Ye Chong Hong
Professor, School of Economics

Global Financial Crisis
The financial market disruptions in 2007 and 2008 have led to the worst financial crisis since the Great Depression and pushed the world economy into the deepest post-World War II recession by far. According to the most recent IMF forecast, global activity is projected to contract by 1.3 percent in 2009 and credit write-downs on assets originating in the USA and other mature market economies since the start of the crisis will reach $4 trillion over the next two years.

The Effect of the Crisis on Korea
The spillover from the global crisis has affected Korea with considerable speed and force. The dramatic collapse of and volatility in the Korean Won/Dollar exchange rate, stock prices, and real estate prices has led to a foreign exchange liquidity crisis and weakened bank balance sheets. The sharp collapse in global demand has resulted in a sharp drop in exports and a full blown real economic crisis follows ― unemployment is rising and small and medium sized enterprises are going bankrupt.

Korea is in the midst of a major downturn. How long and deep is the current recession likely to be, and how vigorous the recovery? In the 1997~98 Asian financial crisis, Korea experienced a deep but short recession and recovered very quickly and vigorously through export-led growth. This time will be different because external demand for Korea’s products is vanishing as the result of sharp deleveraging in advanced economies. Nevertheless Korea has both strengths and weaknesses.

Korea’s Advantages
- International competitive advantage in manufacturing sectors such as electronics, shipbuilding and auto industries ― companies like Samsung electronics, LG electronics, and Hyundai motors
- Large corporations’ low leverage ratio compared to that during the Asian financial crisis
- No. 1 trading partner China’s persistent economic growth and continued demand for Korean products
- With not a small domestic demand, Korea should strive to rebalance toward domestic demand

Korea’s Disadvantages
- Korea’s exceptional integration with the global economy
- High short-term foreign debt to international reserves ratio
- High bank loan to deposit ratio
- Banking sector’s deteriorating huge loans to small and medium sized enterprises, households, and commercial real estate project financing
- Korea discount reflecting political risk premiums such as North Korea’s nuclear programs
- Korea’s working-age population is falling quickly because of the low fertility rate and its aging society
- Low labor productivity in service sector

These advantages and disadvantages pose both opportunities and threats.

Concluding Remarks
This crisis will probably not be over quickly. Forceful fiscal expenditure to boost the domestic demand needs to be sustained to help Korea come out of the recession more quickly and vigorously. Korea’s top priority is to enhance the existing social safety net for low income families and the unemployed. In the short run, it is necessary to build up foreign reserves by keeping the current account in surplus. In the long run, the Korean economy needs to look more at the domestic economy as an engine for growth. For sustainable long term growth, fundamental social reform of the financial and political system should be well planned and properly implemented.

iyoungbi@kookmin.ac.kr