Alarm Bell Rings Over Higher Short-Term Liabilities

South Korea is on the verge of being relegated to a debtor country as early as next month, ending eight years of creditor status. This change will be inevitable as the nation is suffering from a widening current account deficit, banks' increased borrowings from overseas and shipbuilders' sell-off of forward currency deals to hedge against foreign exchange fluctuations.

According to the Ministry of Strategy and Finance, the country's net foreign credit nose-dived to $34.8 billion last December from $120.7 billion two years ago. The ministry forecasts that the nation's total external debt will exceed its entire foreign credit in June, depriving South Korea of its creditor status.

A ministry official said that the government is closely monitoring the debt, adding that South Korea's descent to becoming a net debtor is not posing an immediate threat to its financial health. However, he said the authorities will take steps, if necessary, to prevent the problem from developing serious consequences.

It is desirable for the country to prepare measures for a potential debt crisis as seen in the Asia-wide financial turmoil in 1997-98. Policymakers should neither underestimate nor exaggerate the country's current debt situation if they want to make sure of its financial soundness. Critics remind us of the specter of the unprecedented foreign currency crisis that forced South Korea to go cap in hand to get a bailout program from the International Monetary Fund (IMF) in late 1997.

The country had been a net debtor until the crisis broke out. In a word, the currency turmoil was attributed to overextended capacities, the soaring current account shortfall, and spiraling foreign debt. Thus, South Korea was plunged into a state of default on its external liabilities. The net foreign debt snowballed to $68.1 billion in 1997, compared with $46.2 billion in 1996, $25.4 billion in 1995 and $18.3 billion in 1994.

In particular, the nation's short-term external debt, which had to be repaid in less than a year, accounted for as high as 48.2 percent of the total foreign liabilities. The foreign exchange reserves were depleted due to the debt repayment. The current situation is somewhat similar to the turbulence then. The entire external debt more than doubled to $380.7 billion in December 2007 from the $187.9 billion at the end of 2005.

What matters is that the ratio of the short-term debt to the total external liabilities now exceeds the 40-percent mark. Foreign reserves increased 10-fold to $260 in a decade. However, the problem is that the short-term liabilities account for 60.5 percent of the reserves. The figure is slightly higher than the IMF-recommended level of 60 percent. Thus, the country is faced with potential downgrading of its credit ratings due to the deteriorating debt structure.

In addition, South Korea recorded $5.2 billion in current account deficit for the first three months of this year. The shortfall is expected to grow to over $10 billion by the end of the year, the first red ink in a decade. The country is now faced with mounting challenges from within and without. Let's not forget a valuable lesson we learned from the Asian financial crisis.