Small Firms Bear Big Burden in S. Korea Crisis

A year ago, Koo Ja Kyoung looked into his future and saw nothing but prosperity. Sales of his high-tech industrial washing machine were up 40%. His biggest customer, Daewoo Motors Co., was investing billions of dollars in manufacturing plants in Eastern Europe, China and Southeast Asia.

Business was so good, he and his wife agreed to postpone having children until later this year, when he planned to take his small manufacturing firm public.

Now Koo simply hopes he and his Koni Machinery Industrial Co. survive to see 1999.

“I may have to give up my dream of a child,” the slender 40-year-old said sorrowfully in an interview in his office in Yoido, the financial district of Seoul.

In just a matter of months, the world has been turned upside down for Koni Machinery and countless other small South Korean companies whose major customers were the giant chaebol, or conglomerates, that put South Korea on the map with their aggressive investments in everything from automobiles to Hollywood movies.

Unfortunately, those seemingly invulnerable economic empires were built on a shaky foundation of easy credit that began to crumble last fall when investors--nervous about the $153 billion in debts held primarily by the chaebol, their suppliers and banks--began to pull their money from the country.

Thanks to a $60-billion bailout from the International Monetary Fund and a short-term debt-restructuring agreement forged recently in New York, the foreign lenders that helped fuel this credit bubble are expected to escape with minimal damage. And Daewoo and the other giant chaebol will survive, though they have been ordered to cut back their operations and reform their business tactics.

Not as lucky will be the many small South Korean entrepreneurs, like Koo, who bought into the myth of South Korea’s economic invincibility and are now paying the price. This year, some 4,500 firms are expected to go out of business every month. Many more are barely hanging on.

In South Korea, a conservative society where men are still viewed as the breadwinners, economic failure cuts deeply. The bankrupt, who are technically criminals under Korean law, are forced into hiding to escape from police and bill collectors. Their children are sent away to relatives’ homes so they don’t become the target of harassment by angry creditors.

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The Seoul office of the Korea Federation of Small Business has become an unofficial counseling center for these distraught businessmen, who sometimes come out of hiding to share a meal or talk. Cho Yu Hyun, a federation official, said many confess to “suicidal impulses,” and there has been a sharp rise in reports of suicides among his organization’s 80,000 members.

“These small businessmen are suffering even more because the bankruptcy crisis they are facing is not because of their poor management, but because of the restructuring of big business,” Cho lamented.

Even with hindsight, it is difficult for Koo to understand how things could go so bad so quickly.

In 1986, just a few years out of college, he persuaded a friend’s father to help him set up a small trading firm to sell cheap Korean-made goods abroad and import finished goods such as auto parts.

Those were South Korea’s go-go years, when the economy was growing at double-digit rates and giant chaebol such as Samsung, Daewoo and Hyundai were turning the nation’s farmland and swamps into steel plants and shipbuilding facilities.

Emboldened by their success and faced with increasing competition from lower-wage countries, the chaebol began moving up the technology ladder, sinking billions of dollars into semiconductor and auto plants, and even branching into risky areas such as aircraft manufacturing and movie-making.

The government, which maintained tight control over the financial sector, directed the nation’s banks to support the chaebols. In return, the powerful Korean tycoons greased a very expensive political machine by making huge under- and over-the-table payments to the ruling party.

Loans were based not on credit-worthiness, but on government dictate, recalled Lim Yong Kyoo, general manager of the Commercial Bank of Korea, one of the nation’s largest banks. Leading the list were exporters such as semiconductor and auto producers.

“Because of the government policy, there was a myth that these huge companies or chaebol would never fail, so if we were asked by the chaebol for money, we believed it would be safe,” Lim explained.

Many smaller firms were forced to turn to South Korea’s aggressive merchant banks, which borrowed cheap foreign funds and lent them out at higher rates in the domestic market, or the underground capital market. Funds for the latter often came from individuals attempting to hide their wealth from the government.

Koo’s fortunes expanded along with South Korea’s auto industry. In 1993, his firm teamed with a Japanese company to produce a high-tech machine used to clean and dry auto parts before they are assembled.

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Daewoo, one of Korea’s five largest conglomerates, became his biggest customer. Under the direction of Chairman Kim Woo Choong, Daewoo had embarked on an aggressive overseas expansion with the goal of producing 2.5 million vehicles by 2000. Another big Koo customer: auto maker Kia Motors Corp., the country’s third-largest.

In 1995, Koo needed $1.25 million to upgrade and expand his small manufacturing plant in Inchon, a port city southeast of Seoul, and cover his increased manufacturing costs. He went to Seoul Bank, which was lending aggressively to companies affiliated with Kia, Halla and the other large South Korean auto makers. Koo’s sales continued to expand, but there were already signs of trouble ahead. His biggest headache was labor rates, which were increasing 10% to 20% a year just when new competitors from Southeast Asia and China were starting to come into the market.

Then, last July, Thailand devalued its currency. Markets around Asia tumbled and South Korea’s house of cards began to fall apart.

Investors started pulling their money out of the country, alarmed that even the largest chaebol were carrying debt levels four to five times the level found in the West. Foreign lenders started tightening the noose, boosting interest rates or refusing to roll over loans. The Korean banks, under pressure to raise their capital adequacy ratios to international standards, were forced to turn off the lending spigot.

On July 16, Kia Group, the ninth-largest conglomerate and owner of Kia Motors, declared bankruptcy.

Kia owed Koo $312,000. He was able to recover just $125,000 of it.

Koo began having trouble rolling over his own loans or getting letters of credit to pay for imported goods. Suppliers started insisting on cash payment. And the cost of running Koo’s business soared as the plunge in the value of the won literally doubled the price he had to pay for energy and other imported products, such as motors and cylinders.

On Dec. 6, while the Korean government finalized an agreement that would force it to implement tough economic reforms in exchange for the $60-billion IMF bailout, Halla Group, Korea’s 12th-largest conglomerate, with major financial interests, filed for bankruptcy. Its auto subsidiary owed Koo’s firm $62,500.

But for Koo, the moment when fear turned to despair came a few days later, when one of his largest customers, which he doesn’t want to name, canceled a contract for $2 million worth of Koni Machinery equipment ready for shipment overseas.

That phone call turned his world upside down. If even the mightiest of the chaebol were vulnerable, his entire business was built on quicksand.

Koni’s angry and frightened workers threatened a sit-down strike at the auto maker’s headquarters. But while he appreciated their motivation, the young executive knew that was a bad idea.

“If we did that, we could forget about future business,” he said.

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Now Koo fears the tough economic medicine imposed by the IMF--particularly the measures that have limited credit and boosted interest rates--will kill the patient.

Already, the South Korean government has said it will sell Seoul Bank and Korea First Bank, the nation’s most heavily indebted commercial banks, to foreign investors later this spring. Those banks lost $1.24 billion last year.

The government has also permanently closed 10 of the nation’s 30 merchant banks, which were among the nation’s most aggressive lenders. Four others remain under suspension.

This has drained money from the South Korean economy, pushing even well-managed firms into bankruptcy because they can’t get credit to buy raw materials or roll over their loans. Koo has several friends who were forced out of business--including a small fishing equipment manufacturer who owed him $53,000.

“Many good companies have already fallen,” he said.

Thanks to help from friends and relatives, Koo said, he has been able to stay ahead of his mounting bills. But with rates near 30%, he can barely cover the interest payments on his $1.25 million in loans, let alone reduce the principal.

If he defaults, he will lose everything. His company’s assets and his personal wealth, including his home, were used as collateral for his loans.

In January, Koni Machinery landed a $650,000 contract from Michigan-based Delphi Automotive Systems, a subsidiary of General Motors Corp., that will keep it busy for about a year. An added benefit: That contract will be paid in dollars.

But with talk of mergers or buyouts in Korea’s struggling auto industry and several major projects on hold, Koo is convinced his only hope is to seek business abroad, where he presently does about 25% of his business.

Last year, he began working with a plant in Weihe, China, to develop an auto-painting machine that could be sold to Chinese vehicle manufacturers. And Koo has become a global salesman, embarking on a trip last month to Taiwan, Japan, China and Romania, where Daewoo has a large operation.

“I have no idea where things will turn in Korea,” he said shortly before leaving. “That’s why I have to turn my eyes overseas.”

Koo must re-engineer his company, and his work force, to survive the difficult years ahead. That means cutting some of his present staff and replacing it with bilingual salespeople who can help find business overseas.

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A recent newspaper advertisement to fill six sales openings drew applications from more than 300 people, including graduates from Seoul’s most prestigious universities.

But Koo is still agonizing over which of his longtime employees to let go. Just a month ago, they came to him and offered to give up their annual bonuses and pay raises and even take a cut in salary to keep everyone on the payroll.

“The staff I have, I don’t question their loyalty,” Koo said, pointing to a picture of the Koni corporate family propped against his office wall. “They will carry out what they are told to do. But this is a different era now and that is not enough. I need some people with imagination, with foresight and with a view of the future.”

Chi Jung Nam of The Times’ Seoul bureau contributed to this report.