreign Debt Position
In the wake of debt financing problems in Brazil,
Mexico, and, now, the Philippines, South Korea has
come under increasingly close scrutiny by the interna-
tional financial community concerns center
on the size and maturity structure of South Korea's
debt:
Table 1
LDCs: Major Debtors,
Ranked by Total Debt,
Yearend 1982
? South Korea's foreign debt has increased dramati-
cally over the past decade, reaching $37.2 billion in
1982, the third largest among developing countries.
Seoul's decision in the early 1970s to use foreign
borrowing to speed economic development and the
two oil shocks are responsible for this rapid growth.
? Debt service payments have more than doubled
since 1978, reaching $5.9 billion last year. The debt
service ratio, however, has only increased from 13
percent in 1978 to 21 percent last year, remaining
below the LDC average.'
? The maturity structure of the debt has shortened
considerably over the past five years, with short-
term debt increasing from 25 percent of the total in
1978 to 40 percent last year. The availability and
low cost of short-term funds are the primary reasons
for this rapid growth
Beginnings of Austerity
Aware that the rapid increase in debt was unsustain-
able, Seoul began an austerity program in the late
1970s to hold down new borrowing by dampening
import demand and strengthening export competitive-
ness. In early 1979 the Park government tightened
fiscal and monetary positions, curtailed labor costs,
and slowed private investment plans. The Chun gov-
ernment, which came to power in 1980, strengthened
these policies, further cutting the growth in govern-
ment spending, the money supply, and wages. As a
result, real GNP grew by only 1.7 percent per year
during 1980-82, import volume fell 3 percent during
the same period, and real wages declined 7 percent
Brazil
85.4
Mexico
83.1
South Korea
37.2
Argentina
36.7
33.7
23.5
during 1980-81. Seoul also forced the won to depreci-
ate to increase export competitiveness. Since 1979, the
won has depreciated about 40 percent against the
dollar. Even on a trade-weighted, price-adjusted basis,
the won depreciated about 10 percent between the
fourth quarter of 1979 and the first quarter of 1983.1
The government's policy mix has won praise from the
IMF and foreign lenders and restored rapid economic
growth. We expect real GNP will advance 9 percent
or more this year and 8 percent in 1984, putting South
Korea once again among the world's growth leaders.
Perhaps of even greater importance, inflation has
been reduced from 30 percent in 1980, to less than 5
percent.
The foreign sector has responded well to Seoul's
policies. Export volume has increased about 50 per-
cent during 1980-83, despite slow growth in world
z The trade-weighted, price-adjusted exchange rates relates the
Korean won to the currencies of its trading partners, weighted by
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Figure 1
South Korea: Growth of Foreign Debt
Figure 2
South Korea: Foreign Debt, by Maturity
trade. The strength in foreign sales reflects the com-
petitiveness of South Korea's export sector resulting
from the won devaluation and Seoul's diversification
of its export base. A doubling in ship exports last year,
for example, bolstered foreign exchange earnings at a
time when sales of textiles, electronics, and other
consumer goods declined. South Korean exporters
have also proved adept at finding new markets for
their products in Third World countries, particularly
in Asia and Africa.
Chun's Austerity Plans
The Chun government plans to continue tight fiscal
and monetary policies in 1984 to strengthen export
competitiveness and slow import demand. An austere
budget has been announced for 1984 that will hold
government spending at the 1983 level and reduce the
government deficit from 4 percent to 2 percent of
GNP. Seoul is also taking gradual steps to eliminate
many of the subsidies that have contributed to the
fiscal deficits. The growth in the money supply, which
Medium- and
long-term debt
has been halved from the 29-percent annual average
of 1978-82 to 15 percent this year, will be further
reduced in 1984. In addition, Seoul will continue to
exert pressure to hold down labor costs; wage in-
creases have slowed from 24 percent annually in
1978-82 to 12 percent in 1983. Through these policies,
the Chun government hopes to cut inflation to 2
percent-or even zero-next year.
For 1984-86-the last three years of the current five-
year development plan-Korean economic planners
are revising policies to reduce foreign financing needs.
Seoul hopes to meet these targets by:
? Delaying or canceling industrial and infrastructure
projects. According to press reports, about half of
the foreign-financed projects planned for the next
five years will be postponed.
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Table 2 Billion us $ Figure 3
South Korea: Debt Service South Korea: Major Economic Indicators
Principal repayment
Interest payments
On short-term debt
On medium- and
long-term debt
Total
Debt service to exports
of goods and services ra-
tio (percent)
Estimated.
b Projected.
1.6
1.5
2.0
2.1
2.5
3.0
1.4
2.6
3.7
3.8
3.6
4.1 12
0.4
1.2
1.9
1.5
1.5
1.4
1.0
1.4
1.8
2.3
2.1
2.7
3.0
4.1
5.7
5.9
6.1
7.1
15.2
18.4
20.7
20.9
19.5
20.0
? Putting increased emphasis on expanding exports by
improving quality, enhancing price competitiveness,
and stepping up marketing activity. By moving into
more technology-intensive products, Seoul believes
it can boost exports 10 percent annually over the
next three years.'
? Enacting policies to slow import demand. These
include tougher energy conservation measures to
reduce oil imports and increased efforts at rice self-
sufficiency to curtail foreign grain purchases.
? Boosting domestic savings by maintaining positive
real interest rates and expanding financial instru-
ments. An increase in the domestic savings rate
from the 20 percent of GNP level of recent years to
30 percent by 1986 is planned.
By delaying big ticket industrial and infrastructure
projects, Seoul will save considerable foreign ex-
change. Plans for four nuclear power plants, valued at
more than $5 billion and originally scheduled for
construction beginning in 1983 and 1984, have been
pushed back until at least 1986. Capacity will grow
Growth in Government
Spending
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more slowly than earlier projections indicated in the
auto, shipbuilding, and steel industries. Delays have
also been announced for expensive infrastructure proj-
ects, including a high-speed rail link between Seoul
and Taejon in central Korea and for a second subway
line in the southern city of Pusan.
Seoul has also enacted policies to discourage short-
term borrowing to improve the maturity structure of
the debt. According to press reports, these measures
include shortening the repayment period for trade
credits and limiting the types of goods for which such
credits will be permitted. Seoul is committed under its
IMF agreement to reducing the short-term debt in
absolute terms and as a share of the total debt.
In addition, South Korean economic planners are
liberalizing foreign investment regulations to attract
more equity investment in place of foreign loans. The
Chun government hopes to boost foreign investment
from the $100 million a year average of recent years
to $700 million per year by 1986. To encourage this
expansion, the Ministry of Finance has proposed
changes in investment rules that would (a) permit
foreign investment in all sectors of the economy not
specifically restricted-currently only selected areas
are open to foreign investment, (b) make investment
approvals routine for joint ventures with less than 50-
percent foreign ownership, and (c) eliminate restric-
tions on profit and capital remittances.
Financing Needs
Even with its policies to curtail foreign borrowing, we
believe that South Korea will need about $6.5 billion
annually in foreign capital over the next three years if
it is to achieve its goal of high economic growth. This
would enable Seoul to cover its current account
deficit, meet principal repayments, maintain a reason-
able level of foreign exchange reserves, and provide
for exports on credit (see table 3).
We believe South Korea's policies will gradually
reduce the current account deficit over the next
several years, assuming relatively stable oil prices and
continued global recovery. The deficit, which peaked
at $5.3 billion in 1980 (9 percent of GNP), declined to
$2.7 billion in 1982 and should fall to about $2 billion
this year or 3 percent of GNP (see table 4). For 1984-
86, we expect the deficit will average about $1.1
Table 3
South Korea: Projected Foreign
Capital Needs
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Total 6.6
6.3
6.6
Current account deficit 1.7
1.0
0.5
Principal repayments 3.0
3.4
3.9
Addition to reserves 0.5
0.5
0.8
Exports on credit 1.4
1.4
1.4
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billion per year-only slightly above Seoul's projec-
tions. A substantial increase in oil prices or a faltering
global recovery would push the deficit up considera-
bly.
South Korean exports have picked up significantly
since mid-1983 on the strength of the US recovery; as
global demand increases, South Korea should be in a
good position to expand its foreign sales. Korean
competitiveness has been bolstered as a result of low
domestic inflation and a gradual depreciation of the
won. For 1984-86, we project exports will increase
about 10 percent a year, roughly in line with govern-
ment forecasts. Ships and electronics, which have
outpaced export growth this year, will probably grow
most rapidly. The United States should remain the
largest market.
We expect imports will grow somewhat less rapidly
than exports-about 8 percent a year. Energy conser-
vation and Korea's large investment in heavy industry
in the late 1970s to meet more of its machinery and
equipment needs will begin to pay off. The services
deficit, however, may expand slightly because of
increasing interest payments and a decline in overseas
construction revenue.
In contrast to a declining current account deficit,
principal repayments will increase over the next three
years. Amortization payments will rise from $2.1
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Table 4
South Korea: Balance of Payments
Trade balance
-1,781
-4,395
-4,384
-3,628
-2,595
-2,000
Exports, f.o.b.
12,711
14,704
17,214
20,671
20,879
23,000
Imports, f.o.b.
14,491
19,100
21,598
24,299
23,474
25,000
Service balance
224
-195
-1,386
-1,518
-554
-500
Receipts
4,450
4,826
5,363
6,598
7,476
8,000
Payments
4,226
5,021
6,749
8,116
8,030
8,500
Net transfers
472
439
449
501
499
500
Current account
-1,085
-4,152
-5,321
-4,645
-2,650
-2,000
Net long-term capital
2,166
2,663
1,856
2,842
1,230
1,200
Net short-term capital
-1,171
844
1,945
-82
4
100
-402
-974
-1,889
-2,296
-2,711
-1,400
4,937
5,708
6,571
6,891
6,984
7,300
a Estimated.
b Includes holdings of commercial banks.
billion in 1982 to $3.9 billion in 1986 as principal on
loans arranged in recent years falls due. Foreign
exchange reserves are projected to increase about
$600 million annually to maintain a roughly two-and-
a-half-month import cover.
Sources of Foreign Capital
On the basis of recent trends and known commit-
ments, we believe official sources will provide about
$2 billion per year in foreign capital. Seoul should
draw about $1 billion annually from the World Bank
and the Asian Development Bank and will draw part
of its $4 billion, seven-year commitment from Tokyo.4
Foreign equity investment will probably only provide
several hundred million dollars each year in foreign
capital. As a result, Seoul will need to tap commercial
banks for about $4 billion a year in new credits during
1984-86.
' After almost two years of negotiations, Japan agreed in January
1983 to provide South Korea with $4 billion in low-interest loans
over seven years beginning in Japan FY 1982. Of the total, $1.85
billion will be provided in Official Development Assistance (ODA)
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goods account for more than 90 percent of South
Korea's foreign sales, and Seoul has made dramatic
progress in recent years expanding into new product
lines, notably ships and iron and steel. In 1982 heavy
industrial goods made up 52 percent of the country's
manufactured exports, compared with 38 percent five
years earlier.
Any one of several economic events could undermine
Seoul's efforts to obtain financing. An aborted global
economic recovery, for example, would slow South
Korea's export drive
crisi
rapid runup in oil prices could
also throw the economic game plan off track.
failure of South
tap international capital markets fairly easily. Seoul's
most recent syndicated loans-a $300 million credit
for the Export-Import Bank this summer and a $500
million loan for the Korea Development Bank (KDB)
this fall reflect onfidence. Both
were well received at favorable terms for South
Korea; the LIBOR portion of the KDB loan, for
example, carried a spread of 0.75 percentage point
over LIBOR for the first six years and a spread of
0.875 percentage point for the last two years. In
addition, Korean private firms have syndicated sever-
al loans in recent months with little trouble
Korea's push into s i -intensive industries is one
example. Seoul is taking a risk in moving so heavily
into more technology-intensive industries. It is count-
ing on electronics, shipbuilding, and machinery prod-
ucts for most of the future expansion in foreign sales.
Taiwan, Hong Kong, and Singapore are also moving
into the same fairly narrow range of medium-technol-
ogy products, and global demand may prove too small
to accommodate this capacity. In addition, South
Korea more and more will find itself competing with
Japan in international markets in sectors where Japan
has advantage in marketing and quality control.
A continuing series of major domestic financial scan-
dals could also undermine creditor confidence. Three
such scandals over the past two years and the finan-
cial difficulties of the country's overseas construction
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Figure 4
South Korea: Import Composition, 1982
Figure 5
South Korea: Foreign Debt, by Holder,
Yearend 1982
Multilateral development
institutions 4.5 (12%)
World Bank 2.6
International Monetary Fund 1.2
Asian Development Bank 0.7
Bilateral loans 5.0 (13%)
United States 3.0
Japan 1.3
Other 0.7
Private banks and financial
institutions 27.8 (75%) -
Non-US banks 16.8
United States 11.0
A shortfall in attracting foreign capital would force
Seoul to make rapid adjustments in economic policy,
which would have an extremely adverse impact on the
outward-oriented Korean economy. We believe Seoul
would respond quickly and with flexibility to a financ-
ing problem-but its options would. be limited. Seoul
initially would be forced to draw down foreign ex-
change reserves; such reserves at midyear 1983
amounted to $6 billion, equal to about two-and-a-
half-months' imports. After drawing down reserves,
Seoul would have to curtail imports substantially.
Because a large share of its foreign purchases are raw
materials for its export products (26 percent), oil (25
percent), or capital equipment (22 percent), cutting
imports would be difficult. Unlike many other LDCs,
Seoul has little leeway to cut imports without immedi-
ately and substantially reducing economic growth.
Only 4 percent of Korea's foreign purchases are
consumer goods (see figure 4).
We believe the Chun government would put strong
pressure on consumers and business to tighten their
belts. Economic planners would probably reallocate
government spending in favor of projects that keep
employment up but use few imports. Defense spend-
ing would probably be cut and import liberalization
plans scrapped. Seoul would almost certainly put
pressure on Washington and Tokyo to provide official
assistance.
We cannot quantify the extent to which real GNP
growth would decline as a result of a serious shortfall
in foreign capital. Because the labor force is growing
rapidly-almost 3 percent per year-unemployment
would certainly increase significantly. Inflation would
also accelerate with won depreciation as higher cost
domestic products were substituted for imports.
Implications for the United States
Seoul would certainly look to Washington for official
assistance in a foreign financing crisis and would
point to US security interests in making its case.F_
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In addition to the heavy direct financial costs, a South
Korean debt crisis would hurt the United States in
other ways. South Korea is the ninth-largest market
for US goods with purchases of $6 billion in 1982.
Seoul would be forced to curtail its imports, and the
United States, as South Korea's leading supplier,
would see sales to one of its major markets decline.
The United States would also find it more difficult to
persuade Seoul to continue with its import liberaliza-
tion program.
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Appendix
Major Actors
The Borrowers
The South Korean Government and government-
controlled institutions hold a dominant and growing
share of the long-term debt, enabling Seoul to get
Figure 6
South Korea: Long-Term Foreign
Debt, by Sector
more favorable financing terms and to coordinate its
foreign obligations better. Since 1978, these institu-
tions have accounted for almost 90 percent of the
increase in the long-term foreign debt (see figure 6).
Borrowing by government-controlled financial institu-
tions has grown especially rapidly; they have in-
creased their share of the long-term debt from 8
percent in 1978 to 25 percent in 1982. These funds
have been used for balance-of-payments support and
for relending to the private sector. The Korea Devel-
opment Bank and Korea Exchange Bank, in particu-
lar, have been major participants in the Eurodollar
market. These institutions market several highly pub-
licized loans each year ($300-500 million), and the
terms they receive set the standard for other Korean
borrowers. The Korean Export-Import Bank has also
become active in the Eurodollar market to support the
country's export financing, particularly for ships
The public sector's share of the long-term debt has
remained in the 40- to 45-percent range over the past
five years while the private sector's share has declined
from about 50 percent to about 30 percent, partly
because of slack domestic investment. Most of the
private-sector debt is publicly guaranteed; as a result,
the government bears a major share of the financial
risk imbedded in South Korean foreign liabilities.
Over the past two years, Seoul has covered the foreign
obligations of several private firms that have gone
bankrupt as a result of domestic financial scandals.F_
The Lenders
On the lending side, in contrast, private sources have
accounted for a steadily increasing share of South
Korea's long-term debt, holding almost two-thirds of
the total in 1982. South Korea's more active partici-
pation in the Eurodollar market is responsible for a
big boost in debt obligations to private commercial
banks, particularly Japanese banks. Multilateral de-
velopment banks, such as the World Bank and Asian
Development Bank, nonetheless remain important
sources of foreign funds. Borrowings from these
institutions have financed infrastructure projects, vo-
cational training facilities, and technological develop-
mint projects. Seoul has tapped the World Bank's
structural adjustment program for $250 million, and a
second loan for $300 million is under negotiation.
Credits from these institutions carry lower interest
rates and longer maturities than private-sector loans
and have helped hold down debt-servicing costs.
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The International Monetary Fund (IMF) plays an 25X1
important role in South Korea, not only by providing
foreign funds for balance-of-payments support, but
Financial
institutions
Public
Private
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also by providing a stamp of approval to Seoul's
economic policies. Since 1965, South Korea has
signed 15 standby agreements with the IMF; Seoul
owed the Fund $1.2 billion at yearend 1982. In
several instances, South Korea did not need IMF
funds, but sought standby arrangements for the pres-
tige such agreements give to the country's credit
rating among commercial bankers. In 1982 no stand-
by was signed because Seoul disagreed with IMF
recommendations, especially concerning exchange-
rate policy. This year, the IMF commended Korean
policy prescriptions, and a $600 million agreement
was signed in July
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