KOREAN
FINANCIAL
REVIEW
Quarterly Analysis & Forecast
Vol. 6, No. 4 Winter 1996
CONTENTS
Lead Article: The Relationship between CPI and PPI
and the Sources of Inflation in 1990s
President and Publisher Macroeconomic Developments
Yung Chul Park
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- 6256, Fax, (82- 2) 3705- 6309.
The Relationship between CPI and PPI and
the Sources of Inflation in 1990s
Choong- Lyul Lee
Ⅰ- 1. Introduction
The CPI (Consumer Price Index) generally represents the average price of final goods and services, while the PPI (Producer Price Index) represent that of raw materials and intermediate goods or inputs It would therefore seem only natural that the CPI and the PPI should have some kind of relationship and that this relationship would depend upon production technology as well as market structure.
The relationship between the CPI and the PPI has several implications in economics. For one thing, investigating the long run relationship is one way to discover the source of inflation. Since the PPI represents costs of production while the CPI represents prices of finished goods, examination of the relationship will shed light on how cost changes explain price movements. A change in the relationship is an indication that there must be another source of price movements, so this kind of examination is a means by which sources of inflation can be isolated and understood. The role of the PPI as a leading indicator is also important with regard to economic forecasts or policy making. If there exists a stable lead- lag relationship between the CPI and the PPI, then economic agents or the monetary authorities can use the PPI to extrapolate the future CPI. Investigation of the PPI- CPI relationship is also instructive in demonstrating how and why the relationships between economic variables can change in a rapidly developing economy such as Korea. Since the late 80s when far reaching deregulation and opening of the Korean economy was pursued, the relationships between many economic variables changed in fundamental ways.
In light of the importance of understanding the relationship between the PPI and the CPI, there have been surprisingly few studies on it. Most of the previous
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research on inflation was conducted in efforts to find the direct sources of inflation. They attempted to explain inflation for example by changes in demand, unit labor costs, or foreign exchange rates (Park 1992, Park, 1996, Baek, 1996). According to Kim (1995), the CPI is broken down into agricultural product prices, manufactured product prices, and service fees. Each price equation is then estimated, and an attempt is made to find the source of inflation. The relationship between the CPI and the PPI, however, is not considered. The only place where the relationship between the CPI and the PPI has been considered at all is in large system equation models such as in Baek (1993) or Kim and Choi (1993).
In section Ⅱ of this study, the relationship between the CPI and the PPI is examined by means of applying the unit root and cointegration test methods. An attempt is then made in section Ⅲ to find a stable price equation for the 90s and to explain the reasons for the change in the relationship between the CPI and the PPI which occurred around 1990. The source of recent inflation is investigated as well. A new price equation is formulated and several statistical methods are then applied, such as the cointegration test and estimation of variance decomposition of forecast errors and impulse response function. Section Ⅳ closes with concluding remarks.
Ⅱ. The Relationship between the CPI and the PPI
Ⅱ- 1. The Relationship between the CPI and the PPI: a Derivation
The CPI generally represents the average price of final goods and services, while the PPI represents that of raw materials and intermediate goods or inputs. There can hardly be a doubt that some sort of a relationship exists between the CPI and the PPI although the nature of that relation will of course depend to some degree on production technology or market structure. One of the simpler theories in microeconomics about the relationship between output prices and input prices is the markup theory. It states that the firm charges a price which is a sum of the average cost and margin, generally as a proportion to the average cost. In this case, the price can be written as below:
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Since there is a time lag between production and sales, the above equation can be expressed as below:
The long- run relationship between the CPI and the PPI can be represented by equation (2) when the markup theory is applied, while the short- run relationship can be represented by equation (3). The lead- and- lag relationship between the CPI and the PPI is important. If the PPI leads the CPI, economic agents may use the relationship in forecasting the future CPI. In addition, the monetary authority may also use it to see the effect of their policy before.
Ⅱ- 2. Cointegration Analysis Between the CPI and the PPI
To examine the long- run relationship between the CPI and the PPI as suggested in equation (2), a cointegration test is applied. According to Engle and Granger (1987), if each economic variable has a unit root and if some of the variables are cointegrated, then they have a stable long- run relationship. The cointegration test involves two steps. First, the order of integration for each of the variables under consideration are determined, and second, a cointegration test with integrated variables are run.
As a first step to determine the order of variables, unit root tests are performed for each. Here, the augmented Dicky- Fuller tests and Phillips- Perron tests are applied using the monthly data between January 1983 and October 1996. In each test, two
- 3 -
cases are considered where there is only an intercept and where there are both an intercept and liner time trend in the estimation equation. The number of lags in the autoregressive term in the test model is either 0 or 6.
Table 1 shows the unit root test statistics of the CPI and the PPI. The null hypothesis that the CPI has a unit root is not rejected at the 5 percent significance level, while the hypothesis that the first differenced CPI has a unit root is rejected. The test results are the same in the case of the PPI. It can therefore be concluded that both the CPI and the PPI have a unit root and that they are integrated by a degree of one series.
To test the cointegration relationship between the CPI and the PPI, Johansen's likelihood ratio tests are applied(Johansen 1988, 1991). Since monthly data are used, the seasonal dummy variables are added and 3 or 6 lags are considered in the VAR modeling.
<Table 1> Unit Root Test Statistics
lags |
ADF |
Phillips- Perron Test |
||||
Intercept |
Trend |
Intercept |
Trend |
|||
Level |
PPI
|
0 6 |
0.64 1.88 |
1.36 1.83 |
2.52 1.98 |
1.88 1.88 |
CPI
|
0 6 |
0.13 1.36 |
1.00 2.35 |
1.58 1.42 |
2.33 2.31 |
|
Differenced |
PPI
|
0 6 |
9.48** 3.53** |
9.45** 4.23** |
10.00** 10.35** |
10.79** 10.59** |
CPI
|
0 6 |
10.11** 4.36** |
10.08** 4.82** |
10.11** 12.32** |
10.08** 12.62** |
Note: "Intercept" means that the estimation equation only included the intercept while "Trend" means that it included both the intercept and linear time trend. * and ** means the null hypotheses of the unit root is rejected at the 5% and 1% significant levels, respectively.
- 4 -
Table 2 shows the cointegration test results of the CPI and the PPI. With the data for the period of January 81 to October 96, the null hypothesis that the CPI and the PPI are not cointegrated is not rejected at the 5 percent significance level, indicating that a stable long- run relationship between the CPI and the PPI does not exist. In order to understand how the relationship changes, the cointegration test statistics are estimated sequentially using the data from January 1981 to each period. Interestingly, as shown in Figure 1, the test statistics are very stable for the 1980s, but they suddenly show a drop in 1990.
To understand matters more clearly, the samples are divided into two periods: one from January 1981 to December 1989 and the other from June 1990 to October 1996, and same tests are done. As in Table 2, the null hypothesis of no cointegration is rejected during the 80s while it is not during the 90s. Therefore, it is concluded that
<Table 2> Cointegration Test Statistics
Null hypothesis |
Lags |
Jan. 81 to Dec. 89 |
Jun. 90 to Oct. 96 |
Jan. 81 to Oct. 96 |
No cointegration |
3 6 |
22.49** 26.84** |
13.30 11.10 |
11.61 13.72 |
Note: * and ** mean that the null hypotheses of no cointegration is rejected at the 5% and 1% significance levels, respectively.
<Figure 1> Sequential Cointegration Test Statistics
Between the CPI and the PPI
- 5 -
the stable relationship between the PPI and the CPI holds during the 80s but that thereafter, it did not. The estimated cointegrating coefficient of the CPI and the PPI of 1980s is (1, 0.8), so that the impact of the PPI on the CPI was very large.
Ⅱ- 3. Lead- and- lag Relation of the CPI and the PPI
In order to determine whether or not the PPI leads the CPI, the Granger causality
test is applied. Considering the test results in section Ⅱ- 1, the samples are divided into two periods; 1981 to 1989 and 1990 to 1996. Since they are cointegrated during 1980s but not during 1990s, different models are applied for the causality tests of each period. According to Engle and Granger (1987), the cointegrated system can be expressed by the VEC (Vector Error- Correction) model, which is different compared to the differenced VAR model. Therefore, in the 1980s, when the CPI and the PPI were cointegrated, the VEC model is applied. However, the differenced VAR (Vector Auto- Regressive) model is applied to the 1990s period, when the CPI and PPI were not cointegrated.
The test results are shown in Table 3. In the 1980s, the null hypothesis that the PPI does not Granger- cause the CPI is rejected while the null hypothesis that the CPI does not Granger- cause the PPI is not. It therefore seems that the PPI led the CPI in the 1980s, but this situation did not hold in the 1990s. Both null hypotheses are not rejected, so the lead- and- lag relationship between the CPI and PPI did not hold.
<Table 3> Granger Causality Test Results.
Null hypothesis |
Jan. 81~Dec. 89 |
Jan. 91~Jun. 96 |
PPI ↛ CPI |
8.19* |
0.82 |
CPI ↛ PPI |
0.79 |
0.78 |
Note: The differenced VAR model is applied during 1981 to 1989 period, while the VEC model is applied during 1991 to 1996. * and ** indicate that the null hypotheses of no Granger causality are rejected under the 5% and 1% significance levels, respectively.
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Ⅲ. On the Sources of CPA inflation
Ⅲ- 1. Price Equation
As seen in section Ⅱ, the relationship between the CHI and the PPI changed in late 80s and early 90s. I now investigate the reason for its change. Since the CPI represents the average price of final goods, it can be expressed as a weighted sum of commodity and service prices as below:
As for the service price, the assumption was made that it depends upon the wage since labor is in most cases the most important input in the service sector.
- 7 -
Now, after combining equations (5), (6), and (7), the CPI is expressed as below:
Ⅲ- 2. Cointegration Analysis
The CPI equation as specified by equation (9) is now estimated. Again, a cointegration test method is applied. In the actual test, the PPI, the imported consumer goods price (ICGP), and the manufacturing worker's wage are used to represent the average cost, foreign produced goods price, and wage, respectively. As in the previous section, the monthly data from January 1983 to October 1996 is used.
As in Section Ⅱ- 2, the unit root tests on each variable are done first. Since the unit root test results on the CPI and the PPI are already reported in the previous section, only those for the wage and ICGP are reported in Table 4. As for the ICGP, the null hypothesis that it has a unit root is not rejected at the 5 percent significance level, while the hypothesis that the first differenced ICGP has a unit root is rejected in both cases where the estimated equation has an intercept or an intercept and a linear time trend. However, the test results are a little different with regard to the wage. When including the linear time trend in the test equation, the null hypothesis of unit roots of the wage is not rejected in some cases. In these cases, I assume that the wage has a unit root. This seems reasonable when one considers that 1) in the ADF test, as the number of lags increases to 6, the null hypothesis is rejected, and 2) the wage is generally considered as an integrated series in other studies (Baek, 1996).
Again, the Johansen likelihood ratio tests methods are applied to test the cointegration relationships between the CPI, PPI, ICGP, and wage. To see, how the
- 8 -
relationships have changed within the entire sample period of 1983 to 1996, the test statistics are reported sequentially as below. Cointegration tests are then done on data from periods with different starting dates, and afterwards, the cointegration test statistics for each period are reported. In this way, the test statistics for the data from each of the different different periods ending in October 1996 can be calculated. The estimated sequential test statistics are reported in Figure 4. The figure clearly shows that they spike sharply during 1889 and 1990, indicating that there may be a break during these periods. This being the case, the sample period was broken down into two sub- sample periods - - the 80s and the 90s - - and the cointegration tests were done again on each of these two separate periods.
Table 4 reports the test statistics applying the data of each sub- sample period. The null hypothesis of no cointegration is rejected at the 5% significance level for the data after 1991. However, the null hypothesis of at most one cointegrating relationship is not rejected, so it can be concluded that there is only one cointegrating relationship between the four variables during the 1990s. In the test applying the data for the 80s, the null hypothesis of no cointegration is not rejected, indicating that there is not a stable relationship between the variables. In conclusion, the relationships between these four variables are relatively stable throughout 1990 but not so stable during 1980.
<Table 4> Unit Root Test Statistics
lags |
ADF |
Phillips- Perron |
||||
Intercept |
trend |
Intercept |
trend |
|||
Level |
Wage
|
0 6 |
- 0.29 0.45 |
- 5.50* - 2.54 |
- 2.07 - 2.32 |
- 14.08* - 14.91* |
ICGP
|
0 6 |
- 2.62 - 2.48 |
- 1.53 - 1.54 |
- 2.73 - 2.52 |
- 1.63 - 1.72 |
|
Differenced |
Wage
|
0 6 |
- 10.70* - 6.83* |
- 10.67** - 6.85** |
- 24.19* - 22.92* |
- 24.12** - 22.87** |
ICGP
|
0 6 |
- 7.20* - 4.36* |
- 7.64** - 4.82** |
- 12.49* - 12.32* |
- 12.93** - 12.62** |
Notes: "Intercept" means that estimation equation only included intercept while "Trend" means that it included both the intercept and linear time trend. * and ** mean the null hypotheses of unit roots is rejected at the 5% and 1% significance levels, respectively.
- 9 -
The estimated cointegrating vector of the CPI, PPI, ICGP, and wage = (1, - 0.39, - 0.36, - 0.33). It seems that the long- run elasticity of the CPI with respect to all three variables is close to 0.36
<Figure 2> Sequential Cointegration Test Statistics:
(CPI, PPI, ICGP, Wage)
Note: The 5% significance level for the null hypothesis of no cointegration is 47.21.
<Table 5> Cointegration Test Statistics
(CPI, PPI, Imported Consumer Goods Prices, Wage)
Null hypothesis |
lags |
Jan. 83~Dec. 89 |
Jan. 91~Sep. 96 |
No cointegration |
3 6 |
38.40 37.38 |
48.45* 53.74* |
At most one cointegrating relationship |
3 6 |
16.03 19.57 |
20.07 25.73 |
At most one cointegrating relationship |
3 6 |
3.93 5.58 |
8.59 9.07 |
At most one cointegrating relationship |
3 6 |
0.74 0.00 |
3.01 2.58 |
Note: * means that the null hypothesis of no cointegration is rejected at the 5% significance level.
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Ⅲ- 2. Variance Decomposition and Impulse Response Function.
In this section, the variance decomposition for forecast errors and the impulse response function are applied to examine the dynamics of price movements and the source of inflation in the 90s. Since it is shown that there is a cointegration relationship between those variables during the 1990s, the VEC model is applied.
The results of the decomposition of forecast- error variance of the CPI are shown in Figure 3. It shows that the CPI shock explained only 25 percent of its own forecast error variance, indicating that shocks from other three variables explained more than 75 percent of the CPI forecast error. Interestingly, after 6 quarters, each of the PPI, imported consumer goods price, and wage explained approximately 25 percent of the forecast error variance of the CPI. All three of these variables were therefore of almost equal importance in explaining the movement of the CPI.
The dynamic interactions between these variables is studied using the impulse response function. The results of the estimation model are in Figure 4. All of the shocks to the PPI, imported comsumer goods price, and wage ultimately have a persistent impact on the CPI, and the long- run effect of each seems to be almost the same. A shock of one standard deviation on the PPI or ICGP or wage will change the CPI by 0.0015 after 6 quarters. In the short run, however, the effects of shocks
<Table 6> Estimated Cointegrating Vector
Constant |
CPI |
PPI |
ICGP |
Wages |
3.22 |
1 |
- 0.39 |
- 0.36 |
- 0.33 |
Note: The sample periods are from Jan. 91 to August 96, and the number of lags in the VAR model is 6.
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to each variable on the CPI are different. A shock to the PPI will change the CPI
directly, while those to the wage and imported consumer goods price take more time
to significantly affect the CPI.
<Figure 3> Decomposition of Forecast- Error Variance of CPI
<Figure 4> The Impulse Response Function of CPI to Each Shock
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Ⅲ- 3. Test Results
With these empirical test results in the above section, the following conclusions can be reached. During the 1990s, there has clearly been a stable relationship between the CPI, PPI, imported consumer goods price, and wage. They are cointegrated, and after applying variance decomposition of forecast errors and estimating the impulse response function, it also appears that the CPI is influenced by these variables. The change in the relationship between the CPI and PPI, which is shown in Section Ⅱ, can therefore be explained by the mis- specification of CPI equation (9) by equation (2). As the Korean economy underwent a period of transition in the late 80s and early 90s, the relationships between the CPI, ICGP, and wage also changed. Korea's consumer product market began to open in the late 80s, so the volume of consumer goods imports increased fast. At the same time, the wage rate rose dramatically in the wake of Korean's increasing democratization and the wide- spread labor disputes that it unleashed. The average wage growth rate during 1989 to 1991 was 20.6 percent. This is something which clearly had strong bearing on the CPI, but because it was not duly considered earlier, the CPI equation such as equation (2) may be mis- specified.
The importance of the PPI in so much as it influences CPI inflation has also significantly decreased. This change can be explained by both the opening of the Korean consumer goods market and the expansion of the service sector. In the 80s, when the Korean consumer goods market was closed, most consumer goods were of course produced domestically, so their prices depended to an especially great degree on the domestic raw material price or intermediate goods price. However, after opening of the Korean consumer goods market, substitution between domestic consumer goods and imports good began to increasingly occur. Thus, the impact of foreign producted goods prices on the CPI became greater. In addition, the expansion of demand for services created more upward inflationary pressure of the CPI.
The wage became an important source of inflation in the 1990s. The demand for services has increased enormously in the 90s with the result that the service sector naturally came to have more bearing on the CPI. Since labor is by far the most important input in the service sector, the rapid rise in wages which occurred during
- 13 -
that time caused the service fees and ultimately the CPI to rise.
The slow increase in imported consumer goods prices helped to stabilize the Korean economy and the CPI. As the Korean consumer goods market opened wider, the volume of imports of relatively inexpensive goods from foreign countries rapidly increased and therefore contributed to the stability in the CPI.
Ⅳ. Conclusion
This paper investigates how and why the relationship between the CPI and the PPI in Korea has changed. Several statistical methods such as the cointegration test and the estimation of variance decomposition of forecast error and impulse response function are applied. At the same time, this paper attempts to explain the sources of recent CPI inflation in Korea.
According to this empirical examination, several important facts were found. First, the relationship between the CPI and the PPI has changed in the 1990s: the lead and lag relationship which they exhibited during the 1980s no longer holds. However, when positing a new CPI equation including the PPI, imported consumer goods price, and wage, and applying several statistical test methods, the relationship in the 1990s seems to have been stable. Third, the PPI, wage, and imported consumer goods price are of almost equal importance in explaining current inflation, according to the estimation results of the variance decomposition of forecast error and impulse response function of the CPI equation. Considering that the wage increased very rapidly and the imported consumer goods price was relatively stable during the 90s, one can readily understand why the service sector has been leading the increase in inflation and why the opening of the Korean consumer goods market has helped hold down inflation in Korea.
The change in the relationship between the CPI and the PPI through the 80s to the 90s is a good example of how the relationship between economic variables can change when the economic environment has changed. As the Korean economy rapidly grows and its industrial structure quickly becomes more complex, the relationship between economic variables will change in profound ways. This being the case, the monetary authorities or economic agents should duly consider this fact in their policy making or economic forecasting, lest they should make some serious mistakes.
- 14 -
- 15 -
References
Kim, Yangwoo and Sungwhan Choi, 1993, “The Korean Macroeconomic Model- BOK92,” Monthly Bulletin, The Bank of Korea, February, 20- 88 (written in Korean).
Baek, Woonggi, 1996, “Inflation and the Unit Labor Cost,” in The Analysis on Korean Price Variability and Policy Implication, edited by Woogyu Park, Seoul: KDI (written in Korean).
Baek, Woonggi and Sanghoon Oh, 1996, “The Korean Quarterly Macroeconomic Model- KDI92,” Korean Development Review, 13, 1- 86 (written in Korean).
Clock, Todd E., 1995, “Do Producer Prices Lead Consumer Prices?” Federal Reserve Bank of Kansas City Economic Review, 25- 39.
Dickey,David and Wayne A. Fuller, 1979, “Distribution of the Estimators for Autoregressive Time Series with Unit Root,” Journal of American Statistical Association, 74, 427- 431.
Engle,Robert and Clive Granger, 1987, “Cointegration, Error- correction: Representation, Estimation, and Testing,” Econometrica, 55, 251- 276.
Hargreves, Colin, 1995, “A Review of Methods of Estimating Cointegrating Relationships,” in Nonstationary Time Series Analysis and Cointegration, New York: Oxford University Press.
Hamilton, James, 1994, Time Series Analysis, Princeton: Princeton University Press.
Johansen, Soren, 1988, “Statistical Analysis of Cointegrating Vectors,” Journal of Economic Dynamics and Control, 12, 231- 254.
Johansen, Soren, 1991, “Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models,” Econometrica, 59, 1551- 1586
Kim, Baekeun, 1995, “The Process of Inflation in Korea,” Monthly Bulletin, The Bank of Korea, September, 3- 30 (written in Korean).
Lee, Sangwoo, 1994, “The Service Industry and the Source of Service Inflation in Korea,” Monthly Bulletin, The Bank of Korea, August, 21- 48 (written in Korean).
National Statistics Office, 1996, The Korean Macroeconomic Model- NSQ96, (written in Korean).
- 16 -
Park, Woogyu, 1996, The Analysis on Korean Price Variability and Policy Implication, Seoul: KDI (written in Korean).
Phillips, Peter, 1986, “Understanding Spurious Regression in Econometrics” Journal of Econometrics,” 33, 311- 340.
Phillips, Peter and Pierre Perron, 1988, “Testing for Unit Roots in Time Series Regression,” Biometrika, 75, 335- 346.
Roth, Howard, 1991, “Leading Indicators of Inflation,” in Leading Economic Indicators, edited by Kajal Lahiri and Geoffrey H. Moore, Cambridge: Cambridge University Press.
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<Appendix 1> Variance Decomposition of Forecast Error
(CPI, PPI, ICGP, WAGE)
Note: The ordering in the VEC model is following: ICGP → Wage→ PPI→ CPI
- 18 -
<Appendix 2> Impulse Response Function
(CPI, PPI, ICGP, WAGE)
Note: The ordering in the VEC model is following: ICGP → Wage→ PPI→ CPI.
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Macroeconomic Developments
Economic Growth
1996 was not the best of years for the Korean economy. GDP growth marked a downward trend all year long, falling to 7.1 percent from 8.9 percent in 1995. What was worse, the inflation rate rose to 5.0 percent from 4.5 percent in 1995, and the current account deficit ballooned to a staggering 23.7 billion dollars.
This contraction in economic growth came about almost entirely to slowdowns in exports and investment. As shown in Table 1, the growth in exports in terms of volume fell to 14.1 percent from 24.0 percent in 1995. This was partly due to the depreciation of the Japanese yen. The price competitiveness of Korean exporters was hurt by the rapid depreciation of the yen which began from the autumn of 1995. Especially affected were Korean exporters whose products competed with Japanese products in world markets. As seen in Figure 1, the real effective exchange rate significantly appreciated after the third quarter of 1995. Another major factor responsible for the slowdown in exports was the worldwide surplus of those types of products which comprise the bulk of Korea's exports. The semiconductor and petrochemical industries, which were the main engines of Korea's export growth these last several years, faced sudden slowdowns in demand for their products as well as declining unit prices.
This sudden decline in exports naturally forced Korean firms to reduce their outlays for investment, especially because production facilities had been expanded so greatly in the last few years. The factory utilization ratio fell sharply, and equipment investment grew by only 8.2 percent for all of 1996. Construction investment also remained stagnant throughout the year. Private housing construction, in particular, has been especially slow. As a result of over construction for the past few years, the excess supply in the housing market continued. More than 120,000 apartments actually remain unsold throughout the country. Matters in the real estate market were also compounded by the government's efforts to discourage real estate speculation. These efforts have indeed proved effective toward reducing the demand for the private housing construction. Public construction investment, however, still continued to grow.
- 20 -
In order to prevent the possibility of a very deep recession and to improve the infrastructure, the Korean government has expanded its expenditures for construction.
<Table 1> Economic Growth1)
(percent, year- on- year)
19952) |
19963) |
19974) |
|||||
1/4 |
2/4 |
3/4 |
4/4 |
year |
|||
G D P |
8.9 |
7.1 |
5.7 |
6.1 |
6.6 |
6.7 |
6.3 |
Consumption (Private) Fixed investment (Construction) (Equipment) Exports Imports |
7.2 (8.3) 11.7 (8.7) (15.8) 24.0 22.0 |
6.9 (6.9) 7.1 (6.3) (8.2) 14.1 14.8 |
6.2 (6.2) 4.3 (6.2) (2.1) 7.0 10.5 |
5.7 (5.9) 4.5 (6.2) (2.2) 9.9 10.1 |
5.8 (6.0) 5.3 (6.8) (3.5) 10.4 10.8 |
5.8 (6.2) 5.5 (6.1) (4.6) 12.8 9.9 |
5.9 (6.1) 4.9 (6.3) (3.1) 10.1 10.3 |
Notes: 1) Percentage changes from the previous year.
2) Revised.
3) Estimates.
4) KIF Forecasts.
Source: The Bank of Korea, National Income.
<Figure 1> Real Effective Exchange Rate
Note: As for the actual estimation of real effective exchange rate, see Korean
Financial Review, Spring, 1996, Vol. 6, No 1.
Sources: The Bank of Korea, Monthly Bulletin, various issues; DRI, International Financial Bulletin, December, 1995.
Private consumption finally began to decelerate. It lagged the change in production
- 21 -
growth by a few quarters. However, since it adjusted more smoothly than production, it softened the decline of the economy and made the recession less serious than it would have been otherwise.
Even though the economy had been on a downward trend throughout the year, the rate of the contraction was relatively mild. As seen in Table 1, the GDP growth rate was still as high as 7.1 percent. During the previous recessions of 1992 and 1993, it actually bottomed out at 5.1 and 5.8 percent, respectively. It would therefore seem that this recession is not nearly as serious, and there are several explanations for it. Because of recent changes in Korea's industrial structure, Korean companies decided to accumulate inventories rather than cut production. As seen in Table 2, inventories rose by more than 20 percent year- on- year since the second quarter. The economy is more concentrated in capital intensive industries such as semiconductors or petrochemicals which by their very nature incur high fixed costs but little in the way of variable costs.
This being the case, it is generally more cost efficient for firms in these industries to accumulate inventories rather than cut back production even when demand declines.
<Figure 2> Equipment Investment and Production Capacity1)
Note: 1) Percentage changes from the previous year.
Sources: National Statistical Office, Monthly Statistics of Industrial Production, various issues.
The Bank of Korea, National Income, November 1995.
It is also interesting to note that Korean firms were reluctant to reduce production
- 22 -
and the number of employees because they were concerned about sparking serious
labor disputes.
As the recession continued and the current account deficit widened, some economists and businessmen argued that Korea was amidst an economic crisis and that without drastic change to the industrial structure, the Korean economy may not revive in the near future. They insisted that Korea's economic difficulties were the result of a deep- rooted problem of ‘high cost and low productivity.’
After careful examination of the main causes of the current recession, however, it cannot be considered as such a ‘crisis.’ First of all, this is not a very deep recession, as explained above, and the fact is that the cyclical factor has contributed
<Table 2> Industrial Activity Index1)
(percent, year- on- year)
1995 |
1996 |
|||||
1/4 |
2/4 |
3/4 |
4/4 |
year |
||
Industrial production Producer's shipments Producer's inventory Production capacity Avg. manufacturing operation ratio Unemployment rate2) |
11.9 12.6 14.9 9.3 82.3 2.0 |
8.6 9.9 19.1 7.6 82.3 2.2 |
7.3 6.9 20.2 7.6 81.7 1.9 |
8.0 6.0 20.4 7.7 82.5 1.8 |
9.9 9.5 14.5 8.9 80.5 2.0 |
8.4 8.1 14.5 8.0 14.5 2.0 |
Consumption Wholesale and retail trade Domestic consumption shipments |
7.8 7.4 |
8.3 5.3 |
7.0 7.4 |
6.6 1.9 |
6.0 5.9 |
7.0 5.2 |
Investment Machinery orders Machinery imports permitted Domestic construction orders Building construction permits |
15.8 28.2 21.2 1.0 |
9.7 1.3 47.4 - 7.4 |
22.5 - 24.4 13.1 - 16.7 |
9.2 17.7 18.3 27.6 |
15.7 3.3 22.3 - 5.5 |
14.3 - 3.4 22.7 - 3.0 |
Leading composite index3) Coincident composite index3) |
4.9 6.2 |
3.7 2.2 |
0.5 0.6 |
2.1 1.3 |
0.8 1.8 |
5.4 4.8 |
Notes: 1) Percentage changes from the previous year.
2) Seasonally adjusted.
3) Period averages.
Source: National Statistical Office, Industrial Activity Review, various issues.
to the current recession significantly. It is quite natural that the economy should
- 23 -
slow down after having reached the peak of the business cycle. Since the Korean
economy experienced a boom and reached the peak of the last business- cycle in 1995,
it should not be a surprise to anyone that it slowed in 1996. What is more, the
slump in exports was caused not only by the reduced price competitiveness of Korean
products but also by the global excess supply of them. Nevertheless, it still seems
that Korea's export industries were very competitive in the international market.
Finally, the growth rate of Korea's potential output seemed to have fallen recently.
As Korea joined to the OECD and its per capita GDP surpassed the psychologically
important level of 10,000 US dollars, the work week was slightly shortened and the
productivity of capital fell.
After the recession had firmly taken hold for some time, the Korean government launched a new effort to improve the competitiveness of Korean products in October. This plan is intended not only to revive the economy in the short term but also to raise the economy's growth potential in the long term. Since Korea is a small open economy which heavily depends upon the external sector, improving the competitiveness of Korean products is very important to say the least. According to the plan, the Korean government is trying to improve the efficiency of the public sector by cutting the number of government employees and freezing their salaries in 1997. The government is also seeking to help the private sector raise its productivity by means of more deregulation.
Several changes were noticeable in the production sector in 1996. The manufacturing sector contracted significantly due to the slower growth in exports while the service sector still remained vital. The demand for services kept rising rapidly because the economy had grown substantially in recent years. Production in the manufacturing sector was down, the most in the high- tech, capital- intensive industries. The demand for these industries' exports declined significantly due to global excess supply. These industries lost a great deal of their price competitiveness vis- a- vis Japanese competitors in world markets due to sharp depreciation of the yen. Production in labor- intensive, light industries also marked a steady decline. Firms in these industries became less competitive because of higher wages and tough competition from other developing Asian countries which have cheap and abundant supplies of labor. Only the agricultural sector saw an increase in production. The
- 24 -
weather conditions in 1996 were very favorable for production of rice and other crops.
The recession is expected to continue into 1997. Based on several observations, a near- term rebound in the economy cannot be anticipated. Rather, the economy will not reach the trough of the current business- cycle until the third quarter, and it will only begin to revive slowly afterwards. Exports, the main engine for economic growth for the last thirty years, are not expected to recover significantly any time soon. As long as there is an excess supply of major export products such as semiconductors on the global market, exports cannot be expected to rebound rapidly. At the same time, the continuing weakness of the yen will lower the competitiveness of Korean products against Japanese ones. With the sluggish exports, there will be no major recovery in investment, either. Investment decisions of Korean firms heavily depend upon the demand for exports: more than half of its GNP is derived from international trade. As long as the pessimism prevails in the business environment, there will be no major outlays for investment. In the construction sector, investment is projected to maintain its current growth rate. As previously stated, there are more than 120,000 unsold apartments around the country, which does not bode well at all for the housing construction industry. Although the pace of construction for the public infrastructure will increase, it does not provide enough of a boost to turn the economy around. Private consumption, for its part, will decelerate further as the recession continues. The factory utilization ratio is expected to fall further, and at the same time, the unemployment rate is seen to rise. The unemployment rate is forecast to rise to 2.4 percent. Those firms which accumulated inventories for the past year will eventually find themselves obligated to cut production and employment in 1997. Taking all of these factors duly into consideration, the GDP growth rate will decrease to 6.3 percent in 1997 from 7.1 percent in 1996.
The above forecasts are in line with the latest movements of major leading economic indicators. The composite leading business indicators increased by only 0.8 percent in the fourth quarter of 1996. This indicates that the Korean economy will still be on a downward trend during the first half of 1997. The growth in volume of machinery imports permitted, a leading indicator of equipment investment, remained flat during the fourth quarter, which likewise indicates that equipment investment will
- 25 -
further decelerate during the first half of 1997. The growth in arrivals of letters of credit, the leading indicator of exports, kept decreasing during the second half, so Korean exports will not recover soon during the first half of 1996.
Prices
The CPI inflation rate in Korea rose to 5.0 percent in 1996 from 4.5 percent in 1995. Inflationary pressure remained strong in spite of the recession due to increases in prices of imported products. The depreciation of the Korean won caused the prices of imported consumer products to rise. As the Korean consumer goods market opened further and the domestic and foreign market became more integrated, the CPI was more strongly influenced by changes in prices of imported consumption goods.
Service prices also rose rapidly in 1996 as they have for the past several years. As seen in Figure 3, increases in service prices have been the major source of inflation in Korea for quite some time. The fact is that the demand for services has continuously increased for the last several years in line with the rise in Korea's income level. Most services are luxury goods whose demand elasticity of income is greater than 1. Service prices were also driven up because the supply of services did not increase much. Services differ in a fundamental way from manufactured goods in that they cannot be provided by mass production. In addition, they are not tradable goods which can be supplied through imports.
The PPI inflation rate fell to 2.7 percent in 1996. The decline in international raw materials prices meant that imported raw material prices in Korea remained stable. In addition, the good harvest in Korea translated into significantly lower agricultural product prices.
The CPI inflation rate in 1997 is projected to be 4.5 percent, lower than in 1996. This is obviously an optimistic forecast, but there are many reasons for it. The prolonged recession will finally cause aggregate demand to contract, and stable import prices, especially those of imported raw materials, will prevent the prices for manufactured products from rising. Furthermore, the foreign exchange rate is projected not to depreciate as much in 1997 as it did in 1996. The increased supply of foreign goods, may also help absorb some of the domestic inflationary pressure.
- 26 -
While the Korean CPI inflation rate seems to have settled down, it is not expected to fall below 4 percent. As explained above, excess demand in the service sector will persist with the result that the service sector inflation rate is expected to remain above 5 percent for the next several years.
<Figure 3> CPI inflation Rate and Sectoral Contributions1)
Source: National Statistical Office, Consumer Price Index, various issues.
<Table 3> CPI and Wages
(percent, year- on- year)
1994 |
1995 |
1996 |
19971) |
|||||
1/4 |
2/4 |
3/4 |
4/4 |
year |
||||
Consumer price index Agricultural & marine Manufacturing Service |
6.4 10.8 3.1 6.6 |
4.5 3.0 2.6 6.8 |
4.9 - 0.1 4.0 7.7 |
5.1 2.2 4.2 7.0 |
5.2 2.1 4.9 6.7 |
4.8 1.0 4.4 6.7 |
5.0 1.3 4.4 7.1 |
4.5 2.5 3.6 6.2 |
Producer price index |
2.8 |
4.2 |
3.1 |
1.8 |
1.9 |
2.0 |
2.6 |
2.9 |
All industry wage Manufacturing wage |
12.7 15.5 |
12.0 9.9 |
15.2 15.6 |
11.9 12.0 |
11.4 11.8 |
11.0 11.6 |
12.4 12.7 |
10.4 9.7 |
Note: 1) KIF Forecasts.
Sources: National Statistical Office, Consumer Price Index, various issues.
The Bank of Korea, Monthly Bulletin, various issues.
Current Account and Foreign Exchange Rate
- 27 -
The trade balance and the current account balance significantly deteriorated in 1996. The trade deficit and the current account deficit reached upwards of 15.3 and 23.7 billion dollars, respectively. These were record highs for Korea in both cases.
The main cause of this huge current account deficit was the export slump. The sudden drop in unit export prices and the sluggish growth in export volume seriously hurt Korea's export industries. The prices for semiconductors and petrochemical products, which composed 25 percent of Korea's total exports, began to fall rapidly in April because of the worldwide excess supply. The price of the 16 mega D- RAM chip, one of the most important export products of Korea's semiconductor industry, collapsed from 45 dollars in January to only 8 dollars in December. As seen in Figure 4, unit export prices fell by as much as 15 percent year- on- year during the second half. By reason of its small size, Korea is a price taker on the international market, so its export prices heavily depend upon world prices.
The growth in imports also decreased in 1996, but not as drastically as did export growth, thus causing the trade balance to deteriorate. The growth rate of capital goods and raw material imports fell to 10.0 percent and 10.2 percent in 1996 from 32.5 percent and 32.6 percent in 1995, respectively. However, imports of consumption goods rose greatly. Both imports of inexpensive necessities from other Asian developing countries and expensive luxury goods from the advanced countries rapidly increased. With the opening of Korea's consumer goods market, Korean consumers have been buying more and more imported goods.
The invisible trade balance also significantly deteriorated. The deficit widened to 7.7 billion dollars in 1996. Record numbers of Koreans took vacations abroad, and this was reflected in the worsening travel account. At the same time, the investment income account also deteriorated as the national debt increased due to the expansion of the current account deficit.
The capital account balance recorded a surplus of 17.2 billion dollars in 1996. The opening of the Korean financial market induced large inflows of foreign capital. As much as 12 billion dollars of foreign capital flowed into Korea during the first half alone. During that period, the surplus in the trade credit account amounted to 7
- 28 -
billion dollars. Many Korean importers expecting the foreign exchange rate to
<Table 4> Balance of Payments and Foreign Exchange Rate
(billions of dollars)
1995 |
1996 |
19971) |
|||||
1/4 |
2/4 |
3/4 |
4/4 |
year |
|||
Current account Trade balance Exports Imports Invisible trade balance Capital account Overall balance |
- 8.9 - 4.7 123.2 127.9 - 3.6 13.4 3.0 |
- 4.6 - 2.6 31.5 34.1 - 1.9 4.6 0.4 |
- 5.2 - 3.1 32.5 35.6 - 1.9 7.5 0.8 |
- 7.5 - 5.6 29.7 35.3 - 1.7 0.1 - 5.8 |
- 6.4 - 4.0 34.5 38.5 - 2.1 5.0 - 1.2 |
- 23.7 - 15.3 128.3 143.5 - 7.7 16.9 - 5.7 |
19.0 - 9.0 - 144.2 153.2 - 9.0 17.2 - 3.0 |
Foreign exchange rate won/dollar2) |
771.0 |
783.0 |
786.1 |
820.0 |
830.1 |
804.8 |
846.3 |
Note: 1) Forecasts.
2) Period averages.
Source: The Bank of Korea, Monthly Balance of Payment, various issues.
<Figure 4> Export Growth by Volume and Price
appreciate took out short- term foreign loans to finance their imports. They tried to
- 29 -
take advantage of the large interest rate differential between domestic and foreign rates. In the Korean stock market, foreign investment increased by up to 3 billion dollars. The limit on aggregate stock holdings by foreigners was raised by 3 percentage points last April 1, and it induced an additional inflow of 1.7 billion dollars into the stock market during April alone. At the same time, many Korean companies tried to finance their investments through the international market in order to take advantage of the lower interest rates.
During the second half, however, the volume of capital inflows tapered off significantly. As the foreign exchange rate suddenly began to depreciate in June, the interest rate differentials in terms of the Korean won between the domestic and foreign markets began to narrow. From June to October, the foreign exchange rate depreciated by more than four percent. As a result, the amount of short- term capital inflows, such as trade credits, decreased to 3 billion dollars in the second half. Furthermore, the continued bearishness in the Korean stock market discouraged foreign investors from further stock purchases. In September, in particular, many foreign investors sold their shares of Korean stocks and withdrew their money out of the country. In October, when the purchasing limit was raised by another 2 percentage points, the net aggregate purchase of stocks by foreigners was only 0.7 billion dollars. This was quite in contrast to the 1.7 billion dollars of inflow when the limit was lifted by 3 percentage point in April.
The won/dollar exchange rate depreciated all year long in 1996. The won began in January at 775 to the dollar, but after February it weakened steadily to about 790 by early June. Afterwards, it suddenly plummeted to the 810 level and then kept depreciating until it reached 845 in December.
This could be explained by the changes in the balance of payments. The persistent deficit in the current account created excess demand for foreign currency, namely, the US dollar. The capital account surplus did not increase as expected and therefore did not help offset the current account deficit. And as explained above, the Korean stock market became less attractive to foreign investors. Thus, there was nothing there to prop the won up.
The Bank of Korea intervened frequently in the foreign exchange market to
- 30 -
stabilize the foreign exchange rate as well as to discourage currency speculation. The foreign exchange holdings at the Bank of Korea decreased by more than 10 percent from June to November. This was a very remarkable development because reserves had always increased since 1990.
In 1997, the current account deficit is forecast to be around 19.0 billion dollars. The trade balance will show a substantial improvement such that its deficit will fall to 9 billion dollars from 14.1 billion dollars. Exports will recover mildly as unit export prices are expected to stop falling and even recover slightly. It is expected that the stagnation in the global semi- conductor industry will finally end in 1997. Furthermore, the acceleration in global economic growth will raise the demand for Korean products, and the recent depreciation of the won will increase the competitiveness of Korean exports. Imports will grow more slowly than exports because of the continuing recession of the domestic economy. The sluggish investment and production will translate into lower demand for imports of capital goods and raw materials.
The invisible trade account balance is expected to worsen, rising to 9 billion dollars. More and more Koreans will opt to go abroad on their vacations, so the travel account deficit will increase. At the same time, as the national debt and interest payments rise, the interest income account will likely worsen as well.
The capital account balance is projected to record a huge 18 billion dollar surplus in 1997. The Korean government will continue to pursue opening of the financial market, and because Korea joined OECD at the end of 1996, its financial market and economy will become more integrated with the world market. According to the capital market opening plan, for example, the Korean government will raise the limit on aggregate foreigner stock holdings in the Korean stock market by 3 percentage points every year until 1999, when the limit will be removed completely. More financial institutions, in the meantime, will be permitted to participate in the Korean financial market. Since most of these changes will occur during the first half of 1997, the volume of capital inflows will significantly increase during the second half.
The Korean won is expected to depreciate further. During the first half, it will significantly depreciate because the current account deficit will widen and the capital
- 31 -
account surplus will remain low. It will finally begin to appreciate during the second half. The current account will improve as exports revive and more foreign capital flows into Korea.
<Figure 5> Won/Dollar Exchange Rate
Source: The Bank of Korea.
- 32 -
Money
Unlike the case during the previous year, the rate of growth of M2 accelerated significantly toward the end of 1996. This resulted mostly from the reforms of the money- in- trust system in May. These reforms initiated a sizable shift in funds from money- in- trusts into savings accounts, which is continuing today. Other factors were working to push up the M2 growth rate as well, however. One of these was the increased supply of domestic credit to the private sector. Firms experienced greater short- term financing needs because of accumulating inventories, and this pushed up the growth rate significantly in the second half. Increasing flows of funds between the various types of monetary assets underscored the limitation of M2 as a meaningful monetary indicator. In view of the anomalous behavior of M2 and the rather stable interest rate movements, it would seem that the monetary authorities adhered to a flexible monetary policy throughout the year.
Quarterly analysis of the monetary trends in 1996 indicates that the M2 growth rate remained stable at around 14 percent during the first quarter. The much feared side effects of both the introduction of the comprehensive tax system for financial income and the general elections did not materialize because various tax- saving financial products were offered by banks and insurance companies in advance of the actual implementation of the proposed tax system. However, after
<Table 5> Issuance of Monetary Stabilization Bonds
(billion won)
1995 |
1996 |
|||||||||
April |
May |
June |
July |
Aug. |
Sep. |
Oct. |
Nov. |
Dec. |
||
New issues |
39,468 |
4,400 |
633 |
3,392 |
343 |
246 |
3,070 |
452 |
3,547 |
6,106 |
Redemptions |
38,984 |
822 |
1,168 |
3,125 |
442 |
1,470 |
3,263 |
2,006 |
4,512 |
5,880 |
Net increase |
485 |
3,578 |
- 535 |
267 |
- 99 |
- 1,225 |
- 193 |
- 1,554 |
- 965 |
226 |
Outstanding |
25,825 |
29,107 |
28,573 |
28,840 |
28,741 |
27,516 |
27,323 |
25,769 |
24,804 |
25,030 |
Source: The Bank of Korea, Monthly Bulletin, various issues.
- 33 -
the minimum reserve requirement on banks was reduced by two percentage points
early in the second quarter of 1996, the monetary aggregates began to give conflicting signals; M2 growth rose to 15.2 percent, while the growth in reserve money showed a dramatic decline to 3.1 percent. The direct impact of the lower
<Table 6> Money Growth Rates, Multipliers, and Velocities1)
(percent)
1993 |
1994 |
1995 |
1996 |
|||||
1/4 |
2/4 |
3/4 |
4/42) |
|||||
Reserve Money3) |
Growth Rates |
20.8 |
16.2 |
13.4 |
11.9 |
3.1 |
- 0.6 |
- 5.5 |
Velocities |
3.58 |
3.56 |
3.61 |
3.17 |
3.85 |
4.15 |
4.77 |
|
M14) |
Growth Rates |
22.1 |
11.9 |
11.6 |
11.2 |
9.9 |
9.1 |
7.0 |
Multipliers |
1.37 |
1.32 |
1.30 |
1.29 |
1.38 |
1.40 |
1.49 |
|
Velocities |
2.62 |
2.70 |
2.78 |
2.45 |
2.78 |
2.97 |
3.20 |
|
M25) |
Growth Rates |
18.6 |
15.6 |
15.5 |
14.0 |
15.2 |
17.3 |
18.2 |
Multipliers |
5.56 |
5.53 |
5.63 |
5.62 |
6.35 |
6.64 |
7.14 |
|
Velocities |
0.65 |
0.64 |
0.64 |
0.56 |
0.61 |
0.62 |
0.67 |
|
M2 + CDs |
Growth Rates |
17.0 |
17.9 |
16.3 |
13.5 |
14.9 |
16.1 |
17.1 |
Multipliers |
6.21 |
6.30 |
6.46 |
6.36 |
7.26 |
7.58 |
8.12 |
|
Velocities |
0.58 |
0.56 |
0.56 |
0.50 |
0.53 |
0.55 |
0.59 |
|
MCT6) |
Growth Rates |
22.9 |
23.5 |
21.6 |
22.3 |
22.7 |
21.9 |
20.0 |
Multipliers |
9.14 |
9.72 |
10.42 |
10.74 |
12.40 |
12.97 |
13.77 |
|
Velocities |
0.40 |
0.37 |
0.35 |
0.30 |
0.31 |
0.32 |
0.35 |
|
M37) |
Growth Rates |
21.7 |
22.0 |
19.9 |
18.6 |
19.9 |
19.7 |
- |
Multipliers |
17.64 |
18.50 |
19.58 |
19.83 |
22.90 |
- 23.76 |
- |
|
Velocities |
0.20 |
0.19 |
0.18 |
0.16 |
0.17 |
- 0.17 |
- |
Notes: 1)Changes from the corresponding period of the previous year, average balance. Money multipliers are the ratios of each monetary aggregate to the volume of reserve money. Velocities of money represent the ratios of nominal GDP to each monetary aggregate.
2)Estimates.
3)Reserve money = bank notes + reserves of deposit money banks.
4)M1 = currency + demand deposits.
5)M2 = M1 + time and 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, Monthly Bulletin, various issues.
The Bank of Korea, Current Monetary Statistics, various issues.
- 34 -
reserve requirement on the money supply was mitigated by the sale of monetary
stabilization bonds in April, but the extension of maturities for money- in- trusts
from one year to 18 months caused the shift of maturing short- term money- in- trusts to savings accounts to accelerate. Coming into the third quarter, increased substitution among monetary assets and demand for money caused the
M2 growth rate to reach upwards of 17 percent over the corresponding period of
the previous year. This was followed by a steady increase in M2 growth to 18
percent in the fourth quarter. Unlike the widely fluctuating M2 figures, the growth in MCT remained stable throughout the year, except during the fourth quarter when it showed a slight decline with the introduction of MMFs (Money Market Mutual Funds).
<Table 7> Recent Deposit Changes at Financial Institutions1)
(billion won)
1996 |
||||
1/4 |
2/4 |
3/4 |
4/4 |
|
Bank accounts |
- 11,262 |
86,677 |
74,747 |
24,588 |
Demand deposits |
- 31,842 |
8,880 |
8,074 |
- 6,704 |
Savings deposits |
20,580 |
77,797 |
66,673 |
2,340 |
Money in trusts |
100,803 |
92,587 |
45,048 |
17,606 |
Financing firms |
85,847 |
37,206 |
33,094 |
48,539 |
(CMAs) |
12,229 |
- 5,342 |
- 15,696 |
7,275 |
(CP sales) |
70,078 |
40,249 |
- 8,521 |
25,839 |
ITCs |
49,346 |
27,103 |
13,351 |
- 3,370 |
(Bond type) |
54,728 |
36,146 |
4,400 |
- 5,658 |
(Stock type) |
- 5,967 |
- 8,703 |
9,142 |
2,411 |
Securities firms |
||||
Customer deposits |
- 1,908 |
5,821 |
- 1,479 |
1,552 |
Borrowings |
- 19,170 |
9,297 |
6,213 |
3,985 |
Note: 1)Average changes during the period.
Sources: The Bank of Korea, Monthly Bulletin, various issues.
The Bank of Korea, Current Monetary Statistics, various issues.
- 35 -
<Table 8> Money Supply by Sector1)
(billion won)
1995 |
1996 |
|||||||
1/4 |
2/4 |
3/4 |
4/4 |
1/4 |
2/4 |
3/4 |
4/42) |
|
Private |
48,298 |
100,174 |
67,209 |
71,970 |
54,947 |
121,691 |
184,643 |
51,146 |
Public |
- 65,994 |
- 27,074 |
- 24,433 |
76,906 |
- 53,509 |
- 15,415 |
- 23,083 |
58,262 |
Foreign |
- 8,988 |
- 5,224 |
25,145 |
13,866 |
4,243 |
19,559 |
- 49,487 |
- 10,028 |
Other |
12,650 |
- 22,809 |
- 33,104 |
- 20,969 |
- 28,226 |
- 45,206 |
12,011 |
- 14,098 |
M2 |
- 13,989 |
45,064 |
34,817 |
141,773 |
- 22,545 |
80,631 |
100,062 |
85,282 |
Notes: 1) End of period figures.
2)Estimates.
Sources: The Bank of Korea, Monthly Bulletin, various issues.
The Bank of Korea, Current Monetary Statistics, various issues.
<Table 9> Balance of Payments
(million dollars)
1994 |
1995 |
1996 |
|||||
year |
3/4 |
1/4 |
2/4 |
3/4 |
4/4 |
||
Current account |
- 4,530.8 |
- 8,947.6 |
- 2,115.7 |
- 4,644.0 |
- 5,237.4 |
- 7,475.4 |
- 6,359.2 |
Trade balance Invisible trade and transfer payment |
- 3,145.3 - 1,989.2 |
- 4,746.6 - 3,640.4 |
- 800.3 - 1,027.8 |
- 2,553.7 - 1,929.9 |
- 3,090.4 - 1,891.4 |
- 5,594.5 - 1,726.7 |
- 4,039.2 - 2,134.6 |
Capital account |
9,024.9 |
13,4192 |
4,569.3 |
4,631.2 |
7,471.5 |
102.6 |
5,023.6 |
Long- term capital transactions (Portfolio investment) Short- term capital transactions (Short- term trade credits) |
5,861.9 7,275.7 3,163.0 1,948.8 |
7,827.3 8,915.2 5,591.9 3,232.0 |
3,610.1 4,085.2 959.2 619.7 |
1,301.0 2,858.0 3,330.2 2,437.4 |
4,245.1 4,285.8 3,226.4 2,553.1 |
2,419.8 2,254.6 - 2,317.2 - 725.1 |
3,839.6 2,649.5 1,184.0 158.3 |
Source: The Bank of Korea, Balance of Payments, various issues.
- 36 -
<Table 10> Contribution of Money and Interest Rates
to Output Growth and Prices
(percent)
Sample period |
Lag |
M2 |
Corporate bond yield |
Won/Dollar exchange rate |
Industrial production |
CPI |
|
Growth |
83.1~ 88.12 |
3 |
12.4 |
9.7 |
10.1 |
59.0 |
8.9 |
6 |
11.2 |
9.2 |
8.3 |
41.3 |
29.9 |
||
9 |
16.1 |
8.5 |
10.6 |
33.8 |
31.0 |
||
12 |
14.6 |
7.4 |
11.1 |
30.6 |
36.4 |
||
89.1~ 96.5 |
3 |
6.1 |
2.0 |
20.8 |
68.6 |
2.5 |
|
6 |
14.1 |
6.8 |
24.0 |
50.9 |
4.2 |
||
9 |
14.8 |
9.3 |
25.7 |
45.2 |
4.9 |
||
12 |
16.6 |
11.3 |
28.4 |
36.7 |
7.0 |
||
Price |
83.1~ 88.12 |
3 |
2.2 |
4.1 |
7.2 |
10.7 |
75.9 |
6 |
6.2 |
9.4 |
8.6 |
17.6 |
58.1 |
||
9 |
9.5 |
11.0 |
16.0 |
21.1 |
42.4 |
||
12 |
15.0 |
9.8 |
18.1 |
16.6 |
40.5 |
||
89.1~ 96.5 |
3 |
8.9 |
5.6 |
2.2 |
12.6 |
70.6 |
|
6 |
20.5 |
12.7 |
2.2 |
12.7 |
51.9 |
||
9 |
13.4 |
34.4 |
9.2 |
8.3 |
34.6 |
||
12 |
11.9 |
36.0 |
14.5 |
8.5 |
29.2 |
Note: The figures are the results of forecast error decomposition for monthly data from January 83 to May 96. The causal ordering is determined as money → interest rate → exchange rate → output growth → inflation, which reflects the traditional transmission channels of monetary policy.
<Figure 6> Real Money Growth and US T- Bill Rate
Note: Real money growth rates are year- on- year percentage changes of M2/CPI. The
T- Bill rate is the U.S. 3- months treasury bill rate.
- 37 -
The growth in the money supply through the private and foreign sectors was in sharp contrast with the contraction through the government and other sectors. Claims on the government diminished during the first half due to increased tax revenue in addition to increased bond financing via grain securities and national investment funds. These more than offset the increase in government expenditures on infrastructures. Claims on other assets shrank significantly as banks increased their issuances of CDs and as non- financial intermediaries relied more on call loans. Claims on the private sector increased steadily as bank lending continued to increase due to the financial crunch experienced by firms in the major export industries. Furthermore, there was a net inflow of foreign capital for stock investment and short- term trade credits despite the rising current account surplus. During the third quarter, the foreign sector's contribution to the increase in the money supply dwindled because foreign investors became discouraged by the continuing current account deficits. The capital account surplus dwindled with drastic reduction in trade credits. However, claims on the private sector continued to rise by means of active general lending and commercial bills discounting. Claims on other sectors were down because of retirement of call loans and increased sales of bills- backed papers.
The trends in monetary growth were influenced to a great degree by the instability in the foreign exchange market during the second half of 1996. The won was clearly on the decline, so some discord in the conduct of monetary policy with regard to exchange rate management was observed in connection with the tightening of the short- term money market. Overall, however, in view of the relatively stable interest rate movements, the monetary authorities maintained an expansionary monetary policy throughout all of 1996. M2 growth was high, but it is no longer considered by many a reliable indicator of the money supply because of the great degree of substitution between monetary assets which has been occurring in the wake of the reform of the money- in- trust system.
In the fourth quarter, changes in the flow of funds were observed after the introduction of a new tax- exempt long- term savings accounts. The much feared
- 38 -
increase in the money supply associated with the reduction of the reserve ratio in November did not materialize because there was also a reduction in the total lending limit on banks. With the lingering effects of the reform of the money- in- trusts system, the introduction of these new savings accounts accelerated the flow of money into banks savings accounts, raising M2 growth by more than 2.5 percent. Despite the expected increase in the money supply, monetary policy remained flexible given the rising interest rates and increasing exchange rate risks associated with the current account deficit. In short, monetary policy was conducted in an expansionary manner in combination with tight fiscal policy to accommodate the various changes in the financial market.
Forecasts
Drastic changes in the financial landscape are anticipated in 1997, so some changes in the conduct of monetary policy are expected. For one, there will be an increase in capital inflows toward the second half of 1997. Because of the huge current account deficit, capital outflows are seen as one way to reduce upward inflationary pressure. Increased reliance on the exchange rate can be expected in preparation for this change. The authorities are expected to emphasize macroeconomic stability so that the increased liquidity will not cause real estate prices to rise inordinately. In this context, the band for M2 growth will be widened sufficiently so that monetary disturbances will not arise if conditions in the financial market happen to become tight.
From now on, increasing emphasis will be placed on the interest rate and exchange rate as indicators for conducting monetary policy. This shift from monetary aggregates to price variables reflects the instability in demand for money when major changes in the financial markets occur. In the event of large exchange rate fluctuations, maintaining targets for monetary policy is regarded as infeasible and even counterproductive. We therefore expect a shift from the current targeting strategy to the information variable approach. Furthermore, MCT
- 39 -
and M2 will be jointly monitored during the transition period to full use of indirect monetary control according to which the call rate is an operating target.
Another major change which will occur in 1997 concerns the changing nature of capital inflows. They are expected to exert a destabilizing influence on the financial market, causing the exchange rate and interest rate risks to increase significantly. There is also a possibility that the big move will be made to a free floating exchange rate system from the current market average system. At present, daily fluctuations are allowed within a ±2.25 percent band. There is also some discussion about the possibility of introducing a new BBC (Band- Basket- Crawl) system.
Overall, economic policy will continue to emphasize economic stability. In recognition of the substantial changes in the financial environment, the M2 growth rate as a nominal anchor will be allowed to move within a wider band of 14~19 percent, and no monetary tightening is expected as long as MCT remains stable between 15~20 percent. However, the possibility of imposing temporary credit controls cannot be ruled out should a sizable inflow of foreign capital occur.
It is important to use various indicators to determine the level of liquidity including the exchange rate, interest rates, and the MCI (Monetary Conditions Index). The use of nominal GDP or inflation targeting is also being considered in place of the present system which could be described as pseudo- M2 targeting. It is noteworthy that inflationary expectations, foreign interest rates, and credit channels are becoming increasingly important in conducting monetary policy. The exchange rate itself becomes a much more important indicator of domestic liquidity when conducting monetary policy. Ensuring adequate liquidity for price stability therefore requires that the authorities take responsibility for exchange rate policy. As clearly demonstrated in recent episodes, won/dollar depreciation with the in the presence of large current account deficits could make up for competitiveness lost due to depreciation of the Japanese yen, but it also gives rise to the possibility of speculative attacks and a drastic reduction in the level of credit. One- way bets, in
- 40 -
particular, can lead to increased imports through the lead and lag of current account transactions. This results in greater losses in foreign reserves, instability in the foreign exchange market, and interest rate hikes. Thus, to reduce the negative impact of huge current account deficits on domestic liquidity, the authorities should be consistent in implementing policy. Inconsistency gives rise to serious doubts about reliability and credibility of current economic policy and should likewise be avoided. Rather, more timely implementation of various liberalization measures would do much to dispell any uncertainties about exchange rate policy. When the current instability in the foreign exchange market begins to subside toward the second half of 1997, the monetary situation is expected to improve.
Interest rates
Interest had been on the rise since 1995, but they finally reversed themselves and began to decline in May of 1996 in the wake of the reforms of the money- in- trust system. Before these reforms, the supply of money in the call market had been suppressed. The worsening situation in the short- term money market was fueled by expectations of further increases in interest rates and delayed purchases of bonds as well as firms' increased demand for money to finance their rising inventories. Increased volatility of the call rate was combined with increased volatility of exchange rate, while the three- year corporate bond yield remained stable in the 11~12 percent range throughout the year. The decline in interest rates had been sustained for over a year and that it continued through the entire first quarter. Helping interest rates to decline were weak demand for money, stable prices, and increased foreign borrowing by large corporations. The three- year corporate bond yield was recorded at 11.88 percent during the first quarter and continued to slide downwards before bottoming out at 10.43 percent, its lowest level since the second quarter of 1993. The call rate also continued its slide. It averaged 10.53 percent in the first quarter, which was its lowest level since 1992. The co- movement of these two rates became more
- 41 -
pronounced as interest rates in general declined.
In the second quarter, however, the situation changed significantly. An inverted yield curve began to appear in the second quarter due to increased short- term demand for money by firms and a reduction in call money supplied to the call market as a result of the reforms of the money- in- trust system. Also, increased short- term lending by merchant banks and the conversion of investment and finance companies into merchant banks prompted a reduction in their discount activities and an increase in the call rate. Because both short- term and long- term rates increasingly moved parallel to each other, the continued instability in short- term rates translated into upward movement of long- term rates. Contributing to this were the increasingly conservative attitudes of institutional investors in their bond purchasing. They by and large expected further won/dollar depreciation and subsequent inflationary pressure.
Coming into the third quarter, short- term rates became unstable in contrast with long- term rates, which remained around the 12 percent level throughout the quarter. The decline in bond issuance for purposes of interest rate stability prompted firms to issue greater volumes of commercial paper in place of bonds, thus resulting in the CP rate hike. The increase in short- term financing was also partly due to firms' long- term expectations of a break in interest rates. The call rate, for its part, jumped to 16.64 percent around the due date of reserves at the end of August as merchant banks and securities companies increased their call borrowing. The contrasting movement of long- term rates could be partly attributed to earlier government measures to curb bond issuance as well as to the general fall in investment.
There were also some developments which caused the instability in short- term rates which could also be singled out. First of all, banks and insurance companies made a drive in the second quarter to boost lending to households, especially by offering financial products. These entailed the automatic issuance of loans and therefore affected banks and insurance companies financial positions significantly. Even more hard hit, however, were the merchant banks; they had expanded their
- 42 -
discounting activities in an effort to satisfy the greater short- term capital needs by firms during the second quarter. Securities companies also suffered a financial crunch due to their heavy financial needs associated with the newly established trust companies and reverse swaps, in addition to short- term financial difficulties that arose due to the unfavorable developments in the stock market. Another factor which gave rise to the short- term instability was the gradual decline in the balance of money in trust accounts. This significantly weakened the supply of call loans. The unusually high M2 growth rate, furthermore, ignited concerns over future monetary tightening. And as the current account imbalance began to widen, increasing expectations of further depreciation of the Korean won caused the call rate to rise.
Recent measures for reform of the call market taken in November helped restore the stability of short- term rates, even though its immediate impact on the market rate still remains uncertain. Until recently, the Korean call market had been bifurcated to an extreme degree. Despited appearances to the otherwise, there had in effect been two markets; one for banks where lower rates were applied due to collusion among banks and one for securities and merchant banks. Operating expenses were easily raised in each of these separate de facto markets. All this changed when the new measures came into effect. Call loans can now be supplied through accounts at commercial banks, thus substantially closing the gap between bank and non- bank call rates, which at one time was as wide as 5.0 percent. Moreover, a new limit on borrowings for non- bank financial intermediaries meant that securities and merchant banks could no longer engage in monopolistic behavior in the market and that fewer bridge loans - - according to which the recipients are determined in advance - - would be issued. The fact that all financial institutions were allowed to participate in the call market, in CD and RP intermediation did much to smooth the functioning of the call market. Securities and merchant banks nevertheless continued to experience financial stress during the transition period.
Further analysis of the interest rate spread between short- term rates and
- 43 -
long- term rates confirms the earlier observation that short- term rate instability began to become manifest toward the second half of the year. The positive spread earlier in the first quarter began to narrow and finally turned into a negative spread in May. It was not until the fourth quarter that the negative spread finally began to moderate. Despite the rise in long- term rates during the second half of 1996, the ratio of dishonored bills remained low at 0.12 percent throughout most of the second half. This suggests that the structural adjustment of most industries due to the recession was already well underway.
Despite such stabilizing factors as the seasonal factor, inventory adjustment, and the slowdown in investment, increased expectations of inflation associated with expected won depreciation led to upward pressure on interest rates toward the end of 1996. On the demand side, institutional investors' appetite for domestic bonds remained tepid but did not stem the upward pressure on interest rates caused by increased bond issuance. The increased instability in the foreign exchange market, in particular, triggered wider fluctuations of market rates within the 12.1~12.6 percent range. It is striking that the short- term rates began to become stable while long- term rates remained high, resulting in a flatter yield curve than during the third quarter. Earlier measures to reduce the reserve ratio did not lower interest rates because there were too many conflicting expectations about future inflation. What is more, the recently initiated drive to boost Korean firm's international competitiveness by 10 percent caused the disparity between bank lending rates and market rates to narrow. Above all, the increasing instability in the foreign exchange market was a major factor with regard to interest rate risks toward the end of 1996. Continued depreciatory pressure on the won fueled expectations of higher inflation, which in turn raised interest rates in the fourth quarter of 1996.
Market participants' expectations of further decline in interest rates also resulted in increasing use of short- term funds, while the reforms of the money- in- trust system led to financial market tightening by discouraging bond purchases by institutional investors. There was also concern about monetary
- 44 -
tightening. Many expect the monetary authorities to take action to reign in the growth of the money supply because of the introduction of tax exempt savings product and tax saving stock deposits for workers. These have tended to push up the M2 growth rate. On the other hand, introduction of the MMFs (Money Market Mutual Funds) by investment and trust companies and the increased issuance of commercial paper by small and medium- sized companies, together with the introduction of a new type of CMAs by merchant banks, contributed to the stability of the short- term money market. All told, short- term rates regained stability, while pressure increased on long- term rates due to a lack of reserves in the money- in- trusts and investment and trust companies' inability to purchase bonds.
<Table 11> Correlations of Major Interest Rates
Before Interest Rate Liberalization (91.1.6~ 91.11.20 ) |
First Round (91.11.21~ 93.10.31 ) |
Second Round (93.11.1~ 94.11.30 ) |
Third Round (94.12.1~ 95.10.25) |
|
Corporate bond vs Call |
- 0.14 |
0.09 |
0.17 |
0.31 |
Corporate bond vs CD |
0.34 |
0.72 |
0.53 |
0.67 |
Corporate bond vs MSB |
0.63 |
0.85 |
0.51 |
0.68 |
CD vs Call |
0.06 |
0.20 |
0.76 |
0.62 |
MSB vs Call |
0.03 |
0.09 |
0.10 |
0.12 |
MSB vsCD |
0.40 |
0.79 |
0.28 |
0.51 |
Note: Based on weekly data.
Source: Korea Investors Services, KIS- LINE.
<Table 12> Quarterly Interest Rate Movements
(percent)
1994 |
1995 |
1996 |
|||||||
4/4 |
1/4 |
2/4 |
3/4 |
4/4 |
1/4 |
2/4 |
3/4 |
4/4 |
|
Call rate (1 day, average) |
12.73 |
14.07 |
12.90 |
11.37 |
11.11 |
10.53 |
11.15 |
14.01 |
13.79 |
CD rate (91 days) |
14.40 |
15.88 |
14.72 |
13.60 |
12.00 |
11.63 |
11.16 |
13.98 |
13.77 |
Bank Debenture (1 year) |
14.22 |
15.35 |
14.93 |
13.58 |
12.05 |
11.96 |
11.27 |
12.81 |
12.93 |
Corporate Bond Yield (3 years) |
13.93 |
15.06 |
14.75 |
13.44 |
11.93 |
11.88 |
11.18 |
12.14 |
12.28 |
National Housing Bond (5 years) |
|||||||||
12.97 |
14.01 |
13.38 |
12.06 |
10.14 |
10.39 |
10.41 |
11.31 |
11.34 |
Sources: The Bank of Korea, Current Monetary Statistics, various issues.
Korea Investors Services, KIS- LINE.
- 45 -
<Table 13> Seasonal Components of Corporate Bond Yields
(percent)
Monthly |
1 |
2 |
3 |
4 |
5 |
6 |
7 |
8 |
9 |
10 |
11 |
12 |
Seasonal factors |
- 0.13 |
0.06 |
- 0.15 |
- 0.28 |
0.11 |
- 0.12 |
- 0.17 |
0.03 |
0.26 |
0.03 |
- 0.14 |
0.06 |
Source: Korea Investors Services, KIS- LINE.
<Table 14> Determinants of Interest Rates
(percent, billion won)
1995 |
1996 |
||||
4/4 |
1/4 |
2/4 |
3/4 |
4/4 |
|
Corporate bond issuance |
8,414 |
8,283 |
7,060 |
5,948 |
8,612 |
Net issuance |
4,972 |
4,729 |
3,414 |
2,183 |
4,586 |
Stock offerings |
1,405 |
970 |
983 |
1,631 |
1,461 |
Public offerings |
246 |
264 |
159 |
118 |
851 |
Rights offerings |
1,159 |
706 |
824 |
1,514 |
609 |
CPI |
4.5 |
4.9 |
5.1 |
5.2 |
4.8 |
Equipment Investment |
1.5 |
4.3 |
3.5 |
8.7 |
4.11) |
Note: 1) An estimate.
Sources: The Bank of Korea, Monthly Bulletin, various issues.
Korea Investors Service, KIS- LINE.
<Table 15> Daily Absolute Changes in Interest Rates
(percent)
|
1995 |
1996 |
|||
4/4 |
1/4 |
2/4 |
3/4 |
4/4 |
|
Corporate bond yield |
0.0375 |
0.0294 |
0.0617 |
0.0405 |
0.0528 |
CD yield |
0.0448 |
0.0329 |
0.0904 |
0.1319 |
0.0817 |
Bank debenture yield |
0.0348 |
0.0226 |
0.0642 |
0.0366 |
0.0418 |
Call rate |
0.2679 |
0.2067 |
0.2586 |
0.3579 |
0.2703 |
Note: Period averages.
Sources: Korea Investors Service, KIS- LINE.
- 46 -
<Figure 7> Recent Interest Rate Volatility
Note: Weekly data of the three- year corporate bond yields and the 1- day call rates were used for estimation. EGARCH is a measure of conditional volatility due to D. Nelson's (1991) Exponential GARCH.
<Figure 8> Recent movements in Major Interest Rates
Source: Korea Investors Service, KIS- LINE.
- 47 -
<Figure 9> Recent movements in Major Short- term Interest Rates
<Figure 10> Long trends in Major Interest Rates
Source: Korea Investors Service, KIS- LINE.
- 48 -
<Figure 11> Yield Curve Shifts
Source: Korea Investors Service, KIS- LINE.
- 49 -
<Figure 12> Daily Absolute Changes in the Corporate Bond Yield
Note: Based on monthly averages of absolute daily changes in interest rates.
Source: Korea Investors Service, KIS- LINE.
<Figure 13> Daily Absolute Changes in the Call Rate
Source: Korea Investors Service, KIS- LINE.
<Table 16> Bond issuance
(billion won)
Apr. |
May |
Jun. |
Jul. |
Aug. |
Sep. |
Oct. |
Nov. |
Dec. |
|
Issuance |
2,924 |
2,068 |
2,068 |
1,723 |
2,125 |
2,100 |
2,602 |
3,182 |
2,829 |
Redemption |
1,193 |
1,267 |
1,345 |
1,171 |
1,094 |
1,363 |
1,090 |
1,375 |
1,561 |
Net issuance |
1,731 |
801 |
723 |
552 |
1,031 |
737 |
1,513 |
1,807 |
1,267 |
Outstanding |
67,898 |
68,699 |
69,422 |
69,973 |
71,004 |
71,741 |
73,253 |
75,060 |
76,327 |
Note: The figures from October to December are estimates.
Source: The Bank of Korea, Monthly Bulletin, various issues.
- 50 -
<Figure 14> Interest Rate Spreads
Note: Spread A = Corporate bond yield - Call rate.
Spread B = CD yield - Call rate.
Sources: Korea Investors Service, KIS- LINE.
The Bank of Korea, Monthly Bulletin, various issues.
<Table 17> Ratio of Dishonored Bills1)
1995 |
1996 |
|||||||||
1/4 |
2/4 |
3/4 |
4/4 |
1/4 |
2/4 |
3/4 |
4/4 |
|||
Call rate (1 day, average) |
14.07 |
12.90 |
11.37 |
11.11 |
10.53 |
11.15 |
14.01 |
13.79 |
||
CD yield (91 days) |
15.88 |
14.72 |
13.60 |
12.00 |
11.63 |
11.16 |
13.98 |
13.77 |
||
Corporate bond yield (3 years) |
15.06 |
14.75 |
13.44 |
11.93 |
11.88 |
11.18 |
12.14 |
12.28 |
||
ored ratio1) |
Seoul All areas |
- (0.13) 0.17 |
- (0.12) 0.17 |
- (0.12) 0.17 |
- (0.11) 0.16 |
0.10 (0.13) 0.16 |
0.07 (0.09) 0.12 |
0.07 (0.09) 0.12 |
0.08 (0.10) 0.14 |
|
Number of firms with disho- nored bills |
By region |
Seoul All areas |
1,315 3,081 |
1,402 3,478 |
1,503 3,674 |
1,467 3,759 |
1,115 2,887 |
1,000 2,629 |
1,043 2,625 |
1,428 3,448 |
By size of firms |
Larger firms Smaller firms Individual |
3 1,289 1,789 |
1 1,465 2,012 |
0 1,603 2,071 |
1 1,670 2,089 |
3 1,228 1,656 |
0 1,150 1,479 |
1 1,169 1,455 |
3 1,603 1,842 |
Note: 1) The figures in parentheses do not reflect adjustments for electronic settlements.
Sources: The Bank of Korea, Monthly Bulletin, various issues.
Korea Investors Service, KIS- LINE.
- 51 -
<Figure 15> Won/Dollar Depreciation and Corporate Bond Yield
Note: The (+) sign indicates won depreciation. The figures for 1997 are forecasts.
Source: Korea Investors Service, KIS- LINE.
Forecasts
The prospects for interest rate movements in 1997 are for a downward trend in view of the ongoing opening of Korea's financial sector, Korea's joining the OECD, and the economic recession. As evidenced by earlier experience, the level of aggregate expenditures was largely unaffected by the deterioration in the terms of trade (TOT) during most of 1996, thus contributing to the widening current account deficit. However, the terms of trade shock will begin to have a contractionary effect on investment activities in early 1997. Strikingly, the inventories of firms in major export industries underwent a very gradual process of adjustment, and this has tended to cushion the adverse economic impact of the economic recession. The gap between savings and investment should shrink considerably in 1997 such that firms' shortage of funds will diminish from 17.9 percent in 1996 to 14.7 percent in 1997. As a result, the private sector's surplus over firms' deficit will be on the rise. On the demand side, some upward pressure on interest rates due to economic recovery is expected, but with an expansionary monetary policy, the increasing exposure to foreign borrowing opportunities, and the increase in the savings rate, interest rates
- 52 -
should not rise sharply.
One of the major concerns on the supply side is that increasing foreign capital inflows are likely due to stagnation in major capital markets around the globe and ongoing liberalization of capital movements. Liberalization measures being taken at present range from the lifting of restrictions on delayed payments for imports to extensions of advance payments for exports. Stability in the foreign exchange market after the first half and increased overseas issuance of bonds are, more than any other factors, expected to induce greater inflows of capital from abroad, and there is considerable concern that a sudden surge in capital inflows may occur and disrupt macroeconomic stability. The monetary authorities would most likely respond by broadening the band for maximum daily exchange rate fluctuations.
As far as it is a determinant of interest rates, inflation will continue to be a concern for policymakers even though inflationary pressures due to increases in wages and service charges will moderate considerably as the recession drags out. Depending on the degree to which the authorities' decide to intervene in the money market, inflation is expected to affect the expansion of domestic credit. In conclusion, even with such uncertainties arising from the presidential election at the year end, the increased exposure to the international financial market, and the monetary authorities' efforts to stabilize the domestic financial market, interest rates should mark a downward trend.
Among the various determinants of interest rate movements, the slowdown in business activity will clearly pull interest rates down in 1997. However, despite the longer- term prospects for a continued decline in interest rates, various external factors such as possible hikes in international oil price, widening of the current account deficit, and a strong drive by the authorities to overhaul the existing financial system to improve overall efficiency may have destabilizing effects on the economy in the short run. Labor turmoil early in the year, in particular, could become prolonged depending on the political situation, and a continued rise in international oil prices could rapidly drive the economy into a deep recession.
In sum, with the baseline forecast of a downward trend in interest rates, some temporary instability is expected with the introduction of a comprehensive set of
- 53 -
productivity boosting measures and asset price inflation. Real estate prices are marking a steep increase, but their upward climb should moderate later this year because the huge current account deficit will prevent the real estate market from becoming overheated.
The growth in the money supply is expected to follow different patterns as compared to the previous year. Claims on foreign assets are expected to increase significantly even though these showed negative numbers toward the end of 1996. The government and the private sector will contribute increasingly to the money growth in 1997. A further increase in the private sector's surplus due to consumption cutbacks is expected. Furthermore, the current account deficit should begin to shrink while the capital account will record a sizable surplus.
The major uncertainty factor with regard to interest rate forecasting in 1997 is the volume of foreign capital inflows. Whatever the case, they will certainly mean more favorable borrowing rates for some corporations, and many factors will work to bring foreign capital in. Foreigners' increasing participation in the domestic stock market, increasing flows of FDI, creation of bond type funds for investment by foreigners in domestic bonds, expansion of overseas funds for domestic stock investment, increased issuance by domestic firms of overseas securities such as DRs, CBs, and SOC related commercial loans are all expected to lead to an enormous balance of payment surplus. All in all, increased inflows of capital together with the availability of a wider array of financing instruments will serve to bring interest rates down gradually.
While it is true that increased capital inflows can work to lower interest rates, thereby benefiting large corporations, their short- term effects cannot be ignored. The fact is that they could greatly disrupt macroeconomic stability. Greater opportunities to raise needed capital through overseas bond issuance can lead to polarization of interest rates applied to specific groups of corporate clients. As increased capital inflows increase expenditures, they can translate into even larger trade deficits and raise prices in nontradable sectors. Also, the expected real appreciation which inflows naturally bring about can undermine the competitiveness of exporters while resources can shift into nontradable sectors. And this is not all.
- 54 -
Various risks can increase, and greater capital outflows might be necessary, but these entails substantial adjustment costs. Monitoring costs are also an issue. They can be high because the lack of monitoring would aggravate the moral hazard problem and can lead to speculative bubbles. Finally, when exchange rate stability is emphasized, monetization can cause the monetary authorities to lose significant control.
The presidential election in 1997 is not expected to have serious destabilizing effects on the economy. Indeed, election related expenditures have had less and less impact on the economy since 1980. A more serious concern is the contractionary effect on the economy of various comprehensive measures that are designed to reduce the current account deficit.
In consideration of the business cycle, the current account balance, and increased financial opening, interest rates during 1997 should decline by about 1 percent from 1996 to about 10.9 percent. However, due to increased exposure to overseas shocks in 1997, short- term interest rate hikes cannot be ruled out even though the prevailing trend may be downward. Interest rates should decline during the first quarter of 1997, despite continued expectations about future depreciation of the Korean won. Labor disputes over the new labor law, which effectively puts an end to the tradition of jobs for life in Korea, could mean tighter conditions in the financial market, but interest rates should move downwards nevertheless. During the second quarter, the interest rate decline should be even more pronounced, mainly as a result of sluggish investment and ongoing inventory adjustment, despite instability in the foreign exchange market. In the third quarter, the economy should finally bottom out, but it will be too early for an increase in interest rates. Coming into the fourth quarter, interest rates may actually fall to nearly 10 percent with abundant money supply and price stability.
Bank rates are under continued downward pressure due to lower reserve requirements. Most Korean banks, however, are creaking under the weight of bad loans and they are facing increased exposure to interest rate and exchange rate risks. This may require a delay in a substantial cut in the lending rate. With
- 55 -
increased financial liberalization and deregulation of the banking industry, especially in connection with the newly formulated special committee on financial reform, banks are under pressure to emphasize profitability rather than deposits. This implies more sensitive adjustment of bank rates to market rates, but given the general direction for banks rates, a decline in bank rates can hardly be expected in the short term. Foreign rates will not likely to decline much in the first quarter either because of the increased foreign exchange risks. It is also feared that due to increased difficulty in asset management, disintermediation, and tougher competition, the profitability of the entire banking industry may suffer. It is also interesting to note that Korean banks' lending rates are now lower than the market rate. This is in sharp contrast with the situation in some advanced countries and should be taken seriously in consideration of the heated arguments for lowering interest rates. Along with these developments, different rates will now be charged to customers depending on their credit standings.
With the significant progress that is expected in the process of financial liberalization in Korea, the financial status of corporations will vary greatly depending on their ability to access overseas funds. In particular, with the continued increase in long- term foreign borrowing by banks, issuance of stock market related securities by larger corporations is expected to increase, e.g. in the form of convertible bonds or DRs. The improvement in financial conditions of larger corporations because of greater opportunities to borrow from abroad will stand in sharp contrast with the deteriorating conditions of smaller firms which have no access to foreign capital markets.
No visible changes are expected in the patterns of financial flows in 1997, except for some adjustment in the area of operations for financial institutions and institutional rearrangements. Financial flows from the banking sector into the real estate or securities market are especially likely if financial reform is pursued in an overly aggressive way or the decline in interest rates is more pronounced than expected. Bond issuance will be on a steady increase due to firms' increasing reliance on direct financing, and a wider array of financial instruments with various
- 56 -
maturities will become available to investors, e.g. SOC long- term bonds with maturities beyond five years. With the decline in interest rates, tax exempt long- term household savings will continue to attract funds, thereby strengthening the market basis for bonds. Securities companies may also be successful in luring funds against the backdrop of declining interest rates, while the MMFs offered by investment and trust companies will contribute to the overall stability of short- term rates. When short- term rates do in fact become stable, the interest rate spreads will widen toward the end of 1997, by which time a normal sloping yield curve should obtain.
As earlier stated, the most important determinant of interest rates in 1997 will be the timing and the volume of expected capital inflows. Various empirical findings suggest that financial instability is likely as an increasing share of these inflows will be in the form of portfolio investment. Some concern has been raised about the possibility of excessive inflows of short- term capital. Whatever the case, the authorities are likely to stand firm and do what they can to ensure adequate liquidity as well as financial market stability in the face of the changing nature of capital inflows. If there is a sudden surge in short- term capital inflows, the authorities are likely to adopt a capital transactions tax (Tobin tax) à la Chile or a VDR (variable deposit requirement) to stem the possible side effects of hot money on economic stability.
Some policy considerations are in order in the face of increased financial opening. Because economic agents will find themselves having to confront changing financial circumstances, especially with increasing interest rate and exchange rate risks, it is imperative that they develop various techniques to better predict various price variables as well as acquire skills to hedge against increased risks. It is also important that firms adopt appropriate risk management techniques. The authorities, for their part, are also considering a plan to foster short- term markets and to take action to ensure the proper functioning of the market mechanism.
- 57 -
<Table 18> Firms' Shortage of Funds and Investment Ratios1)
Firms' shortage of funds (billion won) |
Firms' shortage of funds as percentage of nominal GNP |
Savings ratio as percentage of nominal GNP |
Investment ratio as percentage of nominal GNP |
||
96 |
1/4 |
19,368 |
22.8 |
33.8 |
36.5 |
2/4 |
17,303 |
18.6 |
36.1 |
37.8 |
|
3/4 |
18,544 |
20.0 |
35.9 |
35.8 |
|
4/4 |
11,326 |
10.1 |
39.8 |
40.1 |
|
yearly |
66,541 |
17.9 |
36.4 |
37.6 |
|
97 |
1/4 |
15,408 |
16.7 |
34.4 |
36.0 |
2/4 |
16,629 |
15.1 |
36.4 |
37.1 |
|
3/4 |
17,381 |
17.2 |
36.0 |
35.7 |
|
4/4 |
12,130 |
9.8 |
39.5 |
39.8 |
|
yearly |
61,548 |
14.7 |
36.6 |
37.2 |
Note: 1) Recent figures are based on the KIF Flow of Funds model. Note that savings = current GNP - final consumption, thus includes foreign investment; Investment = gross capital formation in the National Income Account.
Sources: The Bank of Korea, Flow of Funds Account, and National Income Account,
various issues.
<Figure 16> Firms' Shortage of Funds and Households' Surplus
Note: Firms' shortage of funds is measured by the ratio of business sector's shortage of funds over the current GNP. Households' surplus shows the ratio of households' surplus to business' deficit. Figures for 1997 are KIF forecasts.
Sources: The Bank of Korea, The Flow of Funds and National Income Account, various issues.
- 58 -
<Table 19> Sectoral Breakdown of the Shortage of Funds
(billion won)
Financial sector |
Non- financial sector |
Rest of the world |
||||
Business |
Government |
Private |
||||
92.1 |
- 507.7 |
- 1,199.4 |
- 9,420.6 |
3,475.4 |
4,745.8 |
1,707.1 |
2 |
274.6 |
- 542.3 |
- 6,624.5 |
1,764.3 |
4,318.0 |
267.7 |
3 |
176.6 |
- 286.0 |
- 8,034.8 |
1,731.6 |
6,017.2 |
109.3 |
4 |
990.3 |
- 1,569.0 |
- 6,863.4 |
- 3,955.7 |
9,250.1 |
578.7 |
Yearly |
933.8 |
- 3,596.5 |
- 30,943.4 |
3,015.7 |
24,331.1 |
2662.8 |
93.1 |
- 810.2 |
558.8 |
- 9,169.9 |
4,256.7 |
5,472.0 |
251.4 |
2 |
542.9 |
- 1,174.5 |
- 8,580.6 |
1,709.9 |
5,696.2 |
631.6 |
3 |
488.6 |
- 759.5 |
- 9,464.0 |
1,122.1 |
7,582.4 |
270.9 |
4 |
862.1 |
65.0 |
- 7,131.3 |
- 2,243.9 |
9,440.2 |
- 927.1 |
Yearly |
1,083.4 |
- 1,310.2 |
- 34,345.8 |
4,844.8 |
28,190.8 |
226.8 |
94.1 |
- 688.6 |
- 1,229.5 |
- 12,455.0 |
4,577.1 |
6,648.4 |
1,898.1 |
2 |
847.1 |
- 1,553.2 |
- 10,692.7 |
2,994.9 |
6,144.6 |
706.1 |
3 |
839.7 |
- 2,326.7 |
- 13,796.1 |
3,880.9 |
7,588.5 |
1,487.0 |
4 |
1,217.8 |
- 2,175.2 |
- 11,130.1 |
- 3,940.4 |
12,895.3 |
957.4 |
Yearly |
2,236.0 |
- 7,284.6 |
- 48,073.9 |
7,512.5 |
33,276.8 |
5,048.6 |
95.1 |
503.7 |
- 3,668.9 |
- 16,814.9 |
6,340.6 |
6,805.4 |
3,165.2 |
2 |
1,413.4 |
- 3,462.4 |
- 15,737.4 |
4,975.0 |
7,300.0 |
2,049.0 |
3 |
1,277.4 |
- 2,917.7 |
- 16,509.2 |
5,103.4 |
8,488.1 |
1,640.3 |
4 |
- 4,273.2 |
3,038.6 |
- 7,974.0 |
- 4,592.6 |
15,605.2 |
1,234.6 |
Yearly |
- 1,078.7 |
- 7,010.4 |
- 57,035.5 |
11,826.4 |
38,198.7 |
8,089.1 |
96.1 |
3,121.0 |
- 6,553.0 |
- 19,368.0 |
5,144.0 |
7,671.0 |
3,432.0 |
2 |
1,828.0 |
- 7,176.0 |
- 17,303.0 |
3,422.0 |
6,705.0 |
5,348.0 |
3 |
- 259.4 |
- 4,105.7 |
- 18,545.0 |
5,606.4 |
8,832.9 |
4,365.1 |
4 |
- 3,894.9 |
- 350.0 |
- 11,326.2 |
- 928.2 |
11,904.3 |
4,245.0 |
Yearly |
794.7 |
- 18,184.7 |
- 66,542.2 |
13,244.2 |
35,113.2 |
17,390.1 |
97.1 |
- 4,319.2 |
- 2,224.4 |
- 15,408.5 |
4,731.9 |
8,452.3 |
6,543.5 |
2 |
- 1,494.1 |
- 5,807.4 |
- 16,629.3 |
2,703.7 |
8,118.3 |
7,301.5 |
3 |
- 6,174.7 |
- 1,181.3 |
- 17,381.5 |
6,810.0 |
9,390.3 |
7,356.0 |
4 |
- 6,325.4 |
- 511.6 |
- 12,130.3 |
- 995.2 |
12,613.9 |
6,837.0 |
Yearly |
- 18,313.4 |
- 9,724.7 |
- 61,549.6 |
13,250.4 |
38,574.8 |
28,038.0 |
Note: The figures for 1997 are forecasts based on the KIF interest rate forecasting model.
Source: The Bank of Korea, The Flow of Funds, various issues.
- 59 -
<Figure 17> Volatility Tradeoffs
Note: Volatility is measured by average of daily standard deviations.
Source: Korea Investors Service, KIS- LINE.
<Figure 18> Inflation, M2 Growth Rate and M2 Velocity
Note: The M2 velocity is adjusted for seasonal variation. The figures for 1997 are the KIF forecasts.
Sources: The Bank of Korea, Monthly Bulletin and Current Monetary Statistics, various issues.
- 60 -
<Figure 19> M2 Velocity and Corporate Bond Yield
Note: The M2 velocity is adjusted for seasonal variation. The figures for 1997 are the KIF forecasts.
Sources: The Bank of Korea, Current Monetary Statistics, various issues.
Korea Investors Service, KIS- LINE.
<Figure 20> Financial Asset Accumulation and M2 Velocity
Note: Financial asset accumulation ratio = total financial assets / nominal GNP
Sources: The Bank of Korea, Current Monetary Statistics, The Flow of Funds, and National Income Account, various issues.
- 61 -
<Table 20> Macro Statistics of Major Industrialized Countries
(1995 figures, yearly averages, percent)
Public bond yield (i1) |
Bank lending rate (i2) |
Growth rate (y) |
CPI inflation (p) |
Public bond yield - (Growth rate + Inflation) i1- (p+y) |
Real bank lending rate i2- (p+y) |
|
U.S. |
6.14 (8.3) |
8.83 (8.9) |
2.0 (2.8) |
2.7 (3.5) |
- 1.56 (2.0) |
4.13 (2.6) |
Japan |
2.65 (5.0) |
3.40 (5.7) |
3.5 (3.0) |
- 0.1 (1.4) |
- 0.75 (0.6) |
- 0.0 (1.3) |
U.K. |
8.10 (9.7) |
6.69 (10.0) |
2.8 (2.5) |
2.6 (4.6) |
2.70 (2.6) |
1.29 (2.9) |
Germany |
6.14 (7.1) |
10.94 (10.6) |
2.5 (2.5) |
2.3 (2.5) |
1.34 (2.1) |
6.14 (5.6) |
Italy |
10.82 (12.7) |
12.48 (15.5) |
2.6 (2.1) |
4.1 (6.6) |
4.12 (4.0) |
5.78 (6.8) |
Singapore |
‥ |
6.37 (6.9) |
6.1 (7.4) |
2.3 (1.8) |
‥ |
- 2.03 (- 2.30) |
Taiwan |
‥ |
‥ |
6.1 (8.4) |
5.2 (4.0) |
‥ |
‥ |
Korea |
11.21 (13.4) |
9.0 (9.8) |
6.3 (8.9) |
4.5 (5.1) |
0.41 (- 0.5) |
- 1.80 (- 4.2) |
Note: The figures in parentheses are yearly averages of IFS statistics for 1983∼95.
Sources: DRI, World Markets Executive Overview, 1996 Second Quarter.
IMF, International Financial Statistics, 1996.
<Table 21> Real Interest Rate Comparison
(yearly average, percent)
Korea |
U.S. |
Japan |
||||
Bank lending rate1) |
Public bond yield2) |
Bank lending rate1) |
Public bond yield2) |
Bank lending rate1) |
Public bond yield2) |
|
Nominal interest rate (i) Real GNP growth (y) CPI inflation (cpi) |
9.0 6.3 4.5 |
11.21 6.3 4.5 |
8.83 2.0 2.7 |
6.14 2.0 2.7 |
3.4 3.5 - 0.1 |
2.65 3.5 - 0.1 |
Real interest rate (i- cpi) |
4.5 |
6.71 |
6.13 |
3.44 |
3.5 |
2.75 |
Growth rate - Real interest rate (= y- (i- cpi)) |
1.8 |
- 0.41 |
- 4.13 |
- 1.44 |
0 |
0.75 |
Notes: 1) Based on 1995 figures.
2) The figures are DRI forecasts for 1997.
Sources: DRI, World Markets Executive Overview, 1996 Second Quarter.
IMF, International Financial Statistics, 1996.
- 62 -
<Table 22> Quarterly Interest Rate Forecasts
(percent, billion won)
1996 |
1997 |
|||||||||
1/4 |
2/4 |
3/4 |
4/4 |
year |
1/4 |
2/4 |
3/4 |
4/4 |
year |
|
CPI inflation |
4.9 |
5.1 |
5.2 |
4.8 |
5.0 |
4.9 |
4.6 |
4.3 |
4.1 |
4.5 |
GDP growth |
7.9 |
6.8 |
6.4 |
6.9 |
7.0 |
4.8 |
5.8 |
6.1 |
6.0 |
5.7 |
M2 growth |
14.0 |
15.2 |
17.3 |
18.3 |
16.2 |
18.0 |
17.2 |
16.3 |
16.2 |
16.9 |
KIF Financial Indicator |
0.7 |
2.7 |
4.7 |
4.8 |
3.2 |
4.3 |
3.5 |
3.8 |
3.5 |
3.8 |
Corporate bond yield |
11.9 |
11.2 |
12.1 |
12.3 |
11.9 |
11.9 |
10.5 |
11.1 |
10.3 |
11.0 |
CD yield |
11.6 |
11.2 |
14.0 |
13.8 |
12.6 |
12.6 |
10.8 |
11.8 |
10.7 |
11.5 |
Call rate |
10.7 |
11.2 |
14.0 |
13.8 |
12.4 |
12.0 |
10.4 |
11.3 |
10.1 |
11.0 |
Note: The figures for 1997 are forecasts based on the KIF interest rate forecasting model.
Sources: The Bank of Korea, Monthly Bulletin, various issues.
Korea Investors Service, KIS- LINE.
<Figure 21> KIF Financial Indicator and Three- year Corporate Bond Yield
Note: The figures for 1997 are forecasts based on the KIF interest rate forecasting model.
Source: Korea Investors Service, KIS- LINE.
- 63 -
<Figure 22> Forecasts for Interest Rate Risks
Note: The interest rate risks are based on the state- dependent conditional standard deviation of the corporate bond yield. EGARCH is a measure of conditional volatility due to D. Nelson's (1991) Exponential GARCH.
Source: Korea Investors Service, KIS- LINE.
- 64 -
Financial Market Developments
Banking
Deposit Market
Total bank deposits at deposit money banks including deposits in won, CDs, and bills based on commercial and trade papers rose 17.2 percent in 1996 to 221.2 trillion won. This was a strong showing compared to previous years and can be attributed to several factors. One of these was the money supply. Despite the deceleration in export growth and the poor domestic sales performance, the money supply rose and led the increase in total bank deposits. The demand for CDs and bills based on commercial and trade paper was especially strong due to the high market interest rates. Another factor was the reforms of the money- in- trusts system. The maturities on bank trusts were lengthened and the early withdrawal penalties were raised, thus inducing a tremendous shift of funds from bank trusts, such as corporate trusts, into fixed- rate, high return regular savings deposits and time deposits. The banks' own aggressive marketing efforts after the bank trust reforms created yet greater demand for bank deposits; banks actively promoted public benefit products such as retirement accounts and mutual installment savings deposits in an effort to counteract the outflow of funds from bank trusts and to make bank products more competitive against those offered by non- bank financial institutions. Then there was the introduction of new tax- exempt long- term products in October. These new products were made available in order to encourage household savings and to discourage consumption, ultimately with the objective of reducing the trade deficit. As the interest earnings from these new products are completely tax exempt, the demand for them was high, as was expected. Finally, the outflow of funds from the bearish stock market and the weak real estate market also raised the demand for bank deposits.
The only major factor which worked to slow the growth in deposits was the new banking regulations. A large volume of bank deposit funds were shifted to trusts and bond instruments offered by non- bank financial institutions due to the implementation
65
of the new comprehensive tax system on financial income.
The volume of funds in demand deposits fell 2.4 percent to 24.0 trillion won in 1996. Due to the stability in the capital market and seasonal factors related to deposits, the volume fell sharply in the first quarter but rose for the rest of the year as firms' demand for bank overdrafts increased.
The growth in time and savings deposits was very meager in the first quarter due to the implementation of the new comprehensive tax system on financial income. After the bank trust reforms in May, however, time and savings deposits grew moderately for the rest of the year, amounting to 140.5 trillion won by December. The introduction of tax- exempt long- term deposits in the fourth quarter, furthermore, contributed to the growth in time and savings deposits. 3.4 trillion won in new funds had been induced into banks, including bank trusts, in only two months. These new products were as popular as expected since they are long- term investments
which favor stable financial institutions such as banks.
<Table 1> Bank Deposits1)
(billion won, percent)
1995 |
1996 |
||||
4/4 |
1/4 |
2/4 |
3/4 |
4/42) |
|
Deposits in won Demand Time and Savings |
139,054 (9.8) 24,617 (26.8) 114,437 (6.7) |
138,114 (- 0.7) 21,603 (- 12.2) 116,511 (1.8) |
146,850 (6.3) 22,571 (4.5) 124,279 (6.7) |
152,294 (3.7) 23,318 (3.3) 128,976 (3.8) |
164,473 (8.0) 24,018 (3.0) 140,455 (8.9) |
CDs |
28,330 (- 0.1) |
28,783 (1.5) |
29,771 (3.4) |
30,548 (2.6) |
31,526 (3.2) |
Bills based on commercial and trade papers |
3,414 (- 8.9) |
3,551 (4.0) |
3,889 (9.1) |
5,452 (40.2) |
5,945 (9.0) |
Foreign Deposits |
17,851 (6.0) |
18,199 (1.9) |
17,844 (- 1.9) |
18,830 (5.5) |
19,207 (2.0) |
Total |
188,649 (7.4) |
188,647 (- 0.0) |
198,354 (5.1) |
207,124 (4.4) |
221,151 (6.8) |
66
The growth in CDs was an indirect result of the sharp increase in the money supply after the bank trust reforms. The reforms resulted in an increase in issuances of CDs as banks expected the BOK to pursue a tight monetary policy. The demand for CDs as compensating balances was also high due to the general shortage in short- term working capital among firms. The fact that investment and trust companies were allowed to sell MMFs (Money Market Mutual Funds) in September also served to increase the overall demand as well because they are partly invested in CDs.
The volume of bills based on commercial and trade papers sharply increased in 1996. The growth of bills based on commercial and trade papers was slow in the first quarter due to the decline in the volume of discountable bills, which itself was due to the series of bankruptcies among small and medium- sized firms. However, the total volume has grown moderately since the bank trust reforms took effect. In the
<Table 2> Time and Savings Deposits1)
(billion won, percent)
1995 |
1996 |
|||
4/4 |
1/4 |
2/4 |
3/4 |
|
Regular savings Preferential savings Corporate savings Installment savings2) Other savings3) |
18,880 (10.7) 19,397 (0.5) 7,150 (33.1) 17,733 (3.7) 51,277 (5.9) |
20,187 (6.9) 19,868 (2.4) 6,523 (- 8.8) 17,971 (1.3) 51,962 (1.3) |
21,623 (7.1) 19,810 (- 0.3) 7,231 (10.9) 18,647 (3.8) 56,968 (9.6) |
23,056 (6.6) 20,614 (4.1) 6,713 (- 7.2) 19,691 (5.6) 58,902 (3.4) |
Total |
114,437 (6.7) |
116,511 (1.8) |
124,279 (6.7) |
128,976 (3.8) |
67
third quarter, the demand for bills based on commercial and trade papers was sharply increased as rumors spread widely concerning requiring reserves for CDs. This moderate growth was attributed partly to the high interest rates.
The balance of foreign deposits had risen by 7.6 percent to 19.2 trillion won. Throughout most of the year, they actually declined; it was not until the fourth quarter that any gain was realized. Foreign deposits related to exports had fallen as the volume of exports declined, and foreign deposits for stock investment declined due to the bearishness in the stock market. It was not until the won depreciated steeply against the US dollar in the fourth quarter because of the widening trade gap that foreign deposits finally rebounded.
In 1997, the volume of total bank deposits is forecast to grow to 269.9 trillion won, an increase of 22.0 percent over the previous year. CDs and bills based on commercial and trade papers are expected to increase sharply by 29.5 percent and 40.0 percent, respectively. Deposits in won and foreign deposits are projected to rise by 19.8 percent and 23.4 percent, respectively.
These forecasts are based on several expectations, the first being a decline in the market interest rates and a decline in demand for bank- loans because of the deceleration in exports and poor domestic retail sales performance. Banks will clearly have less incentive to attract funds by offering high interest rates. On the other
hand, the volume of tax- exempt household long- term deposits is expected to grow
<Table 3> Interest Rates on Selected Bank Deposits1)
(percent)
1995 |
1996 |
||||
4/4 |
1/4 |
2/4 |
3/4 |
4/42) |
|
Preferential savings Time (1 year) Time (2 year) Discounts on commercial and trade bills3) CD4) |
3.0~10.0 7.5~10.0 9.5~11.0 7.0~11.5 7.0~11.5 |
3.0~10.0 7.5~10.0 8.5~11.0 7.0~11.0 7.0~11.0 |
3.0~10.0 7.5~10.0 8.5~10.5 7.0~11.5 7.0~11.5 |
3.0~10.0 7.5~10.0 8.5~10.75 7.0~14.0 7.0~13.09 |
3.0~10.0 7.0~10.0 8.0~10.2 7.0~13.5 7.0~13.0 |
68
moderately, although at a slower rate than in 1996.
With Korea's accession to the OECD, the government advanced the schedule for opening of the financial market, and the foreign exchange market is expected to grow rapidly. Foreign deposits are therefore expected to increase significantly in 1997.
Loan Market
Total bank credits including loans in won, loans in foreign currencies, and guarantees and acceptances stood at 268.7 trillion won at the end of 1996, an increase of 22.5 percent from the previous year. This sharp increase in total bank credits reflected the shortage in working capital which stemmed from the continued deceleration in exports and the poor performance in domestic sales. While loans in won and in foreign currencies grew steadily, the growth in guarantees and acceptances grew moderately in the first and the second quarter, but nearly froze in the third and fourth quarters.
<Table 4> Bank Loans1)
(billion won, percent)
1995 |
1996 |
||||
4/4 |
1/4 |
2/4 |
3/4 |
4/42) |
|
Loans in won Banking funds Government funds Loans in foreign currencies Guarantees and acceptances |
152,478 (1.8) 140,983 (1.7) 11,495 (3.7) 17,653 (3.5) 49,283 (0.8) |
155,606 (2.1) 143,792 (2.0) 11,814 (2.8) 18,470 (4.6) 53,070 (7.7) |
164,065 (5.4) 151,600 (5.4) 12,465 (5.5) 20,238 (9.6) 58,129 (9.5) |
178,748 (8.9) 165,608 (9.2) 13,140 (5.4) 21,588 (6.7) 57,925 (- 0.4) |
186,224 (4.2) 172,729 (4.3) 13,495 (2.7) 23,078 (6.9) 59,373 (2.5) |
Total |
219,414 (1.7) |
227,146 (3.5) |
242,432 (6.7) |
258,261 (6.5) |
268,675 (4.0) |
69
There were, once again, several factors which seemed to have affected the growth in total bank credits. The deceleration in exports and the poor performance in domestic sales meant that large firms experienced a shortage in short- term working capital. These firms naturally had greater needs for short- term loans as a result. The second factor was the high market interest rates. Firms incurred higher costs in financing themselves in the securities market, so they relied more heavily on bank loans. Third, the implementation of the bank trust reforms gave rise to greater concern about tight monetary policy and resulted in disguised demand for funds. In addition, with the shrinking of volumes of funds in bank trust accounts, funds at non- bank financial institutions were less readily available for firms.
The volume of bills discounted decreased in the first quarter due to a spate of bankruptcies among small and medium- sized firms, but it began to increase during the second quarter and rose throughout the rest of the year. The increase in issuance of commercial papers by large firms more than offset the decline in the volume of trade papers and, in the third quarter, the Korean Thanksgiving holiday in September actually helped to increase the demand for discounted bills further.
The volume of overdrafts fluctuated widely throughout 1996. Overdrafts in the first quarter continued to grow weakly as they had since the implementation of the
<Table 5> Loans with Banking Funds1)
(billion won, percent)
1995 |
1996 |
|||
4/4 |
1/4 |
2/4 |
3/4 |
|
Bills discounted Overdrafts General loans Others |
22,049 (7.7) 8,383 (- 19.0) 70,542 (4.2) 40,009 (- 0.4) |
21,080 (- 4.4) 8,144 (- 2.9) 73,967 (4.9) 40,601 (1.5) |
22,063 (4.7) 8,847 (8.6) 79,532 (7.5) 41,158 (1.4) |
23,474 (6.4) 13,117 (48.3) 87,494 (10.0) 41,522 (0.9) |
Total |
140,983 (1.7) |
143,792 (2.0) |
151,600 (5.4) |
165,607 (9.2) |
70
third round of the interest rate liberalization at the beginning of 1995. Overdrafts in the first quarter therefore decreased as firms satisfied more of their financing needs through direct means. During the second quarter, the market interest rates remained high, so large firms made greater use of bank overdrafts for short- term working capital. The demand for overdrafts was especially high in the third quarter: large firms were experiencing a shortage in working capital, and they were generally making use of short- term financial instruments because they expected a break in interest rates in the near future. The volume of overdrafts grew at a slower rate as the short- term market interest rates declined.
General loans recorded sound growth in 1996 because of firms' rising working capital needs and an increase in household loans. The latter were aggressively promoted by banks and actually contributed considerably to the overall growth in general loans. Banks realized greater profits from household loans than corporate loans because they had higher spreads and did not entail obligations on the part of banks to extend credit guarantee funds.
The volume of loans in foreign currencies increased moderately all through the year despite the decline in both equipment investment and payments for royalties and technology transfers. The government extended loans in foreign currencies partly in an effort to encourage investment in capital goods but also as a means of reducing the trade deficit.
<Table 6> Interest Rates on Selected Bank Loans1)
(percent)
1995 |
1996 |
||||
4/4 |
1/4 |
2/4 |
3/4 |
4/42) |
|
General loans Overdrafts Discounts on commercial and trade bills Loans overdue |
9.0~12.5 14.39~14.89 9.0~12.3 18.0~19.0 |
8.75~14.75 11.5~12.9 9.0~11.5 17.0~19.0 |
8.75~15.75 12.5~16.8 7.0~11.3 17.0~19.0 |
8.75~15.75 15.0~20.5 7.0~12.5 17.0~19.0 |
8.5~15.5 14.75~20.25 7.0~12.3 17.0~19.0 |
71
Total bank credits by the end of 1997 are forecast to rise 18.7 percent, a slower rate than in 1996, as no rebound in equipment investment is expected at any time before the later part of the year. Equipment investment generally does not pick up until the market has fully recovered. As a result, banks are expected to have difficulties in finding borrowers, but the growth rate of guarantees and acceptances is still not expected to be high because of banks' concerns over the increasing risk of bankruptcies among small and medium- sized firms.
Bank Trust Market
The total of trust account balances at deposit money banks is estimated to have risen by 17.1 percent, amounting to 146.3 trillion won by the end of 1996. The movement of bank trust account balances can be explained largely by changes in the government regulation during the year. The implementation of the comprehensive tax system for financial income encouraged greater shifting of funds between financial instruments while at the same time raising the popularity of money- in- trusts as tax
shelters. Accordingly, bank trust balances increased moderately in the first quarter. However, after the bank trust reforms in May, the volume of the bank trust balances had fallen since firms and investors, who usually managed their funds with time horizons of less than one year, transferred their funds from bank trusts into short- term fixed rate products offered by banks such as time savings deposits or mutual installment savings deposits. The rate of increase in bank trusts declined after the reforms as a result, although it was better than expected as some banks offered customers favorable interest rates and monthly compound interest payments in an effort to prevent further outflows of funds from bank trusts. The introduction of tax- exempt household trusts also helped to increase the volume of money- in- trusts. Since the maturities on these new trusts are over three years, these products are not subject to the bank trust reforms.
Household trusts rose sharply to 38.8 trillion won, a 47.0 percent increase from the previous year. Household trusts performed strongly during the first and the second quarters before the bank trust reforms. There had been fierce competition between banks to attract more funds by promoting bank trusts that offered higher
72
returns compared to other bank and non- bank investment products. After the bank trust reforms, the growth in household trusts slowed dramatically, although banks attempted to spur demand for them by lowering the trust management fees and increasing the monthly compound interest payments on them.
Corporate trusts were greatly affected by the bank trust reforms and posted a decline. Since corporate trusts had been used by firms as short- term fund management tools, most of the funds in corporate trusts had maturities of only one to three months. After the bank trust reforms, these funds were moved into the CMAs offered by investment and finance companies. The shortage in working capital among
<Table 7> Trust Accounts1)
(billion won, percent)
1995 |
1996 |
||||
4/4 |
1/4 |
2/4 |
3/4 |
4/42) |
|
Household Corporate Development Retirement Pension Nonspecific Specific Personal Pension Tax- exempt Bank Trust Other |
26,388 (8.9) 7,848 (1.0) 15,247 (- 0.5) 9,246 (- 4.8) 36,205 (28.1) 24,929 (6.6) 2,143 (23.2) - - 2,878 (33.4) |
32,590 (23.5) 8,836 (12.6) 15,059 (- 2.1) 8,748 (- 5.4) 37,401 (3.3) 25,585 (2.6) 2,337 (9.1) - - 2,842 (- 1.3) |
36,611 (12.3) 8,828 (- 0.1) 15,333 (1.8) 8,400 (- 4.0) 40,786 (9.0) 25,711 (0.5) 2,701 (15.6) - - 3,072 (8.1) |
37,616 (2.7) 7,832 (- 11.3) 15,272 (- 0.4) 8,021 (- 4.5) 41,815 (2.5) 26,632 (3.6) 2,836 (5.0) - - 1,327 (- 56.8) |
38,782 (3.1) 7,049 (- 10.0) 14,997 (- 1.8) 7,700 (- 4.0) 43,279 (1.1) 27,431 (3.0) 3,035 (7.0) 2,706 - 1,287 (- 3.0) |
Total |
124,891 (10.3) |
133,398 (6.8) |
141,442 (6.0) |
141,351 (- 0.1) |
146,266 (3.5) |
73
firms which came about as a result of the sluggish export and domestic sales performances also affected the growth in corporate trusts.
By the end of 1996, the volume of nonspecific trusts reached 43.3 trillion won, an increase of 19.6 percent from the previous year. Despite the abolishment of general nonspecific trusts earlier this year, the increase in nonspecific trusts was primarily due to the strong performance of specific purpose installment trusts. These later trusts were in high demand because they made monthly compound interest payments.
Tax- exempt household trusts were introduced on the 20th of October and were well received by the public. They took in 1.2 trillion won in only two months. Since the maturities of these new products are over three years, it seems that they led individual investors to choose banks which are more stable and more convenient than other financial institutions.
In 1997, the volume of money- in- trusts is expected to rise 8.0 percent to 158.0 trillion won. This is a significantly slower rate than those recorded in 1994 and 1995, and this forecast is based on several factors. The outflow of funds from trust accounts induced by the bank trust reforms is expected to continue. General nonspecific trusts offering fixed returns are slated to be abolished, and development trusts, on which returns are also fixed, are expected to decline as the BOK plans to lower the issuance limit. Corporate trusts are expected to decline moderately due to the shortage in working capital which many firms are experiencing. Tax- exempt household trusts, on the other hand, will continue to induce funds into banks.
<Table 8> Loans Funded by Bank Trusts and Investment in Securities1)
(billion won, percent)
1995 |
1996 |
|||
4/4 |
1/4 |
2/4 |
3/4 |
|
Loans funded by Bank Trusts Investment in Securities2) |
44,374 (35.6) 80,113 (64.4) |
45,725 (34.0) 88,641 (66.0) |
49,343 (34.9) 92,235 (65.1) |
53,487 (36.3) 93,670 (63.7) |
74
Non- bank Financial Institutions
Overview
In 1996, total deposits at Non- bank Financial Institutions (NBFIs) posted far higher growth than the previous year. They are expected to have amounted to 269,000 billion won. Yet, total deposits at NBFIs grew sluggishly during the first half of the year due to the fall in both commercial paper sales by Merchant Bank Corporations (MBCs) and beneficiary certificates sales by Investment and Trust Companies (ITCs). The former was caused by the decline in demand for bank trusts after the bank trust reforms went into effect in May. During the second half of the year, however, total deposits at NBFIs exhibited rapid growth. The increase in own paper issuances at MBCs was one factor for the increase; the limit on own paper issuance was abolished when some Investment and Finance companies (IFCs) were transformed into MBCs. Other factors were the increase in MMF sales by ITCs and total deposits at Mutual Savings and Finance Companies (MSFCs) and the introduction of tax- exempt household savings products.
Total credits at NBFIs in 1996 grew at roughly the same rate as the previous year. One noticeable change in total credits at NBFIs during the year was a sharp reduction in total credits at regional financial institutions such as MSFCs and Mutual Credits (MCs). Banks made greater efforts promote themselves among small and medium- sized firms since large firms had by and large been disintermediated from banks. During the second half of the year, however, the rate of decline slowed down as many large firms financed their short- term working capital needs by issuing new commercial papers. The increase in commercial paper issuances resulted partly from the fall in both exports and domestic sales and partly from difficulty in financing through the primary market because of restrictions on the volume of bond issuances and the bearishness in the stock market.
As is the case with regard to total credit, total deposits at NBFIs in 1997 are
- 75 -
also expected to grow at about the same rate as during the last year, but total deposits at MBCs are likely to grow sluggishly. Since interest rates are not expected to move much, sales of commercial paper will not increase, and the volume of own paper issuances is not likely to grow as quickly as in 1996. Investment in new CMAs, which are expected to have higher returns, will significantly increase, and the regional financial institutions are likely to experience growth in total deposits at about the same pace. In 1997, the market for deposits amongst NBFIs will be more competitive because of the introduction of new products, such as CMA, MMF, and the tax- exempt household savings, and the efforts on the part of the new MBCs to increase their deposits. The MSFCs and MCs will also witness steady growth in total deposits because of deregulation and the introduction of new products. The fact that much has been done to ensure the stability of the MSFCs will certainly have a positive effect on total deposits when the Managerial Information Disclosure requirements go into effect next year.
Total credits at NBFIs are expected to exhibit slightly higher growth in 1997 than this year. During the first half of the next year, there will still be strong demand for short- term working capital even if the demand for long- term capital for investment remains low because of continued weakness in exports and domestic sales. This situation may change during the second half of next year, however; the demand for loans by firms may significantly increase if the economy rebounds from recession. Firms may therefore increase their long- term capital investment outlays as a result. Total credits at MBCs are likely to rise more quickly than during 1996 as the demand for funds rises, but the demand for loans by small and medium- sized firms through factoring is likely to grow only after the economy recovers. The regional financial institutions such as MSFCs and MCs will experience a rise in both deposits and credits from households and, possibly, from small and medium- sized firms if the economy finally begins to show some strength. Credit companies will take a more prudential approach with regard to both expanding membership and the loan business. Leasing companies will face a better business environment if firms do in fact expand long- term capital investment during the second half of 1997. Installment loan
- 76 -
<Table 9> Deposits and Credits for NBFIs1)
(billion won, percent)
1994 |
1995 |
1996 |
19976) |
||||
1/4 |
2/44) |
3/4 |
4/45) |
||||
(Deposits)2) Merchant Bank Corporations Investment and Trust Companies Mutual Savings and Finance Companies Mutual Credits Credit Unions Community Credit Cooperatives Postal Savings |
42,392 (32.4) 53,981 (18.2) 22,677 (23.6) 34,366 (20.1) 8,252 (26.7) 13,110 (18.9) 5,909 (29.9) |
57,101 (34.7) 60,261 (11.6) 25,679 (13.2) 40,534 (17.9) 10,199 (23.6) 15,616 (19.1) 6,036 (2.1) |
65,694 (34.2) 65,188 (18.8) 26,852 (16.5) 42,252 (21.6) 10,835 (24.6) 16,566 (21.9) 6,312 (2.0) |
69,054 (40.1) 67,898 (23.6) 27,601 (13.7) 44,443 (24.8) 11,524 (26.8) 17,573 (24.6) 6,404 (3.6) |
72,933 (35.4) 69,233 (20.9) 27,649 (12.2) 47,710 (26.5) 12,394 (29.2) 18,747 (26.0) 6,972 (13.8) |
79,467 (32.4) 68,450 (13.6) 29,631 (15.4) 52,429 (29.3) 13,035 (27.8) 19,801 (26.8) 6,669 (10.5) |
96,748 (21.7) 77,300 (12.9) 34,272 (15.7) 69,735 (33.0) 17,854 (37.0) 26,301 (32.8) 7,819 (17.2) |
TOTAL |
180,688 (23.1) |
215,426 (19.2) |
233,699 (23.0) |
244,579 (26.4) |
255,638 (25.3) |
269,482 (25.1) |
330,029 (22.5) |
(Credit)3) Merchant Bank Corporations Mutual Savings and Finance Companies Mutual Credits Credit Unions Community Credit Cooperatives |
44,983 (30.0) 22,808 (24.3) 26,499 (22.5) 7,419 (25.6) 9,917 (16.1) |
59,287 (31.8) 25,752 (12.9) 30,471 (15.0) 8,957 (20.7) 11,492 (15.9) |
66,031 (32.7) 25,856 (11.0) 31,377 (16.0) 9,263 (19.9) 11,773 (15.3) |
69,791 (39.4) 26,411 (7.5) 33,220 (16.8) 9,634 (18.1) 12,329 (16.3) |
74,497 (34.6) 27,215 (8.4) 34,830 (17.8) 10,098 (18.4) 13,006 (18.4) |
79,786 (34.6) 28,221 (9.6) 34,452 (13.1) 10,489 (17.1) 13,386 (16.5) |
108,589 (36.1) 31,183 (10.5) 39,551 (14.8) 12,576 (19.9) 15,809 (18.1) |
TOTAL |
111,686 (25.4) |
135,959 (21.7) |
144,300 (22.2) |
151,386 (24.2) |
159,646 (23.3) |
166,334 (22.3) |
207,708 (25.1) |
Notes: 1) End of period. The figures in parentheses are percentage changes from the previous quarter.
2) Deposits of non- bank financial institutions = Merchant Bank Companies (issuance of their own papers + 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 of non- bank financial institutions = Merchant Banking Corporations (paper
discounts) + Mutual savings and Finance Companies (loan + paper discounts) +
Mutual Credits (loans) + Credit Unions (loans) + Community Credit Cooperatives
(loans).
4) Revised.
5) Estimates.
6) KIF Forecasts.
Sources: The Bank of Korea, Association of Investment and Finance Corporations, Association of Mutual Savings and Finance Companies, and Association of Credit Unions, Korea Credit Rating Agency.
- 77 -
companies are also expected to expand their business even if they may experience difficulty in financing external funds.
Merchant Banking Corporations
By the end of 1996, total deposits at MBCs rose 39.2 percent since the beginning of the year. Such a rise was mainly due to a sharp increase in issuance of commercial paper. Sales of commercial paper, however, were sluggish. Commercial paper comprises the major source of deposits at MBCs, but CP sales rose only slightly compared to 1995. Sales were actually fairly strong during the first half but lost all their momentum in the second half because of weakness in demand. The volume of CMAs remained flat. The reforms for bank trust accounts and the extremely short maturities of newly issued commercial paper discouraged institutional investors from investing heavily in it. Since July, the increase in total deposits of MBCs was led by the rise in own paper issuances by MBCs. The limit on the size of own paper issuances had been abolished when some IFCs were transformed into MBCs.
Total credits at MBCs rose by 34.6 percent over the previous year. This was an especially strong rise in light of the fact that overall demand for funds declined as the recession continued and it occurred because of a rise in demand for short- term working capital and an increase in demand for paper discounts by firms. The discounts for both trade bills and factoring bills declined. The former was due to the fall in exports and the latter due to the reluctance of MBCs to discount commercial paper issued by small and medium- sized firms: MBCs became very concerned about the rise in the ratio of bankruptcies. Factoring companies, for their part, continued to carve out larger shares of the market for discounting of commercial paper.
In 1996, the market situation for MBCs shifted in a profound way. In July, those IFCs which had been established in order to institutionalize the private loan market were transformed into MBCs, and they have since played a major role in the call market. There are now 30 MBCs in total. The underlying reason for their
- 78 -
transformations was the change in the business environment: IFCs had been able to borrow and lend at higher interest rates than other financial institutions since there was always excess demand for loans. However, large- sized firms can now easily satisfy their capital needs either in the primary market or from overseas at lower interest rates, so the IFCs' market dried up. They had no other choice but to expand into new financial services including leasing and international finance.
In 1997, the growth in total deposits at MBCs is likely to slow. Sales of commercial paper will decelerate as interest rates become more volatile, and the issuance of own paper will not rise as quickly as in 1996. However, the volume of deposits through CMAs, especially new CMAs whose assets are invested in commercial paper issued by small and medium- sized firms, is expected to grow more quickly than in 1996 because these CMAs have higher implied yields. In 1997, the
<Table 10> Deposits and Credits of MBCs1)
(billion won, percent)
1994 |
1995 |
1996 |
19973) |
||||
1/4 |
2/4 |
3/4 |
4/42) |
||||
(Deposits) Sales of bills CMA Issuance of own paper |
42,392 (32.4) 36,414 (37.4) 318 (- 22.8) 5,660 (10.8) |
57,101 (34.7) 48,221 (32.4) 859 (170.1) 8,021 (41.7) |
65,694 (34.2) 55,236 (29.3) 1,213 (154.8) 9,245 (60.7) |
69,054 (40.1) 58,944 (40.4) 1,563 (157.1) 8,547 (27.9) |
72,933 (35.4) 59,390 (31.7) 6,356 (838.8) 7,187 (- 11.1) |
75,624 (32.4) 60,244 (24.9) 7,235 (742.3) 8,145 (1.5) |
91,706 (21.3) 72,054 (19.6) 9,631 (33.1) 10,021 (23.0) |
(Credits) Paper discount Factoring |
44,983 (30.3) 35,631 (18.7) 9,353 (104.0) |
59,287 (31.8) 51,746 (45.2) 7,541 (- 19.4) |
66,031 (32.7) 57,850 (11.8) 8,181 (- 10.4) |
69,791 (39.4) 62,448 (8.0) 7,343 (11.0) |
74,497 (34.6) 72,139 (15.5) 2,358 (- 59.6) |
79,786 (34.6) 77,653 (7.6) 2,133 (- 71.7) |
108,589 (36.1) 106,500 (37.1) 2,089 (- 2.1) |
Notes: 1)End of period. Figures in parentheses are percentage changes from the previous
quarter.
2) Estimates.
3) KIF Forecasts.
Source: The Association of Investment and Finance Corporations.
- 79 -
new MBCs are also expected to be allowed to borrow from overseas, so their expansion should be greatly facilitated.
Total credits at MBCs are expected to grow at a slightly more rapid rate in 1997 than in 1996 since the demand for short- term capital by firms will continue to rise. As both exports and domestic sales continue to fall, firms can be expected to issue greater volumes of commercial paper. It should be noted, however, that the volume of loans for small and medium- sized firms, e.g., the discounting of factoring bills, will continue to fall in the first half of the year but that there will be some increase if the economy recovers during the second half. The competition in the credit business, in particular, will be much more severe since the new MBCs will enter into leasing and other services. The new MBCs are still unlikely to grow fast in the short run, however, due to their lack of specialized expertise in new services and their low degree of recognition by foreign financial institutions. Furthermore, in the leasing business, the new MBCs' growth will be restrained because of strong competition with other financial institutions and less demand for long- term investment due to the economic recession.
<Figure 1> Deposits and Credits of MBCs
- 80 -
MBCs have grown in terms of size, but their managerial efficiency has deteriorated. Their net business profit between April and September, for example,
was actually about 30~40 percent lower than during the previous year. This was in part due to the increase in the financial costs of borrowing from the call markets. The MBCs have found themselves in a situation where they have had to refinance insufficient funds because of the fall in sales of commercial paper. In part, there was a decline in revenue from security activities since the stock market was performing poorly, but there was also a slowdown in the leasing business as firms cut back their long- term capital investment.
Investment and Trust Companies
The balance of stock funds was recorded at 12.58 trillion won during the year, showing a slight 1.5 percent increase from last year. Bond funds excluding MMFs amounted to 49.76 trillion won, posting a 4.5 percent increase from the previous year. The balance of MMFs introduced in September increased dramatically to 5.97 trillion won by the end of the quarter. It would seem that the high short- term interest rates
made them attractive investment instruments. The total balance of all types of funds together during the year amounted to 68.54 trillion won, which was a 13.7 percent increase from 1995.
〈Table 11〉 Bond Market Forecasts
(percent, billion won)
1994 |
1995 |
1996 |
19972) |
||||
1/4 |
2/4 |
3/4 |
4/4 |
||||
New issues Corporate bond yields1) |
20,033 12.91 |
23,581 13.90 |
8,283 11.88 |
7,060 11.18 |
5,948 12.14 |
8,612 12.28 |
30,000 10.90 |
Notes: 1) Average yields.
2) Forecasts.
Source: Korea Investors, Inc., KIS- LINE.
- 81 -
The amount of money invested in stocks by ITCs during the year is estimated at 12.6 trillion won, a 6.2 percent decline from 1995, while the amount invested in bonds is estimated at 53.6 trillion won, an 11 percent increase from 1995. Though the balance of bond funds excluding MMFs declined, total bond holdings by ITCs in fact increased during the year. This shows that ITCs invested more heavily in bonds because they yielded relatively higher returns than did stocks.
The balances of stock funds are expected to grow at an even faster rate in 1997 because the new ITCs which just recently began operations are so far only permitted
to sell stock beneficiary certificates. In addition, as the stock market reverses itself and rebounds gradually, it will encourage fund managers to put more money into stock portfolios.
The growth in bond funds will slow because they will become increasingly less attractive investment instruments as the market interest rates decline. Bond fund
managers, concerned about the uncertainties regarding the future demand for capital and the possibility of higher inflation and tight monetary policy, are expected to invest
〈Table 12〉 Deposits at ITCs1)
(billion won, percent)
1995 |
1996 |
|||||
3/4 |
4/4 |
1/4 |
2/4 |
3/4 |
4/42) |
|
Stock funds Bond funds [MMFs3)] Stock savings |
12,697 (- 1.8) <22.7> 44,322 (0.9) <77.4> 224 (12.6) <0.4> |
12,388 (- 2.4) <20.6> 47,625 (7.5) <79.0> 228 (1.8) <0.4> |
11,819 (- 4.5) <18.1> 53,090 (11.5) <81.4> 279 (22.4) <0.4> |
10,949 (- 7.4) <16.1> 56,705 (6.8) <83.5> 244 (- 12.5) <0.4> |
11,863 (8.3) <17.1> 57,145 2,091 (0.8) <82.6> 225 (- 20.1) <0.3> |
13,000 (9.6) <18.4> 57,500 5,000 (0.6) <81.3> 250 (11.1) <0.4> |
Total |
54,943 (0.2) |
60,261 (4.2) |
65,188 (8.1) |
67,898 (4.2) |
69,233 (1.9) |
70,750 (2.2) |
Notes: 1) End of period. The figures in brackets are percentage weights, and the figures in parentheses are percentage changes from the previous quarter.
2) Forecasts.
3) Sold since September 6, 1996.
Source: Korea Investors, Inc., KIS- LINE.
- 82 -
greater shares of their funds in commercial paper and CDs than in long- term corporate bonds. MMFs are also expected to grow rapidly as well.
〈Figure 2〉 Deposits at ITCs
〈Table 13〉 Investment by ITCs1)
(billion won, percent)
1994 |
1995 |
1996 |
19973) |
||||
1/4 |
2/4 |
3/4 |
4/42) |
||||
Stocks |
13,394 (27.1) <23.7> |
13,430 (0.3) <21.9> |
13,121 (- 2.8) <20.8> |
12,639 (- 6.1) <19.4> |
13,057 (1.37) <19.5> |
12,600 (- 3.5) <19.0> |
15,200 (20.6) <20.1> |
Bonds |
43,196 (14.0) <76.3> |
48,285 (11.8) <78.1> |
50,029 (18.6) <79.2> |
52,483 (22.3) <80.6> |
53,824 (17.16) <80.5> |
53,600 (- 0.4) <81.0> |
60,400 (12.7) <79.9> |
Total |
56,590 (16.8) |
61,715 (9.1) |
63,149 (13.4) |
65,124 (15.6) |
66,881 (13.7) |
66,200 (- 1.0) |
75,600 (14.2) |
Notes: 1) End of period. The figures in brackets are percentage weights.
2) Estimates.
3) Forecasts.
Source: The Bank of Korea.
- 83 -
Mutual Savings and Finance Companies
Total deposits at MSFCs grew somewhat more quickly in 1996 than during the previous year. The growth had been sluggish during the first half of the year, but it accelerated during the second. In the first half, the interest rates offered by MSFCs and banks converged, and banks worked hard to strengthen their retail banking business. MSFCs also suffered a blow to their credibility due to financial failures which occurred at some of them. Matters finally turned for the better in the second half with the deregulation measures that were taken. Among these, MSFCs were permitted to open new branches, which of course allowed them to become more visible and reach more clients. They also received a needed boost to their credibility with the requirement for Managerial Information Disclosure, and the newly introduced tax- exempt savings accounts are certain to increase total deposits at MSFCs.
By the end of 1996, total credits at MSFCs are expected to have risen 9.6 percent. It seemed that the growth in credits at MSFCs was restrained throughout most of the year. During the first half, there was a fall in total deposits, and the MSFCs were not eager to issue loans to small and medium- sized firms as the incidence of bankruptcies had risen.
A modest recovery in total credits occurred during the second half because of the increase in total deposits and the increase in demand for working capital from firms. A particularly large part of the loan demand from households and small and medium- sized firms during this time was absorbed by the MSFCs as well.
During 1997, total deposits at MSFCs are expected to grow 15.7 percent. The deposit will grow because the MSFCs will be able to expand through mergers and acquisitions with other MSFCs and open new branches as a result of deregulation measures implemented by the Ministry of Finance and Economy. To be sure, the requirement for managerial information disclosure will enhance the MSFCs' credibility and therefore induce higher deposits. The new tax- exempt long term household savings accounts will cause total deposits to rise even further, at least over the short term. The interest rates offered by MSFCs on these savings accounts are actually 1~
- 84 -
2 percentage points higher than at other financial institutions. This may be good for clients, but it will pose difficulties to the MSFCs in managing their assets, so it is not likely that the growth of total deposits through new tax- exempt household savings accounts will last long.
Total credits in 1997 will rise by 10.5 percent due to the expansion of the deposit business. The greater part of the demand for loans by households and small and medium- sized firms is once again expected to be satisfied by MSFCs. Those MSFCs which previously had sufficient reserves of funds and were reluctant to lend to small and medium- sized firms will need to extend loans to these firms by improving their credit rating skills or by establishing a pool of loanable funds among themselves.
The regional financial institutions such as MSFCs have charged relatively higher interest rates on loans than others. Recently, the spread between the lending and borrowing rates has tended to narrow as large financial institutions, e.g.,
<Table 14> Deposits of MSFCs1)
(billion won, percent)
1994 |
1995 |
1996 |
19973) |
||||
1/4 |
2/4 |
3/4 |
4/42) |
||||
Installment savings Demand deposits Time deposits Other deposits |
3,513 (7.1) 1,258 (13.3) 17,906 (28.3) |
3,641 (3.6) 1,087 (- 13.6) 20,428 (14.1) 524 |
3,538 (- 3.9) 1,065 (- 2.3) 21,623 (18.3) 626 |
3,331 (- 9.6) 1,188 (- 1.4) 22,450 (16.9) 632 (253.1) |
3,228 (- 12.9) 1,092 (5.3) 22,596 (15.8) 733 (90.4) |
3,196 (- 12.2) 1,211 (11.4) 24,352 (19.2) 872 (66.4) |
2,887 (- 9.7) 1,465 (11.7) 28,955 (18.9) 965 (10.7) |
TOTAL |
22,677 (23.6) |
25,679 (13.2) |
26,852 (16.5) |
27,601 (13.7) |
27,649 (12.2) |
29,631 (15.4) |
34,272 (15.7) |
Notes: 1)End of Period. Figures in parentheses are percentage changes from the previous period.
2) Estimates.
3) KIF Forecasts.
Source: The Association of Mutual Savings and Finance Companies.
- 85 -
banks, have become much more competitive in retail banking business. As a result,
an increase in total deposits cannot be expected to directly lead to an increase in total
credits. MSFCs will also find themselves somewhat hamstrung in their ability to pursue aggressive fund management strategies. On the one hand, they cannot easily
lower their interest rates on loans by a substantial margin or extend greater volumes
of credits since they have little expertise in credit analysis, and on the other hand, banks are expected to lower their interest rates on loans as the basic rate declines.
Installment finance companies and factoring companies have kept their competitive edge by offering low interest rates on loans. This will put pressure on MSFCs and likely cause their profit margins to suffer drastically. They cannot charge high
interest rates on loans and will experience difficulty in their security activities. This being the case, the MSFCs will have to take maximum advantage of their superior information about local markets and to engage themselves more aggressively in lending to small and medium- sized firms and households. In the near future,
<Figure 3> Deposits and Credits of MSFCs
- 86 -
consumer finances are expected to grow, so MSFCs will need to increase their growth
potentials by exploiting the retail business in the region. It will also be necessary for MSFCs to satisfy customers' financial needs beyond their own regions by establishing links with other financial institutions. Regional financial institutions, moreover, should move quickly to do these things because they are actually at a great advantage vis- a- vis large financial institutions at this point in time, because they will not be nearly as affected by the opening of Korea's financial markets.
Financial Institutions Specialized in Lending
In 1996, a new proposal was put forward for the restructuring of financial institutions which engage in specific types of loan operations without taking any deposits. These institutions typically handle leases, credit cards, installment finances. They were bedeviled by managerial inefficiency and engaged in risky transactions due to severe competition in each specific area of business. In addition, large firms
<Table 15> Credits of MSFCs1)
(billion won, percent)
1994 |
1995 |
1996 |
19973) |
||||
1/4 |
2/4 |
3/4 |
4/42) |
||||
Loans Paper discounts Other credits |
1,366 (- 9.5) 5,811 (31.3) 15,631 (26.0) |
1,257 (- 8.0) 6,716 (15.6) 17,778 (13.7) |
1,181 (- 12.0) 6,821 (14.6) 17,854 (11.5) |
1,053 (- 20.8) 7,574 (17.7) 17,784 (5.9) |
978 (- 26.7) 8,281 (27.3) 17,956 (4.0) |
956 (- 23.9) 8,954 (33.3) 18,311 (3.0) |
903 (- 5.5) 11,124 (24.2) 19,156 (4.6) |
TOTAL |
22,808 (24.3) |
25,751 (12.9) |
25,856 (11.0) |
26,411 (7.5) |
27,215 (8.4) |
28,221 (9.6) |
31,183 (10.5) |
Notes: 1)End of period. The figures in parentheses are percentage changes from the previous period.
2) Estimates.
3) KIF Forecasts.
Source: The Association of Mutual Savings and Finance Companies.
- 87 -
increasingly raised needed capital by issuing stocks and corporate bonds in the primary market or by borrowing directly from overseas. Banks also made more loans to households. As the domestic financial markets further open, the competition among financial institutions is likely to become more and more intense. Mergers of these institutions are considered as one way of increasing their competitiveness. A fundamental institutional change is therefore expected because large financial institutions which engage in the full range of loan- related financial services will emerge.
The credit card business is expected to grow rapidly in the future. Consumers have been making greater percentages of their purchases with credit cards year after year with the increase of national income. In 1997, when the market for credit cards is finally open to foreign institutions, many foreign credit card companies can be expected to enter the market, as will a greater number of domestic companies. One major caveat is in order here, however; the rapid growth which credit card companies have experienced lately has occurred mainly due to excessive issuance of new cards. Many credit card companies have therefore become burdened by huge amounts of overdue or delinquent credit card balances. These have been rising as credit cards have been made more easily available to consumers. Clearly, the credit card companies must in the future be much more thorough in their credit analysis when issuing new cards and deciding on credit limits. In the short term, the credit card companies should make efforts to centralize the processing of all information about card usage and develop a system by which illegal transactions can be detected at the point of sale. They also need to consider setting up a system of various interest charges which reflect customers' credit ratings. What is more, they should begin to provide basic services for card holders such as balance confirmation by phone and the like. To be sure, the entry of foreign credit card companies will eventually encourage domestic ones to do all of these things, but there will not likely be much change in the short term in light of the significant up- front costs of entering this business.
Installment finance companies which had opened for business in February in 1996 have grown significantly in size even despite their lack of expertise and excessive
- 88 -
competition. Because of the growth in national income, the boom in installment finances will continue. Since installment finance capacities may not assume debt in amounts in excess of ten times their own capital, their ability to expand their business is likely to be restrained. As a result, there is a possibility that the domestic market may be overrun by large foreign installment finance companies as financial opening continues.
Leasing companies have played a unique role in providing funds for long- term capital investment during Korea's economic development. In the past, the leasing market had been rather oligopolistic, so its marketing was rather facile and the profit margins were rather high. This began to change in 1989 when 17 new regional leasing companies were set up. Furthermore, in 1996, all 15 of the investment and finance companies were allowed to be converted into merchant banks. With such an increase in the number of financial institutions engaged in the leasing business, the profit margins have been driven down drastically. Moreover, owing to the current economic recession, the demand for long- term capital investment has sharply fallen. It is therefore expected that the growth in both the number of lessees and business profits will decelerate. In the future, the business environment for leasing companies is likely to become even more adverse as firms will prefer to raise needed capital through the primary financial market.
- 89 -
Money and Capital Markets
Stock Market
Except for the early second quarter, the Korean stock market had been sluggish throughout 1996. At the beginning of the second quarter, the stock market recovered from the stagnation of the first quarter; it was fueled by the raising of the ceiling on foreigners' aggregate stock ownership, the decline in interest rates, and the dissipation of political uncertainties after the general elections. The stock market lost its momentum in May, however, and began to decline as the current account deficit increased and interest rates rebounded in spite of repeated efforts by the government to boost the market. The Korean Composite Stock Price Index (KOSPI) started at 888.85 in early January, recorded the year's high of 986.84 in early May, and then began to decline before finally bottoming out at 651.22 in late December, its lowest point since March, 1993. The daily average of the KOSPI during the year was 833.69, which was down 11 percent from last year.
The daily average trading volume during the year amounted to 26.66 million shares, which was a marginal two percent increase over last year. The trading
〈Figure 4〉 KOSPI and Customer Deposits
volume was the highest during the second and fourth quarters. The heavy trading
- 90 -
during this period was attributed to both individual and institutional investors' frequent rebalancing of their portfolios in reaction to the wide stock price fluctuations which were then being observed. The daily average trading volume was recorded at 486.2 billion won, a slight decline from last year. The trading volume therefore did not decline as much as stock prices, which dropped by 11 percent from last year. This indicates that the trading during the year was centered more on relatively high- priced stocks and that the stock market's stagnation tended to discourage trading in relatively low- priced stocks. The high degree of stock price volatility observed during the year was attributed to investor uncertainty. Investors were sharply divided with regard to expectations over future corporate performance and government monetary policy.
Even though the stock market stagnated badly throughout most of the year, customer deposits stood at 2.26 trillion won by the end of December, recording a marginal increase of one percent from last year. Outstanding credit loans amounted to 2.77 trillion won, showing a 28 percent increase for the period. The ratio of
〈Table 16〉 KOSPI, Trading Volume, and Fund Inflow1)
(billion won, thousand shares, percent)
1994 |
1995 |
1996 |
||||
1/4 |
2/4 |
3/4 |
4/4 |
|||
KOSPI (average) KOSPI (end of period) |
965.70 (32.62) 1,027.37 (- 2.20) |
934.92 (- 3.19) 882.94 (- 14.10) |
866.17 (- 9.57) 874.16 (- 6.48) |
910.60 (5.13) 817.42 (- 6.49) |
808.28 (- 11.23) 789.7 (- 7.32) |
749.14 (- 7.32) 651.22 (- 17.54) |
Trading Volume (daily average) |
36,862 (4.93) |
26,104 (- 29.18) |
21,756 (2.90) |
33,820 (55.40) |
20,576 (- 39.16) |
29,315 (42.47) |
Trading Value (daily average) |
776 (35.24) |
487 (- 37.24) |
383 (- 13.38) |
651 (69.89) |
407 (- 37.56) |
481 (18.38) |
P/E Ratio2) |
16.2 |
16.4 |
15.9 |
17.4 |
19.4 |
14.7 |
Customer Deposits |
2,394 |
2,251 |
2,031 |
2,591 |
2,443 |
2,263 |
Notes: 1) The figures in parentheses are percentage changes from the previous period. 2) End of Period. Firms with negative profits are excluded.
Source: Korea Stock Exchange.
customer deposits to outstanding credit loans declined from 135 percent in 1994 and
- 91 -
102 percent in 1995 to only 82 percent in 1996. It is therefore clear that investors had increasing needs for credit loans and that there was growing investment risk due to the high stock price volatility. Investors' greater dependency on credit loans itself increases stock price volatility since it leads to an oversupply of stocks through the closure of customer accounts in a bear market and also to excessive demand for stocks in a bull market. This phenomenon was prevalent in the fourth quarter as a significant volume of credit loans matured and put too much pressure on the market.
The supply of new stocks made available through initial public offerings (IPOs) and seasoned offerings amounted to 5.04 trillion won during the year, a decline of 18 percent from last year. New stock issues through IPOs amounted to 1.39 trillion won, showing an increase of 140 percent from last year. This was attributed to the increase in public offerings by promising small and medium- size firms. New stock issues through seasoned offerings declined by 35 percent from last year to 3.65 trillion won. This sharp fall was mainly due to the reduction in corporate investment and government regulation which was intended to control the volume of offerings to
boost the depressed stock market.
〈Figure 5〉 Daily Volatility Trends of Trading Volume
During the year, investment and trust companies (ITCs) and investment banks rec
- 92 -
orded large net sales, while commercial banks and insurance companies continuously reduced their net purchases until the second half; commercial banks began to record net sales in the third quarter, and insurance companies began to record net sales in the fourth quarter. In addition, individual investors recorded net sales during the first half of the year and net purchases during the second half, whereas foreigners continuously recorded net purchases, although most of their sales were in the first half. It would seem that the continuing stagnation in the stock market widely discouraged trading, particularly by institutional investors and foreigners.
Securities companies and ITCs recorded net sales of 1,664.5 billion won and 645.3 billion won, respectively, on a cumulative basis during the year as they were not only disappointed at the persistent decline in stock prices but also sought to cut their losses on the stocks that they already held. ITCs accounted for a net purchase of 349.2 billion won in the third quarter, but it should be noted that most of this
〈Table 17〉 Stock Offerings and Credit Loans
(billion won)
1994 |
1995 |
1996 |
||||||
1/4 |
2/4 |
3/4 |
4/4 |
|||||
Initial Public Offerings |
Non- finance Finance Sub- total |
220.6 330.5 579.5 |
504.0 76.1 580.1 |
0 264 264 |
158.8 0 158.8 |
117.6 0 117.6 |
NA NA 851.1 |
|
Rights offerings of listed cos |
Non- finance Finance Sub- total |
2,991.3 2,446.5 5,378.7 |
4,472.3 1,111.5 5,583.8 |
705.8 0 705.8 |
824.3 0 824.3 |
1017.5 496.3 1,513.8 |
NA NA 609.4 |
|
Total |
5,958.2 |
6,163.9 |
969.8 |
983.1 |
1,631.4 |
1,460.5 |
||
Margin account Balance1) |
1,777.1 |
2,166.6 |
1919.7 |
2,588.0 |
2,751.0 |
2,774.0 |
||
Short Sales Outstanding1) |
11.1 |
40.1 |
56.0 |
35.0 |
42.0 |
34.7 |
||
Loans overdue(A)1) Accounts receivable(B)1) (A) + (B) |
8.5 88.2 96.7 |
29.6 52.0 81.6 |
12.8 47.6 60.4 |
4.0 60.0 64.0 |
14.0 80.0 94.0 |
9.4 39.6 49.0 |
Notes: 1) End of Period.
Sources: Korea Stock Exchange, Securities Supervisory Board, and Maeil Economic Daily.
was by the newly established ITCs which had been permitted to begin managing
- 93 -
stock funds in July. Net purchases by commercial banks began to fall in the first quarter and finally began to record net sales in the third quarter. Their total net sales for the year were 281.1 billion won. While insurance companies actually accounted for a net total purchase of 553.8 billion won during the year, much of this came in the first quarter. They also recorded declining net purchases during the year and even net sales in the fourth quarter.
〈Table 18〉 Investors' Stock Trading (Accumulated Net Sales)
(billion won)
Security companies |
Insurance companies |
ITCs |
Banks |
Other Institutions |
Indi- viduals |
Foreigners |
|
1993 1994 1995 1996 1/4 1996 2/4 1996 3/4 1996 4/4 |
- 1,039 - 1,202 - 1,532 - 392 - 499 - 341 - 433 |
196 687 966 350 188 15 - 12 |
- 775 432 50 - 218 - 706 349 - 70 |
455 2,122 419 107 16 - 111 - 293 |
- 530 - 1,164 981 520 75 - 128 - 210 |
- 2,637 - 1,820 - 2,198 - 655 - 820 32 177 |
4,329 929 1,318 289 1,818 199 768 |
Source: Korea Stock Exchange.
〈Figure 6〉 Investors' Cumulative Net Purchases
Foreigners, for their part, recorded a net purchase of stocks of 3,738 billion won
- 94 -
during the year. Almost half that amount, or 1,817.8 billion, was recorded in the second quarter when the ceiling on foreign aggregated stock ownership was raised from 15 percent to 18 percent. This figure was nevertheless somewhat short of the 2,273 billion won in net purchases by foreigners in the third quarter of 1995 when the ceiling had been increased from 12 percent to 15 percent. The ceiling on foreigners' stock ownership was increased again to 20 percent in early October, but because of the continued bearishness of the stock market and the greater exchange rate risks, total net purchases by foreigners only amounted to 767.7 billion won.
In addition to the raising of the ceiling on foreigners' stock ownership, there were several other important developments in the stock market in 1996; the opening of the stock index futures market, the opening of the KOSDAQ Securities Co., the dissolution of the stock market stabilization fund, the introduction of the new trading mechanism, and the announcement of the stock market reforms were among these.
The stock index futures market opened in May and enabled investors to hedge the risks of their stock portfolios. It is expected to bring a greater measure of stability to the stock market and therefore encourage even more active stock
investment. It will also help ensure efficient pricing of stocks by allowing for better
〈Figure 7〉 Institutional Investors' Accumulative Net Purchase
communication of information on future stock prices throughout the market. The
- 95 -
trading in stock index futures was concentrated most heavily on futures with short- term maturities, which indicates that the investment horizons of futures traders were mostly short- term, less than or equal to three months.
The KOSDAQ Securities Co. opened in July, and it will facilitate the over- the- counter market. In the first three months after its opening, until September, 18 companies previously registered with the over- the- counter market filed for the exchange and 13 companies newly registered to the KOSDAQ. However, the daily average number of issues traded increased from 43 in June to 76 in September. In addition, the government lowered the tax on trading in the over- the- counter market in August and announced plans to reform the over- the- counter market in September. Changes which will be made include allowing foreigners and workers who hold stock savings accounts to trade in the over- the- counter market, the easing of registration requirements in the over- the- counter market, and the introduction of the KOSDAQ index. All these are expected to help small and medium- sized firms raise needed capital through the stock market.
The dissolution of the stock market stabilization fund means that the stock market will have more autonomy. In the process of dissolution, cash and bonds were returned to the contributors, but the stocks are to be held by the Securities Depository for the next seven years as their immediate sale on the stock market would greatly aggravate the already bad market situation.
〈Table 19〉 Foreign Investment in the Korea Stock Exchange
(billion won)
1994 |
1995 |
1996 |
||||
1/4 |
2/4 |
3/4 |
4/4 |
|||
Purchases Sales Net Purchases |
6,101 5,172 929 |
7,602 6,284 1,318 |
1,796 1,499 297 |
4,015 2,197 1,818 |
1,609 1,410 199 |
2,689 1,921 768 |
Source: Korea Stock Exchange.
〈Table 20〉 Stock Index Futures Trading1)
(unit: point, contract, percent)
- 96 -
1996 |
|||
2/4 |
3/4 |
4/4 |
|
End- of- period Stock Index Futures (%) KOSPI 200 96. 62) 96. 92) 96. 122) 97. 32) 97. 62) 97. 92) |
89.29 95.00 <95.24>3) 88.80 89.95 90.00 95.00 |
82.30 (- 7.83) 84.05 (- 5.34) <84.20>3) 83.30 (- 1.83) 84.70 (- 5.89) 88.00 (- 7.37) 95.55 |
67.93 (- 17.46) 71.35 (- 14.35) 65.00 (- 23.26) 66.70 (- 24.20) 72.00 (- 24.65) |
Quarterly Average Trading Volume 96. 6 96. 9 96. 12 97. 3 97. 6 97. 9 |
3,223.09 919.11 7.62 5.55 0 |
2,924.94 744.08 17.34 0.27 0 |
4,465.63 811.94 5.44 1.40 |
End- of- period Open Contracts 96. 6 96. 9 96. 12 97. 3 97. 6 97. 9 |
1,174 3,620 105 215 0 |
0 4,152 729 10 0 |
4,721 156 31 0 |
Notes: 1) Opening on May 3, 1996.
2) The maturity date is the second Thursday of the month of settlement.
3) KOSPI Index 200 on maturity date.
Source: Korea Stock Exchange.
Under the new trading system introduced in November, investors may now make use of market orders, conditional limit orders, and orders for trading after the close
- 97 -
of the market in addition to limit orders. The new system also allows for wider daily price fluctuation of 8 percent as compared to 6 percent previously. Needless to say, this new system is expected to improve the liquidity and efficiency in stock pricing.
The stock market reforms announced in the third quarter are intended to improve the primary and secondary market system as well as to facilitate mergers and acquisitions. They should, furthermore, protect individual investors and allow the securities industry greater autonomy in addition to improving its efficiency.
1997 should see a slow recovery of the stock market after its long slump in 1996. The economy is expected to go through an adjustment stage, bottom out some time in the third quarter, and then begin to rebound along with the business cycle. The further raising of the ceiling on foreigners' stock ownership
planned for 1997, the entry of foreign securities and investment companies into new
〈Table 21〉 Major Macro Economic Indices and Forecasts
(percent, billion won)
1994 |
1995 |
1996 |
1997 |
||||||
1/4 |
2/4 |
3/4 |
4/4 |
year |
first half2) |
second half2) |
|||
GDP Growth Rate1) Gross Fix. Cap. Formation (Construction) (Equipment) CPI Inflation Current Account Capital Account |
8.2 11.7 4.6 23.3 6.2 - 4.5 9.0 |
9.0 12.4 9.9 15.9 4.5 - 9.0 13.5 |
7.9 7.5 10.5 4.3 4.9 - 4.6 4.9 |
6.8 4.3 4.9 3.5 5.1 - 5.2 7.6 |
6.4 6.5 4.7 8.7 5.2 - 7.3 0.9 |
6.9 4.6 4.9 4.1 4.8 - 5.2 - 4.6 |
7.0 5.6 6.0 5.2 5.0 - 22.3 16.9 |
5.9 4.4 6.2 2.2 4.7 - 10.6 8.0 |
6.6 5.4 6.4 4.0 4.2 - 8.4 10.0 |
Corporate Bond Yield3) |
12.91 |
13.90 |
11.88 |
11.18 |
12.14 |
12.28 |
11.88 |
11.10 |
10.70 |
Notes: 1) Percentage changes from the previous year.
2) Forecasts.
3) Average of the period.
Sources: Securities Supervisory Board and the Bank of Korea.
financial services in the domestic market, greater stock investment by pension funds, and the tax exemption on workers' stock savings will all be factors which will help
- 98 -
the stock market. Nevertheless, the recovery may be very slow because of the gloomy prospects for improvement of the current account deficit, the massive stock offerings which will be carried out for privatization of public companies, and the possible oversupply of stocks from seasoned offerings by a number of firms. The KOSPI is expected to average 730~740 in 1997, marking a high of 900 and a low of 600.
The opening of the stock index options market and the gradual opening of the market will be among the most important changes in the stock market in 1997. Together with the stock index futures, the stock index options will provide investors yet another means of hedging. These instruments will render price manipulation in the market more difficult and encourage forecasts on the underlying asset prices, thereby contributing to the efficiency and autonomy of stock pricing. The ceiling on foreigners' stock ownership will be raised from 20 percent to 23 percent in 1997. Foreign investment banks are now allowed to set up subsidiaries or participate in the share- ownership for existing domestic investment banks. Foreigners are also allowed to own up to 49 percent of joint investment companies with domestic partners.
Bond Market
Interest rates were highly volatile during 1996. Interest rates marked a declining trend from the beginning of the year until late April because corporations cut back
〈Table 22〉 KOSPI Average and Supply of Stocks
(billion won, points)
1994 |
1995 |
1996 |
19971) |
||||
1/4 |
2/4 |
3/4 |
4/4 |
||||
Supply of stocks KOSPI (average) |
5,958.2 965.70 |
6,163.9 934.92 |
969.8 866.17 |
983.1 910.60 |
1,631.4 808.28 |
1,460.5 749.14 |
6,200.0 740.00 |
Note: 1) KIF Forecasts.
Source: Securities Supervisory Board.
their investment and institutional investors' were in better financial condition and therefore able to purchase more bonds. Short- term interest rates, on the other hand,
- 99 -
began to rise in May due to the increase in demand for working capital, market participants' concerns about tight monetary policy, and the investment and trust companies' and bank trust accounts' inability to purchase bonds due to cash flow problems. This forced short- term rates above the long- term rates by a large margin, resulting in a downward- sloping yield curve. This situation was compounded by the decline in corporate earnings and the greater demand for short- term working capital which came about due to the poor export and domestic sales performances during the second half of the year. The rise in short- term rates, including CP (commercial paper) rates and CD rates, also led to a lesser rise in long- term rates including the corporate bond yield. Corporate bond yields were around 11.88 percent on average in the first quarter, and declined to 10.43 percent by the end of April. Then they
increased, hitting 11.18 percent on average in the second quarter and then 12.14
percent and 12.28 percent on average in the third and the fourth quarters, respectively. The average corporate bond yield was 11.88 percent, but this was more than two percentage points lower than the 13.90 percent level in 1995.
There were at least three factors which caused the corporate bond yield to begin
〈Figure 8〉 Bond Yields
rising in May. The first factor was the volatility in interest rates in the short- term capital market. Firms' worsening financial conditions led to an increase in demand
- 100 -
for short- term working capital and therefore a rise in short- term interest rates. This in turn brought about an increase in long- term interest rates including the corporate bond yield because firms in fact satisfied some of their short- term financial needs through the issuance of corporate bonds.
The second factor was financial institutions' lack of purchasing power to buy corporate bonds. Bank trust accounts and ITCs could not secure sufficient funds for the purchase of bonds after the bank trust reforms went into effect. The ITCs' bond funds excluding MMFs (Money Market Mutual Funds), in particular, began to decline as short- term interest rates rose in the second half of the year, and this led to the rise in the corporate bond yields which began in mid August.
The third factor was market participants' concerns about tight monetary policy. Though the government continued to insist that it would not pursue a tight monetary policy, most market participants were concerned about the increase in the money supply (M2), thinking that the monetary authorities might be obligated to assume a
tight monetary stance afterwards regardless of its original intentions. Many market participants therefore hedged their positions by reducing their purchases of corporate bonds.
The total issuance of corporate bonds during the year is estimated at 29.9 trillion
won, a 26.8 percent increase. The net issuance was 15.3 trillion won, which was up
〈Table 23〉 Bond Yields1)
(percent)
1994 |
1995 |
1996 |
||||
1/4 |
2/4 |
3/4 |
4/4 |
|||
MSB2) Bank Debenture2) Corporate Bond3) National Housing Bond |
12.33 13.21 12.91 12.29 |
13.46 13.96 13.90 12.37 |
11.84 11.96 11.88 10.39 |
11.24 11.27 11.18 10.41 |
12.54 12.80 12.14 11.31 |
12.80 12.93 12.28 11.34 |
Notes: 1) Average yield.
2) 1 year maturity.
3) 3 year maturity.
Source: Korea Investors Service, Inc., KIS- LINE.
14.9 percent from the previous year. Many firms during the year were forced to issue corporate bonds to meet their needs for working capital as the slowdown in
- 101 -
business activity reduced corporate earnings and cash inflow. It also turned out that corporate bond issuance became a more attractive financing option than CDs or commercial paper (CP) because short- term interest rates exceeded corporate bond yields every month since May. Corporate bond issuance for purposes of raising working capital amounted to 19.43 trillion won, or 65 percent of total corporate bond issuance, whereas corporate bond issuance for investment in equipment and facilities accounted for 15 percent of the total. In addition, 89 percent of the total issuance was made by large firms, and 92 percent of the total was guaranteed.
There was a number of important institutional changes in the bond market in 1996. These included the bank trust reforms, the reinforcement of the investor registration system for the holding of convertible bonds and bonds with warrants, the introduction of the MMFs (Money Market Mutual Funds) and new CMAs, the introduction of the Korea Bond Fund (KBF), and the raising the limit on bond issuance.
〈Table 24〉 Bond Issuances
(billion won)
1994 |
1995 |
1996 |
|||||
1/4 |
2/4 |
3/4 |
4/4 |
||||
Corporate Bonds |
New issues Net increase1) |
20,033 8,039 |
23,581 13,358 |
8,283 4,729 |
7,060 3,414 |
5,948 2,183 |
86,124 5,019 |
Monetary Stabilization Bonds2) |
Net issues Net increase |
36,178 325.1 |
40,421 5,065 |
2,728 - 420 |
8,825 3,219 |
1,085 - 1,855 |
10,904 - 2,256 |
Bank Debentures3) |
Net issues Net increase |
12,201 2,424 |
14,700 4,405 |
3,880 - 194 |
4,164 777 |
4,050 1,283 |
3,590 998 |
Notes: 1) Net increase = the value of newly issued bonds - the value of retired bonds. 2) MSB = Treasury Bond + FESF + BMB.
3) Bank Debenture = KDB Bond + KLTCB Bond + IBK Bond.
Sources: Securities Supervisory Board and the Bank of Korea.
The bank trust reforms induced investors to move their money out of trust accounts and into savings accounts. This was one of the important factors that
- 102 -
spurred the rise in interest rates during the second quarter. The MMFs and CMAs,
on the other hand, were introduced in order to stabilize interest rates. The new
MMFs are invested in commercial paper, CDs, call loans, and short- term bonds with
maturities of less than one year, and the earnings derived are distributed to the MMF investors. The new CMAs are a new type of savings instrument in which more than 50 percent of customer deposits are invested in bills and commercial paper issued by
〈Table 25〉 Corporate Bond Issuances1)
(percent, billion won)
1992 |
1993 |
1994 |
1995 |
1996 |
|||||
Ⅰ |
Ⅱ |
Ⅲ |
Ⅳ |
||||||
Use of Proceeds |
Refunding Operating Capital Fixed Capital |
4,553 (40.9) 2,004 (18.0) 4,580 (41.1) |
7,798 (50.0) 3,675 (23.6) 4,126 (26.4) |
5,730 (28.6) 11,897 (59.4) 2,406 (12.0) |
5,350 (22.7) 13,932 (59.1) 4,300 (18.2) |
1,624 (19.6) 5,296 (63.9) 1,362 (16.5) |
1,464 (20.7) 4,261 (60.4) 1,335 (18.9) |
1460 (24.5) 3,533 (59.4) 955 (16.1) |
1,359 (15.8) 6,336 (73.6) 917 (10.6) |
Company Size |
Large Small & Medium |
9,370 (84.1) 1,767 (15.9) |
13,101 (84.0) 2,498 (16.0) |
17,450 (87.1) 2,583 (12.9) |
20,940 (88.8) 2,641 (11.2) |
7,561 (91.3) 721 (8.7) |
6,130 (86.8) 930 (13.2) |
5,258 (88.4) 689 (11.6) |
7,577 (88.0) 1,035 (12.0) |
Type |
Guaranteed Non- Guaranteed |
8,328 (74.8) 2,809 (25.2) |
11,194 (71.8) 4,405 (28.2) |
11,455 (57.2) 8,578 (42.8) |
16,450 (69.8) 7,131 (30.2) |
7,319 (88.4) 964 (11.6) |
6,549 (92.8) 511 (7.2) |
5,483 (92.2) 463 (7.8) |
8,026 (93.2) 587 (6.8) |
Maturity |
Less than 4 yrs 4yrs~5yrs over 5 yrs |
9,738 (87.4) 541 (4.9) 858 (7.7) |
14,028 (89.9) 779 (5.0) 792 (5.1) |
18,773 (93.7) 339 (1.7) 922 (4.6) |
22,152 (93.8) 50 (0.2) 1,379 (5.8) |
7,635 (92.2) 35 (0.4) 612 (7.4) |
6,820 (96.6) 15 (0.2) 225 (3.2) |
5,858 (98.5) 10 (0.2) 80 (1.3) |
NA NA NA NA NA NA |
Total |
11,137 |
15,599 |
20,033 |
23,581 |
8,283 |
7,060 |
5,948 |
8,612 |
Note: 1) The figures in parentheses are percentage weights.
Source: Securities Supervisory Board.
small firms. The introduction of these MMFs and CMAs helped stabilize short- term interest rates by expanding the demand for short- term instruments. The corporate
- 103 -
bond yield rate also went down as some investment banks began to purchase bonds in expectation of lower interest rates in the future.
The corporate bond yield rate is expected to decline in 1997. Among several factors which will act to force it down, the government is pursuing a policy toward lower interest rates, and firms are continuing to cut back investment. Investors should keep in mind, however, that the monetary authorities could pursue a tight monetary policy if inflationary pressures become too great. The corporate bond yield rate should increase slightly next September and then begin to fall before the end of the year, preceding the business cycle by two or three months. On average, the corporate bond yield is expected to be about 10.90 percent, which would be an approximately 100 basis point decline from 1996.
〈Table 26〉 Bond Market Forecasts
(percent, billion won)
1994 |
1995 |
1996 |
19972) |
||||
1/4 |
2/4 |
3/4 |
4/4 |
||||
New issues Corporate bond yields1) |
20,033 12.91 |
23,581 13.90 |
8,283 11.88 |
7,060 11.18 |
5,948 12.14 |
8,612 12.28 |
30,000 10.90 |
Notes: 1) Average yields.
2) Forecasts.
Source: Korea Investors, Inc., KIS- LINE.
- 104 -
Insurance
Life Insurance
The life insurance industry experienced steady growth in both total assets and premium income in 1996, despite the economic recession, and its managerial efficiency somewhat improved. Total assets are estimated to have increased by 15.7 percent and premium income by 6.0 percent, which in both cases is greater than the previous year's figure. This came about on the strength of the steady growth in protection- oriented policies, personal annuities, and long- term insurance products. In addition to the rise in term life insurance sales, total policies in force sharply
<Table 27> Key Life Insurance Industry Indicators1)
(billion won, percent)
1995 |
1996 |
||||
4/4 |
1/4 |
2/4 |
3/4 |
4/42) |
|
Total assets3) |
66,865 (8.4) |
69,676 (4.2) |
72,140 (3.5) |
75,099 (4.1) |
77,317 (3.0) |
New contracts Policies- in- force3) |
177,588 (7.4) 1,133,281 (6.5) |
178,388 (0.5) 1,198,736 (5.8) |
193,720 (8.6) 1,271,056 (6.0) |
181,277 (- 0.1) 1,332,952 (4.9) |
196,647 (8.5) 1,396,958 (4.8) |
Premium income Investment income |
11,667 (46.9) 1,563 (- 2.5) |
8,439 (- 27.7) 1,947 (24.6) |
8,792 (4.2) 1,720 (- 11.7) |
8,210 (- 0.1) 1,457 (- 15.3) |
10,322 (25.7) 1,539 (5.6) |
Claims Expenses |
6,273 (14.9) 1,655 (7.8) |
5,464 (- 12.9) 1,784 (7.8) |
6,096 (11.6) 1,676 (- 6.1) |
5,312 (- 12.9) 1,708 (1.9) |
6,601 (24.3) 1,694 (- 0.0) |
Increases in total assets |
5,157 (122.2) |
2,811 (- 45.5) |
2,464 (- 12.3) |
2,959 (20.1) |
2218 (- 25.0) |
Notes: 1)Figures in parentheses are percentage changes from the previous quarter. 2) Estimates.
3) On a balance basis.
Source: Insurance Supervisory Board, The Monthly Insurance Review.
1
increased by 23.3 percent. The life insurance industry also experienced much in the way of change. The domestic insurance market was continually being opened wider, there was greater competition with other financial institutions, and tougher solvency margin requirements were imposed.
As for the asset composition of life insurance companies, the share of cash and deposits significantly rose while that of loans fell. The reason for this is the elimination of restrictions on the amount of cash holdings and deposits. The amount of loans outstanding declined as the spread between the deposit and loan rates had been falling since the end of 1995, except for a short- lived rise during the second half of 1996 due to the bearishness in the stock market. The share of securities declined to 26.9 percent of total assets in September.
The ratio of claims to premiums and the lapse and surrender rates fell to 16.5 percent and 67.1 percent, respectively. These figures are 3.2 and 1.0 percentage points lower than the corresponding figures for 1995. It is expected that the decline will continue in 1997. On the other hand, the return on total assets and invested assets fell to 9.8 percent and 10.4 percent, respectively, due to the recession in the real- estate market and the bearishness in the stock market.
Sales of protection- oriented insurance policies continued to rise while the growth in sales of savings- oriented insurance policies excluding personal annuities decelerated. The acceleration in sales of protection- oriented insurance policies occurred because of
<Table 28> Composition of Assets at Life Insurance Companies
(percent)
1995 |
1996 |
||||
4/4 |
1/4 |
2/4 |
3/4 |
4/41) |
|
Loans Securities Cash&Deposits RealEstate Other2) |
45.8 26.2 14.2 7.1 6.6 |
45.3 27.6 13.8 7.3 6.0 |
44.0 27.6 15.0 7.4 6.0 |
44.9 26.9 15.1 7.4 5.7 |
44.3 26.0 16.7 7.2 5.8 |
Notes: 1) Estimates.
2) Mostly deferred assets.
Source: Insurance Supervisory Board, The Monthly Insurance Review.
2
1) the public's increasing recognition of the need for protection against all manner of accidents and diseases and 2) the insurance companies' own efforts to develop new products and promote sales. Moreover, mid and long- term insurance policies are becoming more popular with the extension of the minimum tax- exemption period on interest gains for insurance policies to seven years.
In February, the regulatory authorities raised the solvency margin requirements to 10 percent of policyholder' reserves from the absolute criterion of 10 billion won for individual life insurance companies. This implies the improvement in equity among insurers by basing the solvency margin on each insurer's size. Moreover, the decline in issuance of insurance policies with variable interest rate payments has also been counted as a solvency margin. The change in each operating expense is now measured on the basis of ratios over total operating expenses other than on the size of actual expenses. These changes would seem to provide the life insurers incentive to promote protection- oriented insurance and reduce issuance of those insurance policies which require larger policy reserves and bear greater interest rate risks. The authorities also issued warnings to seven life insurers which failed to raise new
<Table 29> Managerial Efficiency of Life Insurance Companies
(percent)
1993 |
1994 |
1995 |
1995.4~9 |
1996.4~9 |
|
New Business Ratio1) Lapse and Surrender Ratio2) Ratio of Claims to Premiums3) Ratio of Expenses to Premiums4) Investment Income to Total Assets5) |
77.0 30.2 82.2 15.0 10.8 |
79.5 28.4 71.9 18.4 10.9 |
70.3 27.8 63.5 18.2 10.8 |
33.1 17.1 70.3 19.6 10.4 |
31.3 16.1 67.1 19.9 9.8 |
Notes: 1) New contracts / Policies- in- force at the beginning of the period.
2) Lapses and Surrenders / New contracts and Policies- in- force at the beginning of the period.
3) Benefits paid / Premium income.
4) Management expenses / Premium income.
5)〔2×Investment income / (Beginning balance of assets + Ending balance of assets - Investment income)〕×12/m, where m = number of months.
Source: Insurance Supervisory Board, The Monthly Insurance Review.
3
capital by March to satisfy minimum requirements as previously ordered and to seventeen other insurers which for other reasons fell short of the minimum level of capital requirements. Tougher regulation such as this is expected to facilitate these life insurers' efforts to both raise new capital and reduce operating expenses, and, eventually, to bring about needed structural change in the life insurance industry, eg. through M&As.
In 1997, the life insurance industry will continue to grow, 6.4 percent higher growth. Premium income will steadily rise with the increase in issuance of protection- oriented insurance sales and that of pure endowment policies through the new tax- exempt family savings- insurance system introduced this year. Also, the amount of claims paid is expected to increase by 13.6 percent than in 1996. Growth in operating expenses is unlikely to accelerate due to life insurers' efforts to improve managerial efficiency, even though there is a possibility of a rise in operating expenses due to marketing of the new tax- exempt family savings- insurance accounts.
The business for endowment insurance is expected to significantly grow along with the rise in protection- oriented product sales and because of the introduction of the tax- exempt family savings- insurance accounts. These saving- insurance accounts, however, will likely cause the sales of pure endowments such as retirement annuities to decline. However, owing to the extension of the minimum tax- exemption period on interest gains on insurance policies to seven years, it is expected that the growth
<Table 30> Life Insurance Industry Forecasts
(billion won, percent)
1994 |
1995 |
19961) |
19972) |
|
Total assets |
55,910 |
66,865 |
77,317 |
89,997 |
Premium income |
26,168 |
33,726 |
35,763 |
41,592 |
Claims paid |
20,896 |
22,015 |
23,473 |
26,665 |
Increases in total assets |
5,710 |
10,955 |
10,452 |
12,680 |
Notes: 1) Estimates.
2) KIF Forecasts.
Source: Insurance Supervisory Board, The Monthly Insurance Review.
4
in mid and long- term insurance policies will accelerate. Growth in group insurance policies will also accelerate, if firm pension scheme is introduced.
The third experienced life table will be in effect in 1997. The currently used life table does not reflect the increase in life expectancy with the result that a large surplus of life insurance funds has accumulated. This revision will translate into a decline in insurance premiums for most policies except for annuities. The premiums on annuities will remain at the same level or increase because of the rising life expectancy.
It is expected that the insurers having low solvency margins will be able to raise new capital since all of the largest companies except the five largest conglomerates can now invest in life insurance companies as large stockholders. M&As will actually be able to occur in the life insurance industry in 1997 because the law on the restructuring of financial institutions is going to be implemented. Thus, life insurers will have much greater incentive to enlarge themselves and become financial conglomerates.
The tightening of solvency margin requirements for insurance policyholders' benefit and the internationalization and development of the life insurance industry is expected to continue in 1997. Deregulation of asset management, development of new products, and liberalization of rates will proceed further as planned unless there is unexpected change in economic conditions. In April, both the mortality rate and the dividend rate from interest surpluses will be liberalized, as will the interest rates in 1998. And if the structural change of the financial sector continues and financial institutions are indeed permitted to engage in other financial services, the life insurance industry will face more competition from other financial institutions such as banks. Life insurance companies will therefore need to develop new products tailored to consumer needs and also establish strategic linkages with other financial institutions.
Non- life insurance
The non- life insurance industry exhibited steady growth in size and operational
5
improvements in 1996, even despite the lackluster performance of the economy. Thanks to the growth in the automobile insurance and personal annuities, written premiums continued to rise, and as a result of the improved managerial efficiency of automobile insurers, both profits and the loss ratio improved. The non- life insurance industry, however, experienced significant change because of the additional opening of cross- border transactions, the introduction of the insurance broker system, further liberalization of reinsurance, and the aggravation of the surety and bond insurance business due to the economic recession. Total assets of the non- life insurance industry are estimated to have risen 25.1 percent, and total written premiums are estimated to have risen 26.0 precent. These increases were mainly due to the growth in automobile insurance and long- term insurance.
Automobile insurers registered profits of 50 billion won from April through September, thus improving the non- life insurance industry's overall financial position. During this period, there was a fall in both the accident rate and loss rates, in addition to some institutional amendments. As for asset composition, the share of securities fell to 32.1 percent in September. The share of cash and deposits increased after the change in the rules on asset management. The total loss ratio fell owing to the fall in the loss ratio of the automobile industry. At the end of September, the returns on total and invested assets were 8.4 percent and 10.3 percent, respectively, which were roughly the same levels as during the previous year.
The government introduced the independent agent system in April and carried out the second stage of liberalization of reinsurance. Only companies which employ more than four persons who have experience in non- life insurance are permitted to hire independent agents. This system, however, will also apply to the general individual agent system after April in 1997. In the reinsurance market related to both marine and automobile insurance, the competition will intensify because the rule that the outflow of reinsurance policies should be reinsured by domestic reinsurers in principle was eliminated in April.
The third stage of liberalization of the non- life insurance industry was implemented according the overall plan for liberalization of insurance rates. It entailed a free rate for 13 policies including hull and cargo insurance and a band rate
6
for long- term non- life insurance policies. Insurance premiums are expected to fall and the differentiation between direct non- life insurers will diminish as liberalization proceeds, but it may also cause some negative effects such as a decline in business profits. According to the results of a survey on the effects of rate liberalization
<Table 31> Key Non- life Insurance Industry Indicators1)
(billion won, percent)
1995 |
1996 |
||||
4/4 |
1/4 |
2/4 |
3/4 |
4/42) |
|
Total assets |
12,016 (10.1) |
12,711 (5.8) |
13,561 (6.7) |
14,456 (6.6) |
15,035 (4.0) |
Direct premiums written |
3,162 (20.0) |
2,838 (- 10.2) |
3,111 (9.6) |
3,279 (5.4) |
3,738 (14.0) |
Investment income |
185 (- 13.6) |
230 (24.3) |
234 (1.7) |
273 (16.7) |
287 (5.1) |
Direct claims paid |
1,448 (5.1) |
1,568 (8.3) |
1,403 (- 10.5) |
1,610 (14.8) |
1,519 (- 0.1) |
Management expenses |
603 (3.6) |
695 (- 36.7) |
691 (- 0.6) |
860 (24.5) |
769 (- 10.6) |
Increase in total assets |
1,098 (35.9) |
695 (- 36.7) |
850 (22.3) |
895 (15.3) |
579 (- 35.3) |
Notes: 1) The figures in parentheses are percentage changes from the previous quarter.
2) Estimates.
Source: Insurance Supervisory Board, The Monthly Insurance Review.
<Table 32> Composition of Assets at Non- life Insurance Companies
(percent)
1993 |
1994 |
1995 |
1996.9 |
|
Loans Securities Cash&Deposits RealEstate Other1) |
17.4 34.1 20.3 10.0 18.2 |
22.3 32.6 17.3 9.5 18.3 |
21.9 32.7 18.8 8.8 17.8 |
21.3 32.1 19.5 8.8 18.3 |
Note: 1) Mostly deferred assets.
Source: Insurance Supervisory Board, The Monthly Insurance Review.
7
analyzed in terms of individual insurance policies and their risk characteristics by the Korea Insurance Regulatory Institute, the rate liberalization seems to have had a positive effect by bringing about fair competition among direct non- life insurers.
In August, automobile insurance policies were revised such that claims were reimbursed in amounts which more accurately reflected the level of actual losses. In addition, the premiums for compulsory coverage have increased while the full coverage premiums have fallen. Also, the direct non- life insurers are now freely permitted to set rates within an additional 10 percent band plus the basic premium,
and the insurance premiums for compulsory coverage have been more rationalized by
the introduction of the bonus- malus system and experience rating system.
The non- life insurance industry is expected to steadily grow in 1997, and managerial efficiency should continue to improve. Premium income is estimated to rise 20.6 percent, while direct premiums should rise 18.2 percent over the corresponding figures in 1996. Automobile insurance and long- term insurance will be the main sources of this growth. As for long- term insurance, the sales of tax- exempt savings- oriented insurance will rise, and automobile insurance will continue to grow due to revisions concerning automobile insurance premiums and institutional changes in spite of the fall in domestic car sales. The managerial efficiency of the automobile insurance industry is expected to improve as well. With the progress in industrialization and technology development, a greater volume of liability- related insurance policies should also rise in 1997. The new insurance policies for product liability, malpractice insurance, and liability insurance for local authorities, for example, are expected to be marketed for the first time.
All non- life insurance products excluding long- term insurance and compulsory automobile insurance will be subject to a free rate system in 1997. Liberalization related to non- life insurance will therefore have reached the final stage. Earlier than planned liberalization of reinsurance will also allow direct non- life insurers to deal with foreign reinsurers more easily, possibly bringing about a decline in inflow of reinsurance premiums for domestic non- life insurers. Rate competition among
domestic non- life insurers will intensify as a result, especially in the various areas of corporate insurance.
8
The lifting of regulations on cross- border transactions will clearly facilitate
foreign non- life insurers' activities in the domestic market. In April, the
insurance broker system for non- life insurance products will be established. This will benefit policyholders by allowing for brokerage independently of insurers and also by facilitating new product development and competition in
rates and customer services. The brokerage system will also intensify competition between different distribution channels, which may increase the efficiency of distribution channels. In particular, it is expected that large foreign insurance brokers which have more specialized expertise and which offer a wider range of customer services will thrive in the non- life insurance industry.
Even if there happens to be no substantial regulatory change, there exists the possibility that the regulatory authorities may establish some new rules akin to the solvency margin requirements for life insurers so that the direct non- life insurers can extend their underwriting capacity in the future. Since deregulatory measures related to asset management will continue to be implemented, the insurers will have to make
great efforts to map out and follow sophisticated investment strategies and use
<Table 33> Managerial Efficiency of Non- life Insurance Companies
(percent, billion won)
1993 |
1994 |
1995 |
1995.4~9 |
1996.4~9 |
|
Loss ratio1) Ratio of net operating expenses2) Combined ratio3) Investment income to total assets4) |
92.9 22.2 115.1 10.0 |
86.5 22.6 109.1 9.4 |
80.9 22.6 103.5 8.3 |
83.0 22.4 105.4 7.6 |
79.3 25.5 104.8 8.4 |
Underwriting profit Investment profit Total profit |
- 931 637 - 294 |
- 801 714 - 87 |
- 690 776 86 |
- 414 362 - 52 |
- 464 507 43 |
Notes: 1) Incurred losses/Earned premiums.
2) Net expenses/Premiums written.
3) Loss ratio + Expense ratio.
4)〔2 × Investment income / (Beginning balance of assets + Ending balance of assets - Investment income)〕× 12/m, where m = number of months.
Source: Insurance Supervisory Board, The Monthly Insurance Review.
9
specialized investment techniques. And in the third area such as care and injury insurance, life insurers and direct non- life insurers are expected to set up joint operations. Thus, direct non- life insurers will develop more strategic links with other financial institutions in 1997.
<Table 34> Non- Life Insurance Industry Forecasts
(billion won, percent)
1994 |
1995 |
19961) |
19972) |
|
Total assets |
9,063 |
12,016 |
15,035 |
18,132 |
Premium income |
7,896 |
10,294 |
12,966 |
15,326 |
Claims paid |
4,850 |
5,400 |
6,100 |
7,210 |
Increase in total assets |
1,089 |
2,953 |
3,019 |
3,097 |
Notes: 1) Estimates.
2) KIF Forecasts.
Source: Insurance Supervisory Board, The Monthly Insurance Review.
10