Economic stability and diversification of foreign borrowing, 1979 to 1985

From the late 1970s, the Korean Economy began to recover from the consequences of the first oil shock. For the first time in Korea’s history, a current account surplus was recorded in 1977, due to the recovery of the world economy and the Middle East construction boom. Because of these factors, the government had to closely monitor foreign borrowing. The government screened foreign loan applications in advance, and where needed, adjusted planned projects. Restrictions on unfavorable foreign borrowing were intensified. In turn, the government implemented foreign currency loans funded by its foreign exchange reserves.

However, from the end of the 1970s to early 1980s, Korea’s economy deteriorated. There was an upsurge in foreign borrowing in the aftermath of the second oil shock of 1979. Korea’s total foreign debt nearly doubled from 1979 to 1983. The structural imbalances and general economic inefficiency caused by the misallocation of resources in the 1970s substantially reduced Korea’s export competitiveness. Moreover, the Middle East construction boom aggravated skilled labor shortages. Accordingly, rapid increases in unit labor costs also contributed to reducing export competitiveness. And, the insolvency problems of some Latin American countries caused instability in the international financial markets and this exacerbated Korea’s foreign debt problems by raising interest rates. It added an extra burden to the previously mentioned foreign debt repayment plans. Consequently, foreign debts sharply increased during this period.

Given the structural imbalances, rampant inflation, the growing current account deficit and future uncertainty surrounding the Korean economy, foreign borrowing was not only difficult, but very costly due to the prevailing high interest rates. The new government therefore adopted a serious of stabilization policies during the early 1980s. Moreover, in managing the economy, the new government had to move toward private initiatives and away from government intervention in order to reform the nation’s economic structural abnormalities.  Stabilization and liberalization strategies were implemented simultaneously. In line with these new economic development strategies, restrictions on foreign borrowing were gradually lifted.

In 1983, the “Public Loan Inducement and Supervision Law” and the “Foreign Capital Supervision Law” were merged into the broad new “Foreign Capital Inducement Law”. This new law not only integrated similar laws but enhanced the effectiveness of foreign capital management. Further assistance came from simplifying the procedures for technology transfer. In almost all cases, technology transfer agreements were approved by simply reporting them to the relevant Ministry.
When the Foreign Capital Inducement Law was revised, the policies covering FDI were also reformed. Under the new law, a negative list system for FDI approval was introduced, in which any industry not specified on the list was opened to foreign investment. This presented a change from the old system, in which foreign investment was allowed only in the sectors specified on the FDI list. Following liberalization of FDI in 1983, the government continued to enact more measures to loosen the remaining restrictions on FDI. Virtually all of the manufacturing sectors, with the exception of a few limited cases such as public utilities, were opened to FDI.

During this period, Korea’s total foreign borrowing was $34.9 billion, of which 34 percent or $11.9 billion were bank loans. For the first time, bank loans instead of commercial loans represented the bulk of foreign borrowing. In line with the international securitization trends, 8.6 percent of total borrowing was introduced by issuing foreign bonds. Private enterprises issued foreign bonds for the first time in 1981 and issued a total of U$834 million (See Table 8).

[Table 1-1] Foreign Borrowing, 1979 to 1985
 

Note: Includes bonds issued by the Seoul & Pusan City municipal governments
Sources: MOF, EPB, BOK
 
Public loans were introduced to compensate for the current account deficit and to improve the industrial structural imbalances. During this period, public loans amounted to $10.1 billion, 28.9 percent of the total foreign debt, while commercial loans decreased to $7.9 billion, 22.7 percent of the total foreign debt.

As the sources of foreign borrowing were diversified, Korea’s major borrowing gradually shifted from the U.S. and Japan, to the EC countries and others. Particularly, Japan’s share of public loans, and FDI was sharply reduced.

Most foreign capital introduced during this period was channeled into expansion of the social infrastructure and the strategic export industries like electronics. Also, foreign capital was used for industrial rationalization, development of small and medium industries, and improvement of regional imbalances in industrial development. Korea never had any repayment problem and capital flight was never a serious problem in Korea, unlike some of the Latin American countries.
 

Note:
1) Public loans, commercial loans, bank loans, IMF Fund, and foreign inter-bank accounts included

Notes:
1) Long-term repayment basis
2) Short-term interest included
3) Long-term repayment + Short-term interest/New loans * 100
Sources: MOF, EPB, BOK
 
In 1985, the DSR of long-term loans peaked at 18.7 percent, together with short-term loans at 21.7 percent. Even though this was lower than that of Latin America’s, it presented a dangerous level of debt-servicing.

Source: Ministry of Strategy and Finance. Republic of Korea and The Korea Development Bank. 1993. Foreign capital and the Korean economic development. Seoul.