The Impact of Oil Crisis on Korean Economy

 

Paper for the Eighth Annual Meeting of the International Economic Consultative Group for Korea, July 2, 1975.

 

              We are fortunate, I think, in the timing of this meeting, since the major impact and consequences of the world economic recession have by now made themselves felt, an objective evaluation of the policy measures required to surmount these difficulties can now be undertaken, and we can talk about the future will some confidence in the relevance of our assumptions.

 
World Economy
 

The difficulties the world economy is now experiencing are greater in scope, magnitude, and duration than at any time since the 1930s. For more than a year now, growth has been very low or negative in many countries, inflation has been running at record levels, and external accounts have been in serious imbalance. While inflation is showing signs of moderating, there are as yet no clear indications that demand and production are recovering, or that the current account deficit of the oil-importing nations with the OPEC bloc is being reduced.

I am cautiously optimistic, however, about the longer-term future. The prolonged slowdown has produced a climate more conducive to price stability, and it is encouraging that several of the largest industrialized countries are now placing greater emphasis on fiscal and monetary policies disigned to restore growth and employment to more normal levels. I am confident that continuation of these policies, together with the expansion in the import capacity of the oil-exporting nations, will contribute to considerably brighter short-term prospects in the latter half of 1975.

 
Korean Economy in 1974
 

The Korean economy was by no means exempted from the general recessionary contagion. Like many other countries, we have had to face business slowdown, increased unemployment, inflation, an unfavorable trade environment, and a deteriorating balance of payments. I do not think that the world community is dealing with a permanently cripping economic disease, however, and I believe that our experience of so pervasive a problem will leave us collectively wiser in the ways by which this phenomenon can in the future be moderated and controlled.

Korean economic performance in 1974 as a whole was dominated by the need to secure speedy and effective adjustments to external developments. Despite the strains and difficulties imposed by these developments, annual real GNP rose by 8 percent, well below the 14 percent registered in 1973 but somewhat less than the average over the preceding decade. This was due partly to the continued strong demand for heavy industry products such as steel, ships, and rolling stock, but mainly to the strong carryover into early 1974 of the considerable momentum built up during 1973. Real GNP registered a sizable increase in the first quarter, but the buildup of inventory that began during this period, together with declining export demand for major light industry products such as textiles and plywoods, caused GNP to level off in the middle part of the year, and growth remained very low in the second half.

Domestic prices rose substantially as the government sought to eliminate existing distortions in the price structure and to accommodate the large increase in the prices of international trade products.

The area of economic activity most seriously affected by the ongoing external disturbances was the balance of payments. The current account deficit amounted to $1.8 billion, an increase of $1.5 billion over the deficit registered in 1973. We should note, however, that price increases of petroleum, grain, and other imported products in 1974 added an increment of $2.5 billion to Korean import expenditures-an amount much greater than the current account deficit.

While capital inflow covered the current account deficit, it permitted only a very small increase in reserves in 1974. This was due partly to the great increase in uncertainty on international capital markets, and the tendency of banks under such circumstances to concentrate their loans on more traditional customers in the developed countries. Fortunately, the resulting vacuum was partially filled by special loans from IMF and other international financial organizations. Furthermore, toward the end of the year Korea successfully negotiated a substantial bank loan on favorable terms. While only a part of the proceeds of this loan was available in 1974, net long-term capital inflow for the year was about twice that of 1973.

 
Policy Measures
 

The government's initial response to the increasingly unfavorable effect of external conditions on the domestic economy was to initiate the Special Measures of January 1974. The purposes of these measures were to curb inflation, assist citizens in low-income brackets, reduce consumption of imported goods through the fuller utilization of domestic resources, promote business recovery, and improve the balance of payments position.

Further steps became necessary as the international recession continued to deepen, and on December 7, 1974, the government announced its "Special Measures for Improvement of Balance of Payments and Business Recovery." The main feature of the December measures was the immediate depreciation of the exchange rate from 400 won to 485 won per U.S. dollar in order to strengthen the financial position of Korean export industries and reduce the volume of imports in the year ahead, and to accommodate immediate necessary price adjustments of some key commodities.

Other aspects of the December 1974 measures were intended to stimulate production and employment. A special depreciation system has been introduced to foster investments that use domestically produced machinery and equipment, and a special low-interest fund established to assist private investment projects. The government also made provision for advance payment on a large portion of its budgeted construction, manufacturing, and supply contracts for 1975 in order to spur production and employment in the early part of the year.

Although we fully acknowledge current setbacks and future problems, we should not preclude the possibilities that optimism suggests, or lose sight of our potential in the fog of current difficulties. The recession, debilitating though it has been, seems now to be in the process of abating, leaving in its wake a sterner but still manageable international economic balance.

 
The Plan for 1975
 

The government's Overall Resources Budget for 1975 projected an increase in real GNP of 7 percent, an expansion in exports of $6 billion, and a reduction in the current account deficit of the balance of payments to $1.4 billion from the 1974 level of $1.8 billion. Because international economic recovery has been slower than we had hoped, the continuing constraint upon our export performance has left a larger balance of payments deficit at the end of the first five months of 1975 than we originally projected.

Nevertheless, we still expect to approach fairly closely our 1975 targets. One reason for this expectation is that in spite of sluggish exports, the first quarter of 1975 recorded a real GNP growth of 4.5 percent over the same period of 1974, which seems to reflect-among other factors-the effects of the government's December 1974 measures and the continued inflow of capital goods. If there is no further deterioration in the terms of trade and if world demand begins to revive, the present payment imbalance is expected to be corrected over the next few years as a result of continuing structural improvement in terms of import substitution and the diversification of export products and markets.

Some favorable signs are already evident in recent indicators. Export orders are increasing rapidly for such goods as agricultural and fisheries products, textiles, plywoods, and electronic products, and beginning in April 1975 the value of letters of credit received began to exceed that of imports licences issued. In May, for the first time since the oil crisis, the cash balance of the Korean Foreign Exchange Account recorded a surplus of $15 million. Although it would be premature at this time to predict our actual exports for 1975, I am confident that the net result of the balance of payments management will be a steady improvement over 1974, due mainly to the expected continuing revival of export activities in the coming months, to the current decrease in international raw material prices, and to our efforts to reduce imports of nonessential items.

Nevertheless, the current account deficit in 1975 will still remain at a high level, requiring the long-term capital inflow of $1.6 billion on an arrival basis. Drawing from IMF's Oil Facility, bank loans, and borrowing from the Commodity Credit Corporation will meet part of the gap, but additional quick disbursing assistance will be required if we are not to rely on foreign short-term credits.

Because it is the rise in import prices that has been the principal factor in general domestic price movement, I believe that if the former continue their recent moderating trend, the domestic wholesale price increase throughout 1975 will be kept within 20 percent. Thirteen percent of that increase has already taken place during the first five months, and a relatively stable norm should be maintained over the balance of the year.

For the remainder of 1975 the government will continue its conservative monetary policy. In spite of the expansion in the public sector, the money supply as of the end of May 1975 has decreased by 3.5 percent from the level of December 1974. Private savings increased, and the rate of increase of domestic credits, which was 13.5 percent in the first quarter, declined sharply thereafter.

One of the consequences of the fiscal measures taken at the time of upsurge in international resources prices in 1973-1974 to assist citizens in the low-income brackets by means of tax reductions and subsidized selling price of food grains and fertilizer was an accumulation of a large fiscal accounts deficit. This growing deficit, though accepted as inevitable at the time of crisis, became a matter of considerable concern to the government in view of its adverse effects on monetary management and on government savings, which had already been experiencing a weakening trend over the past several years.

Reflecting these considerations, the government raised sales prices of rice and barley by 28.7 percent in April. With the increase of the domestic flour price by 30 percent and the decrease in the import price of wheat, it is expected that no further subsidy will be needed to maintain the domestic flour price at a stable level. Cigarette prices were also raised in April by an average of 45 percent, substantially increasing government revenues. As a result of these measures, the combined balance of the General and Special Accounts of the Budget recorded a surplus in April and May, indicating an improvement of the government's financial operation.

 
Outlook for 1976
 

Although the general outlook for 1976 is for better growth performance, stabilized price movement, and an improved balance of payments, it is difficult to make a precise projection of the 1976 economy and of the policy measures appropriate for the year. Clearly, we must adjust flexibly to changing conditions while continuing to mobilize and develop every available national asset.

We will continue, of course, to strengthen, consolidate, and refine the responses to recessionary stress that were initiated in 1974 and 1975, while adjusting promptly and appropriately to evolving international conditions. In view of the nation's large capital inflow requirements, Korea must necessarily continue to depend heavily on official financing sources, while intensifying its efforts to broaden the base and increase the amount of medium and long-term private loans and foreign investments. Concurrently, however, we will also continue to assiduously explore our virtually untapped opportunities to broaden the nation's export market, particularly among the resource-producing countries with rapidly growing needs for the wide range of products Korea has developed over the past decade; and we will continue to expand and consolidate these and other markets by enhancing the quality, technological sophistication, and diversity of our export commodities.

We will continue our efforts to stabilize prices on the basis of a more rational price structure consistent with market conditions at home and abroad, and on the basis of healthy financial management and greater government savings. Our policy effort will be directed toward the augmentation of government savings in order to reverse their currently declining ratio to GNP.

Through these internal and external measures, involving flexible response on the one hand and energetic initiative on the other, we will make every possible effort to achieve a base of the greatest possible strength and stability for the launching of our next five-year economic development plan.

 
The Fourth Five-Year Plan
 

The Fourth Five-Year Economic Development Plan for 1977-1981, on which our government has already commenced work, will be finalized in 1976. This Fourth Plan, pursuing the basic goals of "Growth," "Equity," and "Efficiency," will aim at the consolidation of a more self-supporting economic structure, devote further resources and effort to the achievement of equitable social and welfare development, and intensify technological innovation and socioeconomic efficiency.

Although many of the plan's specific sectoral targets necessarily require further refinements, these basic developmental goals are a summation of fundamental national requirements that we cannot defer or evade, and that can only be achieved through the promotion of domestic savings, the improvement of our balance of payments position, the expansion of the nation's industries, and the achievement of agricultural development.

Although the provisional average annual economic growth rate to be set for the Fourth Plan will be lower than the average growth rate over the last ten years, a more conservative target seems most appropriate in view of the rapidly changing internal and external conditions, and will be the minimum rate of growth Korea requires to maintain an acceptable level of employment.

Under the assumption of reasonable growth of exports and imports, our tentative projection of long-term capital requirements is for an annual average in excess of $2 billion for the next several years. Our debt-servicing ratio has risen since the oil crisis, and will continue to remain higher than originally projected. We have every expectation, however, that it will be kept within tolerable limits.

The Fourth Five-Year Plan is being formulated in the context of the increased cost of essential raw materials in recent years and the continuing slow pace of international trade. Nevertheless, in the light of the significant reduction in the balance of payments deficit Korea was able to achieve over the years prior to 1974, and the concerted efforts now being made to minimize the present payment imbalance and to accommodate and surmount the other stresses we are now experiencing, I am confident that the specific sectoral targets of the Fourth Five-Year Economic Development Plan will constitute full and realistic guidelines for the maximum possible achievement of those economic and social goals toward which we must direct our national efforts in preparing for the further challenges of the 1980s.

 
Concluding Remarks
 

The lack of predictability or favorability in the elements with which a planner must deal does not relieve him of the obligation and necessity to plan. He must make the most realistic possible assessment of the unknowns and the problems with which he is confronted, and from that assessment must plot the optimum course to the only fixed point he has: the national goal. We can advance timidly or we can advance boldly; the uncertainties of the future will admit of either attitude. But as Franklin Delano Roosevelt once said, at a time when his country was beset by great difficulties and even greater doubts, "The only thing we have to fear is fear itself."

At no time since the inception of its First Five-Year Economic Plan have Korea's external circumstances been fully predictable or particularly favorable. Yet despite this, we have achieved remarkable growth and development. Future conditions are even less predictable, and present external circumstances certainly less favorable than they were in the preceding decade. I think it would not be unrealistic, however, to say that the position in which we now find ourselves, as we prepare to attack the difficulties that lie ahead, is a far stronger position than the one from which we launched our attack upon the lesser difficulties of the past. We advanced with confidence then; we must continue to advance with confidence now.

To the extent that the fullest realization of our ability to overcome these difficulties continues to depend on the good will and assistance of this organization and its member nations, I believe we have achieved over the past decade a degree of economic credibility and a record of national accomplishment that justify your continuing support. And at the risk of sounding presumptuous, I would like to say that I believe we deserve your continuing support. Our needs are great; but we also have much to give, above and beyond the simple repayment in cash of the debts and obligations we have incurred. The economic interdependence of the world community of nations that has evolved in recent years has led to the fresh recognition of an old truth: The growth of each of us contributes to the well-being of all of us. Clearly, this does not mean that a nation can evade the responsibility of doing its utmost in its own behalf; and I hope that it is evident that Korea is continuing to exert every effort to make the most of the advantages we have, the growth we have attained, and the assistance we have received. I am confident, however, that as Korea continues to progress and develop, it will be better able not only to help itself but to expand the scope of its own contribution to the well-being of the international economic community, in the full realization that participation and cooperation are a matter of multilateral traffic, involving reciprocal contributions to the common prosperity of all our countries.