Facing The Threats And Challenges Of The Korean Economy Presentation material September 7, 2004 This report is solely for the use of client personnel. No part of it may be circulated, quoted, or reproduced for distribution outside the client organization without prior written approval from McKinsey & Company. This material was used by McKinsey & Company during an oral presentation; it is not a complete record of the discussion.
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Facing The Threats And Challenges Of The Korean Economy
Facing The Threats And Challenges Of The Korean Economy
Presentation materialPresentation material
September 7, 2004September 7, 2004
This report is solely for the use of client personnel. No part of it may be circulated, quoted, or reproduced for distribution outside the client organization without prior written approval from McKinsey & Company. This material was used by McKinsey & Company during an oral presentation; it is not a complete record of the discussion.
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