The Republic of Korea’s economic history---insofar as financial crises are concerned---has been a mixed bag. It successfully navigated the emerging market debt crises of the early 1980s, but the Asian crisis of 1997/98 hit the economy especially hard. Korea’s experience with the current global crisis has been somewhat less painful than the severe shock the economy went through in 1998, but it has nonetheless experienced significant spillover effects as a consequence of the crisis. Between August 2007 and November 2008, the won lost almost 50 percent of its value, before recovering a good share of its value with a 20 percent appreciation (see figure).
Equity markets have followed a similar pattern, with the benchmark KOSPI 200 index falling to a low of 948 points in November 2008 (from 2,054 points a year before) before regaining to current levels at 1,684 points. Other financial sector indicators, such as interest rates and capital flows, have demonstrated signs of stress. Capital inflows, for example, fell sharply during the crisis, with portfolio and FDI contracting by 47 and 31 percent, respectively (see figure).
Korea’s real economy, however, has fared relatively better through this current episode, especially compared to the Asian crisis. To be certain, as an export-oriented open economy, it has experienced slowdowns along with the rest of the world. However, net exports remained remarkably robust through the crisis, and GDP has fallen markedly less than in 1997/98 (see figure). Likewise, investment has remained strong throughout most the period---it dipped slightly below 2 percent on a year-on-year basis for two quarters, and has since returned to positive territory---in contrast to the large declines in 1998. Importantly, Korea has also not faced balance of payments difficulties this time round that would necessitate IMF assistance.
What is most remarkable is that the strong (relative) economic performance of Korea this time round has occurred in an environment of very weak global demand. Although the region underwent a severe recession during the Asian crisis, it was able to muster a V-shaped recovery, largely on the back of export recovery fueled by healthy demand in the developed world (mainly the United States). This time, with the epicenter of the crisis in the developed world, the ability of Korea to weather the storm has been admirable. Indeed, the Development Prospects Group's forecast for 2010 and 2011 has the East Asia and Pacific region leading global recovery with 8.1 and 8.2 percent growth rates, respectively, and Korea is expected to follow the region in exiting the global recession.
Another thing that makes Korea's sidestepping of a crisis more amazing is the debt context in which all this has occurred. Corporate debt is at an elevated level (113 percent of GDP in 2008), which is comparable to levels prior to the Asian crisis. Bank lending to households reached about 40 percent of GDP. Together, these account for about 150 percent of GDP. The government fiscal balance, at KRW 33.0 trillion, is 3.2 percent of GDP for 2009, and expected to grow to KRW 49.8 trillion (4.7 percent of GDP). While the future is never certain, the significant compression on credit default swap spreads for major Korean financials and corporates (see figure) suggest that the storm has passed, at least for now.
What enabled the Korea to weather the current crisis? Some would argue that Korea's reserve war chest has something to do with it. Indeed, recent research has shown that countries with larger reserve holdings have managed to maintain the strength of their currencies through the crisis, regardless of their current account balances or short-term debt levels. While the jury is still out on the specifics of the Korean case, a better understanding of the role of reserves in crisis mitigation will certainly be illuminative.
UPDATE: David Pilling makes some similar points in this op-ed (registration required) in the FT.