With shrinking foreign debt levels and a clean-up of its financial system underway, South Korea's economy looks set to grow on a sounder footing than its critics suggest
It has been more than five years since Alan Greenspan raised his infamous concern about 'irrational exuberance'' in the US stock market. Yet economic policy makers are no closer to figuring out when market rallies are bubbles and when they're for real.
Take South Korea, an economy that's surprising even the optimists with its strong growth and robust asset markets. Ratings agencies, too, are impressed by its performance. Moody's Investors Service yesterday raised its sovereign debt rating two notches to A3.
What heartens Moody's, which cited solid growth, shrinking foreign debt and progress in cleaning up the financial system, are the same trends driving investors to buy Korean shares. The benchmark Kospi index has risen more than 28% so far this year. Home sales, meanwhile, are booming. All of this has some observers wondering if South Korea is experiencing dangerous asset inflation.
'What you're seeing in the Korean economy is a bubble and it's a cause for concern,'' said Andy Xie, chief economist at Morgan Stanley Dean Witter & Co. in Hong Kong.
Or is it that investors are merely realising that South Korea is a buy? This could very well be the case, considering how much work President Kim Dae Jung has done to retool an economy that just four years ago lay coughing and wheezing amid Asia's financial crisis.
To be sure, myriad challenges lie ahead for Asia's third- largest economy. Not the least of these is selling off assets Seoul acquired during the Asian crisis. The Government is still struggling to sell off such marquee assets as Daewoo Motor, Hynix Semiconductor and parts of Hyundai Group.
But the notion that nothing has changed in Korea is simply wrong. Following the 1997-1998 Asian crisis, Seoul spent some $115bn to bail out and rebuild the financial industry. Its banks posted a combined profit of 5.2 trillion won last year, the first since 1996. Japan has been putting off such steps for 11 years and counting.
Kim's team also worked to diversify the economy, leaving it less reliant on electronics and semiconductor exports and better able to stimulate domestic growth. That's why South Korea avoided the recession that slammed much of Asia last year, when domestic demand, looser fiscal and monetary policy helped keep the nation in the black. The result was a boom in old economy sectors like autos, homes and ships. Last year saw a huge increase in South Korean auto sales around the globe, and signs global growth is recovering have analysts upgrading growth forecasts for the north Asian country. Many see 5% growth this year, following last year's 3%.
At the microeconomic level, the picture is very different. Considerable work still needs to be done in the financial and corporate sectors. Corporate governance, for example, remains a major concern for investors. That explains why many South Korean companies boasting decent profits have smaller market capitalisation than similar companies in other countries. Corporate transparency is improving ” just not fast enough.
Financial reform also needs to be stepped up. Yet the Government's work to date is paying off, improving Corporate Korea's access to capital. Prior to the Asian crisis, commercial banks provided much of the corporate sector's financing. This helped the Government control who received money and who didn't. It also meant under-utilised and inefficient capital markets. In recent years, the trend has gone in the opposite direction.
Most importantly, however, the Kim Administration is chipping away at the Japan-style business practices dominating its economy.
Reforming the nation's infamous business groups, known as chaebol, remains the first goal. Seoul ordered them to reduce debt, sell businesses and increase transparency. While much remains to be done, the government is steadily ending business as usual for the conglomerates.
That's not what you read in the popular media, which is distracted by labour protests around Seoul. Reporters tend to tell us what we already know: South Korea is having trouble striking deals to sell big companies to foreign investors.
But investors who write off South Korea do so at their own peril. Japan remains in perpetual recession, while the US and Europe aren't poised for stellar growth rates in the next couple of years. Many Asian economies, meanwhile, are grappling with political instability or high debt levels. South Korea, by comparison, seems an island ' peninsula, actually ' of stability.
'Equities and corporate credits should continue to outperform,'' says Suktae Oh, a Seoul-based economist with Salomon Smith Barney. That is, unless fears of asset bubbles in Korean markets are validated. After all, bubble trouble was at the heart of Asia's meltdown in 1997. Morgan Stanley's Xie says South Korea's household credit has been inflated due to the popularity of short-term housing loans known as 'bullet mortgages'' and the perception that property prices won't fall. If the market continues to grow, the economy could accelerate, boost inflation and force the central bank to tighten monetary policy.
The 'bullet mortgage'' isn't really a mortgage product, Xie says. Typically, it's a three-year loan, with an apartment as collateral. Borrowers pay interest for three years and then repay the principal at end of that period.
In practice, though, the loan is generally rolled over on similar terms. As such, there's little debt repayment. Banks don't have to find new borrowers to replace old ones ” the old borrowers just become new borrowers. That's why banks' balance sheets have expanded so rapidly. Xie isn't alone in thinking the central bank should raise rates by 50 basis points immediately to cool credit demand.
Still, South Korea is a very different economy than it was in 1997. That's left today's rising asset markets on sounder footing than many critics might appreciate.
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