POSCO project, expressing the view that building an integrated steel mill in Korea at the time was premature and lacked economic feasibility, and that Korea would find it difficult to repay foreign credit due to its rising foreign debt. See Appendix 3 for details.
Table 6.1 Sources of investment capital for POSCO's Pohang mills, 1970-83 (per cent)
First stage Second stage Third stage Fourth stage (04/70-07/73) (12^3-05/76) (08/76-12/78) (02/79-05/83)
Domestic capital" (123) (199) (618) (945)"^
of which (per cent) (618) (945)"^
Government investment 81.2 8.9 36.4 15.4
Policy funds'' 1.9 17.9 16.3 42.9
POSCO's internal capital 0.0 73.2 47.4 41.7
Foreign capital" (178) (348) (766) (839)
of which (per cent) (766) (839)
Reparation funds 43.3 12.1 0.0 0.0
Japan 42.7 32.2 53.0 59.4
Others 14.0 55.7 47.0 40.6
Notes a Million US dollars in parentheses.
b 'Policy funds' includes the government's National Investment Fund and the funds raised by the Korea Development Bank. c Shares are only for the first phase completed in February 1981, of which total domestic capital
investment was US$726 million. Domestic capital for the second phase was all suDplied bv POSCO itself.
Sources POSCO's internal information;
Economic Planning Board (Korea), Korea Statistical Yearbook, various issues; Bank of Korea, Economic Statistics Yearbook, various issues.
domestic and international markets by channelling and/or rationing domestically available capital to the steel industry and by intervening in international loan negotiations and providing actual and de facto guarantees for foreign loans. The government consistendy ensured that the industry had access to capital on favourable terms not only for capacity expansion but for facilities investment, rationalisation, introduction of new technology and development of secure sources of raw materials.
International development banks, notably the World Bank, financed a substantial amount of the developing countries' steel industry development in the 1970s and 1980s. As the steel industry in industrial countries entered a recession in the mid-1970s, a number of leading steel-makers began to view the export of equipment to developing countries as a means of offsetting slackening demand. This brought about intensified competition among the industrial countries to sell equipment to developing countries, supported by national export-import banks. A highly competitive lending environment also developed among the various private commercial banks in industrial countries as a substantial portion of the oil exporting countries' huge trade surpluses, following the oil price increases in the mid to late 1970s, were deposited in the banks, which then sought borrowers for these deposits (Howell et al, 1988).
Despite the competitive lending environment, winning a particular bid was subject to the potential borrowing country's economic status and the economic feasibility of the project concerned. In many cases, therefore, insufficient capital was
140 an obstacle to construction of the most up-to-date steel-making processes. Lall (1987) argues, for example, that the Indian steel industry suffered from second-rate technology at the hands of the only source of finance available to it. In the case of the POSCO project, while the Japan group was very enthusiastic about providing technical and financial assistance, international lending institutions and some research institutions continued to advise against its expansion, even when it came on stream in the early
1970s. According to POSCO, for example, the World Bank, which denied loans to the first stage project of POSCO, was still refusing loans for its expansion project in 1973. In this environment, the Korean government gave assurances that it would provide guarantees for the foreign investment. Involvement of the government in loan negotiations and its guarantees of repayment as well as the successful inception of POSCO's first stage gradually attracted many foreign capital lenders. A number of foreign export and impon banks agreed to extend favourable equipment financing to POSCO's expansion projects. Even the United States Export-Import Bank, which at first was against the POSCO project, entered the loan competition, providing US$75 million in equipment financing in 1975-77 (Howell et al, 1988).
In the domestic capital market, the government as a major shareholder was one of the main sources of finance. As shown in Table 6.1, the government supplied more than 80 per cent of domestically raised capital for POSCO's expansion projects. In the 1970s, the government also contributed to the company's finances by allowing POSCO not to pay dividends on its shares (Howell et al, 1988). As POSCO expanded, it became able to finance the second phase of the Pohang works' fourth stage and the Kwangyang works without government investment but with its own capital and foreign loans.
FINANCIAL POLICY: THE PRINCIPAL AGENT IN INDUSTRY PROMOTION From the early 1970s, the Korean government explored ways to support the nation's economic growth through heavy and chemical industrialisation, vigorously pursuing an industrial targeting policy. Even though various industry specific promotion laws had been promulgated, the most significant and important policy tool exercised by the government was its control over financial markets and its power to allocate national resources, not only to strategically targeted industries but also to individual investment projects, and to subsidise them with controlled interest rates.^ Most of the banking institutions served as arms of the government's financial policy. The favoured sectors 8. See Hong (1979), Kwack and Chung (1986), Hong and Park (1988), Kim (1990) and Nam (1990) for
included the heavy and chemical industries and some export-oriented light industries such as textiles and clothing. The steel industry was formally designated a target industry by the government in the 1970s. Although the policy was applied to all strategic firms and industries, the construction and expansion of POSCO was singled out as a priority.
Credit rationing and interest rate control
As the Korean economy developed, the magnitude of total domestic loans from domestic financial institutions also rapidly increased, rising from equivalent to just about 10 per cent of GNP prior to 1960 to about 35 per cent in the 1970s, to more than 50 per cent in the early and mid-1980s, and to more than 70 per cent by the end of 1990 (Bank of Korea, Economic Statistics Yearbook, various issues).' The importance of borrowings from financial institutions in corporate financing also increased, at least until the early 1980s. According to the Bank of Korea (1975-90), funds from financial institutions accounted for less than an average of 30 per cent of total corporate funds in the 1960s. The average proportion increased to about 34 per cent during 1971 and 1976 and then, until the early 1980s, to about 40 per cent, with a slight decrease afterwards. A shortage of national capital created a bottleneck in corporate financing, not only in the 1960s when an export-oriented economic strategy was adopted, but also in the 1970s when a rapid economic development strategy (through the heavy and chemical industry drive) was implemented. The Korean economy, though growing rapidly, encountered problems of low domestic savings rates and, at the same time, excess demand for loans. These led to a severe shortage of domestic funds and, consequently, increasing foreign debt. The Korean government actively intervened in the financial 9. Financial institutions in Korea can be classified as (numbers in parentheses, as of the end of 1990):
(1) Monetary institutions: • The Bank of Korea • Deposit money banks
Commercial banks: nation-wide commercial banks (11), local banks (10), and foreign banks in Korea (69).
Specialised banks: the Korea Exchange Bank, the Small and Medium Industry Bank (also called as the Industrial Bank of Korea), the Citizens National Bank, the Korea Housing Bank, and the Citizens Agricultural, Fisheries, and Livestock Cooperatives.
(2) Non-monetary institutions:
• Development instimtions: the Korea Development Bank, the Korea Export-Import Bank, and the Korea Long-Term Credit Bank.
• Investment institutions: the Korea Securities Finance Corporation, investment and finance companies (32), merchant banking corporations (6), and investment trust companies (8).
• Savings institutions: the mutual saving and finance companies, credit unions, mutual credit, etc.
• Insurance institutions: domestic (25) and foreign (4) life insurance companies, Korean-foreign joint life insurance companies (5), etc.
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market and controlled the flow of credit to help key industries overcome the financial bottleneck, to speed up construction, and to increase exports.
The most important channel of credit rationing was government directed 'policy funds' mobilised from various sources including deposits from banking institutions and foreign borrowings. The loans from the funds, known as 'policy loans', were rationed to designated industries/projects.'" They were made through the deposit money banks including both commercial and specialised banks and through the government-owned development institutions. Until the early 1970s, credit was extended to selected industries mainly through specialised banks, since the participation of commercial banks in policy loans was limited primarily to export financing with the aid of rediscount facilities at the central bank. However, with implementation of the rapid economic growth strategy and the heavy and chemical industry drive, the shortage of funds became more serious, and commercial banks were also brought into the process of mobilising and directing funds to targeted industries.
The government's control and rationing of credit was applied not only to policy loans but to most non-policy loans such as discounted commercial bills and loans based on general banking funds.'^ Furthermore, low interest foreign loans were also allocated directly to entrepreneurs, amounting to about 6 per cent of GNP each year on average in the 1970s (Hong and Park, 1986, p. 168). Such strong government intervention in the financial market continued until the mid-1980s.
With formal implementation of the heavy and chemical industry drive policy, the government instituted the National Investment Fund in January 1974. The fund had been the most visible and clearly directed policy fund for specific industries and played a significant role in financing various large-scale heavy and chemical industry projects. The fund was raised mainly through compulsory deposits from banking institutions, national savings associations, insurance companies and various public funds managed by central and local governments and other public entities.^^ Loans from the fund were allocated mainly through the deposit money banks and the Korea Development Bank to the electricity sector, the primary sector and the important manufacturing sectors. The 10. Some other forms of policy loans including short-term credits and earmarked loans for agriculture,
fisheries and housing were in general free from government control.
11. Overdrafts, loans based on instalment savings deposits, loans for the populace, remunerations and loans by the branches of foreign banks might be regarded as non-policy loans free of government control, though they still seem to have been subject to favouritism and political influence (Hong and Park, 1986, p. 167).
12. Banking institutions' compulsory deposits made up the bulk of the fund's resources. They were required to deposit 13 per cent of the increase in time and saving deposits in the fund. The contribution rate thus varied over time. National savings associations, which channelled mandatory savings by public and private employees, also contributed all of their savings to the fund, though this accounted for just a minor portion of the fund. Transfers from various government budgetary accounts also contributed to the fund. See Kim (1990).
Table 62a Allocation of the National Investment Fund by sector in Korea, 1974-83 (percent)" 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 Total sectors * (75.4) (123.7) (178.5) (240.7) (380.2) (439.8) (438.4) (606.7) (730.0) (732.6) HC industries"" 58.5 49.6 56.4 61.2 63.0 64.9 60.8 54.9 61.0 65.0 HC industry promotion 34.6 20.0 25.4 23.5 29.0 332 26.0 13.3 11.6 6.0
Domestic machinery purchase 6.2 5.3 14.9 7.9 8.3 7.9 9.4 10.5 21.5 30.9
Machinery factory construction 132 10.1 6.1 14.0 117 10.0 4.0 3.5 5.4 2.5
Planned shipbuilding - 4.9 3.3 8.2 6.4 7.4 12.5 15.9 16.8 187
Defence industries 4.5 9.3 6.8 7.6 7.5 6.5 9.0 11.6 5.6 6.4
Agriculture 14.0 9.2 10.9 42 3.9 4.5 5.0 6.4 62 6.1
Power industries 22.5 34.9 22.4 20.8 242 227 27.4 26.4 192 5.5
Exports on deferred payment basis - 2.4 5.6 12.5 7.8 6.8 6.8 12.4 137 23.9
Other 5.0 3.9 47 1.5 1.1 1.1 0.0 0.0 0.0 0.0
Note a Because of rounding, figures may not add to 100 per cent. b Trillion (million million) won at current prices in parentheses,
c Heavy and chemical industries.
Source Bank of Korea, Economic Statistics Yearbook, various issues.
Table 6 Jb Shares of loans from the National Investment Fund in major banking institutions'total domestic credit, Korea, 1974-83 (percent)
1974 1975 1976 1977 1978 1979 1980 1981 1982 1983
Commercial banks 0.6 1,5 3.1 4.3 4.4 4.0 3.4 3.0 2.9 2.9
Specialised banks 1.3 3.0 3.8 4.1 4.3 4.1 32 3.1 3.5 42
Envelopment finance institutions 9.5 192 27.6 29.8 35.7 36.8 31.3 30.6 26.1 24.5
Korea Development Bank 9.6 202 28.0 29.6 372 37.8 33.8 34.3 33.2 29,8
Korea Export-Import Bank - - 23.1 32.0 22.7 26.5 16.3 15.5 15.3 19.4
Total banking institutions 2.2 5.0 7.6 92 10.5 10.8 9.7 9.4 8.9 8.7
Note Domestic credit includes aU loans and discounts to the private sector by deposit money banks
and the r^-o development institutions (the Korea Development Bank and the Korea Export- Import Bank but excluding the Korea Long-Term Credit Bank).
Sources World Bank, Korea: Managing the Industrial Transition, 1987;
Bank of Korea, Economic Statistics Yearbook, various issues.
latter included steel, non-ferrous metals, chemicals, machinery and shipbuilding. More than 50 per cent of the fund was allocated to the heavy and chemical industries during the period of the heavy and chemical industry drive (Table 6.2a). Although constituting a small proportion of total domestic credit, loans from the fund increased until the end of the 1970s, reaching almost 11 per cent of total outstanding loans by major financial institutions (Table 6.2b).
Other forms of policy funds were also raised; those relevant to financing steel and/or other targeted industries included the Export Industry Equipment Fund, the Industry Rationalisation Fund, the Foreign Loan Fund, the Foreign Currency Loan
144
Table 6 J Shares of policy loans in domestic credit in Korea, 1975-85 (per cent)
Not earmarked " Foreign trade ^ Earmarked Total
1975 27.67 8.86 18.52 55.04 1976 26.98 9.84 17.78 54.61 1977 29.52 10.20 18.03 57.76 1978 32.14 10.62 19.17 61.93 1979 33.05 10.49 16.34 59.88 1980 32.76 11.15 15.44 59.35 1981 31.52 12.56 16.24 60.31 1982 29.65 12.16 14.25 56.05 1983 27.70 12.56 15.98 56.24 1984 25.73 12.62 16.94 55.29 1985 25.03 12.75 16.98 54.76
Notes a Includes the National Investment Fund loans, foreign currency loans, all loans by the Korea
Development Bank, and other miscellaneous items.
b Loans for international trade by deposit money banks and all loans by the Korea Export-
Import Bank.
c Loans for agricultural industries, small and medium-sized firms, home-building, and so on. d Not earmarked + Foreign trade -(- Earmarked.
Sources Yoo (1989);
Economic Planning Board, Korean Economic Indicators, 1986; Bank of Korea, Economic Statistics Yearbook, various issues.
Fund and the Machine Industry Fund. Loans from these funds aimed to support various industrial needs for development and exports, as their titles imply. All policy loans other than those for international trade and earmarked projects increased their shares of total domestic credit to take more than 30 per cent during the Fourth Economic Development Plan period (1977-81), when much of the heavy and chemical industry drive was actually implemented (Table 6.3). That is, during this period, the government controlled about 60 per cent of total domestic credit under the name of policy loans, and one-half of this went towards the industrial promotion policy.
In addition to control over the flow of funds, the Korean government also controlled interest rates on loans by imposing low ceilings, which led to an increasing excess demand for loans and rationing of credit. Even though interest rate control was relaxed in the early 1980s, it nevertheless continued until 5 December 1988, when most of the interest rates were liberalised. In addition to imposing low interest rate ceilings, the government maintained high inflation rates through expansionary monetary policy and hence extremely low real interest rates (calculated as the difference between the nominal interest rate and the rate of change in the GNP deflator). As a result there were negative real interest rates for extended periods. Moreover, exchange rates were maintained at 484 won per US dollar during 1977 and 1979, despite the fact that domestic prices were rising at about 19 per cent per annum, while the weighted average
Table 6.4 Interest rates on various loans in Korea, 1971-85 (percent)
Curb Corporate Selected policy loans Inflation market bonds General Export MIPE" NIFD'' (GNP deflator)
1971 46.41
.
22.0 6.0 13.92 1972 38.97 19.0 6.0 16.11 1973 33.30 15.5 7.0 10.0 0 13.40 1974 40.56 15.5 9.0 12.0 12.0 29.54 1975 41.31 20.1 15.5 9.0 12.0 12.0 25.73 1976 40.47 20.4 17.0 8.0 13.0 14.0 20.73 1977 38.07 20.1 15.0 8.0 13.0 14.0 15.67 1978 41.22 21.1 18.5 9.0 15.0 16.0 21.39 1979 42.39 26.7 18.5 9.0 15.0 16.0 21.20 1980 44.94 30.1 24.5 15.0 20.0 22.0 25.60 1981 35.25 24.4 17.5-18.0 15.0 11.0 16.5-17.5 15.90 1982 32.60-33.12 17.29 10.0-16.0 10.0-12.0 10.0-15.0 10.0-16.5 13.2/7.6 1983 25.77 14.23 10.0 10.0 10.0 10.0 3.00 1984 24.84 14.12 10.0-11.5 10.0 10.0-11.5 10.0-11.5 3.90 1985 24.00 14.20 10.0-13.0 10.0 10.0-11.5 10.0-11.5 3.50Notes a Machinery Industry Promotion Fund. b National Investment Fund.
Sources World Bank, Korea: Managing the Industrial Transition, 1987;
Bank of Korea, Economic Statistics Yearbook, various issues.
price level of its major trade partners, the United States and Japan, was rising at about 6 per cent per annum (Hong and Park, 1986).
The anomaly of negative real interest rates did not disappear until prices stabilised in the 1980s. The significance of credit policy can be better understood by looking at the interest rates of policy loans. As shown in Table 6.4, until the early 1980s, the ceilings on policy loans were even set below those on commercial loans.
The Korean steel industry, especially POSCO, received substantial direct and indirect public financial support for its investment projects. In the 1970s, the government had formally designated the steel industry as one of the priority sectors for lending. In particular, the POSCO project was regarded as the core of its steel industry promotion policy and the government not only directly invested in the project as a major shareholder but also channelled into the project capital from the Korea Development Bank and other commercial banks. POSCO benefited in particular from policy funds raised by the Korea Development Bank through foreign borrowing, issuing bonds and borrowing from the National Investment Fund (Table 6.1). The bank became POSCO's largest single domestic creditor by 1978 when construction of the third stage was finished (Howell et al, 1988).
Government intervention in the financial market implies that the steel industry and other targeted industries/firms were not only able to procure their investment
146
capital relatively easily but were also indirectly subsidised by the low interest rate ceilings on their loans, particularly the policy loans.'' The total benefits realised by the favoured sectors and/or firms as a result of credit subsidy would have been larger, since interest rates on commercial loans were also restrained by the government. In mid-
1982, the government reduced commercial loan interest rates from 14 to 10 per cent, which meant that POSCO and the nation's nine other steel-makers were able to save US$146 million in 1982 interest payments (Howell et al, 1988). By contrast, the firms not on the priority list for bank lending faced severe fund shortages and, in many cases, had to pay very high curb market rates for financing (Table 6.4).
Subsidised credit rationing and capital deepening
The government's channelling of subsidised funds to the targeted industries, alongside repayment guarantees on foreign loans, helped the nation's steel firms, especially POSCO, procure the necessary investment funds not only for initial construction but also for capacity expansion. Moreover, the interest subsidies, by reducing the firm's financial burden, further stimulated investment in capacity expansion through capital deepening. In other words, financial policy through subsidised credit rationing had a significant positive impact on expansion of the nation's steel industry. This section examines the extent of credit rationing and interest subsidy that was provided to the steel industry and looks at the implications for the steel industry's expansion through capital deepening in the 1970s and early 1980s.
The figures in Table 6.5 show how, relative to the manufacturing average, domestic bank loans and foreign borrowings have been allocated. The amount of loans per value added (LV) or the share of loans in total capital (LFQ in an industry relative to the manufacturing average was used as an indicator of credit rationing. That is, given the shortage of funds and excess demand for loans, the ratios in a sector above the manufacturing average imply that the sector was able to receive a relatively large amount of credit per value added or per capital stock.
The iron and steel industry received relatively favourable treatment with respect to loan allocations during the heavy and chemical industry drive period (Table 6.5). Table 6.5 shows that both LV and LK in the steel industry were greater than the figures for the manufacturing average in most years in the 1970s and 1980s, implying that.