As South Korea's stock market doubled in value earlier this year, many observers were amazed that it all happened in the absence of widespread, sustained corporate restructuring. Restructuring, after all, was what Korea's bloated corporate titans -- and the economy -- needed.
When that simple realization began dawning on investors in July, their enthusiasm for Korean stocks quickly waned.
The turning point in the West's attitude toward Korea came when the country's second-biggest industrial group could no longer service its estimated $50 billion in debts. As the
, the big industrial conglomerates that populate the Korean economy, sought a bailout by creditors, stocks began a 20% plunge from their highs. The benchmark
index is now at 820.95, more than 22% below its July high.
That tumble may only be the beginning. As creditors gathered in Tokyo on Thursday to figure out how much of their Daewoo loans might be recovered, an even bigger problem loomed. On Nov. 10, a possible mass redemption of Daewoo debt not only could throw South Korea into economic reverse once more -- it could set off a brand new financial crisis.
The doomsday scenario works this way: When Daewoo was bailed out this summer, the government capped at 50% the proportion of bond funds that could be redeemed from investment trust company mutual funds, which hold at least $20 billion of Daewoo paper. Next month, that redemption limit moves to 80%.
At least two of the trust companies will likely need government money to keep going when redemption day hits. Otherwise, "a large-scale redemption could cause a systemic crisis in the Korean financial system, and hence another financial crisis," wrote
economist Andy Xie earlier this month. By extension, this means the government may eventually have to bail out the whole Daewoo group.
While Xie said this week he thinks enough government money will prevent a full-scale crisis, the Daewoo debt saga has opened the second phase of the Korean restructuring story. The first phase ended when the foreign debt bubble burst two years ago, sending Korea to the
International Monetary Fund
. The second phase began as the country's appetite for domestic debt reached its limit.
Whatever happens next month, Stella Um, analyst at
in Hong Kong, figures a corporate collapse the size of Daewoo's will push interest rates higher, something that could weigh on the overall economy. "Definitely, market interest rates will go up," she said.
That will hurt an already battered credit market. Korea's
said this week that corporate bond issuance since July had plunged to less than $2 billion, compared with almost $6 billion in the first half of the year.
The best case scenario (from the people who had buy recommendations on Korea all the way up), is that the good and the bad will be punished as rates rise, exposing plenty of low-debt companies worth buying.
Having downgraded the Korean market in July,
Credit Suisse First Boston
says the possible shakeout next month could prove a buying opportunity for good companies with manageable debt. Stocks such as
Pohang Iron and Steel
(Posco) "would be interesting" if the whole market got dragged down further by the Daewoo bond problem, said CSFB strategist Nitin Parekh.
Morgan Stanley's Xie agrees. "If markets are tumbling, it's time to get in," he said, also endorsing Posco, a company Morgan Stanley has underwritten in the past. Xie also said
is worth looking at because of its relatively strong balance sheet and the presence of
as an equity investor.
This hardly makes for clear sailing. Assuming creditors get what they want, Daewoo's 100,000 workers have threatened to go on strike if major assets get sold to foreigners. The "creative destruction" that textbooks prescribe for successful capitalism can prove a rocky road in reality.