Financing South Korea's economic development in the 1990s was expected to differ from previous decades in two main respects: greater reliance on domestic sources and more emphasis on equity relative to debt. Beginning in the 1960s, foreign credit was used to finance development, but the amount of foreign debt had decreased since the mid-1980s. According to the Sixth Five-Year Economic and Social Development Plan (1987-91), an average annual growth rate of 8 percent was expected, together with account surpluses of about US$5 billion a year through 1991.

To realize these growth targets, South Koreans needed the gross domestic savings rate to exceed the domestic investment rate; additionally, they needed the financing of future economic growth to come entirely from domestic sources. Such a situation would involve reducing foreign debt by US$2 billion a year; and South Korea would become a net creditor nation in the mid-1990s. Through the promotion and reform of the securities markets, especially the stock market, and increased foreign investment, the sixth plan encouraged the diversification of sources and types of corporate finance, especially equity finance.

Domestic savings were very low before the mid-1960s, equivalent to less than 2 percent of GNP in the 1960 to 1962 period. The savings rate jumped to l0 percent between 1970 and 1972 when banks began offering depositors rates of 20 percent or more on savings accounts. This situation allowed banks to compete effectively for deposits with unorganized money markets that had previously offered higher rates than the banks. The savings rate increased to 16.8 percent of GNP in 1975 and 28 percent in 1979, but temporarily plunged to 20.8 percent in 1980 because of the oil price rise. After 1980, as incomes rose, so did the savings rate. The surge of the savings rate to 36.3 percent in 1987 and 35.8 percent in 1989 reflected the sharp growth of GNP in the 1980s. The prospects for continued high rates of saving were associated with continued high GNP growth, which nevertheless declined to 6.5 percent in 1989.

According to Donald S. Macdonald, through the early 1980s funds for investment came primarily from bilateral government loans (mainly from the United States and Japan), international lending organizations, and commercial banks. In the late 1980s, however, domestic savings accounted for two-thirds or more of total investment.

Throughout the 1980s, the financial sector underwent significant expansion, diversification of products and services, and structural changes brought about by economic liberalization policies. As noted by Park Yung-chul, financial liberalization eased interest ceilings. Deregulation increased competition in financial markets, which in turn accelerated product diversification. In the early 1980s, securities companies were permitted to sell securities through a repurchase agreement. By 1985 banks also were allowed to engage in the repurchase agreements of government and public bonds. In 1981 finance and investment corporations started dealing in large-denomination commercial paper. The new form of commercial paper was issued in minimum denominations of 10 million won, compared to the previous minimum value for commercial paper of 1 million won.

In order to extend their ability to raise cash, investment and finance companies introduced a new cash-management account with a 4 million won minimum deposit in 1983. Investment and finance corporations managed client funds by investing them in commercial paper corporate bonds and certificates of deposit. Money-deposit banks in the mid-1980s began offering similar accounts, known as household money-in-trust. Trust business formerly had been the exclusive domain of the Bank of Seoul and Trust Company; however, after 1983 all money-deposit banks were authorized to offer trust services.

The financial system underwent two major structural changes in the late 1970s and 1980s. First, money-deposit banks saw a sustained erosion of their once-dominant market position (from 80 percent in the 1970 to 1974 period to 55 percent by 1984). One reason for this decline was that in the 1970s nonbank financial intermediaries, such as investment trust corporations, finance companies, and merchant banking corporations, were given preferential treatment. Further, because the costs of intermediation at these nonbank financial institutions were lower than at banks (with their many branches nationwide and their multitudes of small savers and borrowers), their cost advantages and higher lending rates allowed them a larger market share.

The second structural change was the rapid increase of commercial paper and corporate debenture markets. Another development was the steady growth of investment trust corporations in the 1980s.

Because of the introduction of tax and financing incentives by the government that encouraged companies to list their shares on the stock market, the Korean Stock Exchange grew rapidly in the late 1980s. In 1987 more than 350 companies were listed on the exchange. There was an average daily trading volume of 10 million shares, with a turnover ratio of 80 percent. In 1989 the stock market was tarnished by accusations of insider trading among the five major South Korean securities firms. The Securities and Exchange Commission launched an investigation in late 1989. The popular index of the market soared to a high of 1,007.77 points on April 1, 1989, but plunged back to the 800s in late 1989 and early 1990.

Business financing was obtained primarily through bank loans or borrowing on the informal and high-interest "curb market" of private lenders. The curb market served individuals who needed cash urgently, less reputable businesspeople who engaged in speculation, and the multitudes of smaller companies that needed operating funds but could not procure bank financing. The loans they received, often in exchange for weak collateral, had very high interest rates. The curb market played a critical role in the 1960s and 1970s in pumping money into the economy and in assisting the growth of smaller corporations. The curb market continued to exist, along with the formal banking system, through the 1980s.

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Source: U.S. Library of Congress