KERI: Stagflation feared for Korean economy next year

If restructuring progresses at its current sluggish pace until next year, the Korean economy may enter a stagflation period in which prices surge.

The Korea Economic Research Institute (KERI), affiliated with the Federation of Korean Industries, gave this warning in a report on the restructuring experience and policy of the Japanese economy.

KERI suggested that Korea should not take the path Japan did after missing the appropriate timing for restructuring, which led to a 10-year depression. The report also pointed out that the government's restructuring effort has been pushed forth in complete disregard of market principles, hence leading to a situation in which choosing between the strong and the weak is not possible. Restructuring should from now on be implemented according to market principles, it added.

Huh Chan-Guk, a senior researcher for KERI remarked that in spite of the government's diligent restructuring efforts, financial instability has continued due to the group-oriented prescription provided by the government, which does not adhere to market principles. Due to the uniform application of the BIS ratio standard of 8% and the debt ratio of 200%, without considering the differing characteristics possessed by financial institutions and companies, the mechanism for determining which companies should survive and which should be liquidated has collapsed.

In relation to financial restructuring, the sympathetic attitude towards unhealthy banks should be abrogated and the sizing up of banks should not be used to revive ailing institutions.

According to KERI, if restructuring is not accelerated, considering the rise in national debt from the injection of public funds and the credit crunch being experienced by the corporate sector, an undesirable cycle of financial tightness, corporate insolvency, blunted growth and a rise in inflation will emerge. In this case, economic growth would drop from 4.6% to 4.5% in 2002 and 3.9% in 2003, and inflation will stand at 4.3% next year.

Park Won-Jae parkwj@donga.com