June 11, 2008 / 9:19 AM / 9 years ago

Troubled South Korea not anywhere near crisis

SEOUL (Reuters) - South Korea's president warns the economy risks tipping into crisis from surging prices and slowing growth but analysts say it isn't anywhere near as gloomy.

Asia's fourth-largest economy is being confronted by its toughest challenge since the 1997 Asian financial meltdown, but relatively healthy business and macroeconomic fundamentals suggest it is not close to a crisis, they said.

President Lee Myung-bak, who has seen his approval rating plummet to under 20 percent from more than 50 percent after barely three months in office, warned on Tuesday the country faced a "resource crisis". He described it as the gravest threat to the economy since the 1997 financial debacle.

South Korea relies heavily on imports of most energy, food and raw materials supplies, making it especially vulnerable to skyrocketing oil and commodities prices.

Analysts said Lee was right to draw attention to the threat from inflation, but may be overstating the dangers.

"I think he's trying to rally support for his beleaguered government by pointing out an external threat to the economy. I also think he is overstating the threat," said Tim Condon, Singapore-based Asia economist at investment bank ING.

South Korea's current account is in deficit, external debt rising and the won weakening, but these won't drive the $1 trillion economy into a full-fledged crisis, analysts said.

The corporate and financial sectors, furthermore, are stronger than they were a decade ago.

"The macroeconomic imbalances are nowhere near as large as they were in the run-up to the Asian financial crisis," said Frederic Neumann, Hong Kong-based Asia economist at HSBC. "Now, foreign exchange reserves are ample, external debt (is) nowhere near as high, and the currency appears fairly valued."

The won's freefall after years of current account deficits run up during greedy expansion by companies had put South Korea on the verge of a sovereign default in late 1997, only to be rescued by an International Monetary Fund-led bailout.

"The overleveraged corporate sector, a key vulnerability behind the Asian crisis, has deleveraged significantly," said Meral Karasulu, the IMF's representative in Seoul.

"The financial sector, which lacked commercial orientation and ability to assess risks has been transformed into a vibrant one, with high levels of capitalization and low levels of non-performing assets," she said.

TOUGH CHALLENGES

President Lee, who won by a landslide in December after a campaign focused on jump-starting growth, is looking to defuse public anger over a resumption of U.S. beef imports and dissatisfaction with his governing style.

South Korea expects to post its first current account deficit since the 1997 crisis this year. Short-term external debt as a ratio of foreign reserves has doubled in three years and consumer price inflation is running at a 7-year high.

"The small current account deficit would need to be viewed within the context of a global economic slowdown and the sharp rise in commodity prices that Korea is not immune to," said IMF's Karasulu.

"The build-up in short-term external debt should be monitored closely, but the risks should not be exaggerated, as the nature and uses of the short-term external inflows are very different from a decade earlier," she added.

FAIRLY VALUED

South Korea has since the Asian crisis opened up its capital markets, introduced a strict supervisory framework over its financial and corporate sector and abandoned a managed peg on the won, as mandated by the IMF for its bailout package.

"Back then, Korea's short-term external debt was a multiple of the country's foreign exchange reserves and the exchange rate appeared broadly overvalued," said HSBC's Neumann.

The won had been more than 20 percent overvalued against a basket of currencies in the late 1990s even amid current account deficits, but is now valued on par even after 10 years of surpluses, a measure by research firm IDEAglobal shows.

"A slight current account deficit does not represent a major macroeconomic imbalance and, in fact, appears justified at a time when international commodity prices, of which Korea is a major importer, are hitting all-time highs," Neumann said.

This year's current account deficit seen at 1 percent of the annual gross domestic product is way below 4 percent in 1996, and the end-2007 short-term external debt at 60 percent of the foreign reserves is below 312 percent in 1997.

The corporate sector's overall debt-to-equity ratio has fallen to around 100 percent from more than 400 percent in 1997.

The central bank was also granted full autonomy from the finance ministry in 1998.

"The main threat posed by the oil price shock is that monetary policy is too accommodative and it becomes a broad-based inflation shock. This has happened in Vietnam and it has driven that economy to a near-crisis point," said ING's Condon.

"Korea is nowhere near that stage and the recent turn toward hawkishness by the authorities suggests to me that Korea will not get to that stage, that policy will tighten and inflation expectations will remain well contained," he added.

Editing by Keiron Henderson and Jacqueline Wong

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