Korea is still facing an enormous challenge in its road
to recovery. Most critical is the severe credit crunch. Despite
substantive progress in the financial sector restructuring, credit
flows are not yet normalized, largely due to increased credit
risks in the corporate sector. If the current credit crunch is not
resolved within a short period of time, the expected benefit from
the progress in the financial sector will be not only limited but
also short-lived. It is not a remote possibility that the Korean
economy falls into a vicious cycle of prolonged credit crunch and
economic contraction. Such adverse development, if occurs, will
make the overall reform process unsustainable. History shows
that this line of argument is not just theoretical possibility.
Indeed, prolonged economic stagnation and the continued credit
crunch experienced by the Latin American countries in the 1980s
and Japan in the 1990s proves this point.
In this context, swift and comprehensive corporate
sector restructuring is essential for Korea's durable economic
recovery. At this juncture, what matters is the speed and scope
of corporate restructuring. Given the preponderance of chaebols'
market share and economic influence, chaebols' debt
restructuring is of particular importance.
Given the fact that corporate debt problem translates
directly into problems in asset portfolios of financial institutions,
financial institutions must be ready to clean up their balance
sheets on an ongoing basis throughout the course of chaebol
restructuring. At the same time, financial institutions must
apply corporate workout programs only to viable firms, and
utilize various means of debt reduction, particularly debt-equity
swaps and asset sales, in order to expedite the restructuring
process. The government needs to mobilize fiscal resources to
support the clean-up efforts by financial institutions.
But these efforts must be made in line with market
principles and clear loss-sharing scheme in order to prevent
moral hazard. To this end, major shareholders of chaebols --
particularly chaebol owners -- and creditor banks must bear the
primary burden of adjustment. The government's support must
be provided conditional upon the strong and exhaustive
rehabilitation efforts by chaebols and creditor banks.
In order to minimize the risk of the aforementioned vicious
cycle, however, corporate sector restructuring need to be
supplemented by other policy measures, including macroeconomic
adjustment and fiscal reform. Let me briefly touch upon a few
policy agenda that are intrinsically related to corporate sector
First, asset deflation must be prevented, as it has
extremely detrimental effects on restructuring and the resolution
of the credit crunch. The prolonged recession of Japan in the
1990s and the Great Depression of the United States in the
1930s clearly shows the danger of asset deflation. Asset
deflation is particularly dangerous for the heavily debt-ridden
countries like Korea: it could threaten the reform process itself.
In light of this, an expansionary macroeconomic policy
is called for. Both monetary and fiscal policies need to be
aligned in such a way as to generate a market expectation for
stable and modest inflation. Monetary expansion and subsequent
reduction in interest rates will serve this purpose. At the same
time, fiscal expansion is necessary not only for economic
stimulus but also financing the cost of economic restructuring.