S. Korea just got a major thorn out of its side. For the benefit of those who are visual learners, the thorn, in life size, looks like this:

"-"

Although this mark seems pretty tiny to concern Asia’s third largest economy, this little minus sign can be a lot more powerful than it looks. Especially when it’s attached to something like a rating category from behemoth credit agency Standard and Poor’s. A tag like this can mean billions of dollars in higher interest expense for a country trying to issue bonds and get other financing to help its economy.

That’s why a move by S&P last week meant great news for South Korea. The rating agency upgraded the country’s foreign currency debt rating from A- to A. Although this bump didn’t change Korea’s actual rating category (it still remains in “A”, which means that it is somewhat more susceptible to bad economic conditions), the little tweak of removing the minus sign upgrades Korea’s relative standing within that category.

This is great news for a country that has been plagued by debt turmoil for much of the last decade.

During the 1990s the problems were with chaebols, a group of a few dozen huge conglomerate companies that were granted easy loans despite sour growth prospects. Year after year, more of these mammoth companies, which represented 50% of South Korea’s GDP, went bankrupt due to corruption and severe indebtedness used to finance their massive expansions. The giant impact of each of their falls pitched Korea into a deep recession and massive unemployment.

Then came the 1997-1998 Asian financial crisis. After few good years of great GDP growth had lured in a flood of short-term foreign investment, Korea found itself in the same conundrum as its neighbors: it had borrowed a ton of cash in the form of foreign currency without hedging for devaluation; and it had financed long-term assets with short-term debt, creating a maturity mismatch that would dissolve liquidity in its banking system almost overnight once foreign investors got spooked. Foreign reserves were drained, the government was forced to default, and its economy plummeted once again. into recession.

Scrambling to get back on its feet after the crisis, the country implemented certain restructuring programs that helped recovery. The stock market rebounded, and this Asian tiger seemed to catch a second wind. Because many large corporations were still risky borrowers, banks capitalized on these good times by turning to consumers. The government would pressure banks to increase lending, seeing that the extra cash in consumers’ pockets was fueling spending and therefore contributing to a faster economic rebound. In fact, the cozy government-bank relationships characteristic of the country affected lending significantly. Banks lent with little care for repayment risk, as they knew that the government was encouraging debt spending. They also implicitly understood that the loans were backed by the national treasury.

This started a credit card wave that spread like the plague. Girls in miniskirts would stand on streets and sign up passers-by for credit cards with minimal credit checks. Circulation of credit cards hit 100 million, more than double the national population. It became common to hear of university students with credit-card debt above $100,000. Household debt surpassed $375 billion in 2003, about 84 percent of South Korea's GDP. More than 3.4 million creditors were in default.

Sure enough, the unsustainable pattern came to a crashing halt, when the country’s largest credit card issuer, LG Card Co., went bankrupt and needed to be bailed out by the government and leading banks.

It took another two years to get back on track.

Now, finally, there’s been some good news on the debt front in South Korea. Standard and Poor’s upgrade will boost the country’s status both in Asia and in the world as a source for foreign investment.

But Koreans shouldn’t jump for joy just yet. According to a report this week in the Wall Street Journal, news on delinquency rates for small and midsize business loans has brought a gray cloud over this good news. Rates on these loans have increased from 2.1% to 2.8% over the past two years. Luckily, the country’s monitoring agency is all over the issue, collecting data every 10 days to make sure the lending doesn’t get out of control.

Let’s hope that Korea can learn from its past mistakes when dealing with this issue and avoid any new thorns in the near future.

Posted by Michelle Smith on August 6, 2005 06:23 PM