ASIAN FINANCIAL CRISIS IN 1997-98 IN SOUTH KOREA AND INDONESIA

ECONOMIC CRISIS OF 1997 IN SOUTH KOREA

At the end off 1997, South Korea companies were unable to pay off their loans, the stock market crashed and the Korean currency lost half of its value. The South Korean government had go begging to the International Monetary Fund for a $58 billion loan---the biggest IMF rescue package ever---but even that wasn't enough. Japan, the United States and other countries coughed up more money to prevent the South Korean economy from totally collapsing.

Unemployment rose from 2 or 3 percent to 8.7 percent. At end of December 1997, the stock market had declined by 49 percent and the currency had depreciated by 65.9 percent. A black market for dollars opened in Myongdong in Seoul. Growth in 1998 was -7.8 percent.

The 1997-1998 Asian financial crisis was a blow to South Korea’s pride. The crisis took hold just months the country reached the $10,000 per capita income level for the first. The collapse of the won (the South Korean currency) quickly reduced it to $6,600 and the world's 11th largest economy was suddenly the 17th largest economy behind Russia, Mexico, India and the Netherlands.

Problems began in July, 1997 when Thailand devalued its currency and markets fell all over Asia. Investors began taking a hard look at South Korea and they were not happy with what they saw: namely inefficient companies with massive debt burdens. They began taking their money out of South Korea and tightening credit. By October, foreign reserve were dwindling dangerously low. Without a supply of credit, Korean companies found themselves unable to pay back their loans and faced defaulting. The entire South Korean economy came close to collapsing.

The crisis in South Korea was rooted in its chaebols (large industrial conglomerates) which had their fingers in many pies, often spent money wastefully and had accrued massive debts. South Korea's financial problems began in earnest with the collapse of Hanbo Steel, an arm of Hanbo, the country's 14th largest chaebol. The company had borrowed $6 billion to build a huge modern steel plant on a capital base of $343 million. By 1997, Hanbo's debt was 22 times more than its net worth. The Hanbo Group had 23 subsidiaries, 22,000 employees and annual sales of $8 billion. In early December 1997, the Halla Group, South Korea’s 12th largest chaebol, went bankrupt, with debts that were 30 times its equity.

Also in early December 1997, the Korean government revealed it was $160 billion in debt (the figure would expanded to $450 billion, 1.5 times South Korea’s GNP, a month later). In a meeting in mid-December, the Clinton administration decided that if South Korea wasn't saved the collapse of its economy could set off a dangerous chain reaction that might have repercussions all around the globe, so it put in motion a rescue plan.

Chaebols and Causes of Economic Crisis of 1997 in South Korea

The immediate main cause of the crisis was a shortage of foreign reserves, which had been sucked up by government-backed low interest-loans given to risky investments and expansion programs by the chaebols. Knowing that the government would bail them out, the chaebols seemed more intent on taking over the world than making profits. They produced millions of products with establishing market share as their primary objective.

Chaebol waste was closely tied to corruption and cronyism between the chaebols and the South Korean government. In addition, concessions to labor created higher wages and made it more difficult to lay off workers. Companies were vastly overstaffed.

The chaebols invested heavily in wasteful projects. They sunk billions into semiconductors and auto manufacturing and even things like aircraft making and movies. Samsung and Ssangyong started mult-billion auto industries in a market that was already flooded. Samsung invested $6 billion in a plant capable of producing 60,000 luxury cars a year "because the chairman likes fast cars." The chairman of Ssnagyang was a "car maniac" who once owned 20 cars including a Jaguar, Lotus, Lamborghini, BMW and Mercedes.

Much of South Korea’s debt was owed by the chaebols. The chaebols maintained debt burdens three times that of businesses in the West. Their debt to equity ratio was an astonishing 400 to 1,000 percent. They started costly businesses at the drop of a hat and were so heavily in debt they tied down much of the country's money.

In 1997, seven chaebols announced they were insolvent. Among the other major chaebols that went bankrupt in 1997, in addition to the Hano and Hall Groups, were Sammi Steel ($2 billion in debt) and Kia Motors. Jinro Distillery, the nations 19th largest company nearly went bankrupt. Even though Kia was bankrupt it still produced 40,000 cars a month and talked about becoming a "top-10 global automaker in the 21st century." Its plant was capable of producing 650,000 cars a year, with 90 percent of the work done by robots. Daewoo acquired Ssangyong's car plant without paying a penny. It simply assumed 60 percent of Ssnagyang's debt.

The bankruptcies also hurt thousands of subcontractors that did businesses with the bankrupt companies. Unable to get credit and payment they too had to declare bankruptcy. In 1998, 1,000 companies went bankrupt a month.

Impacts of the Economic Crisis of 1997 in South Korea

During the Asian financial crisis in South Korea, shoppers stormed supermarkets and hoarded foreign products; workers shaved their heads to protests lay-offs. Newspapers had few pages. Television stations broadcast at shorter hours. Stores replaced imported products with domestic ones. In an efforts to raise foreign currency, companies encouraged workers to turn in loose dollars or yen they might have lying around the house. Executives accepted 20 percent pay cuts. a clothing manufacturer forced to lay off a third of its work force told Newsweek, "Before, companies that had done business with us for a decade would help us out in times of trouble. But no more."

Security guards were brought in to restore order outside banks that we in danger of collapsing. Analysts said the country was "just 10 days away" from "a major financial catastrophe." One economist told Newsweek, "A year ago foreign banks were so eager to lend us money. Now some of them don't even answer our phone calls...Asking the IMF for help is like filing for national receivership."

Restaurants offered IMF menus; citizens stocked up on bulk supplies of milk and flour; expense accounts were curbed; street lamps were turned off; commuters stopped driving; and teachers encouraged student to use their pencils until they were stubs. Pblic holidays were canceled. Weddings and trips were postponed. Elevators were programmed to stop at every other floor to save energy. Hospitals---which imported 90 percent of their supplies---delayed nonemergency surgeries.

Koreans complained that there was too much foreign meddling in Korean affairs. Problems were blamed on the IMF and foreign investors. As part of the xenophobia backlash, foreign shows were canceled; protesters at the airport harassed Koreans leaving for foreign vacations, schoolgirls burned foreign products; and smokers refused to buy foreign cigarettes, Financial analysts said some of these moves were self destructive because no one would want to lend them money.

Ordinary South Korean were encouraged to turn in their wedding rings and jewelry so they so be melting down to boost gold reserves. One bank manager said, "there's a Korean saying that by gathering dust you can create a mountain." The gold drive collected 15 tons of gold and raised $2 billion. Korean-Americans sent hundreds of millions of dollars to South Korea. Even so it barely made a dent in the money that South Korea owed. There were rumors that Japan would extend $10 billion in emergency funds in return for disputed Tokdo islands.

Kim Dae Jung, Economic Reforms and the Economic Crisis in 1997-98

After soliciting the advice of international financiers like George Soros, before he even officially took office as president, the newly-elected Kim Dae Jung floated the won, liberalized the bond market, raised the cap on interest rates to 40 percent, negotiated with union to make sacrifices and made enough reforms to encourage bankers to reschedule their loans,

Kim Dae Jung was able to convince unions, companies and government to cooperate to get the economy going again. He passed laws that required South Korea companies to be audited and required to them to obtain loans publically rather than secretly. He made it easier for foreign inventors to enter South Korea by getting rid of laws that limited foreign investment and allowing foreigners to take over whole companies if they wanted.

In return for the $58 billion loan package the IMF insisted that South Korea get its house in order and this meant passing new fiscal and monetary policies, deregulation, economic transparency, bank reforms, major liberalizations in trade and capital inflows. It also meant allowing interest rates to rise, encouraging foreign investment and improving the structure and governance of Korean corporations.

Kim Dae Jung more or less followed the complicated plan that the IMF worked out. The government recapitalized banks, set up a public asset-management company to get rid of bad loans. Kim walked a fine line with the chaebols as he restructured and reformed them without letting them fail. He also lifted foreign investment limits in banking, real estate and stocks. Most foreign exchange controls were lifted in the early 2000s.

The South Korean government set up a $1.2 billion investments fund for small- and medium-size companies. The top five chaebols were banned from borrowing from the fund. Plans to privatize the railway and power industries were slowed by strikes.

Chaebol Reforms

After the Economic Crisis of 1997-98, the chaebols went through profound changes, many of them mandated by the government. They slimmed down, sold off divisions and concentrated on their core businesses. They were broken into pieces and each unit had to stand on its own. Sudbisdaries that couldn’t make the grade on their own were written off or allowed to fail.

Half the chaebols were allowed to fail, break up, or come under foreign ownership. Companies began operating under the principal of increasing shareholder value. Emperor-like chairmans lost their power. The units that were left were downsized and restructured in part to lure back foreign investors.

Some critics claimed the reforms were superficial and mostly “smoke and mirrors.” Later corruption scandals showed a bribe-free system in South Korea was wishful thinking. And although the chaebol families own only an average of 5 percent of their companies they still managed to run them like fiefdoms.

The chaebols ended becoming more powerful than less. In 1998, top five chaebols accounted for 37 percent of gross output and 44 percent of exports as sub-contractors and small business went bankrupt. In 2001, the government bailed out Ssangyong, one of the worst managed chaebols, with debts of $2.5 billion. Investors and reformers saw this as a bad sign. Other losers heped out by the government included Hyundai Engineering, with debts of $3.4 billion, Hyundai Electronics, with debts of $6.2 billion, and Daewoo Motors.

Unemployment and Impact of the Economic Reforms in South Korea

South Korea, like Thailand, followed the IMF advise and rebounded much quicker after the Asian financial crisis than countries like Indonesia that did not follow the advice. The currency was allowed to floats freely, reserves of foreign currency increased, mostly by exporting to the United States, and the practice of borrowing from abroad on the short term was curtailed. Foreign capital began pouring in after the government removed barriers on foreign investment deregulate markets and force companies to disclose more about their financial conditions.

By some estimates over 2 million workers lost their jobs in 1998 and more than 800,000 people were laid off in 1999 and 2000. Unemployment hit 9 percent. Some unemployed men started up new business and took jobs with small companies, where they conditions were often better than at the the chaebols. Some returned to the countryside to work as farmers. Others took jobs in faraway towns and moved away from their families. In addition, people were put to work in low- paying public works program and some job training programs were set up. The government scrambled to create a safety net. In the past people were kept on the payroll instead of laid off. That was the welfare system.

Hardships in South Korea the Post-1997-Crisis Economic Reforms

There were increases in alcoholism, divorce and crimes such as burglary and assaults of debtors. Visits to counselors and psychiatrist increased. At one point one businessman a day committed suicide after their business failed and their life savings were lost. There were also reports of increase number of orphans as parents abandoned their children and even parents killing themselves and their children because things were so bad, .

Children were pulled out of school. People were unable to heat their homes. Some lost their homes. Shoe repair shops had increases in business as people chose to repair their old shoes rather than by new ones. There was less traffic in the streets as people had no jobs to go to and increases in gas prices encouraged people to take the bus and subway.

People hoarded their hard currency and began being more careful about what they ate, avoiding higher priced imported foods. Swamp meets and flea markets were set up so people could sell heir personal belongings.

Shelters were set up for out of work white collar workers. Some ne were so humiliated they dressed up the morning as they were going to work, left the house, killed time in park or library, and returned home, talking about what a tough day they had. Young people had hard times getting work. One university graduate said that "finding a job is harder than pulling a star out of the sky." There was a lot of labor unrest after the economic crisis in 1997-98.

Asian Financial Crisis in Indonesia

The Indonesian economy collapsed in the second phase of the Asian Financial crisis along with South Korea’s. The crisis in Indonesia was brought about by a sudden lack of confidence by foreign investors who suddenly began pulling their money out of Indonesia as they had elsewhere in Asia. The attack on the Indonesian currency seemed somewhat unfounded. For years, Indonesia had low inflation, high steady growth, balanced budgets and a healthy trade balance of payments. Only weeks before the crash the World Bank reported that Indonesia was performing well and the high growth rates in had posted in the past should continue.

The capital flight caused the currency to drop dramatically, causing businesses with foreign loans to have to pay pack more money. This caused further lack of confidence in the Indonesian economy, sending it spiraling downward.

The rupiah lost 80 percent of its value. Between July 1997 and January it dropped from 2,400 rupiah to the dollar to 10,000 rupiah per dollar. During the first week of January the rupiah lost 10 percent its value every day and reached levels of 14,000 rupiah to the dollar before Suharto's resignation in May 1998. Later it climbed to 16,000 per dollar before stabilizing around 10,000 per dollar.

The Asian Financial Crisis coincided with severe droughts caused by El Niño When the rupiah fell, banks were straddled with huge foreign currency debts they could not pay, which made the currency fall even more. Depreciation of the rupiah caused per capita income to drop from $1,200 to $300 in a few months. At end of December 1997, the stock market had declined by 49 percent. In 1998, unemployment rose to 13.2 and the economy shrunk by 15 percent.

Suharto and the Asian Financial Crisis in Indonesia

During the 1997-1998 Asian financial crisis, investors took a closer look at the Indonesian economy and found it burdened with wasteful investment in thing things like automobiles and jet industries resulting from crony capitalism. Confidence was shattered some more when Suharto, rather than bolding addressing the problems, appointed his golfing buddy Mohammed "Bob" Hasan and his daughter Siti "Tutut" Hardijanti Rukmana to his cabinet.

Suharto blamed the economic problems on "plots" by unnamed enemies and told friends he thought the economic crisis was part of a Zionist ploy intended to keep Indonesia from leading the Islamic world to prosperity. He refused to enact economic reforms that the threatened the interests of his cronies and family members. In the midst of the crisis he allowed a bank owned by one son to reopen under a new name and approved an expensive, unnecessary power-generating project for his daughter Tutut.

In his speeches, Suharto seemed misinformed, out of touch and unwilling the face the reality of Indonesia's economic problems and incapable of rising to the occasion and making necessary reforms. Instead he lived in a kind a fantasy land. In a policy speech given in the midst of the rupiah's collapse and soaring inflation he unrealistically promised that inflation would remain under 10 percent for the year and the rupiah would stabilize at around 4,000 to the dollar (at the time when it was already around 10,000 to the dollar). In the meantime he encouraged Indonesians to covert their dollars to rupiah out of patriotic duty.

Consequence of the Asian Financial Crisis in Indonesia

During the 1997-1998 Asian financial crisis in Indonesia, people lost their savings and stores emptied as people hoarded and looted goods. Companies went bankrupt, the property market and banks teetered on the edge of collapse and prices of basic food skyrocketed. Banks ran out of money as people panicked and withdrew all their saving, poor people shouting "We Are Hungry!" rioted in the streets.

Fistfights broke out in supermarkets as customers pushed and shoved to snatch up and hoard cooking oil, noodles, flour. sugar and other staples. The demand for cooking oil was so intense in some places it was distributed at police stations. "If they didn't sell cooking oil at police stations," one man told Newsweek "people would kill each other."

During the crisis many mothers could no longer afford milk, which tripled in price. They feed their babies tea instead. People couldn't afford to go the hospital and died because the couldn't afford foreign drugs. People who needed medical treatments like kidney dialysis went without it because they couldn't afford it. Hospitals could no longer afford plastic bags to hold blood for transfusions and so hospital employees were asked to collect milk bottles to store blood.

The 1997 economic crisis resulted in a reduction of pollution as people drove less, car sales plummeted, factories reduced their output or were closed, construction ceased and development projects were scrapped. Spending on the environment fell from 36 cents per person to less than 1 cent.

Businesses and the Asian Financial Crisis in Indonesia

During the 1997-1998 Asian financial crisis businesses in Indonesia could not pay the $90 billion they borrowed from foreign banks. Suharto's family members and cronies had taken out huge loans from banks that in turn had borrowed heavily from foreign banks and could not pay pack their debts. Many Indonesian Chinese tycoons moved their capital offshore.

Businesses shut down. Banks closed as depositors formed long lines to get at their savings. Businesses that relied on things like imported wheat or fabric had to shut down because the prices of these items tripled or quadrupled.

Car dealerships changed the prices of their cars on a minute by minuet basis to keep with fluctuations in the value of the rupiah. The price of a delivered Domino's pizza dropped from $9 to 90 cents in dollar terms which meant the price increased more than 10 times for locals paying in Indonesian currency. The Jakarta Post, Indonesia's largest English-language paper, had to figure out a way to survive with paper prices tripling and advertising revenues dropping to practically nothing.

For a while there was a sense of panic and many foreigners left. Companies made contingency plans to evacuate their employees and one international school stockpiled food in the event of serious social unrest. One Canadian business executive told the Washington Post, "You keep $1,000 in U.S. dollars per family member, so you can bribe your way out of the airport if necessary. You keep open return tickets out of Jakarta. You keep provisions of one or two weeks for your house, and you keep a bag packed."

Wall Street investors pulled their money out of Indonesia, throwing the economy in turmoil, but were quick to return to snatch up under-valued enterprises, particularly gold-, nickel- and tin-mining companies.

Poor Indonesians and the Asian Financial Crisis in Indonesia

During the Asian Financial Crisis in 1997-98, the number of people under the poverty line in Indonesia by some estimates expanded from 20 million to 100 million, or around half of the population (other said it increased to 40 million or 20 percent of the population). Explaining what the crisis meant to him one unemployed factory worker said, "It's a matter of the stomach. Stomachs are very sensitive." An estimated 7 million Indonesians suffered from severe food shortages and hunger brought about by disruptions in the food distribution system and the collapse of the rupiah.

In most cases there were adequate food supplies but people didn't have the money to buy anything. People waited for hours in lines to buy rice and cooking oil sold at cheap price by the government and by Chinese merchant aiming to win good wil from the Muslim public. Cooking oil and baby-milk powder was especially expensive and scarce. Instead of eating steamed rice, families stretched their supplies by making watery rice gruel. When meat or more substantial food was found it was fed to men because they needed the energy to work.

Some poor people who could not afford the basic goods were forced to eat tree bark and planted crops on golf courses. They stole shrimp from shrimp ponds and looted stores. Pregnant women were forced to eat bark and roots they foraged in the woods. In West Timor, people ate putak, a porridge made from the boiled splinters of the wood of a palm tree (reportedly pigs usually won't even eat it but it provided enough nutrients to keep people from starving). People also ate grasshoppers, wild potatoes, wild pumpkins, leaves a root called wee-ah (which has to be repeatedly boiled and soaked or else it produces a skin rash). [Source: New York Times, June 8, 1998]

Violence and Workers During the Asian Financial Crisis in Indonesia

Laid off factor workers and mechanics who earned about $1 or $2 a day were forced to collect bottles and cans for recycling, from which they earned about 10 cents a day. Other workers became homeless. They had no money for rent and were too ashamed to return to their home towns. Even those who kept their jobs could not make ends meet. A university lecturer told Time, "Every time I go shopping I feel sad and angry. Almost my whole wage goes for milk for the children."

Workers that attempted to get more money often lost their jobs. Time described an auto mechanic who earned 80 cents a day and participated in a strike for a wage increase of $1.50 a day. His bosses responded by shutting down the business and firing all 40 workers. To survive he collected scrap metal for recycling and earned about 10 cents a day.

Indonesian economic immigrants in Malaysia suddenly were told to pack up and go home. One group of Indonesians picked and put in a detention center rioted, leaving one dead.

Children were forced to drop out of school because their parents couldn't afford the $2 for a school uniform and books. Most of those forced to drop out were girls. Even middle class families were forced to forage for meat and fish and skip meals to save money. Things could have been worse were it not for subsidies on some foods, government services and gasoline and oil.

Riots broke out all over Indonesia, with the main targets being Chinese-owned businesses and enterprises associated with the Suharto regime. In East Java mobs attacked Chinese-owned shops. On Flores protesters shouting "Hungry! Hungry!" marched out the Central bank, owned by a Suharto crony. There were similar outbursts in Central Java, South and Central Sulawesi, Sumatra and the island of Sumbawa. In some places there were clashes between baton-wielding police and rock-throwing protestors. Tear gas was fired and some people were injured. One Indonesian official told AP, "The people become easily insulated, emotional and provoked by rumors, leading them to attack one another and to acts of arson.”

IMF Bailout in Indonesia

The International Monetary Fund gave Indonesia a $14.1 billion aid package (much smaller than what it gave South Korea) in return for promises that it would carry out austerity measures and economic reforms, be more transparent (provide accurate information so a companies health can be accurately ascertained) and end monopolies and expensive industrial projects supported by the states and in many cases headed by Suharto's family members or cronies. In a famous photograph the IMF head Micheal Camdessus is shown standing like as disapproving school principal while Suharto sits and signs the agreement like a disciplined school child.

The Hong Kong investor Philip Tose told Newsweek, "When the IMF package came in, it was widely felt that Indonesia was probably was going to be one of the first to pull through. However as things began to unravel, Indonesia did all the wrong things. The main problem with Indonesia was it was just unable to implement measures that gave any degree of confidence to the marketplace. It appeared as if there was a power vacuum and nothing was going on....Moody's downgraded Indonesia from investment garde o junk. And S&P did the same."

In January 1998, Suharto was expected to announce IMF-proposed economic reforms but instead he proposed pumping up the value of the rupiah by pegging it against the dollar to increase the value of the rupiah in part to save companies owned by cronies and family members from going bankrupt. After Suharto announced the plan the rupiah plummeted 40 percent in three days and the IMF threatened to scuttle the aid program and the idea was dropped. Suharto also renewed contracts for expensive, unnecessary power plants associated with his daughters and one crony and allowed a troubled bank owned by son to reopen under a different name.

Thailand and South Korea followed IMF advise and rebounded much quicker after the Asian financial crisis than countries like Indonesia that did not follow the advice. Indonesia backtracked on reforms and failed to go through with programs that were politically unpopular. The World Bank and IMF employed a multilayered monitoring and supervision system to make sure that they money wasn’t wasted or embezzled. Even so it was.

Some of the IMF reforms were ill advised such as removing food and fuel subsidies which led to hunger and social unrest and made a bad situation worse. Demands by the IMF that Indonesia overhaul its judiciary diverted attention away from bailing out the troubled banking system, a more pressing need.

Indonesian Bank Restructuring Agency in Indonesia

The Indonesian Bank Restructuring Agency (IBRA, a kind of national repossessing body) dominated the financial scene after the crisis. It was set up in 1998 at the height of the crisis to rescue the Indonesian banking system

During the crisis the government closed 67 banks, took over 13 and recapitalized dozens more, and turned much of their assets over to the IBRA, whose goal was get borrowers to pay back as much as possible and make them make up the difference by selling their assets for as much as possible. Owners of Indonesia's largest companies and conglomerates visited IBRA offices and negotiated extensions on debts and turned over assets such as factories, banks, office buildings, ships and shrimp ponds. Company owners that didn't go along could have their assets repossessed.

At its height IBRA controlled a third of Indonesia’s economy. It managed ro recoup $17.4 billion of the $77.5 billion needed to secure the banking system before in closed its offices in 2004. All in all it didn’t receive high marks. Plagued by political meddling and corruption, it was blamed for delaying the recovery and turning off foreign investors. It had difficulties dealing with well-connected Suharto cronies who controlled many of Indonesia’s banks and businesses and was hamstrung by a legal system that failed to back it up. Time mandates and delaying tactics were used by the cronies, who in the end were able aquire their original holdings through offshore companies at fire sale prices even though they were not supposed to.

Image Sources: Wikimedia Commons

Text Sources: New York Times, Washington Post, Los Angeles Times, Times of London, The Guardian, National Geographic, Smithsonian magazine, The New Yorker, Time, Newsweek, Reuters, AP, AFP, Wall Street Journal, The Atlantic Monthly, The Economist, Global Viewpoint (Christian Science Monitor), Foreign Policy, Wikipedia, BBC, CNN, NBC News, Fox News and various books and other publications.

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© 2008 Jeffrey Hays

Last updated November 2012

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