KOREAN FINANCIAL

REVIEW

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

QUARTERLY ANALYSIS & FORECAST

Vol. 12, No. 1                              Spring 2002

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

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

CONTENTS 

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

Lead Article: Estimating a Pricing Kernel

Using Option Prices   󰠜󰠜󰠜󰠜󰠜󰠜󰠜 3

President and Publisher

Macroeconomic Developments 󰠜󰠜󰠜󰠜󰠜󰠜󰠜󰠜󰠜󰠜󰠜󰠜 29

Hae Wang Chung

Current Status and Prospects

Money and Interest Rates 

Financial Market Developments 󰠜󰠜󰠜󰠜󰠜󰠜󰠜󰠜󰠜󰠜 76

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- 6272, Fax (82- 2) 3705- 6285.

Estimating a Pricing Kernel Using Option Prices

Sangil Han*

Ⅰ. Preface

1. The Necessity for Studying the KOSPI 200 Index Option Markets 

In March 2002, the trading amount and volume of the KOSPI 200 Index options recorded about 6 mil and 480 billion won. These figures are ranked as one of the largest trade amount in the world for a single item. Option trades for interest rate futures were listed last May and the OTC derivatives for securities companies will be permitted beginning July 2002. Hence, the derivative markets are expected to grow continuously. However, empirical studies on the KOSPI option markets have not fully progressed compared to those on the KOSPI spot and future markets. 

Currently, many estimation methodologies for a pricing kernel have been presented in academia. Therefore, to study the KOSPI index option markets, it is necessary to review the existing option pricing models and perform statistical studies on the advanced markets which has empirical facts. This paper will briefly review the option pricing models and estimate the parameters under a risk neutral economy.

* Research fellow at KIF.

- 3 -

In particular, we will estimate a pricing kernel using the data of implied volatility by Ait- Sahalia & Lo(1998). If there is an one- to- one correspondence between volatility as a latent variable and implied volatility, then it will be possible to estimate the parameters using the observable data of implied volatility. 

The composition of this report is outlined below. First, the present option pricing models are examined in the next section. Second, various estimation methodologies for stochastic processes are examined in the chapter 3. Third, the parameters of a stochastic process itself and a pricing kernel are estimated using the data by Ait- Sahalia & Lo(1998) in the chapter 4. Last, the chapter 5 includes the conclusion.

2. A Brief Survey of the Literature 

If the stochastic process of underlying assets is a constant geometric Brownian, then, according to the Black- Scholes Option Pricing Model (BSOPM), the implied volatility induced by option prices should be constant regardless of their moneyness(exercising price/price of underlying assets) and maturities. However, the implied volatility calculated by the BSOPM varies according to its moneyness and maturity. If the implied volatility is high in ITM or OTM, and low in ATM, it is called the smile phenomena. In the U.S. market, the smile phenomena was observed before the Black Monday in 1987, and the smirk phenomena was observed afterwards in which the implied volatility of ITM is low, but that of OTM is high. Normally, ATM options is the most liquid product. So, the implied volatility can be calculated by using it. However, assuming the volatility calculated from the implied volatility of ATM in the BSOPM, the pricing of OTM or ITM options could be biased due to the smirk phenomena. In addition, if the volatility is time varying, the valuation of long or short term options under the assumption of a fixed volatility is not theoretically consistent. If the implied volatility of short term option prices is calculated by the BSOPM, then the implied volatility could as high as 10 sometimes. Therefore, the BSOPM is not a appropriate model in pricing short term options. 

- 4 -

The solutions for the BSOPM problems are classified into two categories. First, Hull- White(1988)'s method of calibrating a stochastic process of underlying assets by inputting the smile phenomena into the model, then calculating relative values of the other assets belongs to one category. Second, the method of Merton (1976), Heston (1993) and Bates (1996) setting a stochastic process of the underlying assets, then estimating the parameters which determine a pricing kernel under equilibrium or no arbitrage condition is the other category. The former has focused on developing efficient algorithms, and the latter has focused on estimating the probability distribution of option prices and underlying assets. According to the stochastic process of the underlying assets and volatility, the option pricing models can be classified into the BSOPM, Merton(1976)'s jump diffusion model, Heston(1993)'s stochastic volatility model, and Bates(1996)'s universal volatility model. The pricing formula for each model can be induced by placing appropriate restrictions on the stochastic process of underlying assets. The stochastic volatility model is especially simple, and provides an explanation for the smile phenomena. The purpose of this research is to empirically analyze the Heston(1993)'s model.

When estimating the stochastic process of underlying assets, the problem that is arises is how to statistically estimate the stochastic process. The estimation methods for diffusions include MLE(maximum likelihood estimation), QLE(quasi- likelihood estimation), GMM(generalized method of moment), Kalman Filter and Gallant- Tauchen's EMM(efficient method of moment). When the stochastic process to be estimated has a simple structure, such as the Geometric Brownian motion, MLE may be the most efficient method. But, if the stochastic process has mean reverting or has level effects, it will be very difficult to estimate the parameters through MLE because the distribution function of the square root process is composed of Bessel functions. In this case, QLE may be used, but it does not use the full information of the stochastic process. And, GMM needs additional information about the moment distribution to be applied. On the contrary, EMM is based on SME(simulated method of moment), therefore the information on the distribution of moment is not necessary. Chernov- Ghysels(2000) estimated the 

- 5 -

parameters of the option pricing formula by using EMM. In addition to these parametric methods, Ait- Sahalia & Lo(1998) proposed a non- parametric estimation of the pricing kernel using option prices. This method, however, can invoke over- fitting problems to the observed data. In this paper, several estimation methodologies were examined, then the parameters of SDE(stochastic differential equation) by using option data from Ait- Sahalia & Lo were estimated. Lastly, the pricing parameters under a risk neutral economy were estimated.

Ⅱ. The Analysis Model

1. The Black- Scholes Model

- 6 -

The solution of the above partial differentiation can be obtained by using separations of the variables or Fourier transform technique, and it is called the Black- Scholes formula.

- 7 -

In the formula above, the density function of the equivalent martingale measure can be separated. Let's call it a pricing kernel. Financial products with complex payoff structures, such as exotic options can be evaluated by using Harrison- Kreps's theorem(1979) if the payoff function and a pricing kernel is known. The pricing kernel is a normal distribution when the underlying assets follows the Geometric Brownian process. Because Harrison- Kreps's theorem(1979) holds under the other diffusion process, the methodology using the martingale measure can be an efficient method even when the returns of the underlying assets does not follow the Brownian process.

2. The Stochastic Volatility Model

- 8 -

- 9 -

<Picture Ⅱ- 1 > The Smile Phenomenon Explained by the Heston Model

- 10 -

The implied volatility, which is calculated by the Black- Scholes pricing formula, has a smile form when an option price is determined by the stochastic volatility model. And, <Picture Ⅱ- 1> shows a graph, under an appropriate stochastic volatility process revealing the implied volatility calculated by the Black- Scholes pricing formula after having options priced by the Heston model, when the prices of the underlying assets are 1, and the exercise prices moves from 0.5 to 3. <Picture Ⅱ- 1> explicitly shows that the Heston model can explain the smile phenomena in the market. However, real market data show the jump and volatility clustering phenomena in the time series of the  implied volatility. And, it should be proved whether the Heston model can explain these phenomena. Therefore, the empirical analysis is discussed in the next chapter to estimate parameters by using the Heston model. 

Ⅲ. The Estimating Methodology of Diffusion 

1. MLE, Kalman Filter and QLE

The diffusion process is a special type of Markov process, and the Kolmogolov backward equation  can be expressed by the mean and distribution terms.

- 11 -

2. GMM

When estimating the pricing kernel, the joint density of option prices and underlying assets should be obtained before calculating the moment. However, if the stochastic process of underlying assets follows the square root process, it is very difficult to analytically obtain the joint distribution function. Instead of calculating the joint distribution of option prices and underlying asset, Pan(2002) obtained the joint distribution of the underlying assets and the implied volatility, and then applied GMM. The moment is calculated by using the fact that the joint distribution becomes moment when the partial derivatives of CCF(conditional characteristic function) becomes 0. However, the GMM estimation of this method can only be used when the shape of the joint distribution function is known.

Chan- Karolyi- Longstaff- Sanders(1992) estimated the parameters of a SDE by using GMM, after assuming that the unrestricted model follows the below short- term interest rate model.

- 12 -

Chan- Karolyi- Longstaff- Sanders(1992) suggested a discrete approximation to empirically test the parametric short- term interest rate model, which is an unrestricted model, using data which had been observed discontinuously. 

From this formula,

- 13 -

3. EMM

1) An overview of EMM 

- 14 -

- 15 -

Quasi MLE can be calculated below.

To estimate the distribution function, the values of <table  Ⅲ- 1> must have been selected before. Various kinds of distribution functions can be determined as shown by <Table Ⅲ- 1> or by BIC (Schwarz's Bayesian information Criterion) in the formula Ⅲ- 14 below.

In the first step, the score below can be calculated under the moment condition in the semi- non- parametric (SNP) estimation and the expected value is 0.

- 16 -

EMM, the minimum chi- square estimated value, can be defined as below.

Here,

- 17 -

2) Application on Estimating a Pricing Kernel

- 18 -

Ⅳ. Empirical Analysis

1. The Analyzing Method and Its Data

In this research, the joint distribution function of stock returns and the implied volatility by using the trade data of options provided by Sahalia- Lo(1998) were estimated. The data used by Sahalia- Lo is outlined below.

Firstly, the call and put option prices of 16,923 pairs, which were calculated by averaging the bid and ask prices of S&P 500 index options having been traded in CBOE from January 4, 1993 to December 31, 1993, were selected. Among these options, options of which maturities were shorter than one day, of which volatilities were above 70%, and of which prices were less than 1/8 were excluded. The number of the remaining options was 14,431. The mean and standard deviation of return on the investment of S&P 500 indexes were 7.98% and 10.28% respectively. Short term interest rates were rather even, from the minimum of 2.85% to the maximum of 3.21%.

<Picture Ⅳ- 1>     The Implied Volatility for the Short Term Options 

- 19 -

By using the relation between futures and spots, the put- call parity can be defined as follows, and implied futures prices can be induced. The future prices obtained like this have all the information about the put options. Therefore, it is 

- 20 -

possible to empirically analyze the whole option markets with the call options and the implied future prices. Because dividends are not included in the option pricing function, the dividend problem disappears. 

To induce the prices of futures, the proper prices of ITM call options are calculated after having calculated future prices by using the put- call parity. In this report, the options having moneyness between 0.7 and 1.3, and of which maturities were longer than 10 days were selected. <Table Ⅳ- 1> shows the implied future values calculated like this and simple statistics of the time series. The time series are shown in  <Picture Ⅳ- 1> and <Picture Ⅳ- 2>.

<Table Ⅳ- 1>     Simple Statistic Values for S&P 500 Index Options

Std. Dvn.: Standard Deviation, Exer.: Exercise, Fur.: Future, Int.: Interest

- 21 -

2. The Analysis of the Time- Series Characteristics of the Implied Volatility 

Although Ait- Sahalia&Lo used future prices for analysis, it is necessary to directly use returns of stock prices. The formula <Ⅳ- 1> shows the calculation of spot returns by using short term interest rates and maturities, without considering dividends. The distribution of the spot returns is stationary in <Picture Ⅳ- 2>, but not in <Picture Ⅳ- 3>. So, the unit root tests were done to find the stationarity in the statistical values. <Table Ⅳ- 2> shows the result of the ADF unit root tests. According to the result, the implied volatility itself is non- stationary, but ADF of the implied volatility is - 3.821339, which is less than - 3.4586, the 1% level of significance. Therefore, the log volatility seems to be stable, and is the subject of the empirical analysis. 

First, the distribution function of the log volatility was estimated by the kernel density method which is a non- parametric estimation method. <Picture Ⅳ- 4> and <Picture Ⅳ- 5>. shows the results. Especially, <Picture Ⅳ- 5> shows that the volatility is in the non- gaussian form. The Jarque- Bara statistical value, 0.147583, confirms the fact. 

<Picture Ⅳ- 2> Returns           <Picture Ⅳ- 3> Implied Volatility

- 22 -

<Table Ⅳ- 2>                    Unit Root Test

<Picture Ⅳ- 6> Periodogram of Returns    <Picture Ⅳ- 7> Periodogram of Imp Vol

- 23 -

3. Estimating the Parameters of SDE and the Pricing Kernel

- 24 -

To estimate parameters of the implied volatility under risk neutral conditions, the short term interest rate was assumed to be 4%, and using EMM the stochastic process was estimated directly with the following formula. <Table Ⅳ- 4> shows the estimation result of parameters by using EMM.

- 25 -

<Table Ⅳ- 3>                  Goodness of Fit

<Table Ⅳ- 4>      Parameters under a Risk Neutral Economy

Ⅴ. Conclusion

In this report, the distribution function of the implied volatility was estimated by using SNP. According to the result, the distribution function of the implied volatility has the GARCH effect at the same time it posessing a non- linear and non- parametric distribution function rather than the normal distribution. And, the parameters under the risk neutral condition were estimated by using EMM, and it was found that it can explain the mean reversion effect for some degree. However, the fitness of the stochastic volatility model itself was low. This methodology can produce abundant empirical results if it is applied to the domestic option market. Especially, because the EMM methodology can be applied to the time series itself, it also can be applied to the level of interest rates, the stock index, and the foreign exchange rates.

However, in this research, the empirical analysis using step by step the BIC selecting procedure was not achieved. When these experiments were performed, then the usefulness for hedging of each model can be evaluated by the domestic option market data.

- 26 -

References

Ait- Sahalia, Y., Lo, A., 1998. Nonparametric Estimation of State- price Densities Implicit in Financial Prices, Journal of Finance 53, 499- 548.

Bates, D.S., Jumps and Stochastic Volatility: Exchange Rate Processes Implicit in Deutschemark Options, Review of Financial Studies, 1996. 69- 107 

Chan,  K., A. Karoli, F. Lonstaff and A. Sanders, 1992, An Empirical Comparison of Alternative Models of the Short Term Interest Rate, Journal of Finance, July,  1209 -  1226

Chernov, M., E. Ghysels, 2000, A Study Toward an Unified Approach to the Joint Estimation of Objective and Risk Neutral Measures for the Purpose of Options Valuation, Journal of Financial Economics 56, 407- 458

Cox, J., Ingersoll, J., Ross, S., 1985. A Theory of the Term Structure of Interest Rates, Econometrica 53, 385- 408.

Duffie  D., and K. Singleton, 1993, Simulated Moment Estimation of Markov Process Models of Asset Prices, Econometrica, 61, pp. 929~953

Duffie, D., Pan, J., Singleton, K., 1998. Transform Analysis and Option Pricing for Affine Jump- Diffusions, Econometrica, 68, 1342- 1376

Gallant, A.R., Tauchen, G., 1989. Seminonparametric Estimation of Conditionally Constrained Heterogeneous Processes: Asset Pricing Applications, Econometrica 57, 1091- 1120.

Gallant, A.R., Tauchen, G., 1996. Which Moments to Match? Econometric Theory 12, 657- 681.

Gallant, A.R., Hsieh, D., Tauchen, G., 1997. Estimation of Stochastic Volatility Models with Diagnostics, Journal of Econometrics 81, 159- 192.

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

Harrison, M., Kreps, D., 1979. Martingales and Arbitrage in Multiperiod Securities Markets, Journal of Economic Theory 20, 381- 408.

- 27 -

Heston, S.L., 1993. A Closed- Form Solution for Options with Stochastic Volatility with Applications to Bond and Currency Options, Review of Financial Studies 6, 327- 343.

Hull, J., White, A., 1987. The Pricing of Options on Assets with Stochastic Volatilities, Journal of Finance 42, 281- 300.

Merton, R., 1976, Option Pricing When Underlying Stock Returns are Discontinuous, Journal of Financial Economics, 3, 125- 144

Pan, J., 2002, The Jump Risk Premia Implicit Evidence from an Integrated Time Series Study, Journal of Financial Economics, 63, 3- 50

- 28 -

Macroeconomic Developments

Current Status and Prospects

Economic Growth

1) Review

According to the 2001 National Accounts (provisional version) by the Bank of Korea in March, the Korean economy grew by 3.0 percent year- on- year as a result of slumps in equipment investments and exports, which centered on the IT industry including semiconductor, computer, and telecommunication apparatus (<Table 1>). This was attributable to the recession in advanced economies, including America, Japan, and Europe, additional setbacks in the global economy due to the September 11th terrorist attack on the U.S. and the War on Terrorism, and the aggravated terms of trade.

By sector, private consumption grew by 4.2 percent year- on- year and contributed only 2.2 percentage points to the GDP (gross domestic product), which was down from the previous year (<Table 2>). Spending on services increased while spending on durable and semi- durable goods decreased. Equipment investments decreased by 9.8 percent as investments in electric and electronic machinery, including computer and wire telecommunication apparatus, vessels, aircrafts, and buses declined. The decrease in equipment investments was the major impediment for economic growth. With a 1.0 percent increase in exports and a 2.8 percent decrease in exports, net imports, contributed 1.7 percentage points to the GDP. By quarter, after recording its lowest growth in the third quarter at 1.9 percent, the real GDP growth rate rebounded to 3.7 percent in the fourth quarter as private consumption and construction investments picked up because of an additional reduction in call rates and expansionary fiscal policies after the terrorist attacks on the U.S. 

- 29 -

<Table 1>      Trends and Forecasts of Economic Growth¹⁾

(Unit: %)

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

2) Goods and services.

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

<Table 2>       Contribution to the Growth Rate by Factors¹⁾

(Unit: %)

Note: 1) Year- on- year percentage changes.

Contribution = (Change in each factor/Change in GDP) × GDP growth rate.

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

- 30 -

Korea's GDP is estimated to grow by 4.4 percent in the first quarter of 2002, which is up from the previous quarter. Private consumption and construction investments, which are the engines for economic recovery, are forecast to grow by 4.2 percent and 7.2 percent, respectively. Equipment investments are forecast to decrease by 1.3 percent due to a consecutive drop in exports on a customs- cleared basis. In the National Accounts, total exports are forecast to grow by 1.5 percent while total imports are estimated to build up to 3.7 percent. A glimpse of a higher industrial production index in January led some economists to believe that the Korean economy was overheated. The industrial production index, however, turned to fall in February and exports continued to decline until March, which was a sign that Korea's GDP in the first quarter would not surpass the potential GDP. Conclusive evidence confirming that the economy is overheated has not found so far.

The 4.4 percent GDP growth rate in the first quarter was based on robust industrial activities indices. Although the industrial production index in February lost 2.6 percentage points due to the reduced number of working days accounting for Lunar New Year's holiday, the industrial production index increased by 3.8 percent between January and February due to a 10.2 percent upsurge in January. In particular, automobiles and audio telecommunication apparatus grew by 31.2 percent and 32.5 percent, respectively, in January. Like in January, however, the industries of refined petroleum products and leather/footwear decreased by 22.0 percent and 12.3 percent year- on- year, respectively. 

Producer's shipments between January and February increased by 8.5 percent for domestic demand recovered slowly. In January, with refined petroleum products decreasing, producer's shipments increased by 13.6 percent year- on- year because semiconductors, vehicles, audio and telecommunication equipment rose. Producer's shipments for exports increased by 5.5 percent due to an increase in the industries of semiconductor, audio and telecommunication equipment, vessels, and vehicles. Producer's shipments for domestic use increased significantly by 20.9 percent because of a sharp gain in vehicles, office and computing machinery, basic metals, audio and telecommunication equipment, and semiconductor industries. In February, 

- 31 -

producer's shipments increased by 3.4 percent. Producer's shipments for exports grew by only 0.9 percent due to a brisk increase in semiconductors and petrochemical, while producer's shipments for domestic use picked up 5.5 percent owing to a rise in audio telecommunication, semiconductor, and office and computing machinery.

<Figure 1>         Industrial Production and Consumption

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

<Figure 2>         Growth Rate of Producer's Shipments

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

- 32 -

Producer's inventory of finished goods continued to decline by 5.4 percent in January and 9.4 percent in February, which is down from the 1.7 percent fall the previous quarter as inventory in semiconductors and vehicles decreased (<Figure 3>). The average operations ratio marked 76.5 percent between January and February, which was higher than 72.4 percent the previous quarter. The rise is affected by a robust consumption even though refined petroleum products and office computing machinery declined. 

During the first quarter, private consumption is expected to grow by 4.2 percent as expenditure services and durable goods, also rose including vehicles and cellular phones, which was slightly lower than a 6.6 percent rise the previous quarter. According to industrial activities indices, the wholesale and retail industries jumped to 7.3 percent in January and 8.2 percent in February, up from 6.5 percent in the fourth quarter of 2001. The rise was buttressed by the extended sales of household appliances and vehicles in spite of a slump in agricultural and marine product sales (<Table 3>). Another consumption indicator, consumption goods shipments for domestic demand, grew by 16.9 percent in January, which is up from 0.8 percent the previous quarter. This sharp rise was helped by the solid sales of vehicles, cellular

<Figure 3>                 Inventory Cycle

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

- 33 -

phones, and water purifiers. This indicator continued to increase by 6.2 percent in February. 

Corporate equipment investments in the National Accounts are estimated to decrease by 1.3 percent year- on- year during the first quarter. This forecast is supported by a 2.4 percent rise in the estimate of equipment investment between January and February, which was somewhat higher than 1.6 percent previous quarter. The estimate of equipment investments increased by 5.8 percent in January, hit by a rise in machinery for industry use, while it decreased by 1.0 percent in February because of the reduced number of working days during the Lunar New Year's holiday. Domestic machinery orders increased by 21.2 percent between January and February, up from - 7.1 percent the previous quarter, as private and public orders grew. Construction investments in the National Accounts are estimated to grow by 7.2 percent in the first quarter from 10.7 percent the previous quarter. Domestic construction orders went up by 39.5 percent in January and 41.9 percent in February, affected by an increase in residential construction orders in the private sector and a rise in road and bridge construction orders in the public sector. 

<Figure 4> Equipment Investment Estimates and Domestic Construction Orders

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

- 34 -

As consumption and construction investments went up, the cyclical component of the coincident composite index (CI) in February implied that the Korean economy was recovering after hitting the trough in the third quarter of 2001. The cyclical component of the coincident CI recorded 99.2 in February, up 1.2 percentage points from 98.0 trough in August 2001. Though the growth rate of the cyclical component of the coincident CI was not steep and export growth rates were negative, the speed of recovery seemed to be sluggish. However, the leading CI turned to rise after hitting a low in January 2001, and it reached 5.7 percent in January 2002 and 6.1 percent in February 2002. The rise has been relatively higher than those in the past, with exception to the 1997 economic crisis, indicating that the economy may rebound fast in the second half of the year (<Figure 5>).

<Figure 5> Changes in the Leading CI and Cyclical Component of the Coincident CI

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

<Table 3>           Industrial Activities Indices 

- 35 -

(Unit: yoy, %)

Sources: 1) National Statistical Office, Monthly Statistics of Industrial Production, various issues.

The Bank of Korea, Money & Banking Statistics, various issues.

2) Forecast

For 2002, the Korean economy was forecasted to grow at a slower pace in the first quarter but will grow faster in the second quarter as exports grow positively. This forecast is based on economic sentiments and leading macroeconomic indicators. The leading composite index, year- on- year, and the consumer expectation index continued to rise until February this year. According to the Bank of Korea's ‘Business Survey Index During the First Quarter of 2002’, the manufacturing industry's BSI rose to 90, up from 85 the previous quarter, and the BSI for profit increased to 89, up from 85 the previous quarter. The BSI by the Federation of Korean 

- 36 -

Industries (FKI) rose to 110.7 in February from 75.9 last October. 

<Figure 6>            Business Survey Index (BSI) Trends

Note: The peak of the business cycle (P) in August 2000 and the trough (T) in August 2001 are KIF forecasts.

Source: The Bank of Korea.

<Figure 7>     Trends of Forecasted Business Survey Index (BSI) 

Note: The peak of the business cycle (P) in August 2000 and the trough (T) in August 2001 are KIF forecasts.

Source: The Bank of Korea.

The Korean economy will rebound fast if IT industries in the U.S. recover. 

- 37 -

Recently, inventory adjustment in the semiconductor sector almost ended and demand- supply circumstances in IT industries improved. In the Korean semiconductor

<Table 4>        Trends and Forecasts of Economic Growth¹⁾

(Unit: %)

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

2) Figures in 2002 are KIF forecasts. 

3) Goods and services.

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

<Table 5>      Contributions to the Growth Rate by Factor¹⁾

(Unit: %)

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

Contribution = (Change in each factor/Change in GDP) × GDP growth rate.

2) Figures in 2002 are KIF forecasts. 

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

industry, Samsung Electronics Company and Hynix Semiconductor Inc., two major 

- 38 -

DRAM manufacturing companies, downscaled their excess inventories, and the average price of 128M SD RAM rose from US$1.00 level in October 2001 to US$3.70 in February 2002.

Considering the circumstances above, Korea's GDP in the second quarter is forecast to grow by 5.0 percent due to a sharp increase in consumption and a recovery in exports. Korea's GDP will not reach its expected growth if any of the following occur: heightened fears concerning the financial crisis in Japan, an upsurge in oil prices caused by the expansion of the War on Terrorism, severe trade frictions, and further devaluation of the Japanese yen. The engine for growth will be the low interest policy, fiscal expansion, a rise in private consumption (due to an increase in household credit and a bullish stock market) and brisk construction investments. In particular, since the government enlarged the constructional budget and expanded the volume of common houses to be built, construction investments are forecast to grow in the second quarter.

Due to a bullish stock market, an increase in household credit, additional procurements of the World Cup soccer tournament, and improved terms of trade with the recovery of the semiconductor industry, private consumption is expected to grow by 4.8 percent in the second quarter of 2002. According to a survey by the National Statistical Office, the consumer expectation index, which measures consumers' outlook regarding economic growth and spending for the next six months, increased to 106.7 in January 2002 from 82.2 in December 2000. The BOK's consumption planning consumer survey index (CSI) went up to 121 in the first quarter of 2002 from 111 the previous quarter. The increases in both the consumer expectation index and the CSI foreshadow favorable conditions for consumption in the second quarter.

<Figure 8>       Contributions to the Growth Rate by Factors

- 39 -

<Figure 9>   Consumer Expectation and Consumer Evaluation Indices

Source: National Statistical Office.

Equipment investments in the National Accounts are forecast to increase by 0.5 

- 40 -

percent in the second quarter due to a rise in exports, up from a 1.3 percent decline the previous quarter. This positive forecast is supported by the fact that the BSI for the execution of equipment investments increased to 94 from 89 the previous quarter. Construction investments will increase by 5.0 percent as orders for construction in the public sector increase and housing construction builds up with the government's help in the housing industry.

Price and Wage

1) Review

During the first quarter of 2002, the consumer price index (CPI) increased by 2.5 percent year- on- year and went up by 1.0 percent month- on- month (<Table 6>). Although agricultural product prices and housing rent increased significantly, the CPI continues to be down from last year because of the fall in the prices of petroleum and the public services. In January, the CPI rose by 2.6 percent year- on- year. This was attributable to a 0.3 percent fall in manufacturing product prices, notwithstanding a 8.3 percent gain in agricultural and marine product prices due to the Lunar New Year's holiday and a 5.8 percent gain in housing rent. In February, the CPI increased by 2.6 percent year- on- year due to a 1.2 percent decline in the price of public services and a 7.0 percent fall in petroleum despite a 9.8 percent rise in agricultural and marine product prices and a 6.0 percent gain in housing rent. In March, the CPI rose by 2.3 percent year- on- year in the three consecutive months. By item, food products grew by 4.0 percent, although the vegetables and seaweed products went down 7.3 percent due to an increase in shipments, and fruits and meats both grew by about 22 percent. The price of petroleum decreased by 6.6 percent, stabilizing the CPI. Education fees jumped to 5.2 percent due to an increase in tuition at public schools and fees at private institutions. Throughout the quarter, the CPI continued to rise month- by- month: by 0.6 percent in January, 0.5 percent in February, and 0.6 percent in March. 

- 41 -

During the first quarter, the producer price index (PPI) rose by 0.7 percent quarter- on- quarter. In January and February, agricultural and marine products increased to the seasonal factor and demand during the Lunar New Year's holiday. In March, an increase in the prices of raw materials, including oil, was the main cause for the boost in the PPI. By month, the PPI in January increased by 0.6 percent month- on- month. Agricultural and marine products went up by 3.5 percent month- on- month, and electric, water, and gas prices decreased by 2.8 percent because of a decline in the city gas price. In February, the PPI, month- on- month, went up 0.6 percent. Agricultural and marine product prices increased by 1.5 percent while fruit and vegetable prices also increased due to the seasonal factor. Manufacturing product prices rose by 0.7 percent due to a hike in the imposition tax for public health promotions and a rise in the international price of petroleum products. In March, the PPI increased by 0.6 percent month- on- month. Agricultural and marine product prices dropped by 2.8 percent due to an increase in the shipment of vegetables. Manufacturing product prices, however, only built up to 0.7 percent as crude oil prices rose and petrochemical product prices jumped up. 

In the first quarter of 2002, import prices rose by 2.1 percent quarter- on-  quarter, due to an increase in the won/dollar exchange rate and raw material prices. By month, import prices in January increased by 1.8 percent due to a rise in the

<Table 6>                  Trends of Prices¹⁾

(Unit: %)

Note: 1) Percentage changes from the previous year.

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

- 42 -

prices of fundamental raw materials. In February, import prices rose by 1.0 percent. The rise in import prices was caused by an increase in crude oil prices and the reduced volume of supply, though the price competition amongst domestic products reduced capital and consumption goods prices. In March, import prices grew by 4.4 percent due to a rise in crude oil prices and petroleum products. In particular, raw material prices grew by 5.2 percent. During the first quarter, export prices rose by 1.4 percent quarter- on- quarter. This was basically attributable to the increase in raw material prices and the increased won/dollar exchange rate. In January, export price increased by 1.9 percent month- on- month. The increase in export prices was caused by an increase in raw materials, the won/dollar exchange rate, and demand from the main export area. In February, export prices went up 0.3 percent due to the increase in raw material prices although textiles, cloths, leather and assembling metal goods dropped. In March, export prices continued to increase by 1.9 percent. By item, manufacturing and rubber product prices increased by 2.0 percent and 11.2 percent, respectively, as a result of the weak won, a rise in raw material prices, and a positive outlook on the global economic recovery.

<Figure 10>        Consumer and Producer Price Indices

Sources: National Statistical Office and the Bank of Korea.

In January, the unemployment rate recorded 3.7 percent. The number of people 

- 43 -

unemployed was down to 163,000 (- 0.9 percentage points) year- on- year and the number of people employed went up to 739,000 (3.6 percentage points). This was caused by a decrease in employment in the construction industry and a rise in job searching activities by registered college students. In February, the unemployment rate was the same as it was in January, and the number of people unemployed was down by 267,000 year- on- year. The number of people unemployed decreased in all age groups and, in particular, there was a 4.8 percentage points decline in the juvenile group. The number of employed people increased by 21 million, a 0.4 percent increase from the previous month. Male and female workers both increased, and there was a rise in the number of workers in most of the industries with the exception of the manufacturing industry.

The yearly average wage in all industries grew by 5.8 percent until November 2001, which was lower than the 8.4 percent growth in 2000. In the first quarter, wages increased by 8.6 percent, but the wage rate has slowed by 4.7 percent in the second quarter and 4.8 percent in the third quarter of 2001. During the first quarter of 2002, wages were estimated to grow by 5.8 percent.

<Figure 11>                 Growth Rate of Wages

Source: National Statistical Office.

2) Forecast

- 44 -

During the second quarter, CPI inflation will mark 2.6 percent in spite of the economic recovery. On the demand side, the real GDP is expected to fall short of the potential GDP, reducing inflationary pressure. On the cost- push side, inflationary pressure will not be high for the following reasons. Public service fees will not rise significantly in the second quarter, compared to the first quarter, due to the seasonal factor and the stability of prices for worldwide trade. A global recession will act as a positive factor in stabilizing prices internationally. In addition, unless international instability is widespread, international oil prices, on an annual basis, will not be higher than that of last year.

The World Cup and local elections will not raise inflation. In the past, the CPI growth rate went down from 7.7 percent to 5.4 percent during 11 months before and after the 1988 Olympic Games. Before and after the 1987 and 1997 presidential elections, the CPI growth rate increased by 4.2 percentage points and 4.5 percentage points, respectively, but the CPI growth rate declined by 2.1 percentage points before and after the 1992 presidential election. 

<Table 7>        Trends and Forecasts for Prices and Wages¹⁾

(Unit: %)

Notes: 1) Percentage changes from the previous year.

2) Figures after the second quarter of 2002 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.

The unemployment rate will record 3.8 percent in the second quarter as the 

- 45 -

economy will rebound, which is lower than 4.1 percent in the first quarter. Wages may rise to 5.5 percent, which is lower than the first quarter. An increase in exports and local elections will be factors contributing to the rise in wages, while structural and institutional changes, such as non- regularized employment and reduced working hours, will weaken the call for a raise in wages. 

- 46 -

The Balance of Payments

1) Review

Korea recorded an $1.8 billion surplus in the current account in the first quarter of this year. Despite a $0.3 billion deficit in the travel account and a $0.4 billion deficit in the service account, there was a $0.3 billion monthly surplus in January thanks to the surplus in the goods account. In February, the surplus edged up to $0.4 billion, $0.1 billion improvement from the previous month, though there was a decrease in the number of business days due to the Lunar New Year's holiday and the $0.5 billion deficit in the service account. The current account surplus in the last month of the first quarter shot up to $1.8 billion with the goods account recording a $2.0 billion surplus.

As for the capital account, the inflow of capital was $0.9 billion more than the outflow in the first quarter. The large inflow of foreign portfolio investments in January swamped the redemption of development institutions' long- term bonds and the outflow of net foreign stock investments between February and March.

During the first quarter of 2002, exports on free on board (FOB) terms

<Figure 12>    Exports, Imports, and Balance of Goods Account

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

- 47 -

declined 11.0 percent, recording $35.7 billion. Although the decline in exports slowed down, eventually bottomed out, in the first quarter, exports by month were quite volatile. In January, exports recorded $11.4 billion, which is down 9.9 percent year- on- year. Since May 2001, it was the first time that monthly exports declined less than 10 percent from the previous year. One for the drastic change may be attributable to the Lunar New Year's holiday: Because the holiday is based on the lunar calendar, the dates of the holiday change year by year on the solar calendar.

On a seasonally adjusted base, including the Lunar New Year's Holiday, exports declined about 12 percent in January. Last year the Lunar New Year's holiday fell in January, while this year the holiday was celebrated in February. As effects of the holiday are passed over onto the next month, exports in February suffered a large decline of 17.4 percent from a year ago. In March, exports rekindled hope for recovery by recording $13.3 billion, a mere - 5.7 percent decrease compared to last March.

During the first quarter of 2002, imports (c.i.f) declined by 11.6 percent, recording $33.7 billion. Imports in January shrank by 8.9 percent year- on- year to $11.5 billion.  Behind the deceleration of the shrinkage in imports was an increase

<Figure 13>    Foreign Portfolio Investments, Foreign Direct Investments, 

and Balance of Capital Account

- 48 -

in the import of consumer goods, which stocked up in preparation for the expected spending boom during the Lunar New Year. Imports dipped down by 17.9 percent again to earn $10.5 billion in February. Again, part of decrease was due to the reduced number of business days as the Lunar New Year fell in February this year. Considering the fact that the daily imports volume was around $0.37 billion, the three day holiday made a 9.0 percent difference. In March, imports recorded $11.9 billion, down by 8.1 percent, reflecting the continued inactivity in domestic corporate investments. 

As for exports by commodity, the performance of semiconductors improved in the first quarter, recording $3.7 billion, which is down by 23.6 percent year- on- year.

<Table 8>                Current Account Trends

(Unit: $100 mil.)

Note: 1) Estimates

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

<Table 9>       Trends of Exports (f.o.b) and Imports (c.i.f)

(Unit: $100 mil., %)

Source: Ministry of Commerce, Industry and Energy, Report of Exports and Imports, various issues.

- 49 -

In the previous quarter, it was - 54.5 percent. The rising trend in computer chip prices, especially the prices for long- term contracts helped semiconductor exports. For example, the price of the 128M SDRAM chip improved by 113 percent in the first quarter.

Although exports of computers including peripheral equipments remained flat with a 0.7 percent growth in the first quarter, wireless communication equipment showed a robust growth, recording a 32.1 percent increase year- on- year. A continuous rise in liquid crystal display (LCD) prices with an economic recovery in the U.S. supported the improvement in computer exports. In the case of wireless communication equipment exports, the development of the overseas market, such as the CDMA service in China, was the key factor in the rise. Exports growth of automobiles showed a continuous upward trend throughout the first quarter, recording a 12.7 percent increase year- on- year. On the other hand, petrochemical exports suffered a 8.2 percent decline during the first quarter due to the poor economic performance in the Asian region, including Japan, which has been be largest export market for Korea. Steel exports also decreased by 12.4 percent. The stagnant steel market, which had a chronic over- supply problem, subsequent and tightened import restrictions of steel products in the U.S., and the retaliatory response from other countries including the European Union, had direct effects on the Korean exports of steel products.

As for imports by commodity and by use, the import of raw materials declined by 13.1 percent as the price of crude oil fell continuously in the first quarter. Capital goods imports also continued to fall as domestic equipment investments remained depressed. In contrast, imports of consumer goods increased by 21.0 percent, boosted by an optimistic consumer psychology and the holiday (the Lunar New Year's holiday) spending spree. The import price of raw materials declined by 17.8 percent year- on- year in the first quarter while that of capital goods fell by 14.5 percent due to a steep fall in the unit import price of machinery (- 19.1 percent) and transportation equipment (- 11.3 percent).

As for exports by region, the U.S. remained the first destination for Korean exports, with a particularly large increase in automobile exports. Exports to Japan,

- 50 -

<Figure 14>             Trends in Semi- conductor Prices

Source: Bloomberg

historically the second largest market for Korean exports, continued to decrease and recorded - 24.3 percent in the first quarter; thereby sliding down from the number two slot. The Chinese share of Korean exports jumped up recently with the steady growth of the Chinese economy, making China Korea's second largest trading partner. Despite a rise in the export of wireless communication equipment, exports to EU decreased by 10.5 percent because of the stagnancy in the exports of computers and textiles.

Because the fall in the unit import price far surpassed that of the unit export price, the terms of trade index increased by 6.3 percent year- on- year to 103.7 in the first quarter of 2002. Since the third quarter of 2000, when it recorded 101.3, this was the first time the index topped the 100 point mark.

The won/dollar exchange rate in January gradually rose up to 1,310 won/dollar, following movements in the yen/dollar exchange rate.  In spite of fierce opposition from neighboring Asian countries, the rise in the yen/dollar exchange rate was fuelled by the possible further devaluation of th yen by Japanese policy makers. The won/dollar exchange rate in February remained stable within the band of 1,310 won/dollar and 1,320 won/dollar as supply and demand were balanced in the

- 51 -

<Table 10>       Exports and Imports by Item and Area

(Unit: $100 mil.)

Source: Ministry of Commerce, Industry and Energy, Report of Exports and Imports, various issues.

market. In March, profit taking by foreign investors in the Korean stock market had caused a huge outflow of foreign capital, causing the won/dollar rate to rise again. However, the trade account surplus in March and the stabilization of the yen/dollar rate restricted the upward movement to a moderate level.

2) Forecast

Exports in the second quarter of 2002 are expected to turn around to recorded a positive growth, a possible 10.7 percent increase year- on- year. The gradual recovery of 

- 52 -

the U.S. economy will help boost world demand for imports, and a rise in the prices of major export items will be an additional plus to exports. As exports improve and the economy recovers, imports will show a high growth rate of 17.2 percent year- on- year. In balance, the trade account and the current account during the second quarter are expected to record $2.0 and $1.5 billion, respectively.

Exports are expected to increase 8.6 percent year- on- year to $162 billion, while imports will rise by 9.8 percent to $155 billion in 2002. In balance, the trade account will show a $7 billion surplus. Along with the rising international prices of semiconductors, petrochemicals, and steel products, exports will accelerate as early as the second quarter of 2002, depending on the conditions of the global economy. Trade conditions in the global markets are expected to improve in the second half of 2002, after the major economies, including the U.S. and the European Union, bottom out in the first quarter. Major concerns regarding imports include the movement of crude oil prices and the possibility of overheating the Korean economy. International oil prices are expected to remain stable during the first half of the year, but may rise in the second half as the demand for oil increases. Given the overcapacity accumulated during the past boom period, however, the rising demand for oil may not directly lead to an increase in the import of capital goods.

The dollar is likely to remain weak for some time since the demand for the dollar is expected to weaken. Thus, the won/dollar exchange rate will strengthen. Other factors behind the strength of the won/dollar rate is the expected appreciation of the Japanese yen, the weakening U.S. dollar, and positive domestic economic conditions in Korea. Besides the slow recovery of the U.S. economy, the U.S.'s large current account deficit makes the U.S. dollar appear overvalued and scares investors away from buying assets in dollars. In contrast, Korea's trade balance continued to record a surplus, and foreign investments flowed in as the nation's sovereign credit rating was upgraded by major world credit rating agencies.

The won/dollar exchange rate average is expected to fall back to the 1,250～1,280 won per U.S. dollar band in the second half of the year as foreign capital returns to the U.S. with the steady recovery of the economy and stock markets.

- 53 -

<Figure 15>            Trends of the Book- to- Bill Ratio

Source: Semiconductor Industry Association

<Table 11>  Trends and Forecasts for the Current Account¹⁾

(Unit: $100 mil. %)

Notes: 1) Figures in parentheses represent percentage changes from the previous year.

2) Period averages.

Sources: Ministry of Commerce, Industry and Energy, Report of Exports and Imports, various issues.

- 54 -

Money and Interest Rates

Money

1) Review

During the first quarter of 2002, uncertainties over international and domestic economic conditions still lingered and exports continued their declining trend. However, the Korean economy as a whole showed signs of improvement driven by strong private consumption and construction investments. Despite seasonal factors, like the Lunar New Year's holiday, consumer prices remained subdued due to a decline in oil prices and international raw material prices, which offset increases in agricultural product prices and housing rent. In the financial markets, there was an ample supply of liquidity in the corporate sector because of the weak demand for funds by corporate sectors, the reduced amount of matured bonds and a solid growth in bank loans to small and medium sized enterprises. Low interest rates and bullish stock markets also provided solid grounds for raising funds in the corporate sector. At the same time, there were growing concerns that an increase in speculative funds and household loans would instigate a bubble in real estate prices.

Under such economic conditions, the Bank of Korea (BOK) maintained its benchmark overnight call rate at its current level of 4 percent throughout the first quarter. The decision to do this was based on the consensus that it was still uncertain whether exports would fully recover in spite of increasing apprehension of a possible real estate bubble amid a strong economic recovery. The BOK generally absorbed much of the abundant supply of liquidity through open market operations while keeping the low interest rate policy. In January, the BOK absorbed 3.9 trillion won of short- term excess liquidity that was withdrawn for the redemption of borrowings and year- end closings. Entering March, concerns regarding excess liquidity further made the BOK absorb market liquidity through the net issuance of Monetary Stabilization Bonds (MSBs) and RP operations. 

- 55 -

The growth rates of major monetary aggregates showed high volatility because the Lunar New Year holidays fell on different dates compared to last year. In 2001, the Lunar New Year fell on January 24, while in 2002 it was on February 12. However, the growth rates of major monetary aggregates on the whole showed an increasing trend thanks to the solid growth of bank deposits and loans, and the rebound in the non- banking sectors' deposits.

Despite an increase in domestic credit, the M2 growth rate decreased to 12.6 percent in January compared to the previous month. This was largely attributable to the net absorbtion of liquidity from the government sector following increased receipts of value added tax and the relatively higher level of M2 during the same period of last year. In February, the M2 growth rate increased to 14.7 percent, which was mainly led by the expansion in fiscal expenditures for the Lunar New Year holidays. Entering March, a rapid increase in credit to the private sector, centering on bank lending, contributed to the M2 growth rate's interesting trend.

<Table 12>           Trends in Monetary Growth Rates¹⁾

(Unit: %)

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

2) Preliminary values. 

3) Reserve Money = 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. 

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

- 56 -

In January, the M3 growth rate recorded 11.6 percent, which was up a little from 11.3 percent in December last year, in response to the increased inflow of funds into hybrid stock- type funds and MMFs managed by investment trust management companies (ITMCs). The MCT growth rate during the first quarter also

<Figure 16>     Discrepancies between Monetary Growth Rates

<Table 13>              Stock Investments by Foreigners

Notes: 1) Units are in 100 million dollar.

2) Units are in 100 million won.

Sources: The Korea Stock Exchange, Monthly Bulletin, various issues. 

http://www.kosdaq.or.kr

- 57 -

expanded to 12.7 percent from 10.1 percent during the fourth quarter of 2001. As a result, the discrepancies between the M2 and M3 growth rates have narrowed further while the discrepancies between M2 and MCT growth rates expanded during the first quarter. The growing discrepancies between monetary growth rates imply that monetary aggregates do not accurately reflect market liquidity conditions.

<Table 14>          Monetary Stabilization Bonds Issued

(Unit: billion. won)

Note:1)Preliminary values.

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

<Table 15>                 Multipliers and Velocities¹⁾

(Unit: Times)

Note:1)Money Multipliers are the ratios of each monetary aggregate to the volume of the reserve money. The velocities of money represent the ratios of seasonally adjusted nominal GDP of each seasonally adjusted monetary aggregate. 

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

- 58 -

During the first quarter, deposit- taking by financial institutions showed a stable increasing trend though a portion of the market funds shifted from ITMCs to the banking sector because of expectations of an interest rate hike following the economic recovery. Deposit- taking by deposit money banks (DMBs) jumped by 20.9 trillion won, largely centering on time deposits, while deposits at ITMCs reached 15.0 trillion won. Bond- type beneficiary securities experienced a 5.3 trillion won outflow in the wake of rising interest rates, while MMFs attracted 13.0 trillion won due to the increased appetite for short- term financial assets. Boosted by bullish stock markets, inflow of funds into stock- type beneficiary securities expanded to 7.3 trillion won.

<Table 16>   Recent Deposit Changes at Financial Institutions¹⁾

(Unit: billion won)

Note:1)End of period. Changes from the previous period.

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

- 59 -

<Figure 17>    Short- term Deposit at Major Financial Institutions¹⁾²⁾

Notes:1)Short- term deposits = Demand deposit + Instant access accounts + Short- term marketable deposits (CD+RP+Cover bills) + Short- term bond- type beneficiary securities + MMFs

2) Long- term deposits are the sum of deposits at Deposit money banks, Investment trust management companies, Trust accounts of banks, Merchant banking corporations, and Stock accounts, but exclude short- term deposits. 

<Table 17>                 Trends in Bank Loans¹⁾

(Unit: billion won)

Notes: 1) End of period. Changes from the previous period.

2)Excluding CP discounts.

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

- 60 -

The portion of short- term deposits to the total deposit- taking by financial institutions also increased to 38.6 percent in March 2002, from 32.6 percent in January 2001. Entering this year, the deposit- taking structure of financial institutions became shorter. The move for a shorter structure brought about apprehensions concerning long- term fund raising by the corporate sector since it may be aggravating, and it may incite large scale movements of short- term funds, which would cause disturbances in the financial market. 

In the first quarter, bank loans to the corporate sector, especially to small and medium sized enterprises, maintained a solid growth. In particular, bank loans to the household sector showed a sharp increase, boosted by low interest rates, the rising trend in mortgage loans and the aggressive marketing of consumer loans by banks. Concurrently, stock issuances by corporations and the net issuance of commercial paper (CP) increased, while corporate bonds continued its net redemption. However, the scale of net corporate bond redemptions recorded a sharp decline due to the contraction in the amount of matured bonds and alleviated corporate credit risk.

<Figure 18>       Outstanding Deposit Bank Loans by Type and 

Ratio of Households to Total Loans

- 61 -

<Table 18>        Trends in Firms' Direct Financing¹⁾

(Unit: 100 million won)

Notes:1)End of period. Changes from the previous period. 

2) On the basis of CP discounts of securities companies and merchant banks.

3)Figures in parentheses exclude Primary CBO, Korea Development Bank's Prompt Bond Underwriting and debt restructuring related CBs. Figures in brackets exclude Primary CBO and Korea Development Bank's Prompt Bond Underwriting. 

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

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

2) Forecast

In the second quarter of 2002, the BOK is expected to raise the target for the over night call rate as the economy enters a strong recovery phase, while the rapidly increasing household debts will not slow down anytime soon. 

The Korean economy, which had shown some signs of an economic recovery, will grow further faster, extending beyond the potential GDP level if exports and investments fully recover in the second half. Additionally, the high M3 growth rate, which exceeded the monitoring range ceiling in March, will continuously bring about concerns regarding excess liquidity especially with the current low interest rates. In order to maintain stable economic growth and the proper level of market liquidity, the BOK will probably raise the call rate and alleviate the increase in private credits in the second quarter.

A raise in the call rate by the BOK is further warranted when considering household debts and asset prices. After the government announced its anti- speculation policy measures on March 8, the rising trend in real estate prices was temporarily 

- 62 -

subdued. Given the fast growth of household debts, however, it is still possible that real estate prices will rise again in the near future. To clarify, the combination of an increase in household debts with low interest rates can result in a surge in real estate investments and asset prices. In turn, this will lead to an increase in mortgage values and accelerate the expansion of household debts. In order to slow down the increasing trend in household debts and to prevent the creation of bubbles in the real estate market, the monetary authority needs to raise the call rate and make households reduce their debts gradually. 

Taking all these criteria into account, the BOK will adjust its benchmark overnight call rate upward in the second quarter. Since exports and investments have not yet fully recovered, however, a sharp rise in the interest rate might trigger a severe contraction of domestic demand, a steep decline in asset prices and probably household insolvencies. Therefore, the adjustment of the target call rate seems to be confined to fine- tuning. In the second half, when the Korean economy is expected to show a full- fledged recovery, the BOK will tighten its monetary policy stance through additional call rate hikes. 

In the second quarter, the expansion of household loans will lead to the rapid increase in domestic credits. On the other hand, the inflow of market funds into the banking sectors will be restrictive because of low deposit interest rates, and the corporations' demand for bank loans will not increase sharply until equipment investments will be resumed on a full- scale. As a result, the M2 growth rate is forecast to record around 15.0 percent in the second quarter, slightly higher than the first quarter. The M3 growth rate is expected to be around 12.5 percent, reflecting the shift of funds to non- banking sectors caused by the appetite for short- term financial assets, centering on MMF, and bullish stock markets.

- 63 -

<Table 19>                Monetary Growth Rate¹⁾

(Unit: %)

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

2)M2 is a preliminary value, and M3 is a forecast.

Sources: The Bank of Korea, Monthly Bulletin (various issues), Money and Banking

 Statistics, Trends of Financial Market in March.

- 64 -

- 65 -

Interest Rates

1) Review

Entering 2002, interest rates stabilized downward from a rapid increase during the fourth quarter of 2001. In January and February, long term rates fluctuated in a general downward trend while short term rates exhibited a clear downward trend. Corporate bond yields went down by 0.54 percentage point from 7.22 percent to 6.68 percent, and government bond rates decreased by 0.46 percentage point from 6.17 percent to 5.71 percent. The CP rate and CD rate declined by 0.5 percentage point and 0.43 percentage point, respectively.

During the first quarter, the Bank of Korea (BOK) did not clearly announce its position regarding the future course of the interest rate policy, keeping the target call rate fixed at 4.0 percent. Without any explicit indications of the future interest rate policy, long- term interest rates were determined by market expectations of this year's nominal economic growth. For example, in early January, corporate bond yields were a little bit higher than 7.0 of the percent economic growth. 

However, it was not yet evident if the Korean economy was really entering a solid phase of economic recovery: market participants were not sure if their

<Table 20>     Quarterly Movements of Major Interest Rates¹⁾

(unit: %)

Note:1)Period averages.

Sources: The Bank of Korea, Korea Investors Service, INC., KIS- LINE.

- 66 -

expectations of a 7.0 percent nominal growth would be fulfilled. Therefore, long- term interest rates fluctuated whenever good or bad news about the economic outlook surfaced.

Learning that the exports growth rate was still negative and business investments in equipments were still sluggish, market participants revised downward their expectations of economic growth. 

<Figure 19>            Major Short- term Interest Rates

<Figure 20>             Major Long- term Interest Rates

- 67 -

Considering the reduction in the amount of matured corporate bonds and the alleviated corporate credit risk, the most important factors that determined interest rates in the first quarter were related to expectations of economic growth. The dishonored bills ratio sharply declined to 0.08 percent in February, and the number of firms with dishonored bills largely decreased. This contributed to the decrease in bond market risk and a reduction of the corporate bond yield spread by credit rating.

<Table 21>               Dishonored Bills Rates

(Unit: %, number)

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

2) Figures does not reflect March.

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

<Table 22>  Corporate Bond Yield Spread by Credit Rating¹⁾

(unit: %, Percentage point)

Notes:1)End of Period. 

2) Spreads over benchmark high grade issues(AA- )

Source: The Korea Securities Dealers Association

- 68 -

On the other hand, since the fourth quarter of 2001, the monetary authority has concentrated on easing the money supply without conspicuous efforts to absorb liquidity by issuing monetary stabilization bonds. Especially, the rate of increase of reserve money has been kept relatively high since October 2001, and M3 has continued to rise since the second half of 2000. The M3/GDP ratio recorded 1.87 in 2001, resuming its traditional, sharply increasing trend; it has also continued to rise in 2002, reaching 12 percent y.o.y. in January. As a result, liquidity was quite abundant in early 2002. 

Furthermore, decreases by double digit figures in the commodity export growth rate, which continued in January and February of 2002, discouraged both business investments and the demand for money. All these developments contributed to the decline in short and long- term interest rates in the first two months of 2002.

The target budget deficit was smaller than that of last year, and the net 

issuance of government bonds was just 2.6 trillion won in the first quarter. However, with abundant liquidity and a bearish stock market, bank deposits sharply increased. Bank deposits increased by 1.4 trillion won in January, then by 12.9 trillion won in February. Most of the increase in bank deposits was concentrated on short- term deposits because depositors were unsure about the future prospects of deposit interest rates. In order to secure long- term funds, banks issued 8.2 trillion won in debentures in January and February.

Corporate bonds recorded a net redemption of 4.3 trillion won in January and of 1.0 trillion won in February due to the weakened demand for funds. Deposits in hybrid bond type funds and MMF also increased by more than 13 trillion won in the first quarter, reflecting the abundant amount of liquidity and changes in investors' sentiments that prefer risky assets. Because of this, ITMC increased bond purchases contributing to the decline in interest rates. 

With a sizable increase in short- term deposits and uncertainties concerning the future direction of long- term interest rates, financial institutions concentrated on purchasing bonds with maturities of one or two years. As a result, interest rates on money stabilization bonds and debentures declined more than the government bonds rate.

- 69 -

The Business Survey Index published on March 4, 2002, by the Federation of Korean Industries recorded an all- time high. On March 6, Hynix Semiconductors announced a surplus, and it accelerated its rising trend in stock prices. At the end of March, KOSPI recorded 902.5, which is 30 percent higher than at the end of 2001. At the same time, interest rates departed from their moderately declining trend and rose sharply in March. 

It seems that the BOK's issuance of long- term monetary stabilization bonds on March 5 triggered the subsequent upturn in interest rates. After industrial production was posted to have increased by 10.2 percent y.o.y. during January, the BOK started to control the liquidity in circulation. On March 5, the BOK unexpectedly sold monetary stabilization bonds with two year maturities at 5.87 percent, which was higher than the market rate at that time. Market participants took this as a signal of a turnaround in the monetary policy stance, and interest rates started to rise rapidly. 

<Figure 21>           KOSPI and Corporate Bond Yields

On March 7, 2002, the Monetary Policy Committee (MPC) fixed the target call rate at its previous level of 4 percent, mentioning that an upward revision would be 

- 70 -

considered only after exports growth substantially recovered. 

Entering 2002, rapidly rising apartment prices in the southern area of

Seoul and the speed of the increase in household lending drew serious public attention. Concerns were brought up over the possibility that the asset bubble might have already started to emerge. Market participants became convinced that it was the right time for the BOK to raise its target call rate as a natural policy response. 

The MPC's decision and its comments reassured market participants that a rise in the call rate was now a matter of time and provided them with a specific way to predict the BOK's future actions.

Concurrently, as problems with non- performing loans and macroeconomic risk were alleviated, the interest rate spread between grade AA-  bonds and below BBB grade bonds was reduced to 4.03 percentage points at the end of March. This is the same level as it was in January 2001. Looking at the turnover in corporate bond trade by credit ratings, however, it was hardly considered that the demand for corporate bond expanded to the credit rate which was less than BBB grade.

<Table 23> Non- guaranteed Corporate Bond Issuance by Credit Ratings¹⁾

(unit: 100 million won, %)

Notes:1)Credit rating is based on the time when corporate bonds were issued. Excludes ABS. 

2) Figures in parentheses are percentage weights. 

Sources: Financial Supervisory Service, The Statistics of Direct Financing in from January

to February.

- 71 -

The interest rate spread between lending and deposit rates at banks was reduced a little during the first quarter of 2002 as the lending rate declined by 0.13 percentage point since the end of 2001 while the deposit rate was actually fixed. As a result, the average of interest rate spread between lending and deposit rates in February decreased to 2.82 percentage point. Considering recent efforts to become

<Figure 22>   Spreads Between Lending and Deposit Rates at Banks

<Table 24>   Banks' Weighted Average Rates on Deposits and Loans¹⁾²⁾

(unit: %)

Notes:1)Interest rates are weighted averages of Deposit Money Banks' new lending and deposits. 

2) Spreads between lending and deposit rates at Deposit Money Banks. 

Source: The Bank of Korea, Weighted Average Rates on Bank and Other Financial Institution's Loans and Deposits in February.

- 72 -

become competitive by expanding lending, and the possibility of a raise in short term interest rate in the near future, the reduction in the spread between lending and deposit rates is likely to be maintained for the time being.

2) Forecast

In the second quarter, as a full- fledged economic recovery becomes more evident, a rise in interest rates will be required in order to moderate the current lending boom and to keep the liquidity under the control.

In early March, the government implemented a package of policy measures, consisting mostly of tax- related policy tools, with the aims to contain the real estate market bubble. Although it is rather too early to evaluate the effectiveness of the policy package as of yet, the speed of the increase in real estate prices has slowed recently. Repressing the asset bubble from emerging, however, would not be successful without raising the interest rate in a timely manner.

<Figure 23>    CPI Inflation Rates and Underlying Inflation Rates

More than half of the lending to households has been used to finance real 

- 73 -

estate purchases; therefore, it is highly probable that a serious real estate price hike will come back at any time unless the household lending boom is controlled.

The current inflation is hardly a runaway inflation: the BOK will not find any reason to raise interest rates if it concentrates only on curbing inflation. However, the Japanese experience during the second half of the 1980s strongly suggests that an asset bubble can emerge and expand without being accompanied by runaway inflation, and that preventing the boom and bust cycle in an asset bubble is indispensible for stabilizing the inflation rate in the long- run.

It is useful to remember that the current target call rate was set right after the September 11 terrorist attacks on the U.S. as an emergency policy measure to prop up the economy. Considering that last year's annual real growth rate was 3 percent, and the current economy is headed for a solid economic recovery, it is evident that the goal of the emergency policy measure has been successfully achieved.

Therefore, as soon as the BOK finds a reasonable excuse, such as signs of recovery in exports, it will raise the target call rate immediately. Actually, since early March, the BOK indicated that the target call rate might be raised in the near future. Therefore, if the BOK does not raise it surprisingly high, market interest rates will not overshoot because expectations of an increase in the target call rate has already been internalized in recent market interest rates.

<Table 25>               Interest Rate Forecasts¹⁾

(unit: %)

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

2) CPI, M2 and Corporate bond yields are reported figures, and GDP growth rates are preliminary. 

3) Forecasts.

- 74 -

In the second quarter of this year, long- term interest rates will moderately rise. For example, corporate bond yields will be 7.3 percent, 0.2 percentage point higher than in the first quarter. The rise in interest rates will become more evident in the second half of 2002 when market participants become more reassured of a strong economic growth.

- 75 -

Financial Market Developments

Banking

The total volume of bank deposits, bank credits, and trust accounts increased by 5.7%, 7.3%, and 4.1%, respectively, in the first quarter of 2002. The rapid rise in household loans is the reason why the growth rate of bank credits is higher than bank deposits. Despite the decrease in money in trusts, the dramatic increase in property in trusts made the volume of total trust accounts go up. The low interest rate trend that had gradually decreased throughout 2001 for bank deposits, credits, and trust accounts continued this quarter; however, it has stabilized somewhat. 

<Figure 1>    The volume of bank deposits, credits, and trust accounts

<Figure 2>  The interest rates of bank deposits, credits, and trust accounts

- 76 -

Deposit Market

1) Review

The total volume of bank deposits held by depository banks at the first quarter of 2002 is estimated to have reached 525.7 trillion won, up 5.7% compared to last quarter. The following factors contributed to the increase in bank deposits. First, as the call rate was kept low by the Bank of Korea since last year, there has been ample liquidity in the money market. Around New Year's Day (lunar calender), especially, short- term deposits increased gradually because more liquidity was supplied through government expenditures and commercial loans. Second, flight- to- quality concerns appeared to have continued throughout the quarter. Money was still parked in bank deposits due to investor's preference for safety in spite of optimism for an economic recovery and stable conditions in the financial market. Third, a large amount of floating capital has flowed into short- term bank deposits seeking alternative investment opportunities. Fourth, money withdrawn for the repayment of corporate debts last quarter have returned into bank deposits. Fifth, banks intended to actively sell marketable financial deposits to control bank's liquidity. 

As shown in <Table 1>, deposits in won, consisting of demand deposits and time and savings deposits, rose 4.7 percent in the first quarter, totaling 463.7 trillion won. The amount of demand deposits increased with a similar growth rate compared to last quarter, but time and savings deposits showed a higher growth rate relative to last quarter. Demand deposits have steadily increased due to ample liquidity in the money market and the increase in floating capital.

- 77 -

<Table 1>                 Bank Deposits¹⁾

(unit : billion won, %)

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

percentage changes 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.

The volume of time and savings deposits rose by 4.7%, totaling 424.9 trillion won in the first quarter of 2002. The reason for this rapid increase is that the time deposit increased by 3.2% this quarter while it decreased by 1.0% last quarter. Time deposits with maturities less than 6 months, especially,  increased by 7 trillion won, though it decreased by 5 trillion won last quarter. There were two causes for the fluctuation. First, the money withdrawn for corporations' operational fund at the end of 2001 flowed back into bank accounts. Second, conservative investors did not 

- 78 -

move their funds from time and savings deposits to alternative investment opportunities because yields from the alternatives were not as high as they expected. Investors tended to prefer short- term products to long- term ones; evidenced by the slowdown in the increase of products with long maturities while products with short maturities, such as corporate savings, increased quickly. 

<Table 2>                Time and Savings Deposits¹⁾

(unit : billion won, %)

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

   2) Estimates.

 3) Includes MMDA.

   4) Includes household preferential installment savings deposits.

       5) Includes housing installment savings, workers' long term savings and workers' 

property formation deposits. 

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

The volume of marketable financial products substantially increased by 20.5%, totaling 47.3 trillion won. The notable growth in marketable financial products is the result of the followings. Enterprises have demanded CDs and RPs more than ever 

- 79 -

since their liquidity is easier to manage in operation. Furthermore, declining interest rates have made short- term funding more attractive to banks because it enables them to respond more quickly to changes in interest rates. The decline of deposits in cover bills was due to the creation of electronic methods, such as electronic buyer credit, electronic loans secured by account receivables and corporate credit cards for purchasing. 

The volume of foreign currency deposits fell by 5.0 percent in the first quarter, totaling 14.7 trillion won, which is illustrated in <Table 1>. Foreign currency deposits performed well due to low deposit interest rates and decreased volatility in the exchange rates. Moreover, the demand making for imported products increased at the beginning of this year, making foreign currency deposits decrease.

<Table 3>          Interest Rates on Selected Bank Deposits¹⁾

(unit : %)

Notes: 1) End- of- quarter basis. Weighted average interest rates.

   2) Estimates.

 3) Includes MMDA.

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

- 80 -

The average deposit interest rate fell consecutively throughout the first quarter. One of the reasons for the fall was that the expansionary monetary policy has kept deposit interest rates low. Banks' policies to reduce unprofitable short- term deposit also made interest rates of marketable financial products low. Furthermore, banks tended to decrease deposit interest rates following a decline in loan rates to protect profitability. Decreasing loan interest rates to expand household loans made bank's profitability worse, so banks had to decrease deposit interest rates to keep the spread as before. Banks also did not have to increase deposit interest rates, because bank deposits increased despite low deposit interest rates. 

2) Forecast

The total volume of deposits held by banks is expected to grow by 5.0%, amounting to 552.2 trillion won in the second quarter of 2002. The slowdown in the growth rate of total bank deposits will be caused by the followings. First, the ample liquidity in the market first quarter will show up as an increase in bank deposits in the second quarter. Second, deposit interest rates are expected to increase due to the upward trend in market rates, so bank deposits, especially time and savings deposits, will increase. Third, the bullish stock market will not affect bank deposits significantly since most of the funds invested in the stock market are not from bank deposit accounts but from bank trust accounts. 

Deposits in won, composed of demand deposits and time and savings deposits, are expected to rise by 5.0%, reaching 486.9 trillion won. Demand deposits are expected to grow by 5.1%, as it did last quarter, totalling 40.7 trillion won. One reason for the increase in demand deposits is that ample supply of liquidity in the market will be sustained in the second quarter if the call rate does not rise substantially. Another contributable factor is the economic recovery focused on domestic consumption, which is likely to increase demand deposits. 

The volume of time and savings deposits will show a growth, recording a growth rate of 5.1% and reaching 446.2 trillion won in the second quarter of 2002. 

- 81 -

The growth will be the result of a slight rise in deposit interest rates. The flight- to- quality phenomenon will also continue in the second quarter so that time and savings deposits will still be preferred by conservative investors. Furthermore, because of the recent government policy to stabilize the price of real estate, the floating capital waiting to be invested in real- estate products will return into the time and saving deposits in the second quarter of 2002. 

The total volume of marketable financial products is expected to rise by 5.6%, reaching 50 trillion won in the second quarter of 2002. There are three reasons for the rise in marketable financial products. First, banks prefer financing loans with CDs rather than long- term time deposits because banks can easily respond to volatile short- term interest rates. Second, RPs will increase because the terms of contract can flexibly change. Third, as the volume of promissory notes declines with the diffusion of new electronic payment methods, the issue of cover bills is expected to decrease in the second quarter of 2002.

The volume of foreign currency deposits is expected to increase by 3.4%, reaching 15.2 trillion won due to the upturn in the supply of foreign currencies in the market as exports recover in the second quarter of 2002. 

The average interest rate on deposits is expected to marginally increase in the second quarter of 2002, because the Bank of Korea will probably marginally increase the call rate, depending on inflation pressure from the ongoing economic recovery and increasing exports. The demand for funds from business sectors will also increase with the economic recovery. The relative independence of deposit and market interest rates, however, cannot be ignored in the sense that the former went down while the latter went up in the first quarter. 

Loan Market

1) Review

In the first quarter of 2002, the total volume of depository bank credits reached 

- 82 -

421.5 trillion won, a 7.3% increase compared to the 2.6 % growth last quarter. Several factors contributed to the remarkable loan growth this quarter. First, because facility investment gradually grew in expectation of an economic recovery, the demand for capital was strong. Second, banks competitatively increased household loans this quarter. Third, loans to small- medium sized enterprises for tax payment purposes and other seasonal demands increased substantially this quarter. Fourth, operational capital financed by bank loans increased gradually in corporations, and direct financing shifted to indirect financing. The demand for corporate direct financing, such as IPO and issues of new shares to be purchased, has fallen off by 5% compared to last quarter, 68.5% compared to the previous year. 

Loans in won rose by 8.5% in the first quarter of 2002, totaling 387.8 trillion won while loans in won of banking funds increased to 366.8 trillion won, 9.0% growth, in the first quarter. Banks reduced the amount of loans to major companies while increasing the proportion of credits to medium and small sized companies and individuals. Mortgage loans were also expanded; in particular, enlarging housing- backed loans with low credit risk by lowering commission charges and loan to value (LTV). 

At the first quarter of 2002, the volume of general loans and overdrafts rose by 10.1% and 19.0% respectively, compared with last quarter's ending balance, and bills discounted decreased by 7.1%. Throughout the first quarter, the demand for bills discounted continuously declined, especially with the introduction of new lending instruments such as loans for purchasing, loans collaterized by account receivables and credit cards. An increase in overdrafts was also due to the expanded loan volume for healthy enterprises. The handsome growth in general loans should be attributed to banks' efforts to expand their retail and corporate banking businesses. General loans have steadily increased because general banks tended to enlarge the volume of loans for households and healthy enterprises. 

- 83 -

<Table 4>                    Bank Loans¹⁾

(unit : billion won, %)