Editor

Hae Wang Chung

Associate Editor

Sang Whan Kim

English Editor

Caroline R. Sherman

Contributors 

Lead Article

Sung- Hun Kim

Macroeconomic Developments

Han- Yung Jung and Sangche Lee

Sang Whan Kim

Financial Market Developments

Dong Gull Lee 

Byung Duck Kim

Jieun Lee

Byung- Chul Lim

Jaewook Chung

Copyright by

Korea Institute of Finance 

Seoul, Korea

http://www.kif.re.kr

wmaster@sun.kif.re.kr

Printed by Orom System Co.

Ministry of Culture & Public Information

Registration No. Ba -  1891

Registration on April 17, 1993 

KOREAN FINANCIAL

REVIEW

󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏

QUARTERLY ANALYSIS & FORECAST

Vol. 10, No. 1                                Spring 2000

󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏

󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏

CONTENTS 

󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏

Lead Article:Bond Pricing with Default Risk Dependent on Market Interest Rates 󰠜󰠜󰠜󰠜󰠜󰠜󰠜󰠜󰠜

President and Publisher

Macroeconomic Developments 󰠜󰠜󰠜󰠜󰠜󰠜󰠜󰠜󰠜󰠜󰠜󰠜 

Hae Wang Chung

Current Status and Prospects

Money and Interest Rates 

Financial Market Developments 󰠜󰠜󰠜󰠜󰠜󰠜󰠜󰠜󰠜󰠜󰠜󰠜

Banking 

Non- Bank Financial Institutions 

Money and Capital Markets

Insurance 

󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏󰠏 

Korean Financial Review: Quarterly Analysis & Forecast is published by the Financial Outlook Team of the Korea Institute of Finance (KIF). The views expressed are those of the authors, and do not necessarily reflect official positions of the KIF.

For subscriptions, please direct requests and inquiries to the Financial Outlook Team, Korea Institute of Finance, Seoul, Korea; Telephone (82- 2) 3705- 6321, Fax (82- 2) 3705- 6309. 

Bond Pricing with Default Risk Dependent 

on Market Interest Rates

Sung- Hun Kim*

Ⅰ. Introduction

With the recent discussions on the development of securities markets, the importance of designing a proper method of bond pricing has become an issue of great concern. To this end, the Financial Supervisory Commission (FSC) is promoting the establishment of inter- dealer brokerage houses to increase the efficiency of both bond trading and the sharing of relevant price information. The FSC is also reviewing plans to allow private information providers to disseminate information on market prices of bonds. The study of bond pricing in Korea, however, has made very limitted progress, resulting in a scarcity of studies concerning risky bond pricing. Only recently, Han (1999) analyzed the prices of high yield bonds, i.e., bonds with high default risk, by adopting the model developed by Jarrow‧Turnbull (1995) under the assumption that default risk is independent of the level of interest rates. 

- 3 -

However, the assumption that default risk is independent of the level of interest rates only holds, as pointed out by Jarrow and Turnbull, when assessing a company in good standing with a low default rate. The default probability for a company with a bad credit rating is likely to be closely related to the level of interest rates. This is because, all things being equal, when interest rates rise, the present value of a company's future fund will drop, and this in turn diminishes the firm's liquidity causing financial difficulties. By the same token, if a firm is equipped with sufficient reserves, the demand for external financial assistance will decrease, resulting in a drop in interest rates for the firm.

In relation to the above, Longstaff‧Schwartz (1995) demonstrates that there is a negative correlation between a change in credit risk premium and a change in the profitability of Treasury bonds, by using Moody's corporate bond- related materials. Duffie (1998), using FID data provided by Houston University, gives support to Longstaff‧Schwartz (1995)'s work by reconfirming the negative correlation and taking it a step further, showing that there is indeed a correlation between the default risk and the level of interest rates. Moreover, Oh (1997) by analyzing the case of Korea, demonstrates that there is significant correlation between CP (commercial paper) default rates and macro economic variables including interest rates. These facts suggest that special consideration should be given to the effects of the correlation between interest rates and credit risk in the analysis of the pricing model of risky bonds. 

Hence, this study aims to analyze to what extent the prices of risky bonds are affected when a firm's credit risk fluctuates according to the level of interest rates. For this purpose, this study has adopted the term structure model of interest rates presented by CIR (Cox‧Ingersoll‧Ross (1985)), using the monthly CD (certificate of deposit) yield data observed from March 1991 to December 1999, in addition to the credit rating transition matrix used in the study conducted by Han, in order to analyze the pricing of risky bonds in the instances where a firm's credit risk is independent of interest rates and where credit risk fluctuates according to the level of interest rates. 

- 4 -

This paper is organized as follows. Section Ⅱ describes the risky bonds pricing model of Jarrow‧Turnbull (1995) and Jarrow‧Lando‧Turnbull (1997), which is used in the study. Section Ⅲ discusses the credit rating transition matrix and CD yield data and analyzes in particular the monthly credit rating transition matrix based on the annual credit rating transition matrix. Section Ⅳ examines the pricing model of risky bonds by estimating CIR's term structure model and, on the basis of this estimation, assesses the price of risky bonds. Conclusions are provided in Section V. 

Ⅱ. A Pricing Model of Risky Bonds

- 5 -

Ⅲ. Data

1. Transition Matrix of Credit Ratings and CD Yields

The annual transition matrix of credit ratings presented in Han (1999) is used in this study to estimate the time- varying default rates.

<Table 1>           Transition Matrix of Credit Ratings

(unit: %)

Source: Han (1999).

In order to analyze the prices of risky bonds, the term structure of interest rates should be provided. For this purpose, the data on the three- month CD monthly yields observed for the period of 8 years and 10 months between March 1991 and December 1999 is used in this paper. Such CD yields are useful indices, indicating the marginal costs of financing by financial institutions, especially by commercial banks, and are used as the benchmark in determining the interest rates on loans, a form of risky bond. As illustrated in <Figure 1>, CD yields were high in early 1991, ranging from 18 percent to 19 percent, but showed fluctuations remaining under 15 percent. With the financial crisis in late 1997, CD yields skyrocketed recording 25 percent in December in the year. By the end of November 1997, the yields showed incipient increase and recorded its highest level of 25 percent in December. A year later, in December 1998, the yield recorded the unprecedentedly low level of 6～7 percent as a result of the government`s low interest rate policy, along with the recovery of financial market stability and liquidity. 

<Figure 1>             Monthly Variation of CD Yields

CD

yield

year/month 

- 6 -

2. An Analysis of Monthly Transition Matrix of Credit Ratings

In this study, the migration of credit ratings is analyzed by using the transition matrix of credit ratings given in <Table 1>. Because the figures in <Table 1> represent the probabilities of change in annual credit ratings, it is necessary to compute the generating matrix of credit ratings in order to calculate the monthly default probabilities. For this, the method presented by Jarrow‧Lando‧Turnbull (1997) is adopted. 

(unit: %)

<Figure 2>    Survival Probabilities for Different Credit Classes 

- 7 -

Ⅳ. An Analysis of the Pricing Model of Risky Bonds

1. Estimation of Term Structure of Interest Rates

<Table 3>      Parameter Estimates for CIR Model using GMM

Notes: 1) Figures in parentheses are standard errors of parameter estimates.

- 8 -

In order to estimate the parameters of the CIR model, we are using the GMM (generalized method of moment) as has been adopted by Chan‧Karolyi‧Longstaff‧Sanders (1992). For the estimation of parameters, Equation (18) is reconstructed as the following discrete- time stochastic process:

The moment condition for estimating the GMM parameters is:

2. Analyses of Pricing Model of Risky Bonds

1) When Credit Risk is Independent of Interest Rates

The net present value (NPV) of a bond paying 1 won at maturity T is:

Now we assume that interest rates follow the stochastic process of the CIR model to be estimated on the basis of the CD yield data. We calculate the NPV of 1 won paid at each maturity of 1, 2, 3, 5, and 10 years, and the results are shown in <Table 4>. 

<Table 4>        Net Present Value of the Zero Coupon Bond and

the Term Structure of CD Yields

- 9 -

interest rates is upward- sloping and the spread between the interest rate reported in the table and the interest rate of 7.34 percent as of the end of December 1999 becomes the term premium for each maturity. According to <Table 4>, the term premium for the maturity of 1- 3 years ranges from 0.17 percent to 0.49 percent. The term premium goes up as the maturity increases.

<Table 5>           Net Present Value of Risky Bond and

the Term Structure of Risky Bond Yields

- 10 -

- 11 -

<Table 6>           Net Present Value of Risky Bond and

the Term Structure of Risky Bond Yields

2) When Credit Risk Varies with Interest Rates

<Table 7>          Additional Premiums for Risky Bonds

Sensitive to Interest Rates

- 12 -

interest rate is higher than the equilibrium level, the NPV of cash flows decreases being affected by the high level of discount rates and the resulting high level of default rate. In contrast, when the current interest rates is lower than the equilibrium interest rates, the NPV of cash flow increases being affected by the low level of discount rates and the resulting low default probability. As a result, this amplifies the volatility of future cash flows from the bonds. This leads to the decrease in the value of bonds and is reflected in the credit risk premium. Therefore, the reason why the additional amount of credit risk premium increases as the sensitivity increases is explained by the increase in the volatility of future cash flows. On the other hand, the reason why the additional amount of credit risk premium decreases as the maturity increases can be explained by the fact that the effect of the increase in the volatility of future cash flows becomes relatively smaller as the maturity increases.

<Table 8>          Additional Premiums for Risky Bonds

Sensitive to Interest Rates

Ⅴ. Conclusions

This paper analyzes the pricing model of risky bonds in the case where a firm's credit risk varies with the level of interest rates. To this end, we estimated the term structure of interest rates of the CIR model using the CD yield data observed during eight years and ten months from March 1991 to December 1999. In this study, we estimated the prices and the yields for risky bonds for different credit ratings using the reduced- form model suggested by Jarrow‧Turnbull (1995).

Henceforth, further research and in- depth analyses are called for in developing the pricing models of risky bonds considering the sensitivity of credit risk to the level of interest rates, particularly in Korea.

- 13 -

References

Financial Supervisory Commission, Financial Reform for New Millennium,  2000.3.23.

Yang, J.- Y., Credit Risk Measurement using the VaR Model in Korean Banks: With the Perspective of Bank Supervision, Hanyang University Graduate School Master's Thesis, 1998.

Oh, H.- R., An Analysis of the Relationship between Commercial Paper Default Rate and Macroeconomic Variables: Does the Default Rate Reflect the Business Cycle Properly?,  Korea University Graduate School Master's Thesis, 1997.

Han, S.- I., The Valuation of High Yield Bonds, Korea Financial Review, Vol. 9 (No. 4), 1999, pp. 1- 29.

Chan, K.C., G.A. Karolyi, F.A. Longstaff and A.B. Sanders, "An Empirical Comparison of Alternative Models of the Short- Term Interest Rate," Journal of Finance, Vol. 47, 1992, pp. 1209- 1227.

Cox, J.C., J.E. Ingersoll and S.A. Ross, "A Theory of the Term Structure of Interest Rates," Econometrica, Vol. 53, 1985, pp. 385- 407.

Duffie, G.R., "The Relation between Treasury Yields and Corporate Bond Yield Spreads," Journal of Finance, Vol. 53, 1998, pp. 2225- 2241.

Hansen, L.P., "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Vol. 50, 1982, pp. 1029- 1054.

Heath, D. R. Jarrow, and A. Morton, "Bond Pricing and the Term Structure of Interest Rates: A New Methodology for Contingent Claims Valuation", Econometrica, Vol. 60, 1992, pp. 77- 105.

Hull, J. and A. White, "Valuing Derivative Securities Using the Explicit Finite Difference Method," Journal of Financial and Quantitative Analysis, Vol. 25, 1990, pp. 87- 100.

Hull, J. and A. White, "One Factor Interest- Rate Models and the Valuation of Interest- Rate Derivative Securities," Journal of Financial and Quantitative Analysis, Vol. 28, 1993, pp. 235- 254.

Jarrow, R.A. and S.M. Turnbull, "Pricing Derivatives on Financial Securities Subject to Credit Risk", Journal of Finance, Vol. 50, 1995, pp. 53- 85.

Jarrow, R.A., D. Lando and S.M. Turnbull, "A Markov Model for the Term Structure of Credit Risk Spreads", Review of Financial Studies, Vol. 10, 1997, pp. 481- 523.

Longstaff, F.A. and E.S. Schwartz, "A Simple Approach to Valuing Risky Fixed and Floating Rate Debt", Journal of Finance, Vol. 50, 1995, pp. 789- 819.

Vasicek, O.A., "An Equilibrium Characterization of the Term Structure", Journal of Financial Economics, Vol. 5, 1977, pp. 177- 188.

Wilmott, P., S. Howison and J. Dewynne, The Mathematics for Financial Derivatives: A Student Introduction, Cambridge, UK: Cambridge University Press, 1995.

- 14 -

Macroeconomic Developments

Current Status and Prospects

1. Economic Growth

1) Review

The Korean economy was in good shape during the first quarter, taking its cue from the previous year's upbeat trend. Economic growth was buttressed not only by the strong economies in the developed and developing countries but also by the extended number of working days, due to the reduced Lunar New Year holiday in February. The GDP growth rate is forecast at over 9.2 percent, up two percentage points from last year's forecast. Most of the forecasting institutions expected this year's rates to increase more slowly hit by the double whammy of an unfavorable external environment, including a surge in crude oil prices and an international interest rates hike, and an internal problem of sluggish restructuring. 

<Table 1>          Trend and Forecast of Economic Growth¹⁾

(unit: %)

Notes: 1) Percentage changes from the previous year.

2) KIF forecasts.

Sources: The Bank of Korea, National Accounts, various issues.

Recently, however, all of these forecasters have revised up their estimates. In February, the  cyclical component of coincident composite index decreased by 0.1 percentage point from the previous month, but it was insufficient to indicate a cooling economy. However, twelve- month changes in the leading composite index slid to 2.3 percentage points, demonstrating that the economic growth will cool down slightly. 

All industrial activities indices increased in January but production and consumption decreased slightly in February as compared to January, quelling fears that the economy might be overheating. In February, industrial production and 

<Table 2>              Industrial Activities Indices¹⁾ 

(unit: %)                                                          

Notes: 1) The figures in parentheses are percentage changes from the previous quarter. 

2) End of period. 

Source: National Statistical Office, Industrial Activity Review, various issues.

producer's shipments grew by 25.4 percent and 28.3 percent, year- on- year, respectively. Manufacturing operating ratios reached 78.9 percent, slightly lower than January's 80.5 percent. Meanwhile, producer's inventory increased from 5.9 percent in January to 8.6 percent in February, mainly affected by a surge in semiconductors, audio communication apparatus, and office audit machines. Inventory ratios continued to decrease due to an increase in producer's shipments and slightly decreased inventory from the previous month. 

During the first quarter, private consumption is expected to grow by 7.9 percent, much lower than the 12.1 percent of the last quarter in 1999, as the bearish stock exchange and KOSDAQ markets reduced the wealth effect. The following indicators lend support to this forecast. Wholesale and retail jumped to 15.0 percent on average in January and February, slower than the 15.7 percent in the fourth quarter of last year. Sales of automobiles and auto fuel picked up 29.0 percent in February, which is higher than the figure in January. The other consumption indicator, consumption goods shipments for domestic demand, grew by 19.4 percent in February, greatly affected by a surge in durable consumption goods, even though 

<Figure 1>             Growth Rate of Industrial Activity

Source: National Statistical Office, Monthly Statistics of Industrial Production, various issues. 

nondurable consumption goods increased at a slower rate. Between January and February, however,  consumption goods shipments for domestic demand grew by 20.2 percent, much lower than 24.6 percent during the last quarter. The consumer expectation index in February showed 106.2, meaning that consumers still had an affirmative consumption sentiment, but the level had dropped from the previous month. The consumer evaluation index reveals the current sentiment in household consumption patterns, and it reached 103.7, slightly lower than January's 104.7. 

Corporate facilities investment in February expanded from January, growing 66 percent in the wake of a rise in investments in machinery for industry use, computers, communication apparatus, and transportation apparatus. This growth rate is much higher than the 61.6 percent in the fourth quarter of last year and the 57.1 percent of January 2000. In particular, the investment growth rate for communication apparatus reached 108.9 percent, two times the annual growth rate of 56.9 percent in 1999. The domestic machinery orders increased by 19.8 percent, as private orders picked up while public orders decreased by 11.7 percent. Meanwhile, domestic 

<Figure 2>    Facility Investment and Domestic Construction Orders

Source: National Statistical Office, Industrial Activity Review, various issues.

construction orders rose by 74.5 percent, affected by an increase in housing

orders in the private sector, even though public orders declined. 

On a customs- cleared basis, exports increased by 31.5 percent in January, 37.0 percent in February, and 25.3 percent in March, due to the strong yen and the healthier economic fundamentals in the advanced countries. Imports rose 45.9 percent in January, 57.4 percent in February, and 51.8 percent in March. This was attributable to high crude oil prices and large- scale imports of raw materials, capital goods, and consumption goods as a result of the fast economic growth. The export growth rate in March was high only when considered among other March rates, while the import growth rate in March was an all time high. During the first quarter, the trade surplus reached only $0.75 billion on a customs- cleared basis, since import growth rates far exceeded export growth rates. Therefore, the effect of net exports on the economic growth was reduced from the previous month. 

2) Forecast

During the second quarter, the economy will continue to expand due to abundant market liquidity and a rise in consumption, investments, and exports. After the April 

<Figure 3>                   Inventory cycle

Note: Three- month moving average.

Source: National Statistical Office, Industrial Activity Review, various issues. 

general election, the stock market will move into a correction period, but chances are low that economic fundamentals will worsen rapidly. If government does not move in a contractionary way, the current boom might continue to accelerate the economy. There is a law of inertia for economic growth such that a growing economy continues to grow until the appearance of an external shock. 

The GDP is expected to grow by 7.9 percent in the second quarter and reach 7.2 percent in 2000 for the year. First of all, private consumption has been a main factor in boosting the economy and will increase 5.7 percent, although its contribution to economic growth will be considerably less than the 64 percent of the first quarter. The gross fixed capital formation will jump to 10.1 percent, accounting for 29 percent of total economic growth, up three percentage points from the first quarter. Net exports will occupy 13.0 percent of the economy, similar to the first quarter. Facilities investment is expected to grow further, as domestic machinery orders are rising significantly. In addition, firm survey data by both the BOK and the Minister of Industry, Resources, and Energy support the above argument. This implies that investment sentiment is recovering substantially.

According to the BOK's 'Business Survey Index During the First Quarter  of 2000,' surveyed firms feel upbeat, powered by strong production and sales. This trend should continue during the second quarter. During the first quarter, manufacturing BSI reached 104, the highest since the first quarter of 1995, when it stood at 108. The expected manufacturing BSI during the second quarter is 125, the highest forecast since the 131 of the second quarter of 1995. Facilities investment execution BSI was 104, meaning that facilities investment will expand further during the second quarter. In addition, the survey data done by the Ministry of Commerce, Industry and Energy lend support to the above forecast. The facility investment for manufacturing, such as automobiles, semiconductors, and electronic parts, will grow by more than 50 percent, although steel and iron will lag behind. Both construction permits and domestic construction orders received, two leading indicators of construction investment, built up 78.3 percent and 89.9 percent, respectively, between January and February.

In 2000, the economy is projected to climb over seven percent. The main factors behind this are that facilities investments will increase significantly and that the export growth rate will no longer be suppressed by a benefit of high economic growth in developed and developing countries. It should be stressed that inflationary pressure caused by abundant market liquidity, rising crude oil prices, and an international interest rate hike, could damage the basic underlying fundamentals. Therefore, the profitability of firms will not improve substantially as compared to the speed of overall economic growth. Profitability BSI in the first quarter executed by the BOK came in at 92, meaning that profitability in the manufacturing sector has not improved due to high oil prices and the strong won. It is time to evaluate the origins of the current economic growth, in order to stabilize the economy so that steady- state and quality- oriented growth is obtained. The basic forces of the current economic growth are based on full- scale restructuring after the currency crisis. Many firms have been successful in reducing costs cutting back on staff and reducing wages, thereby improving labor productivity. In addition, the new economy, with greatly expanded information communication and venture firms, boosted this high economic growth. 

<Figure 4>         Producer's Shipment Trends

Source: National Statistical Office, Industrial Activity Review, various issues.

Given these positive developments, it is undeniable that market liquidity has increased while pursuing a low interest rate policy in order to boost the economy and secure restructuring funds. The abundant market liquidity flowed to the venture capital and the stock exchange market. The bullish stock markets then led to a surge in consumption, affected by the wealth effect, eventually yielding higher- than- expected economic growth. It is said that the expected inflationary pressure has been rising for a long time, but there is still no sign of rising current prices. Therefore, a policy to reduce aggregate demand pressure has not yet been implemented. It should be noted that if the economy fails to stabilize by cooling down the current boom, the excessive aggregate demand would induce a rise in prices and imports, significantly reducing the current account surplus.

After the general election, several caveats seem to be necessary. First, the strong won will stabilize prices but will then aggravate the current account by weakening export competitiveness. The economy will also be vulnerable to a speculative attack by hedge funds. Therefore, the government should effectively manage the demand 

<Figure 5> OECD Composite Leading Indicators and Export Growth Rate

Source: OECD, The Bank of Korea.

and supply of the foreign exchange by flexibly adopting several invention methods, such as issuing foreign exchange stabilization bonds. Second, financial institutions strengthened asset prudential regulations, and large conglomerates should abide by the debt to equity ratio. Abundant liquidity among financial institutions did not lead to lending to firms. Instead, liquidity is seeking short- term gain, destabilizing the financial market. Gradually raising the short- term policy interest rates in order to absorb lazy market liquidity might alleviate this problem. Third, Korea has been mired in large scale sovereign debt in the midst of restructuring, and this debt should be efficiently managed to deter snowballing fiscal deficits. In particular, public funds are likely to be managed loosely and to show a very low retrieval rate. Thus, financial regulators should take a closer look at these funds.

2. Prices and Wages

1) Review

During the first quarter, consumer price index (CPI) grew by 1.5 percent, as agricultural- livestock- fishery product prices increased 3.7 percent, industrial product prices 1.7 percent, and public service fares 3.9 percent. Petroleum prices declined over 10 percent, and housing rent decreased 2.3 percent. By month, CPI in January declined by 0.1 percent from the previous month, as manufacturing product prices, housing rent, public service fares, and individual service fares declined. CPI in February increased by 0.3 percent from the previous month, as agricultural-  livestock- fishery product prices benefitted from the additional demand of school graduations and Lunar New Year. In addition, an increase in public and individual service charges pushed the further elevation of CPI. CPI in March increased by 0.3 percent, mainly affected by increased tuition, even though agricultural-  livestock- fishery product prices declined. The real life price index grew by 3.3 percent, owing to the increased necessities prices and public fares. By month, this index increased 0.2 percent in January, 0.4 percent in February, and 0.3 percent in March.

During the first quarter, the producer price index (PPI) increased by 2.2 percent year- on- year. Manufacturing product prices, whose weight is 66  percent, jumped to 2.5 percent, electric- water- gas prices, whose weight is three percent, grew 7.2 percent. By month, PPI in January declined by 0.1 percent from the previous month as petrochemical product prices decreased significantly due to a cut in the transportation tax and the strong won, even though city water and gas prices increased as a result of high crude oil prices. PPI in February maintained January's levels. Service charges decreased due to low interest rates and the strong won, while industrial product prices increased slightly as a result of a rise in import raw materials such as oil and pulp, etc. In March, PPI grew by 0.1 percent, despite the reduced agricultural and fishery product prices, as industrial product prices showed a upward trend due to the growing crude oil prices. It is noticeable that service prices continued to decline between January and February, hit by the decreased lease and securities fees. 

In 1999, nominal monthly average wages in all industries (based on corporations holding more than ten permanent workers) grew 12.1 percent year- on- year. In particular, this indicator surged 23.1 percent in December  due to substantial year- end bonus payments, and the hourly wage jumped significantly, shooting up by 16.3 percent in January 2000. Between January and February, the number of employees declined in the fields of agriculture and fishery, manufacturing, and construction, and this trend was then exacerbated when college students tried to grab jobs during their winter vacation, expanding the number of unemployed to 1.12 million and raising the unemployment rate to 5.3 percent.

2) Forecast

Despite abundant market liquidity and aggravating external factors, like the international raw material prices hike, the domestic price level has been

very low as a result of the continued appreciation of the won, whose value grew a substantial 17.8 percent in 1999 and then dominated the quantity theory of money. Entering 2000, the won's value continued to rise. According to the empirical work done by this institute, an increase in money supply, a depreciation of the won, and an oil price hike tend to push up price levels after six quarters, one quarter, and one quarter, respectively. After the currency crisis, the strongest factors affecting 

<Figure 6>          Consumer and Producer Prices

Sources: National Statistical Office and the Bank of Korea.

<Figure 7>            International Oil Prices 

Note: WTI.

price levels were the won/dollar rate, the money supply, and the economic growth rate, in that order. 

During the second quarter, wage hike pressure and rising international raw material prices will destabilize prices, as the speed of the won's  appreciation will slow further. This unfavorable factors will raise prices slightly higher than the first quarter. In addition, the demand- push inflation factor will be observed as the GDP gap reduces rapidly, reflecting the fast economic growth. This will be supported by the simultaneously reduced output and velocity gaps.

During the second quarter, CPI is expected to increase three percent from the same period last year. Livestock prices will be down because of the  March foot- and- mouth disease outbreak and industrial product prices will be stable. After the general election, however, service fares and wages will pick up significantly, largely affected by the higher economic growth rate. But PPI is expected to rise 3.1 percent as industrial products, such as petroleum products, are stabilized. The real life price index, whose weight heavily hinges on agricultural products and public fares, will grow by 3.5 percent.

<Figure 8>         Trends in Wage Increases by Sector

Note: Three- month moving average.

It should be noted that future prices will surge rapidly even though there is no sign of rising current prices. It will take a very long time for spiraling  prices to calm down, and preemptive polices will be necessary for price stabilization. The awash market liquidity, aggregate demand pressure due to a rise in private consumption and facility investments, and the cost- push factors such as the raw material price hike and high oil prices could shake our stability.

<Table 3>        Trends and Forecast for Prices and Wages¹⁾

(unit: %)

Notes: 1) Percentage changes from the previous year. 

2) Figures after the second quarter of 2000 are forecasts. (Avg. industry wages figures after the first quarter of 2000 are forecasts.)

Sources: National Statistical Office, Consumer Price Index, various issues. 

The Bank of Korea, Monthly Bulletin, various issues. 

Ministry of Labor, Report on Monthly Labor Survey, various issues.

<Figure 9>             Leading Inflation Indicator

Current Account and Foreign Exchange Rates

1) Trend

Korea posted a current account surplus of $1.29 billion during the first three months of this year. A rapid rise in imports, recording a 51.8 percent growth rate as compared to the same period last year, outpaced export growth. Exports increased 30.1 percent to $39.4 billion, while imports reached $38.8 billion. As a result, a trade account showed only a $2.3 billion surplus, compared to $6.8 billion last year. The services account deficit enlarged to $0.9 billion. The income account turned to deficit in March and recorded a $0.4 billion deficit in the first quarter, but the transfer account remained in the black at $0.3 billion.

Among export industries, Korean firms specializing in information and telecommunication equipment or computer chips remain competitive amid the appreciation of the Korean won and rising oil prices. The appreciation of the Japanese yen offset some of adverse effects from the strong won, which has been caused by the significant inflow of portfolio investment capital into the country. In addition, the booming U.S. economy and the gradual economic recoveries in other 

<Figure 10>  Growth Rate of Exports and Imports, Balance of Goods Account

major export markets, including Japan, China, and the European Union, helped boost demand for Korean goods. 

Increasing exports and domestic demand, however, translated into rising imports of raw materials and capital goods. Imports of raw materials increased 64.4 percent to $19.5 billion, of which oil accounts for $6.1 billion. Capital goods imports climbed to $15.7 billion, a 52.6 percent increase year- on- year. The trade with the U.S. and the European Union showed surplus of $1.1 billion and $1.4 billion, respectively, in sharp contrast to the $2.9 billion deficit with Japan. One alarming trend is that Korea's terms of trade are showing signs of deterioration, mainly as a result of galloping international unit prices for raw materials, including crude oil, which surged to 44.1 percent in February of this year from 21.8 percent last October. The terms of trade index, which refers to the units of imports that a unit of export can buy (with 1995 serving as 100), dropped to its lowest level yet, 72.3, in February. The index was 72.6 in January. Unit import prices have been rising faster than unit export prices in local currency since November 1999. Korea's unit import prices have risen more than 20 percent this year, while the growth rate of unit export prices comes to a mere 3 percent. 

<Figure 11   Foreign Portfolio Investment and Foreign Direct Investment, 

Balance of Capital Account

The Korean won continued to strengthen against the dollar in the local 

foreign exchange market as the supply of dollars far exceeded demand. The

inflow of foreign stock investment funds has already reached $7.3 billion in the first quarter of this year, a sizeable jump given the $5.2 billion recorded for the whole of last year.

The continued inflow of foreign stock investment funds, coupled with the selling of dollars by domestic exporters, is putting upward pressure on the Korean won. Alarmed by the rapid rise of the won, which may damage the nation's exports by making Korean products more expensive in overseas markets, the government took all possible measures to rein in the local currency. In the wake of the won's continued appreciation against the dollar, the government issued 2.3 trillion won (300 billion in January, 700 billion in February, and 1.3 trillion in March) worth of 

<Table 4>          Export and Import by Items and Areas

(unit: $ million)

Note: The figures in parentheses represent the percentage change from the previous year.

Source: The Bank of Korea, Monthly Balance of Payments.

<Table 5>    The Trend and Forecasts for the Current Account

(unit: $100 million)

Notes: 1) Forecast after 2000.

2) Period average.

Source: The Bank of Korea, Monthly Balance of Payment, various issues.

<Figure 12>   The Ratio between Korean and Japanese Real Effective 

Exchange Rates and Export Growth Rates

Note: Export growth rate is a three- month moving average.

Source: The Bank of Korea, J.P. Morgan. 

foreign exchange stabilization bonds so far. However, the government's verbal intervention in the exchange arena and its attempts to absorb the excess were overshadowed by the dollar- selling position.

<Figure 13>  The Gap between Gross Savings and Gross Domestic Capital Formation

Note: A Gap is Gross Savings minus Gross Domestic Capital Formation.

<Figure 14>  Exchange Rate Change and Foreign Exchange Market Pressure

Source: The Korea Institute of Finance.

2) Forecast

The underlying momentum behind the growth in exports will continue to be strong in the second quarter. Meanwhile, swelling imports are casting doubts as to whether Korea will be able to achieve its current account surplus goal of $3 billion as set by the government for the second quarter. High international oil prices will not be as troublesome as in the first quarter. However, if the yen's depreciation and the won's appreciation continue, the size of the actual surplus could shrink considerably. Among the two different effects that a stronger won might bring, either hitting exports in the short term or slowing imports- - especially imports of consumer goods- - the former effect would take precedence and pull down the trade surplus significantly. As a result, widespread measures are required to improve the trade balance surplus. One such measure, albeit a long- term project, would be a mid and long- term plan to foster domestic manufacturers of intermediate goods with the goal of ending Korea's chronic trade deficit with Japan, which has been uninterrupted since 1965. 

The Bank of Korea expects that inflationary pressures will emerge in the second quarter of this year and that inflation could surpass the 3 percent threshold by the third quarter, so it is likely to choose a strong won as its policy instrument for pulling back on inflation. It would be wiser, at least for a while, to contract domestic demand through fiscal austerity rather than interest rate increases. A tight money policy would be costly, since it simply induces inflows of foreign capital, with increased speculation. In addition, the underlying financial system is still too fragile for significant interest rate increases. With a mark- to- market policy on investment trust companies' assets to be introduced in July, rate hikes could serve as deterrence across all sectors of the economy, especially considering that Korea's restructuring of corporate and financial institutions is incomplete. Therefore, the authorities will allow the won to appreciate. Although the won has reached its highest rate in two years, there will still be room for the won's appreciation if the Japanese yen strengthens against the dollar. With the balance of payments still in a strong position, the trade balance can take second place to inflation targeting in terms of priorities. In the long term, a strong won policy will be beneficial for exports as it will rein in inflation, boost competitiveness, and increase productivity by forcing companies to be more efficient.

- 15 -

Money and Interest Rates

1. Money

1) Review

Domestic business activities continued to boom in the first quarter of 2000, extending the economic recovery that began in the fourth quarter of 1998. A new aspect in this boom is that the business startups became unusually active, boosted by venture investments in the high- tech industries. Two- digit growth rates in two consecutive quarters gave rise to worries about growing inflationary pressures in the financial market. However, consumer prices recorded lower- than- expected levels, mere 1.5 percent in the first quarter. Overall, strong economic growth with low inflation characterizes the current Korean economy.

<Table 6>           Trends in Monetary Growth Rates¹⁾

(unit: %)

Notes:1)Year- on- year average period percentage changes. 

2) Preliminary. 

3) Reserve Base = bank notes + reserves of deposit money banks. 

4) M1 = currency + demand deposits. 

5) M2 = M1 + savings deposits + foreign currency deposits. 

6) MCT = M2 + CDs + money- in- trusts. 

7)M3 = M2 + deposits in non- bank financial institutions + debentures issued +  commercial bills sold + CDs + RPs. 

Source: The Bank of Korea, Money and Banking Statistics, various issues. 

The monetary authorities raised the RP rate, the short- term interest rate that the Bank of Korea (BOK) operates to control market interest rates, by 25 basis points from 4.75 percent. The BOK has been taking an accommodative stance on interest rates, fixing the call rate below 5 percent since August 1999. The recent call rate hike does not imply that the BOK has taken up a contractional stance. Given that the gap between the long- term and short- term interest rates widened to more than 500 bp, the 25 bp hike is too small to affect market interest rates.

<Table 7>           Multipliers and Velocities¹⁾

(unit: times)

Notes:1)Money Multipliers are the ratios of each monetary aggregate to the volume of the reserve money. Velocities of money represent the ratios of seasonally adjusted nominal GDP of each monetary aggregate. The velocities reported in this issue of the KFR are annual; the velocities reported in the last issue were quarterly. Seasonal adjustments also make a slight difference. 

2) Velocities are estimates. 

Sources: The Bank of Korea, Money and Banking Statistics (various issues) and Trends of the Financial Market in March. 

- 16 -

The fluctuations of the monetary aggregates, which began after the 1997 currency crisis, were still apparent. The M2 growth rate in the first quarter recorded 27.7 percent, due to large U.S. dollar sales by foreign investors for portfolio investment, while the MCT (bank deposits + bank trust funds) growth rate stood at 13.2 percent and the M3 at 6 percent. This is because there is a general preference for bank deposits over capital asset management funds, as the Daewoo bankruptcy steered most individuals away from high returns and toward low risk.

Funding availability has been good. The BOK allowed sufficient liquidity to be injected into the market, while the fund demands have been quite low. The first quarter is usually the period in which businesses' demands for funds are low. In addition, the unusually strong profits in 1999 helped companies increase internal reserves, reducing the need for outside funds. To make up for the diminishing corporate loan demand, commercial banks pushed hard to increase their share in the consumer loan market, which is believed to be the banking industry's future core businesses area. The Korean government is advising large companies, especially chaebol, to stay away from bank loans and fund their investment projects directly from the capital market. Since medium-  and small- sized companies with good credit histories are insufficient in both number and size to absorb loan sales, banks have no choice but to compete in the consumer loan market.

- 17 -

<Table 8>           Trends in Major Financial Indicators

(unit: %)

Notes:1)End of Period.

2)Period averages.

3)Dishonored value based (dishonored bill- ratio adjustment for electronic settlements).

Sources: The Bank of Korea, Ratio of Dishonored- Bill in March and Trends of Daily Financial Market. 

<Table 9>          Recent Deposit Changes at Financial Institutions¹⁾

(unit: 100 million won)

Note:1)Period changes.

Sources: The Bank of Korea, Money and Banking Statistics (various issues) and Trends of Daily Financial Market. 

2) Forecast

Even though inflation fears are spreading, it is not expected that inflation will reach a level that would threaten the stability of the economy. Productivity, one of the driving forces behind the recent economic surge, should continue to accelerate as further developments in the technology sector help companies and workers produce goods and services faster and cheaper. Huge capital funds invested in information technology through KOSDAQ are expected to pay off, boosting productivity and keeping costs down. That investment is expected to affect the economy positively, allowing for a higher level of sustained growth without necessarily triggering inflation.

The monetary policy makers have been in a dilemma with regard to the matter of raising interest rates. Even though inflationary pressure would not actually cause any inflation higher than 3 percent, BOK officials have been leaning toward raising interest rates to slow down the fast pace of economic growth and prevent in advance the possible inflation spree. However, they can not neglect the ever- growing bad debt, which has already reached alarming levels. The market value depreciation caused by the interest rate hike will surely make the banks' cleaning process more painful and expensive. Therefore, considering the harsh reality of the current financial markets, the BOK is expected to lift the benchmark lending rate by only a quarter or half point, while paying close attention to the market response.

<Table 10>           Monetary Growth Rate and Forecast¹⁾

(unit: %)

Notes:1)Year- on- year growth rate of the average balance.

2)Forecast.

Sources: The Bank of Korea, Monthly Bulletin (various issues), Money and Banking Statistics, and Trends of Financial Market in March.

It is expected that the seasonally low demand for cash would lower the reserve money growth rate in the second quarter from the unusually high level of 23.2 percent in the previous quarter. The M3 growth rate, the broadest monetary indicator, is also forecast to remain low, reflecting the switch from stock- related financial products to bank deposits. On the other hand, the M2 growth rate is most likely to record 25 percent due to the continued liquidity inflow to banks.

<Table 11>           Recent Deposit Changes at Financial Institutions¹⁾

Notes: 1) Units are 100 million dollars.

2) Units are 100 million won.

Sources:The Korea Stock Exchange, Monthly Bulletin, various issues. http://www.kosdaq.or.kr

<Table 12>           Monetary Stabilization Bonds Issued

(unit: billion won)

Note:1)Preliminary.

Source: The Bank of Korea, Monthly Bulletin, various issues. 

2. Interest

1) Review

The benchmark three- year corporate bond yield stood at around ten percent in February, which was lower than the fourth- quarter average in 1999. However, it seems that market participants are still very uncomfortable investing their money in the bond market. In fact, critical issues like rehabilitating faltering ITCs, the fast growing public debt, and the second round of bank restructuring give rise to uncertainty in the financial markets. Moreover, the mark- to- market pricing of funds in investment trust funds is scheduled for early July. Looking beyond domestic problems, the Korean financial market, which is particularly sensitive to the U.S. stock price indices, has occasionally been hit by the frequent big swings in the U.S. capital market, which recently became much more volatile out of fear of an interest rate hike. Therefore, with all of these internal and external problems, no one is on solid ground in trying to justify the current interest rate levels and forecast future movement. With uncertainties rising, even a slight shock at this time could cause wide swings. 

<Figure 15>           Long- Term Interest Rates

Even though the market interest rates moved steadily around ten percent, bond trading was very weak. ITCs, the major traders in the bond market, consistently poured their bond holdings into the market. The commercial banks emerged as the main buyer, but they could not absorb the flood. Another factor behind the seemingly stable bond market is the diminished supply of newly issued bonds. Corporate bond issuance was virtually blocked because no institutions would like to actively underwrite corporate bonds, and the government controlled treasury bond issues to prevent the market interest rates from shooting up. 

When the stock market demonstrates instability, the government reacts by insisting that economic fundamentals are robust so there is no rational reason why Korean stocks are poorly valued. The government sometimes even considers direct market intervention by forcing the market interest rate lower than the market participants expect or giving tax- exemption favors to stock- related products. But the most important measure that the government should take is to regain the market's rational valuation functions by getting the financially- ailing institutional investors back on track. Even though the ratio of individuals' trading to total trading has lowered since 1999, it is still too high relative to the major foreign market. As is 

<Figure 16>           Major Short- Term Interest Rates

evident in the KOSPI movements, domestic and foreign institutional investors have been deciding market trends, while individuals just follow their lead. Therefore, the current lackluster market is in some ways caused by the liquidity- drained investment

<Table 13>           Quarterly Movements of Major Interest Rates¹⁾

(unit: %)

Notes:1)Period averages.

2)End of period. 

Source: Korea Investors Service, INC., KIS- LINE. 

<Table 14>           Interest Rate Determinants

(unit: %, billion won)

Notes:1)Year- on- year growth rates.

2)CPI is realized value, other figures are preliminaries. 

Sources: The Bank of Korea, Monthly Bulletin, various issues.

Financial Supervisory Service, Monthly Financial Statistics Bulletin, various issues.

trust companies, which were directly hit by the collapse of Daewoo. In this regard, the long- run policy to pave the way for the more efficient and stable market system should include measures to deter individual investors from directly diving into the market. This may be possible through widening or abolishing the daily limit on price swings or introducing a 24- hour trading system.

<Table 15>       Trends in Stock- Type Financial Commodities¹⁾ 

(unit: 100 million won)

Note:1)Period changes.

Source: The Bank of Korea, Trends of Financial Market in March.

<Table 16>           Dishonored Bills Rates

(unit: %, number)

Note:1)Dishonored value basis. The figures in parentheses indicate that the adjusted ratio does not reflect electronic- based payments.

Source: The Bank of Korea, Ratio of Dishonored Bill in March.

<Table 17>           Daily Absolute Change of Interest Rates¹⁾

(unit: percentage point)

Note:1)Period Averages.

Source: Korea Investors Service INC., KIS- LINE.

<Figure 17>                  Yield Curve

- 18 -

2) Forecast

For the second quarter, the interest rate is expected to increase slightly to 10.3 percent. This is because the high risk premium should prevail in reaction to the aforementioned critical issues lying in wait ahead. However, once all of the unclear issues have been resolved or some convincing resolution plans are announced, it is highly probable that the interest rate will drop to the eight percent level very quickly. Considering only economic fundamentals, there is much room for such a drop. Although the economy is expected to remain strong in the second half, the corporate sector is not planning to increase investment expenditures. In addition, the venture companies, which are most actively expanding their businesses these days, do not need large- scale funding, in contrast to the investment funding in the areas of traditional industries such as automobiles, shipbuilding, and electronics. Therefore the demand for funds will be weaker than expected. Future inflation is not expected to reach levels that could damage macroeconomic stability. Most market participants 

<Table 18>              Interest Rate Forecasts¹⁾

(unit: %)

Notes:1)Interest rates are period averages and the other figures are the percentage change from the previous year.

2)CPI and interest rates are reported figures, and other figures are preliminary. 

3)Forecast. 

Sources: The Bank of Korea, Monthly Bulletin. various issues.

Korea Investors Service, INC., KIS- LINE.

and BOK officials worry that inflationary pressures are building up quickly due to the high oil prices, too much liquidity in the market, the labor union's demand for high wages, and strong consumption. But the cost efficient retail distribution system, with the introduction of large- scale retailers like Wal- Mart, is working as price- stabilizing force. The belief of some market participants that too much liquidity was injected into the market is not supported by the evidence. Even though the M2 is growing very quickly due to the continued flow of market funds into bank deposits, other monetary indices show no signs of high growth. In fact, the growth rates of MCT and M3 are recording very low figures. To sum up, the weaker demand for funds and stable price movement will lower market interest rates in the second half.

- 19 -

Financial Market Developments

Banking

Deposit Market

1) Current Trends

During the first quarter of 2000, the total volume of bank deposits held by deposit money banks, including deposits in won, marketable financial products, and foreign currency deposits, rose by 5.8 percent, totaling 359 trillion won. As illustrated in <Table 1>, bank deposits steadily increased throughout last year and have so far continued this trend in the new year. There are several notable reasons for this increase. First and foremost is the sale of up to 95 percent of Daewoo corporate bonds, which was permitted early this February, causing considerable funds to be retrieved from investment and trust companies (ITCs) and subsequently invested in relatively safer money deposit banks. Despite the government's efforts to introduce policies encouraging the redirecting of funds back to ITCs, market instability combined with the declining competitiveness of indirect investment products has accelerated fund movement toward money deposit banks. 

Second, banks reacted to the anticipated instability that was expected as a result of the government's initiation of financial sector restructuring after the national assembly elections in April 13, 2000 by strengthening their retail banking competitiveness and thereby increasing their deposit reserves. 

Third, scheduled changes in the Deposit Insurance Law from full to partial protection as of early next year have caused the steady movement of deposits to the relatively safer banking sector. This is also the reason behind the noticeable increase in major banks' time accounts, especially during the first quarter of 2000. 

Fourth, funds that were withdrawn from banks and invested into the securities market late last year are now flowing back to the banking sector due to yield rate decline and instability in the securities market. Fifth, the imbalance due to the temporary withdrawal of cash in preparation for Y2K has now been alleviated. Finally, a variety of factors including the promotion of electronic banking services and elimination of various banking regulations have allowed banks to update their financial products and become more competitive in the financial market. 

<Table 1>                     Bank Deposits¹⁾

(unit: billion won, %)

Notes:1)End- of- quarter basis. The figures in the parentheses represent the percentage change from the previous quarter.

2) Estimates.

3) Forecasts.

4) Excludes BOK trust funds.

Sources: The Bank of Korea, Money & Banking Statistics (various issues) and Daily Trend of the Financial Market. 

As shown in <Table 1>, deposits in won, consisting of demand deposits and time and savings deposits, rose 5.9 percent in the first quarter, totaling 326 trillion won. Despite a substantial decline in demand deposit volume, time and savings deposits steadily increased throughout last year and into 2000. This increase in the volume of time and savings deposits is mainly attributable to the increase in time accounts, which comprise over a half of all time and savings deposits and have demonstrated an impressive increase of 16.4 trillion won, or 11.1 percent, as shown in <Table 2>. Such a significant increase is due to new competitive measures, including the bonus interest rate offered by banks in a largely successful attempt to increase deposit reserves. Another eye- catching trend is the substantial increase in 

<Table 2>                Time and Savings Deposits¹⁾

(unit: billion won, %)

Notes:1) End- of- quarter basis. The figures in parentheses represent the percentage change from the previous quarter.

2) Estimates.

3) Includes household preferential installment savings deposits.

4) Includes mutual installment savings, housing installments savings, workers' long-  term savings, and workers' property formation deposits. 

Sources: The Bank of Korea, Money & Banking Statistics (various issues) and Daily Trend of the Financial Market. 

the maturity length of time accounts. In January and February together, of the 13.6 trillion won increase in time accounts, 10.2 trillion won consisted of maturities of over six months. 

As mentioned, demand deposit volume fell considerably in the first quarter, showing a decline of 23 percent, or 6.1 trillion won, ending at 20.5 trillion won. The reasons behind the trend change, from the increases of previous quarters to this quarter's decline, are that demands for year- end payment settlements were alleviated, and floating funds have been absorbed into time and savings accounts, in response to the competitive rates offered by banks. Demand deposits declined substantially in both January and February but began to revive in March. 

The volume of marketable financial products rose by 9.1 percent in the first quarter, totaling 25.2 trillion won. However, marketable financial products were subject to severe fluctuations that belie this rosy picture. In October 1999, the volume of marketable financial products increased by 3 trillion won but then

<Table 3>        Interest Rates on Selected Bank Deposits¹⁾

(unit: %)

Notes: 1) End- of- quarter basis.

2) Estimates.

Sources: The Bank of Korea, Money & Banking Statistics (various issues) and Daily Trend of the Financial Markets. 

declined by 2.8 trillion won in December 1999. January 2000 was calm, but February brought a 2 trillion won increase. When marketable financial products are subdivided into smaller categories, however, as shown in <Table 1>, both cover bills and RPs show only a slight increase, while CDs show a sudden upsurge against the decrease of the previous quarter. Given that banks did not focus on or dramatically improve marketable financial products, this increase must be understood in terms of long- term trends. To look at the big picture, the total volume of marketable financial products dropped suddenly between 1997 and 1998, reaching its lowest point in years. As a result, although marketable financial products may fluctuate, they are likely to increase overall. 

The volume of foreign currency deposits rose 5.4 percent in the first quarter, totaling 7.6 trillion won, as shown in <Table 1>. This decline rested on the belief that the exchange rate would continue to decline in the near future. This belief has been responsible for declines in the purchase of foreign currency for both future purposes and speculative investments. 

The average interest rate on deposits is expected to increase to 6.29 percent due to interest rate increases for long- term depository products, like installment and time savings, that comprise substantial amount of volume of deposits, as shown in <Table 3>. However, banks with sufficient funds have begun to offer lower interest rates in response to a worsening profit structure due to the narrowing of deposit- loan margins following a reduction in loan demands by the corporate sector. In addition, the government has taken a firm stance against high interest rates to mitigate over- heated competition within the banking sector. 

2) Forecasts

The total volume of deposits held by deposit banks in the second quarter is expected to increase to a total of 387 trillion won, a jump of 7.8 percent. This further increase is expected for several reasons. First of all, persisting instability in both the stock and bond markets is likely to direct floating funds into the banking sector. In addition, if the government's plan to mark bonds to markets materializes on July 1, 2000 as scheduled, concerned investors will engage in the sale of bonds, with a resultant flow into the banking sector. 

Second, the expectation that financial sector restructuring will pick up speed after the national assembly elections should cause banks to place greater emphasis on increasing their assets through deposits, hoping to obtain greater financial assistance from the government. In addition, with the expectation that non- banking financial institutions (NBFIs) like loans and savings corporations and credit unions will undergo serious restructuring, deposits will be withdrawn from this sector and are likely to be absorbed by banks and postal savings institutions after fierce competition. The reduction in the amount guaranteed by the Deposit Insurance Law as of early next year will also provide an extra push in directing funds from NBFIs to the banking sector. 

Lastly, with the banks' introduction of housing savings trusts in late March, as well as the extension of subscription eligibility to those over twenty years of age, it is expected that banks will compete heavily to gain a greater market share in housing deposits and savings market, whose value is estimated at 60 trillion won.  We cannot rule out the possibility that these competitive measures may include high interest rates. Hence, during the second quarter of 2000, banks are likely to experience greater increases in the total volume of deposits.

Won deposits are expected to rise 9.3 percent in the second quarter of 2000, totaling 356.4 trillion won. As during the last quarter, this increase will be mainly attributable to an increase in time and savings accounts. Funds will be withdrawn from NBFIs and placed into the banking sector for the reasons discussed earlier. In addition, the development of new financial products such as bancassurance, as a result of the lifting of many sector- dividing restrictions in the financial market, will attract funds to banks. 

The volume of marketable financial products is expected to decrease 7.9 percent in the second quarter of 2000, amounting to 23.2 trillion won in total. As was the case in the first quarter, healthy banks with sufficient funds but few profitable investment opportunities have little reason to offer competitive interest rates for marketable financial products. 

The volume of foreign currency deposits is expected to decrease by 4.3 percent, down to 7.3 trillion won as a result of the continuous decline in the exchange rate that is expected to prolong for some time. 

The average interest rate on deposits in the second quarter is expected to be similar to that of the first quarter. Although there will be considerable market pressure to increase interest rates as competition increases, due to the narrowing of margins and a weakening of the profit structure, an increase in interest rates will not be feasible. Thus, interest rate on deposits will depend largely on the government, whose stance thus far has been to encourage low interest rates. 

Loan Market

1) Current Trends

The total volume of bank credits offered by deposit money banks, including loans in won, loans in foreign currencies, and loan guarantees and acceptances, is estimated to have been 307.7 trillion won in the first quarter of year 2000, an increase of 1.7 percent from the previous quarter. As shown in <Table 4>, this is a slight fall in comparison to 0.6 percent increase of the last quarter. Low increases in total credits offered by banks in both last and this quarter are attributed to the improvement in the financial status of corporations in general along with the growth of the overall economy. In addition, direct financing has become relatively easier, decreasing demand for bank loans. Moreover, it is relevant that the first quarter was a period of low fund demand from the corporate sector. 

Nevertheless, the total volume of bank credit has increased for a couple of reasons. First, the act of "window- dressing," where companies temporarily return loans for the purpose of decreasing their debt- equity ratio for year- end balances, was prevalent in the previous quarter as evidenced by December's 3.6 trillion won decline in the volume of credit given to large corporations as juxtaposed with January's 3.3 trillion won increase. Second, banks, anticipating a lack of borrowing demand from the corporate sector, placed emphasis on strengthening retail banking by, for example, providing loan services through the Internet to offer competitive rates on loans and also to provide convenient access channels for customers, as demonstrated by the rise in household borrowing in the first quarter of the year. 

<Table 4>                       Bank Loans¹⁾

(unit: billion won, %)

Notes: 1) End- of- quarter basis. The figures in parentheses represent the percentage change from the previous quarter.

2) Estimates.

3) Forecasts. 

Source: The Bank of Korea, Money & Banking Statistics (various issues).

Loans in won rose by 3.7 percent in the first quarter, amounting to 259.5 trillion won. As explained above, the window- dressing effect that was clearly present in December 1999 caused a substantial increase in loans in January 2000. In addition, banks loans made to small and medium- sized enterprises (SMEs) and venture corporations have been consistently increasing. In February, however, while corporate demand for loans fell, that of households rose. On the part of corporations, sufficient fund reserves combined with customarily low first- quarter demand for funds resulted in decrease in loans in won. Moreover, large corporations were able to rely on ITCs and the issuing of short- term CPs with relatively lower interest rates. SMEs and venture corporations were able to raise funds through the KOSDAQ market. Regarding households, although subdued excitement over the stock market has meant decreased demand for bank loans, as previously mentioned, the promotion of retail banking has resulted in an increase of banks loans for households. The volume of loans made through banking funds in the first quarter show an increase of 3.9 percent, totaling 238.8 trillion won, as shown in <Table 5>. The volume of discount bills show a large decline due to the large number of

<Table 5>               Loans with Banking Funds¹⁾

(unit: billion won, %)

Notes:1) End- of- quarter basis. The figures in parentheses represent the percentage change from the previous quarter.

2) Estimates.

Source: The Bank of Korea, Monthly Bulletin (various issues).

commercial bills that were issued late last year and have reached maturity. The overdraft volume largely increased as a response to its substantial decline in December 1999 due to the window- dressing effect. 

Loans in foreign currencies declined to 16.7 trillion won, or 9.5 percent, in the first quarter. There are three reasons for this decline. The first is the continuation of last quarter's trend in which a substantial decline was experienced due to a sufficient reserve of funds in large corporations as a result of overseas branch and asset sales made to streamline their businesses. Second, corporations made greater efforts to attain foreign financing. Lastly, the fact that large corporations are still very cautious about making overseas investments explains the low demand for loans in foreign currencies. 

As illustrated in <Table 6>, the average interest on loans in the first quarter of 2000 continued to decline. This is because banks have sufficient reserves on the one hand, but, on the other hand, are unable to use it productively. Consequently, banks are offering competitive rates in an effort to increase demand for household loans. Banks are also increasing their investment in long- term bonds, despite the risk of

<Table 6>        Interest Rates on Selected Bank Loans¹⁾

(unit: % per annum)

Notes: 1) End- of- quarter basis. 

2) Estimates.

Sources:  The Bank of Korea, Money & Banking Statistics, Monthly Bulletin and Trend of Interest Rates Offered by Banks and Non- Bank Financial Institutions (various issues).

reverse- margin effects. Many banks are known to have participated in the bidding for three- year maturity government bonds this February. 

2) Forecasts

The increase in the volume of total credit of loans given by money deposit banks in the second quarter of 2000 is expected to accelerate, with a total increase of 318.2 trillion won, or a jump of 3.4 percent. There are a couple reasons behind this increase. First of all, loan demand tends to increase with the passing of a period of low fund- demand by the corporate sector. Second, corporate investments are expected to increase significantly in the second quarter. Large corporations that require sizable funds for equipment investment will rely on bank loans, since there is a limit to what can be raised through NBFIs and direct financing. In addition, raising investment funds by the issuance of bonds is expected to be difficult as the bond market continues to under- perform. Moreover, the instability faced by ITCs as a result of both the implementation of new measures to mark bonds to the market and financial restructuring is likely to cause a decline in ITCs' bond purchasing power. The direct financing of equipment investment will be more likely for SMEs listed in the KOSDAQ market, but standing corporations will not be able to rely much on the stock market, since it is showing no signs of improvement. To summarize, with investment increases in the second quarter of 2000, corporate demands for bank loans are also expected to grow. 

Loans in won are expected to increase 4.8 percent in the second quarter, totaling 272 trillion won. As suggested above, this increase is attributable to an increase in equipment investment that is expected in the second quarter. In addition, SMEs and venture corporations have maintained continuous demand for bank loans in accordance with various policy supports by the government. Moreover, another factor contributing to the expected increase of loans in won is the increase in the commercial bill discount to compensate for the decline in commercial loans reaching maturity in the last quarter. Households loans will also continue to increase as banks continue promoting retail banking. Banks have introduced such various offers as preferential loans, SME Workers' loans, business trip loans, cyber transaction loans, and so forth. Certain banks have also begun to offer loan guarantees and preferential interest on loans for those that have subscribed to housing savings. 

The volume of loans in foreign currencies is expected to decrease by 5.7 percent, totaling 15.7 trillion won. Taking the current economic situation and corporate financial status into account, and all things being equal, there will be relatively small overseas investments in the near future. Hence, loans in foreign currencies are expected to continue declining into the second quarter. 

The average interest rate on loans is expected to increase slightly in the second quarter of 2000. Because of an anticipated increase in corporate loan demands for equipment investment purposes, banks that have been suffering from a worsening profit structure due to deposit- loan margin reductions will increase their interest rate. The range of increases, however, will depend mostly on the pace by which corporate demand for loans increases. It is, of course, necessary to keep in mind that the government's stance against high interest rates would make it difficult for banks to increase substantially the interest rate. 

Bank Trust Market

1) Current Trends

The total volume of trust accounts at deposit money banks has fallen 6.4 percent, amounting to 92.3 trillion won in the first quarter of year 2000, as shown in <Table 7>. Development Trust and New Installment Savings have been responsible for the continuing decline in overall volume of trust accounts, since both reached maturity in the first quarter. When combined, Development Trust and New Installment Savings contributed to the withdrawal of 7.8 trillion won this quarter.

Last quarter's decrease amounted to 12.4 trillion won, while a decline worth 6.3 trillion won was experienced in this quarter. As a result, the most noteworthy event concerning trust accounts in this quarter is the clear offset of the decline that persisted for the past couple of years. This offset is attributed to an increase in both Specific and Unit Trusts. In the first quarter, Specific and Unit Trusts showed a 2.2 trillion won and 1.3 trillion won increase, respectively. This is an impressive turnaround considering that Specific Trust, for example, experienced a 1 trillion won decline in the previous quarter. 

<Table 7>                    Trust Accounts¹⁾

(unit: billion won, %) 

Notes:1) End- of- quarter basis.  The figures in parentheses represent the component ratio. 

2) Estimates. 

3) Forecasts.

4) Including general unrestricted money trust, restricted installment trust, etc. 

5) From April 12, 1999 to April 12, 2000. 

6) From March 13, 2000 to March 13, 2001. 

Source: Individual Bank Data. 

The overall volume increase in some bank trust accounts can be attributed to several factors. First and foremost, with new amendments to banking legislation, bank trust accounts have been separated from the bank account and thus operate independently. This has meant that restrictions on account operations and maturity structures that bank trusts previously faced have been lifted, making bank trust competitiveness equal to that of ITCs.

Second, Y2K- related restrictions since last November on the introduction of new financial products by financial institutions was lifted in this quarter. As a result, competitive new products have been introduced to the market by the banking sector. For example, the Customized Short- Term Specific Trust that became available this quarter is considered to have incorporated more flexibility to its maturity structure and asset operations, receiving a popular response from investors. To elaborate, Customized Short- Term Specific Trust has less than one- year maturity, and anyone opting to discontinue any time after a period of three months is able to do so without penalty. Moreover, it is a wrap account product through which clients can have a direct say in asset operations, be it in bonds, securities (where up to 70 percent of investment is permitted), or a mixture of both.  Specific Trust sold extremely well in January, somewhat less so in February, but again showed an impressive rate of increase in 

<Table 8> Loans Funded by Bank Trusts and Investment in Securities¹⁾

(unit: billion won, %)

Notes: 1) End- of- quarter basis.  The figures in parentheses represent the component ratio. 

2) Estimates. 

3) Total amount of investment in securities less amount of securities in investment trusts. 

Source: The Bank of Korea, Monthly Bulletin (various issues).

March. Other examples of trusts that have shown competitiveness in this quarter are Unit and Additional Trusts. Unit Trust showed an increase of 0.3, 0.4, and 0.6 trillion won in January, February, and March respectively, for a total increase of 1.3 trillion won. Additional Trust has also contributed to an overall increase in the volume of trust accounts. It has been reported that 4 trillion won worth of investments flowed into Additional Trust on the very first day of its offering. 

The profitability of bank trusts have thus far been disappointing.  The most significant reason for this has been the build up of a provisional bond fund for write- offs. But, with enough reserves to cover existing liabilities, despite the low performance in the stock and bond market, the profit rate of bank trust in the first quarter of 2000 is expected to increase. 

2) Forecasts

The volume of trust accounts held at money deposit banks will continue to decline into the second quarter, but as in the first quarter, the decline will be offset by institutional conditions. More specifically, interdependent trust and bank accounts in investment operations that have made bank trusts less competitive in comparison to ITCs have been amended. Specific, Unit, and Additional Trusts are all expected to continue to increase their volume into the second quarter. In addition, with the introduction of Retirement Trust, whose market is estimated to be worth approximately 20- 30 trillion won, bank trusts have much room for improvement. 

Competition in the trust market is expected to lead to the development of new financial products. With the Internet boom, the on- line sale of trusts will be made possible, and clients will be able to log in to their computers to examine the details of where and how their trusts are being invested, potentially resulting in the greater build- up of clients' confidence in bank trusts. 

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Non- bank Financial Institutions

Overview

In the first quarter of 2000, deposits at non- bank financial institutions (NBFIs) fell by 6.4 percent from the previous quarter. Several factors, such as unstable stock markets and the continuing restructuring of NBFIs, were responsible for this decrease in deposits. Merchant Bank Corporations (MBCs) suffered from an ever deteriorating reputation sparked by the business suspension of Nara MBC on January 21. Deposits at Investment and Trust Companies (ITCs) showed a negative growth rate due to the increasing redemption of bond funds after Daewoo's technical default.  Regional non- bank financial institutions such as Mutual Savings and Finance Companies (MSFCs) and Credit Unions (CUs) also continued to experience negative growth in total deposits. This decline was due to increasing concern about deposit safety since the adoption of a new deposit insurance scheme that, beginning next year, will cover only 20 million won per account.  On the other hand Postal Savings (PSs) and Mutual Credits (MCs) showed positive deposit growth rates due to their fairly competitive interest rates and safety.

The total credits at NBFIs posted a 2 percent decrease in the first quarter of 2000. NBFIs tried to expand their lending by lowering lending rates but had little success. More firms preferred direct financing via bonds and the equity market or borrowing from banks, which offer more favorable rates than NBFIs. In the first quarter, MBCs focused on maintaining a good BIS capital adequacy ratio and reducing risky assets, most notably loans to firms. Other regional NBFIs such as MSFCs have maintained a very conservative stance in granting credit due to future structural reforms, even though the demand for consumer loans has started to pick up.

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<Table 9>Deposits and Credits at NBFIs¹⁾

(unit: billion won, %)

Notes:1)End of period. The figures in parentheses are the percentage change from the previous quarter.

2)Deposit at non- bank financial institutions = Merchant Bank Companies (issuance of their own paper + CMAs + sales of bills) + Investment and Trust companies (beneficiary certificates + stock savings) + Mutual Savings and Finance Companies (deposits) + Mutual Credits (deposits) + Postal Savings (deposits + RP).

3)Credits at non- bank financial institutions = Merchant Banking Corporations (paper discounts) + Mutual Savings and Finance Companies (loans + paper discounts) + Mutual Credits (loans) + Credit Unions (loans) + Community Credit Cooperatives (loans).

4) Estimates.

5) KIF Forecasts.

Sources:The Bank of Korea, Association of Merchant Banking Corporations, Korean Federation of Mutual Savings and Finance Companies, Association of Credit Unions, and Korea Credit Rating Agency.

- 22 -

In the second quarter, most NBFIs, except Postal Savings and Mutual Credits, are expected to experience a decrease in total deposits. The announced "MBCs reform plan" in the first quarter will have positive effects on the remaining MBCs, but it is still unlikely that MBCs will experience dramatic improvements in their business environment.  ITCs will continue experiencing a decrease in deposits in the second quarter as the introduction of the mark- to- market accounting of bond funds from July will reduce the competitiveness of ITC products. Total deposits at regional financial institutions such as MSFCs will also show negative growth in the second quarter because they are expected to reduce interest rates on deposit products in order to overcome the problem of excess liquidity.

The total credits at NBFIs are expected to decline in the second quarter as well.  To meet the one party loan exposure limit regulation, MBCs will have to switch their main target client base from big conglomerates to small-  and medium- sized enterprises (SMEs), but it will not be easy to establish a good SME client base in a short time.  The total credits of regional NBFIs are expected to show negative growth since they have to maintain a relatively high lending rate due to high funding costs, and they are lagging behind large banks in exploring new financial marketing channels such as Internet banking.

Postal Savings have been experiencing a steady increase in deposits for the last several quarters due to their safety and relatively high interest rates. In contrast to the deposits at MSFCs and MCs, for which Korea Deposit Insurance Corp. guarantees partial deposit protection, Postal Savings offer full deposit protection because they are based on different regulations and government acts. In addition, the nationwide postal office network gives postal savings a marketing advantage.  This uneven playing field for Postal Savings and other NBFIs in terms of deposit protection schemes and distribution channels has been criticized by many experts and may cause moral hazard problems.  A leveling of the playing field among NBFIs, including postal savings, is imminent. 

Compared to large financial institutions like banks, NBFIs lag behind in developing an internal risk management system. Since different kinds of NBFIs are engaged in different business lines and face different kinds of risks, NBFI risk management systems should meet a wide range of criteria. To make matters worse, small NBFIs have few resources for developing their own risk management systems, due to the high costs of IT investments. The FSC should be kind enough to direct NBFIs to share the costs and develop a risk management system collectively via their Self- Regulatory Organizations (SROs). However, the emphasis of NBFI risk management should vary depending on its purpose. For example, MBCs should emphasize the analysis of credit risks and market risks, such as exchange risk and interest risk, whereas the main focus of NBFIs specializing in lending, such as leasing companies, should be an asset- liability management system.

Merchant Banking Corporations

In the first quarter of 2000, the total volume of deposits at MBCs fell by 4.3 percent from the previous quarter. The deteriorating reputation of MBCs, which was exacerbated by the closing of Nara Merchant Bank Corp. in January, was mainly responsible for the decrease in deposits. As deposits of Cash Management Accounts, the most competitive product of at MBCs with fairly high interest rates, showed a drastic decrease in the first quarter, MBCs had to increase the issuance of their own paper.

Total credits at MBCs in the first quarter of 2000 fell by 9.1 percent from the previous quarter. MBCs had to maintain good BIS capital adequacy ratios as of the end of their fiscal year by decreasing their risky assets, which were mainly loans to firms. In particular, it is notable that the balance of factoring financing to small-  and medium- sized firms has deceased in the first quarter. In addition, more firms preferred direct financing via corporate bonds or equity, another reason for declining MBC credits to firms.

In the first quarter the Financial Supervisory Commission announced prudential guidelines regarding MBCs' M&A and related business licensing.  If MBCs merge with security houses, the merged entity can engage in the current MBC business line for a limited period, enjoying the potential synergy effects of merging with security houses.  Moreover, MBCs can simply maintain their current MBC status, but most MBCs are considering some kinds of business restructuring since the business environment for MBCs is deteriorating.  After all, the decision regarding business restructuring is up to each MBC given their own core competency and market demands.

Total deposits at MBCs are expected to fall slightly in the second quarter of 2000. Some MBCs are expected to merge with their own related financial institutions, like bank and security houses, which will reduce the total deposits in MBCs.  However the volume of CMAs should grow in the second quarter as the 

<Table 10>Deposit and Credits at MBCs¹⁾

(unit: billion won, %)

Notes:1)End of period. The figures in parentheses are the percentage change from the previous quarter.

2) KIF forecasts.

Source: Korea Credit Rating Agency.

restructuring of ITCs is expected to divert the demand for the ITCs' similar product, Money Market Funds (MMF), to CMAs. Both ITCs' MMF and MBCs' CMA are short- term financial products with fairly competitive interest rates and no maturity.

Like total deposits, total credit at MBCs is also expected to fall in the second quarter. Firms will have demand for working capital but they prefer to finance directly from the capital market by issuing stock or corporate bonds rather than issuing short- term CPs. In the second quarter MBCs will try to reduce large one- party credit exposure and to establish a new business relationship with small-  and medium- sized enterprises. But establishing a new client base of SMEs with good credit standings will not be easy in a short period of time. 

<Figure 1>      Deposits and Credits at MBCs

- 23 -

Investment and Trust Companies

The total balance of ITCs in the first quarter of 2000 is estimated to have decreased 12.1 percent from the previous quarter to 162 trillion won.  The balance of bond funds decreased drastically in the first quarter, due to the redemption of bond funds, including Daewoo's paper. However, the balance of MMF showed a fairly high growth rate due to its high interest rates. The balance of stock funds showed a 16.7 percent increase in the first quarter, but this figure may be somewhat misleading. The increase of stock funds was due to the huge conversion of Daewoo- related bonds funds to Collateralized Bonds Funds (CBOs), or High Yield Funds, which are classified as stock funds. According to the current regulation, all funds with any amount of stock in their portfolio are classified as stock funds.  The FSC is expected to change this rule in the near future.

<Table 11>Deposits at ITCs¹⁾

(unit: billion won, %)

Notes:1)End of period. The figures in parentheses are the percentage change from the previous quarter.

2) Investment and Trust Companies, Merchant Banking Corporations.

3) Deposits, Bills, Call Loan.

4) KIF Forecasts.

Sources: Korea Investors, Inc., KIS- LINE.

Association of Investment and Trust, Beneficiary Certificates.

In the first quarter of 2000, the amount of money invested in stocks and bonds by ITCs is estimated at 24 trillion won and 85 trillion won, respectively. Both figures represent a drastic decrease from the previous quarter. However, the short- term loans, or the overnight call loans of ITCs, increased slightly in the first quarter.

In the second quarter, there will be several influential factors determining  ITC deposits. Most importantly, the structural reform of ITCs, along with the introduction of mark- to- market accounting of bond funds in July, will have negative effects the growth of bond funds of ITCs. In addition, with symptoms of a slowing down in the new economy, the increased volatility of the stock market, especially for new technology and Internet businesses, will allow only meager growth in stock funds. 

The FSC is going to allow ITCs to have privately placed stock funds in 2000.  Since the fund managers of privately placed stock funds have more freedom in portfolio investments, this will be very popular among many institutional investors.  However, without proper prudential regulation, this could be used illegitimately for M&As or insider trading, so stricter examinations and transparent disclosures of fund accounting will be necessary. 

<Figure 2>            Deposits at ITCs

Mutual Savings and Finance Companies

As with other NBFIs, total deposits at Mutual Savings and Finance Companies (MSFCs) posted negative growth in the first quarter of 2000.  The exit of several ailing MSFCs from the market and the anticipation of next year's partial deposit protection scheme aggravated the decrease in MSFCs' deposits. Moreover, the competition between MSFCs and banks in the consumer finance market continues to intensify.  However, several large sized MSFCs posted deposit increases, attracting more clients with high deposit interest rates and newly designed products.

In the first quarter of 2000, total credits at MSFCs posted 17.5 trillion won, a 6.2 percent decrease from the previous quarter. The exit of many ailing MSFCs from the market was the main reason for the decrease in total credits at MSFCs. Even though MSFCs are introducing new loan products that use the Internet as marketing channel, they are no match for similar bank products.  The weak credit evaluation skills of MSFCs are another obstacle for MSFCs' credit extensions. 

<Table 12>Deposits at MSFCs¹⁾

(unit: billion won, %)

Notes:1)End of Period. The figures in parentheses are the percentage change from the previous quarter.

2) Estimates.

3) KIF Forecasts.

Source: Korea Federation of Mutual Savings and Finance Companies.

In the second quarter of 2000, total deposits at MSFCs are expected to decrease about 2.3 percent since many MSFCs are expected to lower interest rates on their deposit products, to avoid the excess liquidity problem.  Several marketing strategies 

<Figure 3>     Deposits and Credits at MSFCs

<Table 13>Credits at MSFCs¹⁾

(unit: billion won, %)