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Financial Policy

Financial market policies

According to Jung-en Woo (1991, p.60), Korea in the 1950s exhibited a textbook example of financial repression. The official lending rate by banks was capped at 20 percent when the curb market rate was well above that. 1) In addition, the credit priority regulation and the credit ceiling regulation enabled the government to control bank lending directly (Pyung-joo Kim, 1995, p.188).

In January 1954, the Korea Development Bank (KDB) was launched as asolely government-owned bank. Its mission was to provide long-term credits to key industries. It financed over 70 percent of total equipment loans and over 10 percent of total working capital loans made by financial institutions (Joon-kyung Kim, 1993). It raised funds by borrowing from the government fiscal loan program (50 percent of the funds in the 1950s) and issuing bonds (37 percent).

The real interest rate remained negative most of the time due to low official rates and high inflation, discouraging savings and increasing demand for credit. Credit demand always surpassed savings despite the regulations mentioned above, and commercial banks had to rely on the central bank rediscount facility to fill the gap. Before 1957, about half of bank lending was financed by the central bank in this way (Jung-en Woo, 1991, p.62).

The excessive reliance on the central bank rediscount facility inevitably generated high inflation. Money supply was increased further by central bank lending to the government to finance essential public services, such as defense and the police. Annual inflation fluctuated between 20 and 400 percent between 1946 and 1957 (Table 2-1). The root cause of high inflation lay in the lack of operational independence of the central bank. Arthur Bloomfield, an economist at the New York Fed, recommended the establishment of an independent central bank resembling the Federal Reserve Bank. Following his advice, the Bank of Korea Act and the Banking Act were enacted in May 1950. The Bank of Korea Act, however, failed to bestow full independence on the central bank.
 

Table 2-1. Price inflation



The implementation of the Banking Act was postponed until August 1954 due to the delay in the privatization and recapitalization of banks. From 1954, the government attempted five times to sell its shares in banks, but failed. It could finalize the sales in February 1957 only after relaxing the eligibility conditions for bids. In the end, each major chaebol came to own abank, which accelerated the concentration of economic power (Pyung-joo Kim, 1995, p.190). The military government re-nationalized the banks in 1961 shortly after seizing power.

Source : SaKong, Il and Koh, Youngsun, 2010. The Korean Economy Six Decades of Growth and Development. Seoul: Korea Development Institute.

NOTE


1)The curb market rate was 48-120 percent according to Sang-cheol Lee (2001, p.463) and 150-240 percent according to Jung-en Woo (1991, p.61).

References


· Woo, Jung-en, Race to the Swift: State and Finance in Korean Industrialization, Columbia University Press, 1991.
· Kim, Pyung-joo, “Financial Institutions and Economic Policies,”in Dong-Se Cha and Kwang Suk Kim (eds.), The Korean Economy 1945-1995: Performance and Korea Development Institute, 1995, pp.179-254 (in Korean).Vision for the 21st Century,
· “Improving the Funding of Policy Loans,”in Daehee Song (ed), National Budget and Policy Objectives, Research Monograph 93-03, Korea Development Institute, 1993, pp.114-176 (in Korean).
· Woo, Jung-en, Race to the Swift: State and Finance in Korean Industrialization, Columbia University Press, 1991.
· Kim, Pyung-joo, “Financial Institutions and Economic Policies,”in Dong-Se Cha and Kwang Suk Kim (eds.), The Korean Economy 1945-1995: Performance and Korea Development Institute, 1995, pp.179-254 (in Korean).Vision for the 21st Century,
· Switching to an Export-led Industrialization Strategy and its Outcome,”in Dae-geun Lee(ed.), New Korean Economic History: From the Late Joseon Period to the High-growth Period of the 20th Century, Na-nam, 2005, pp.377-401 (in Korean).
· Woo, Jung-en, Race to the Swift: State and Finance in Korean Industrialization, Columbia University Press, 1991.

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