S. Korea Floats Its Currency; Markets Surge

Emboldened by signs that its currency may have hit bottom, South Korea scrapped controls on it starting today, allowing the much-weakened won to trade freely.

The unexpected action and other market-liberalization moves, including an invitation to foreign investors to buy control of one of the nation’s major banks, cheered investors and sent both the won and the stock market soaring in early trading today.

At midday today, the benchmark Korean stock index was up 15.47 points, or 4%, to 401.27, after jumping 7.2% on Monday. The index had hit a 10-year low on Friday.

The won strengthened dramatically, rising to 1,350 to the dollar versus Monday’s close of 1,564, before falling back to 1,414 by midday.

The developments reflect fresh optimism that South Korea’s immediate crunch for dollars to pay back short-term debts due in the next few weeks may be easing.

The floating of the won was seen as an expression of confidence and an important step toward freeing up the South Korean economy to greater market forces.

But foreign analysts warned that the market cannot hold up for long without painful economic reforms and that despite the positive signs seen Monday, a major banking crisis is likely to erupt soon after Thursday’s presidential election.

By conservative estimates, South Korean banks are holding about $48 billion worth of nonperforming domestic loans, said Richard Samuelson, head of S.G. Warburg Dillon Read Securities. That’s 13% of the banks’ loan portfolios.

Today’s market surge followed Monday’s jump in the won’s value by the maximum daily 10% limit, after it closed at a record low of 1,702 to the dollar on Friday. Monday’s gain for the won marked the first time the currency had strengthened by the 10% limit since the old 2.25% daily limit was scrapped in November, as downward pressure on the currency increased.

The won was helped Monday by news that after four years of running a trade deficit, South Korea posted a $600-million current-account surplus last month. The data on the current account, the broadest measure of trade in goods and services, was announced about 10 days ahead of schedule in an attempt to further boost the currency market.

Also contributing to the won’s strength was the sale on Friday by the Bank of Korea of $200 million in foreign currency reserves, followed Monday by increased dollar sales by South Korean exporters.

Meanwhile, Finance Minister Lim Chang Yuel announced Monday that one of the two failing commercial banks that were taken over by the government last month should be sold off in 1998--and that foreigners would be welcome to purchase the government’s 59% stake.

“We will not object to the acquisition of either Seoul Bank or Korea First Bank by a foreign bank, and we will use this opportunity to enhance Korea’s credibility in the international community,” Lim said.

That announcement “is genuine good news,” said Kim Hunsoo, head of research at Merrill Lynch. “The market’s getting heady over this. Plus, the market was clearly oversold and the currency was oversold. There was clearly value there. . . . It was ripe for a bounce.”

Also welcome was Lim’s announcement that the government would float $10 billion of dollar-denominated bonds with proceeds used to tide over teetering financial institutions.

But the debt problems remain daunting.

South Korean companies and banks owe an estimated $130 billion in foreign debt and the country now has about $10 billion in foreign currency reserves, not enough to cover the short-term debt due this month. Funds from the International Monetary Fund’s bailout of the nation’s economy are expected to cover most of the difference.

But South Korea’s success in avoiding default may also depend on whether some lenders are willing to roll over loans that come due by issuing new loans.

“The real problem,” analyst Samuelson said, is that the number of bad loans “is going to rise very soon, and it’s going to rise very dramatically.”

Bankruptcies are sure to follow, due to higher interest rates, a depreciated currency with which to pay off foreign debt and an economy that could, according to a Merrill Lynch forecast, contract by 1.8% in 1998. Some studies predict as much as 3% growth, but even that would be a sharp slowdown.

“Of the top 30 chaebol [conglomerates], you could potentially have a third or more in bankruptcy proceedings soon, very soon,” meaning within a few months, Samuelson said. That would further weaken their creditors, the overextended banks, which would be piling up nonperforming loans faster than they could write them off.

But Finance Minister Lim predicted that “when foreigners take over and manage one of the two banks, that will help restore foreign confidence.”

Allowing foreigners to acquire one of South Korea’s largest banks is a brave step toward globalization for a nation--still sometimes referred to as “the Hermit Kingdom”--that has traditionally placed stiff restrictions on foreign stock and real estate ownership.

Starting next year, foreign banks will be allowed to open retail branches. Enticing a foreign investor to buy a sick bank won’t be easy, but it could provide a large number of branches in a single step, making acquisition of either bank potentially attractive if the price is right.

Meanwhile, in Washington, IMF officials reiterated they will not speed up disbursement of bailout funds. The first installment of $5.6 billion reached Seoul on Friday. Another $15.5 billion of IMF funds has been pledged, including $3.6 billion expected to be delivered Thursday.

IMF officials said early disbursement of funds could undercut the economic reform efforts required as conditions of the bailout. The officials said South Korea’s current economic crisis is no worse than was expected when the IMF bailout package was drawn up.

“There is enough money in the program,” one of the officials said.

The total $60-billion IMF-led package includes loans from other multinational institutions and bilateral credits from the United States, Japan and other countries. The World Bank has pledged $10 billion and the Asian Development Bank has pledged $4 billion as part of the plan. The United States has pledged a $5-billion credit line and Japan has pledged $10 billion, but those funds are intended only as second-tier credits if funds from multinational lending institutions prove insufficient.