South Korean borrowers relied excessively on short-term loans in foreign currencies. At the time it was borrowed, the money was cheaper than any alternative financing. Now with lenders, in particular Japanese banks, demanding repayment, its true cost is becoming apparent as it has repeatedly in past debt crises.
According to Arturo Porzecanski, global head of fixed income research at ING Barings in New York, this years experience in Asia is a reminder that the maturity structure of external liabilities should be a crucial factor in the assessment of sovereign creditworthiness.
He points out the short maturity structure of bank loans precipitated the Latin American debt crisis of 1982; the short maturity of dollar-linked Treasury bills turned Mexicos December 1994 devaluation into a debt crisis; and the short maturity of Asian obligations to foreign banks could turn Asias currency crisis into the latest international debt crisis.
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But history repeats itself exactly. Most sovereign debt crises have come about as a result of excessive or inappropriate borrowing abroad by governments rather than, as in the Korean case, the private sector. Furthermore, they have usually been linked with large current account deficits present elsewhere in Asia, but not in Korea.
In 1982, for example, the year Mexico declared its inability to meet obligations to foreign banks and triggered a region-wide crisis, the public sector ran a deficit of 16.8 per cent of the gross domestic product (GDP).
Until 1982, Mexicos average post-war growth had been rapid but this came at the expense of growing budget and current account deficits. Mexico never stopped servicing its debt after 1982, though lenders were effectively coerced into not calling it for repayment. The cost to its economy was heavy and growth was slow for years thereafter. When lending to Latin America and other emerging markets resumed in the early 1990s, lenders believed they could avoid such crises if they did not lend to governments running big public sector deficits, and particularly if they lent to the private sector.
Mexicos 1994-95 crisis came as a shock partly because there was no evidence of government profligacy in the run up to the crisis. Also, the lenders were not banks, but mainly US investment institutions holding marketable debt short-term dollar linked to Treasury obligations known as tesobonos. Mexico had $41 billion of maturities due in 1995, and in trying to defend a pegged exchange rate had allowed its foreign exchange reserves to dwindle to less than $10 billion.
The cost of resolving that crisis with the help of a US government rescue package and a helpful international economic environment was a collapse in Mexicos GDP in 1995 of more than 6 per cent.
The most telling modern day parallel of the Korean story, however, is that of Chiles debt crisis in 1982: and it makes unhappy reading for Korea. The Chinese crisis was perhaps the most damaging of all the 1980s Latin American debt crises the economy contracted by 14 per cent in 1982 alone and it was almost entirely a private sector creation. Nearly two-thirds of Chilean external debt at the end of 1981 was held by the private sector, without any form of government guarantee.
This foreign borrowing, encouraged as in the Korean case by a strong exchange rate, was assumed to be efficient, because it had been contracted by the private sector. Much of the borrowing had been made by a series of conglomerates, the so-called grupos centered on a financial institution.
All this brought about as it did in much of east Asia in the 1990s a sharp rise in the price of non-tradeable goods. In Chile, the price of urban land in 1981 was nine times its price in 1970.
Nonetheless, by 1986, the government had been forced to extend its guarantee to more than three-quarters of the countrys total foreign debt, and the banking crisis that resulted cost the government more than 20 per cent of GDP to resolve.
Chile was not the only country in Latin America to take over private sector debt: Venezuela did the same in 86. But it was the Chilean case that demonstrated the dangers of untrammeled foreign borrowing by the private sector.
Koreas current account deficit running at an estimated 2.5 per cent of GDP is far lower than the 21 per cent of GDP Chile had before things went wrong in 1981. But the lessons from Chile suggest adjustments will be painful. They also suggest that proper government oversight of the banking sector and the private sector borrowing abroad its amount and its maturity is a critical public policy.
The Chile experience shows that pegged exchange rate regimes are likely to encourage excessive foreign borrowing which, if not channeled into productive investment, becomes unserviceable after devaluation.
South Koreas reliance on short-term foreign borrowings was its undoing as in the case of Latin America
The irony is that Korea has been on the brink of financial crisis before. In 1982 it was one of the 10 most heavily indebted developing countries in the world and a Mexican-style crisis looked like a distinct possibility. Instead, the government never rescheduled its debt with creditor banks and grew its way out of the crisis. Fifteen years later, it seems, it has reached a debt crisis that growth alone will not resolve. - Stephen Fidler Financial Times