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Development Overview

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Overview of Korea’s development experience

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Development Overview
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Promotion of the strategic export industries and selective foreign borrowing, 1966 to 1972

Promotion of the Strategic Export Industries and Selective Foreign Borrowing, 1966 to 1972

Korea’s rapid economic development and strong growth from 1966 to 1972 were due almost entirely to the success in establishing a strong manufacturing sector with an emphasis on competitive exports. To finance this expansion of the manufacturing sector, foreign capital was actively solicited. However, the inability to service the huge amounts of debt let to the insolvency of many of the borrowers. Thus, from the last 1960s onwards, basic foreign capital policies emphasized selective foreign borrowing and its effective use.

Korean did not have a firmly coordinated national policy on obtaining foreign loans for the massive economic development the country needed. As a result, there was a lot of overlapped and duplicated borrowing. Thus, a coordinated policy was needed to guide and control the type and amount of foreign loans that Korean firms acquired.

In 1966, “The Foreign Capital Inducement Promotion Act”, “The Law for Repayment Guarantee of Foreign Borrowing” and the “Special Law to Facilitate Capital Equipment Imports on A Long-term Deferred Payment Basis” were merged in to single, broad new law called “The Foreign Capital Inducement Law”. This new law intended to not only integrate similar laws and eliminate overlap, but to also make foreign borrowing more effective, as well as prevent unnecessary borrowing.
    
To further assist this process, the government announced a new regulation, “Overall Rationalization Measures for Foreign Capital Inducement”, in 1967. With this new measures, limits were placed on private foreign loans for equipment as well as foreign cash loans. These measures were also intended to gradually introduce as shift to a comprehensive foreign capital loan program, such as loans from international organizations, bank loans, and foreign bond issues. Bank loans were introduced by the Korea Exchange Bank for the first time in 1968.
    
From late 1960s, the government encouraged foreign direct investment (FDI), in place. To encourage FDI, the government established the Masan Free Trade Zone in 1970, reducing the processing “red tape” and extending tax incentives for FID. A special law was introduced to prevent labor union activities in foreign investment firms. Thus, FDI amounts gradually increased from the early 1970s.
    
From 1966 to 1972, $3.5 million of foreign capital was obtained, with commercial loans totaling $1.9 billion, 45.6 percent of total foreign capital.
    
Following the normalization of diplomatic relations with Japan in 1965, commercial loans increased and continued to climb until the end of the 1960s. The magnitude of the foreign
 
[Table 1-1] Foreign Capital Inflow 1966 to 1972
 
(in million dollar, %)
  1962~65 1966 1967 1968 1969 1970 1971 1972 1966~72
Amount Share Amount Share
Public Loans
Commercial Loans
Bank Loans
FDI
63
71
-
13
7.1
8.0
-
1.5
73
110
-
14
106
124
-
11
70
268
40
19
139
410
30
13
115
367
25
66
303
345
90
43
324
326
20
61
1,130
1,950
205
227
26.4
45.6
4.8
5.3
Sub-total 147 16.6 197 241 397 592 572 781 731 3,512 82.2
U.S. & UN Aid
Claim Fund
739
-
83.4
-
103
30
97
30
106
34
107
31
83
25
51
31
5
27
552
211
13.0
4.8
Total Foreign Capital 886 100.0 330 368 537 730 680 863 763 4,275 100.0
Source: MOF, EPB, BOK

debt caused great concern because of Korea’s current debt-servicing capacity as well as the large number of debtor firms’ bankruptcies. According, in the early 1970s, the government actively discouraged commercial loans.
    
During this period, public loans reached $1.1 billion, 26.4 percent of total foreign capital. Public loans from the WARTIME CLAIM FUND and the Japanese EXIM Bank steadily increased. Particularly, from 1971 to 1972, foreign grain loans sharply increased because of the successive poor rice harvests.
    
During this period, the bulk of foreign loan came from U.S. and Japanese sources. The U.S. sources provided mostly public and commercial loans and FDI, while technology was introduced mainly from Japan. The increasing amount of public loans from Japan and the international organizations was remarkable, while commercial loans from Japan, the U.K., France and Wes Germany also increased sharply.
    
Korea’s ratio of foreign borrowing to GNP went over one third. However, this helped to supplement a domestic funds shortage and transform Korea’s industrial structure from a primary-sector industrial structure encompassing agriculture, fisheries and forestry to a secondary-sector one, to include manufacturing.
    
To improve Korea’s balance of payments, foreign loans were actively directed to the import-substitute and export-oriented industries. This was in line with the export-oriented strategy adopted by the government during this period of development.
    
Pubic loans were used almost solely for infrastructure expansion such as power plants, railroads and highways. Commercial loans were used by the key industries-chemical, petrochemical, cement and iron. This facilitated the industrialization of Korea. Most FDI went to the manufacturing industries such as electronics and textiles. Loans made from the WARTIME CLAIM FUND were invested in the purchase of capital goods for the agricultural and fishery industry, as well as to purchase fertilizer, construction material and machinery.
    
During this period, the infusion of foreign capital had a very positive effect on Korean’s economic development. As well, there was increased diversification of lenders and kinds of loans.
    
Positive changes occurred, in that after 1970, public loans from international organizations like the ADB and the IBRD increased. At the same time, sources for commercial loans expanded beyond the traditional U.S. and Japanese sources to include loans from West Germany, the U.K. and France. Moreover, FDI increased and loans for technology transfer were obtained.
      
Foreign commercial loans increased more than expected during this era, because of the spread between domestic and foreign interest rates.
      
Loans payments reached $959 million during this period (see Table 5). Despite restrictions on the amount, as well as the type of commercial loan, they were heavily introduced during this period. This imposed a tremendous burden regarding repayment. Thus, the debt service ratio (DSR) reaches 20.4 percent in 1971, much higher than the 15 ceiling set by the government.
 
[Table 1-2] Foreign Debt and Repayment 1966 to 1972
(in million dollar, %)
  1966~72 1966 1967 1968 1969 1970 1971 1972 1966~72
Amount Share Amount Share
Long-term Repayments 17 100.0 13 31 45 90 185 230 365 959 100.0
Public Loans
Commercial Loans
Bank Loans
8
9
-
47.1
52.9
-
2
11
-
5
26
-
6
39
-
14
76
-
18
141
26
36
182
12
69
257
39
150
732
77
15.6
76.3
8.1
DSR(%)
Foreign Debt/GNP(%)
Total Foreign Debt
- -
 
2.9
10.6
392
5.2
15.0
645
5.2
23.11,199
7.8
27.3
1,800
18.2
27.7
2,245
20.4
30.8
2,922
18.4
33.5
3,587
-
-
-
-
 
-
 Source: MOF, EPB, BOK
 
Source: Ministry of Strategy and Finance. Republic of Korea and The Korea Development Bank. 1993. Foreign capital and the Korean economic development. Seoul.