By Kim Jae-kyoung
Staff Reporter

All bailout measures and stimulus packages to boost the economy and stabilize the financial market will not prove to be effective unless Korean policymakers restore confidence from both local and foreign investors, analysts said.

An exodus of foreign capital and the deep fall of the local currency indicate that Korea is being exposed to a self-fulfilling financial crisis, a crisis driven by a fall in confidence rather than by bad economic fundamentals, they said.

Growing fears of a recession has forced overseas investors to desert Korea, causing the local currency to tumble. This, in turn, spawns fears that the currency may collapse like it did in the 1997-1998 financial crisis, which again triggers another selling spree.

President Lee Myung-bak and his economic policymakers may be scratching their heads as the financial market turmoil is only turning for the worse despite massive bailout measures for local banks suffering a liquidity crunch.

Foreign media are making headlines day after day with news that Korea is closer to another financial crisis although the government defends the soundness of the economy and solvency of local banks.

The domestic financial markets have been crashing even after a series of rescue efforts. The key index KOSPI dipped below 1,000 points for the first time in 40 months, while the won plunged to a 10-year low against the dollar.

Foreigners net-sold 42.6 trillion won ($29.59 billion) worth of local stocks this year, the largest since the market's opening in 1992. Foreign share holdings accounted for around 30 percent of total market capitalization, down from 42.95 percent in 2004.

Market experts said that in order to escape the trap of a self-fulfilling crisis, the government should put top priority on restoring confidence.

They stressed that unless the country restores confidence, upcoming bailout measures, including additional rate cuts and the central bank's purchase of bank bonds, will not help stabilize the financial markets and stimulate the economy.

``Massive bailout plans are actually good and are steps in the right direction. But the problem is poor confidence in the leadership of the current administration and a lack of coordination between ministries,'' a global investment bank executive told The Korea Times, asking not to be named.

``In my view, the most important issue the government should do is to restore confidence in the global market by convincing creditors that Korean bank debts are safe,'' he added.

He pointed out that if only a massive bailout can protect a country from a loss of confidence, the government should demonstrate its willingness to service bank debts through decisive and timely measures.

Signs of the country heading for a self-fulfilling crisis is evident in the recent fall of the local currency. The currency has shown extreme volatility, while the economy is on a much sounder footing than a decade ago.

Korea is now the world's 13th largest economy with foreign reserves of $239.6 billion in September, the sixth largest in the world and the second largest among OECD member countries.

Corporate debt ratio has fallen to around 95 percent from 420 percent in 1997, while local lenders' Bank for International Settlement (BIS) ratio stands at 10.5 percent, well above the international average of 8 percent.

Despite the nation's sound fundamentals, the won has been depreciating at a much faster pace than other developing economies. It has lost 34.2 percent in value against the dollar since the beginning of this year, compared to Thailand (-13.2 percent) and Taiwan (-2.6 percent).

``Regardless of economic fundamentals, a crisis can visualize if investors do pull their money out en masse due to loss of confidence,'' a market analyst said.

``In other words, if an investor self-confirms that a currency collapse seems likely, a country may suffer an unnecessary crisis,'' he added.

In a recent interview with The Korea Times, McKinsey and Company Asia Pacific Chairman Dominic Barton said that another crisis is unlikely, but Korea has to be careful in handling this turmoil because it can fall into the trap of a self-fulfilling crisis.

A self-fulfilling crisis occurs when an economy is subject to an exodus of foreign capital as a result of investors' loss of confidence in the market where fears feed on other fears. Even if the economy is solvent, the rush of investors to pull their money out of the country at once will cause liquidity in the economy.

kjk@koreatimes.co.kr