Facing The Threats And Challenges Of The Korean Economy
Facing The Threats And Challenges Of The Korean Economy
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September 7, 2004September 7, 2004
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2
KEY MESSAGES
1. Korea does not appear to be facing a financial crisis similar to 1997
2. The economy is however under performing. This will likely continue in the short term… and the medium term if changes are not made
3. Overcoming the challenges ahead will require concerted efforts of government, corporations and labor
3
Countries faced with partial financial issue
Countries hit by financial crisis
Source:IMF; Literature study; McKinsey Analysis
MORE THAN 150 COUNTRIES AROUND THE WORLD HAVE EXPERIENCED FINANCIAL CRISES SINCE 1970
4
De
ve
lop
me
nt
of
Fin
an
cia
l S
ys
t em
6 DIFFERENT TYPES OF FINANCIAL CRISIS HAVE OCCURRED
• U.S. (Saving and Loan case)
• The U.K. (1991)
• The U.K (1973)
• Sweden (1991)
• Denmark (1990)
• Japan (1990s)
• Argentina (1981, 1995)
• Brazil (1995, 1999)
• Mexico (1995)
• Thailand (1997)• Chile (1982)• The Great
Depression of the U.S. (1929)
• Indonesia (1997)
• Russia(1997)
Financial Sector
Financial Sector and Macro Economy
Financial Sector and Real Economy
Financial Sector, Real Economy and Political Sector
Financial Sector, Real Economy, Macro Economy and Political Sector
Type 1
Type 4
Type 2 Type 3 Type 5 Type 6
High
Med.
Low
Fundamental Cause and Seriousness of the Crisis
Korea’s 1997 financial crisis
Source: McKinsey analysis
5
LOOKING BACKWARDS THERE ARE 10 INDICATORS WHICH FORETELL OF CRISIS IN EACH SECTOR
Source: McKinsey analysis
Warning signs
1. Value destruction in the real sector
2. Interest coverage ratioReal sector
Financial system
International Money & Capital Flows
Real Estate Sector
Indicator
• ROIC<WACC
• ICR<2
3. Decreased bank profitability
4. Rapid growth in lending portfolio
5. Shifting deposits or rapidly rising deposit rates
6. Excessive nonperforming loans
7. Inter-bank, money market borrowing rates
8. Government debt
9. Overvalued native currencies
10.Real estate bubbles
• ROA<1% or Net Interest margin<2%
• >20% annually for more than one year
• Decrease of deposit level in consecutive 2 quarters
• NPL>5% of total bank assets
• Several years of 20% or more annual growth in asset prices
• Excessively high Inter-bank call interest rate
• Public debt as percentage of GDP
• FX rate based on purchasing power
6
IN 1997, CLEAR SIGNS OF POTENTIAL CRISIS WERE VISIBLE THROUGHOUT THE KOREAN ECONOMY
Source:Bloomberg; Banking Industry Association; FSS; MOFE; The Bank of Korea; McKinsey analysis
Real SectorReal Sector
Warning sign (criteria)
1. Value destruction in the real sector
2. Interest coverage ratio
Financial System
Financial System
International Money &
Capital Flows
International Money &
Capital Flows
Real Estate Sector
Real Estate Sector
Korea’s situation in 1997
• ROIC<WACC for most listed companies for 3 years from 1995
• Over 70% of listed companies with ICR <2
Level of seriousness
High risk
Moderate risk
Low risk
3.Profitability of banks
4.Rapid growth in lending portfolio
5.Shifting deposits or rapidly rising deposit rates
6.Nonperforming loans
• ROA of bank sector continuously below 1% (1994: 0.4%, 1996: 0.3%, 1997: 0.9%)
• From 1994 to 1997, total lending increased 60%
• Deposit rate increased from 9% in Jan. 1997 to 18% in Jan. 1998
• Total NPL of banking sector was up to 6%, but expected NPL was much higher
7. Interbank, money market borrowing rates
8. Gov’t debt as percentage of GDP
9. Overvalued FX rate
10.Real estate bubbles
• Call rate (21.6%)>market index (3 year government bond: 14.7%)
• Government debt/GDP was comparatively low at 11% to13%
• Overvalued by more than 10%
• Real estate prices grew by 80% between ‘86 and ‘92 although they stabilized in the 1990s
7
Real SectorReal Sector
SERIOUS SIGNS OF AN OVERALL CRISIS ARE NOT APPARENT IN THE KOREAN ECONOMY TODAY
Source:Bank of Korea, KISLIne; MOFE; Kookmin bank; press clipping
Warning sign (criteria)
1. Value destruction in the real sector
2. Interest coverage ratio
• Value destruction (ROIC<WACC) for listed companies over last 8 years – and the gap is getting wider
• ~48% of companies with ICR<2, ~29% with ICR<1 over last 2 yrs
Financial System
Financial System
International Money &
Capital Flows
International Money &
Capital Flows
Real Estate Sector
Real Estate Sector
Korea’s situation nowLevel of seriousness
3.Profitability of banks
4.Rapid growth in lending portfolio
5.Shifting deposits or rapidly rising deposit rates
6.Nonperforming loans
• Banking sector ROA between 0.1% and 0.8% over past 3 years
• Growth of household loans reached about 28% CAGR between 2000 and 2004
• Deposits have risen continuously since money crisis; rates are falling since 1998 Q2
• NPL/assets ratio generally stable since the financial crisis however, the ratio began rising in 2003 due to rising delinquency in retail and SME sector
7. Interbank, money market borrowing rates
8.Gov’t debt as percentage of GDP
9.Overvalued FX rate
10.Real estate bubbles
• Market rate index (5 yr gov’t bond & 3 yr corp. bond) has exceeded the overnight interbank rate since 1998 3Q
• Public debt is 19% of GDP in 2003. Still far less than OECD average (78.2%)
• Korean won is likely undervalued
• Housing sector prices have grown an average 10% p/a for last 3 years. APT in Seoul show around 20% increases
High risk
Moderate risk
Low risk
8
8.43
11.811.2
4.16
9.59.49.0
9.1
9.79.2
8.3
10.3
9.110.2
8.5
8.1
8.6
9.6
7.6
9.4
8.8
3.6
7.4
4.8
8.0
5.9
3.6
0
2
4
6
8
10
12
14
1990 92 94 96 98 00 2002
VALUE DESTRUCTION IN THE REAL ECONOMY IS GETTING WORSE SINCE 1997…
Note:Average figure of 900 listed companies, excluding financial institutions. Number of subject companies change according to available data. Companies we have analyzed take up 57% of overall economy based on revenue size in 1999.
ROIC: (EBIT – tax)/average (Total asset – AP – excessive cash and security – Long term investment – Other asset)
*Cost of Equity: Annual average of 5 year market profitability
Source:Bloomberg, McKinsey
ROICWACC*Sectors with corporate value destruction
IMFCrisis
Percent, 1990~2003
Warning signs
1. Value destruction in the real sector
2. Interest coverage ratio
3. Profitability of banks
4. Rapid growth in lending portfolio
5. Shifting deposits or rapidly rising deposit rates
6. Nonperforming loans
7. Interbank, money market borrowing rates
8. Government debt as percentage of GDP
9. Overvalued FX rate
10.Real estate bubbles
Drivers• Overinvestment• Declining relative productivity
9
323
405456
512548
252
…BUT THE FINANCIAL SECTOR IS NOW RELATIVELY STABLE
*Based on time deposits
Source:The Bank of Korea; MOFE
KRW trillions, percent
Warning signs
1. Value destruction in the real sector
2. Interest coverage ratio
3. Profitability of banks
4. Rapid growth in lending portfolio
5. Shifting deposits or rapidly rising deposit rates
6. Nonperforming loans
7. Interbank, money market borrowing rates
8. Government debt as percentage of GDP
9. Overvalued FX rate
10.Real estate bubbles
Deposits have risen continuously since monetary crisis and rates are falling as well
1998 1999 2000 2001 2002 2003
17.8
4.1
Interest rate*
Total deposits
10
ADDITIONALLY, NATIONAL DEBT RELATIVE TO OTHER MAJOR COUNTRIES IS REASONABLY LOW AND STABLE
*Government debt is classified based on IMF standard (treasury bond, borrowing, other borrowing activities)
Source:MOFE; OECD Economic Outlook (2003.12)
Percent, 2003
Warning signs
1. Value destruction in the real sector
2. Interest coverage ratio
3. Profitability of banks
4. Rapid growth in lending portfolio
5. Shifting deposits or rapidly rising deposit rates
6. Nonperforming loans
7. Interbank, money market borrowing rates
8. Government debt as percentage of GDP
9. Overvalued FX rate
10.Real estate bubbles
Public debt still far less than OECD average
Government debt* to GDP ratio
19%
53%
63%
78%
155%
OECD average
11
KEY MESSAGES
1. Korea does not appear to be facing a financial crisis similar to 1997
2. The economy is however under performing. This will likely continue in the short term… and the medium term if changes are not made
3. Overcoming the challenges ahead will require concerted efforts of government, corporations and labor
12
OVERALL, KOREA IS AT A TURNING POINT TO JOIN THE RANKS OF ADVANCED COUNTRIES
Join the ranks of advanced countries
Restructuring
Credit crunch
Financial crunch
1997
Now
98.6~99.12Daewoo scandal
97-12~98.6High interest rate, high FX rate
• Booming US economy
• Dot com bubble• Consumption-driven
growth
SK Global scandal
Credit card crisis,Foundering bond market
Early 2000 System allowing quick acquisitions of corporate bonds
Mid 2000 Hyundai scandal
2003
13
SUMMARY OF CURRENT ECONOMIC OUTLOOK
Domestic demand has been muted due to highly leveraged household balance sheets
Corporate investment has been stalled due to weak business confidence
Exports have been fueling the economy but the linkage between GDP and GDI has weakened
Korea’s dependence on oil and current high oil price may constrain a strong rebound
Since 1994, capital markets’ view of Korea is negative and getting worse
14
AGGRESSIVE CREDIT WAS EXTENDED TO HOUSEHOLDS AND INDIVIDUALS IN AN ATTEMPT TO DRIVE CONSUMPTION
Source:Bank of Korea; Korea Non-Bank Financing Association
267
342
439
20022001 2003
CAGR 28%
CAGR 28%
Total household debtCredit card usage
Percent
5 8 8
61
56
53
10
10
11
23
27
28
Card loans
CashAdvance
InstallmentLump sum
481
678
237
2000 2001 2002
CAGR 70%
CAGR 70%
DOMESTIC DEMAND
KRW trillion
15
-5.0
0.0
5.0
10.0
15.0
Wholesale/retail sales growth index
THIS HAS CAUSED A SHARP RISE IN CREDIT DELINQUENTS AND SHARPLY REDUCED CONSUMPTION AND DOMESTIC DEMAND
*Repayment of debt/disposable income
Source: National statistics office; Bank of Korea
Credit delinquents trends
Debt repayment ratio*
2.45
3.77
2000 2004. 1Q
Million
Percent
1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q
2002 2003 2004
Consumers are still shackled by their debt obligations accumulated during the credit boom in 2001-02
54%
15
26
2000 2004. 1Q
11%p
16
INVESTMENTS HAVE BEEN WEAK FOR THE PAST 6 QUARTERS PRIOR TO 2Q 2004
7.5
-1.5
1.9
-0.6
-5.0
-2.4
-0.3
6.2
Investment growth rate (YOY)*Percent
2002 20031Q 2Q 3Q 4Q 1Q
*Indexed to the price of 2000; vs. the corresponding period of last yearSource: Korea development bank; Bank of Korea
Investment growth rate under pressure …
Business confidence index
Companies have negative economic outlook
60
80
100
120
2Q 4Q
2002
1Q 2Q 3Q 4Q 1Q 2Q 3Q
2003
2004
2003 2004
INVESTMENT
2Q
17
WHILE EXPORTS ARE THE ONLY PILLAR PROPPING UP KOREA’S ECONOMIC GROWTH…USD billion; YoY growth rate
43.046.1
47.8
56.959.3
64.0
21%
14%16%
26%
38%39%
1Q 2Q 3Q 4Q 1Q 2Q
2003 2004
TotalExport amount
Growth rate
Source: KITA; Bank of Korea
EXPORTS
18
1990 2003
…THE SPILLOVER EFFECTS ON FOREIGN EXCHANGE EARNED AND EMPLOYMENT ARE DIMINISHING
Source: KOTRA; Korea national statistics office; Bank of Korea
FX earned by export
2003
Employment generated by export
Percent Person / USD million
1990 2003
67.7% 43
54.5%
29
• Share of total exports in capital intensive industries is going up
• As a result, there is declining spillover effect in foreign exchange earned and employment
19
GDP GROWTH IS NOT TRANSLATING INTO EQUAL GDI GROWTH
140
150
160
170
180
190
1Q03 2Q03 3Q03 4Q03 1Q04 2Q04
GDP
GDI
Source: Bank of Korea
KRW trillion
20
S&P 500
Europe top 500
KOREAN VALUATIONS LOWER THAN OTHER MARKETS, AND GETTING WORSE OVER TIMEAggregate Market-to-Book ratio
0
1
2
3
4
5
6
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
IBES - China
KOSPI - Korea
HIS – Hong Kong
Nikkei - Japan
Source: Datastream; McKinsey
CAPITAL MARKETS’ VIEW
21
IN THE SHORT TERM HIGH OIL PRICES WILL ALSO BE AN IMPEDIMENT TO THE ECONOMY
0
10
20
30
40
50
2002 2004
Million barrels daily
* data as of 2002
Source: BP Statistical Review of World Energy (2003); Korea National Oil Corporation; OECD; Bank of Korea
2003
Jan. JanJan.Jul. Jul. Jul.
Korea is a the third largest importer of oil * Rising oil prices will impact the economy
5.1
2.0
1.1
1.0
2.8
11.4
Korea
USD/Bbl, Dubai oil
Japan
USA
Canada
China
SouthAfrica
22
A NUMBER OF FACTORS POINT TO CONTINUED ECONOMIC PRESSURE GOING FORWARD
•Export concentration risks
•China’s growing competitiveness
•Relatively low productivity and unproductive labor relations
• Increasing competition for FDI into Korea
•Emerging challenge of aging population
23
KOREAN EXPORTS ARE INCREASINGLY HIGHLY CONCENTRATED
Source; KITA, literature review
100% =
Semiconductor
2001 1H 2004
Wireless telecom. device
Auto
Computer
Shipbuilding
Others
9%
7%
9%
7%
7%
61%
10%
10%
9%
8%
7%
55%
$ 123.5 billion$150.4 billion
39%45%
Percent
Share of items in total exports
EXPORT CONCENTRATION
24
THE MARKETS FOR KOREAN EXPORTS ARE ALSO HIGHLY CONCENTRATEDPercent, 2004
Source:Bank of Korea; Bloomberg, Wall Street Journal
25.9%China
Share of exports to each nation1H 2004
100% = USD 123 bn
US
Japan
Others
22.2%
8.7%
43.2%
GDP growth (vs. the corresponding period of last year)
9.8% 9.6%
2004 1Q 2Q
5.0% 4.8%
2004 1Q 2Q
2004 1Q 2Q
1.6%0.4%
25
China’s key export industries
Percentage in China’s overall exports
Rank Industry Ratio
1 Electrical machinery, etc. 20%
2 Nuclear reactors, machinery, etc 19%
5 Footwear, headgear, etc 3%
6 Iron and steel 3%
9 Optical, measuring, etc. 3%
10 Plastics 2%
Source: United Nations Statistics
CHINA’S KEY EXPORT INDUSTRIES ARE BECOMING MORE COMPETITIVE THAN COMPLIMENTARY
CHINA’S COMPETITIVENESS
Korea’s key export industries
Percentage in Korea’s overall exports
Rank Industry
2 Nuclear reactors, machinery, etc 16%
3 Automobile 12%
4 Shipbuilding 6%
5 Iron and steel 5%
6 Plastics 5%
Man-made filaments 2%
1 Electrical machinery, etc. 28%
Ratio
7 Mineral fuels/oils, bituminous, etc 3%7 Mineral fuels/oils, bituminous, etc 4%
Apparel, clothing accessories 2%
9
10
3 Apparel, clothing accessories 10%
4 Toys, spots requisites, etc 6%
8 Organic/Inorganic chemicals 3% 8 Organic/Inorganic chemicals 2%
2003
26
BASED ON ITS COMPETITIVE WAGES AND GROWING CAPABILITIES, CHINA IS BECOMING A FORMIDABLE COMPETITOR
0.66
9.62
KoreaChina
*Hourly wages of workers in manufacturing sector
Source: IMD World competitiveness annual report; KDB; McKinsey analysis
Labor* cost, 2003
US$
As-is capability gaps with Korea
2.3
2.5
4.5
5.8
7.0Shipbuilding
1.5
3.0
3.0
3.0
White goods
Automobiles
TFT/LCD
Mobile handsets
N/A
Years KDB IMD
27
KOREAN COMPANIES ARE STEPPING UP THEIR INVESTMENTS INTO CHINA
Korean FDI to China
Source:Ministry of Commerce, Industry & Energy; Export-Import Bank of Korea
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
1990 1994 1998 20022003
USD billions
28
KOREA’S RELATIVE LABOR PRODUCTIVITY GROWTH IS POORUNPRODUCTIVE LABOR
Unit labor costs in manufacturing/ labor productivity growth rate
Labor cost per manufacturing unit (based on local currency)
YoY growth
8.1
13.2
8.9
-1.4
11.2
8.1
2001 2002 2003
Wages
Productivity
Source:Ministry of Commerce, Industry and Energy, US labor statistics bureau, Euro monitor source, Ministry of Labor
106.6
106.5
102
91.4
89.8
86.5
Korea
Japan
Taiwan
U.S.
Germany
France
2003
29
COST OF KOREAN LABOR IS HIGH RELATIVE TO COMPETITOR NATIONS
Hourly labor cost in key competitor countries’ manufacturing sector
USD
0.66
5.93
5.98
7.48
9.62Korea
Singapore
Hong Kong
Taiwan
China
Source:Ministry of Commerce, Industry and Energy, US labor statistics bureau, Euro monitor source, Ministry of Labor
30
# of working days lost due to strikes/company shutdown
Productivity of labor management relations
# of working days lost per 1,000 people, 2000~2002 average
KOREAN LABOR RELATIONS ARE POOR
56
32
3 1
111
Source:ILO Labors Statistics Yearbook; Bank of Korea; IMD World Competitiveness Report (2004); Ministry of Labor Affairs; McKinsey analysis
Korea Japan GermanyFrance
Ranking among 60 nations Countr
yScore
1 Singapore
2 Switzerland
3 Austria
5 Japan
21 The US
39 China
60 Korea
Taiwan11
8.52
8.45
8.29
7.92
7.62
7.23
6.48
4.00U.S
31
THE PERCEPTION OF HOSTILE LABOR UNIONS IS AN OBSTACLE TO INVESTMENT BY FOREIGNERS AND KOREANS
Source:MOCIE survey (August 2003), press search
What is the weakest point of Korea as an investment market?
• “Hardline trade unions are strapping the promotion of foreign direct investment” - William Oberlin,
President of Amcham
• “One of controversies in the Korean economy is belligerent trade union”
– William Pesok, Bloomberg Columnist
• “The greatest difference between
other countries and Korea is that negotiations to resolve labor disputes are emotional rather than being rational compromise”
- Marcos Gomez, Chairman of EU Chamber of
Commerce & Industry in Korea
20%
14%
8%
32%Labor relations
Bureaucratic restrictions
High cost
North Korean nuclear issue
32
KOREA’S COMPETITIVENESS AS AN INVESTMENT ENVIRONMENT IS LOW
Source: IMD world competitiveness yearbook (2004), Korea chamber of commerce & industry
On the scale of 10 (figures in brackets show ranking among 60 countries surveyed), 2004
Labor related restriction
Risks from political uncertainty Investment incentives
Korea
U.S.
Taiwan
China
Japan
Singapore
6.13
4.67
7.14
8.15
8.72
3.75
6.94
6.58
8.29
4.77
6.83
5.29(55)
(20)
(54)
(47)
(27)
(13)
(41)
(16)
(23)
(13)
(44)
(1)
6.69
6.14
7.76
5.62
6.37
3.17 (44)
(10)
(12)
(8)
(17)
(2)
INCREASING COMPETITION FOR FDI TO KOREA
33
FDI AS A PERCENT OF GDP IS LOW AND DECLINING Percent
*2002(E)
Source:EIU country index, Global insight, McKinsey analysis
China
Singapore
Ireland
0
5
10
15
20
25
1996 1997 1998 1999 2000 2001 2002
Korea*
Foreign direct investment as percent of GDP
34
IN THE MEDIUM TO LONG TERM KOREA WILL ALSO HAVE TO COME TO GRIPS WITH ITS AGING POPULATION
0
10
20
30
40
50
60
1960 1970 1980 1990 2000 2010 2020 2030 2040 2050
Over 55 years old
25-54 years old
Less than 25 years old
2003 CAGR03-50
-1.5%
-1.0%
-0.2%
2.1%
Total
Korean population by age, million persons
Source: KNSO; McKinsey Household Financial Wealth Accumulation Model
AGING POPULATION
35
BY 2026, TWO PEOPLE WILL NEED TO SUPPORT EACH SENIOR CITIZEN
Source:Korea census, McKinsey analysis
Future Now
Korea in 2003• 3 economically active
people (age 25~54) supporting 1 retired person (age above 55)
CONCEPTUAL
Korea in 2026
Aging trend to accele-rate
Korea in 2013
36
KEY MESSAGES
1. Korea does not appear to be facing a financial crisis similar to 1997
2. The economy is however under performing. This will likely continue in the short term… and the medium term if changes are not made
3. Overcoming the challenges ahead will require concerted efforts of government, corporations and labor
37
EACH ACTOR IN THE KOREAN ECONOMY WILL NEED TO PLAY A ROLE IN CREATING PROSPERITY FOR THE COUNTRY
• Create conditions to attract more FDI–Labor flexibility–Privatize/
restructure–Complete
financial sector reforms
–Manage Korea PR
• Thoughtfully stimulate consumer spending
• Invest in and encourage investment in service and hi-tech sectors (cluster/hub)
• Recognize impact of negative reputation
• Be creative about win-win solutions
• Recognize need for increased productivity
• But, let us focus on what you as corporate leaders need to do…
Government
Labor
Corporations
38
AT A HIGH LEVEL, CORPORATIONS WILL NEED TO SHIFT PARADIGMS IN MINDSETS AND HOW TO MANAGE
Past Future
Stability in external factors
Continuous change
1
Revenue orientation Profit orientation2
Input driven Output driven3
Tangibles Intangibles4
Hierarchy Meritocracy5
Opacity Transparency6
39
CORPORATIONS SHOULD EMBARK ON SEVERAL CHANGES TO ENSURE LONG-TERM SUSTAINABILITY AND GROWTH
Strategic
• Employ more rigorous ROIC metrics to ensure only value-creating investments are made
• Place multiple bets to generate medium and long-term options (“portfolio of initiatives”)–New business generation–Leverage intangibles
Operational
• Get the basics right on cost control and operational excellence (current earnings programs)
• Focus on building resilience to torpedo shocks (risk management)
Organizational
• Improve transparency and credible corporate governance
• Build true performance oriented culture and meritocracy (value-based management)
40
Thank you