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Outlook: Why there can be no pain-free salvage for Korea

One of the ironies of the economic crisis that engulfed Britain in the mid-1970s is that we never had to draw on a penny of the International Monetary Fund aid so painfully extracted to help tide us over our difficulties. The mere fact that the IMF was prepared to lend the money helped restore confidence and ease the liquidity crisis. This, of course, is how IMF support is supposed to work. Unfortunately, it hasn't turned out that way with South Korea. Record breaking though the IMF and other international aid for Korea is, it still looks insufficient. As a result and in contrast to what happened with Britain, it has already been drawn on, payments have had to be accelerated and unless creditor banks can agree collectively to roll over their debt, it will soon run out.

Hence the sudden flurry of meetings among international bankers and policymakers and the renewed feeling of crisis about the Far East as the new year gets under way. The immediate problem is that the amount of debt owed by Korean banks and corporations that matures over the next six months easily outstrips the $60bn of support agreed by the international community. The Koreans have been borrowing short and lending long. If there was no crisis, this short term debt might have been rolled over almost automatically and everything would have continued as normal.

But things are not normal. What has caused and deepened the South Korean problem is that bankers have not been prepared to do this. They have called in their loans in ever growing quantities with the result that what began as a banking crisis has now become a sovereign one too. The country is quite literally running out of foreign currency reserves as corporations and banks attempt to convert their unwanted Korean wons into dollars to satisfy the international bankers. A string of corporate and banking insolvencies threatens to turn in this way into a national insolvency.

As a result, proposals from JP Morgan and other investment bankers to solve the crisis by issuing Korean sovereign debt against the banking loans, look more than a little implausible. Very few investors would be prepared to take on Korean sovereign debt at present except on terms the Korean government would find too onerous to accept. Either that or there would have to be some kind of World Bank or IMF guarantee of the coupon, at which point the bonds would become not Korean debt, but in effect US debt. It is not clear the US tax payer would be up for that one.

There is, in any case, a philosophical argument against this approach. The IMF would not be keen to see the Korean government guarantee all, or even part, of the country's foreign debt, for this would merely encourage such bad lending to continue. There might eventually come a time, after confidence has been restored and the immediate liquidity crisis has eased, when it would be possible to refinance these debts with government-backed bonds, but this would very much be for the post-operative stage of recovery.

As in most insolvencies, bankers for the time being have little option but to agree collectively to roll over their debts and hope the country eventually manages to work out its bad loans. Unfortunately, the prognosis at this stage cannot be one of total recovery. JP Morgan, Goldman Sachs and the host of other Wall Street investment banks trying to get a fee- earning foot in the door all claim to be able to deliver a pain-free way out of the crisis. That's there job.

Lamentably, it is hard to see how this can be the case. There's no such thing as a free salvage. One way or another, international banks with an exposure to Korea are going to end up taking a hit and South Korea's future ability to borrow will be correspondingly harmed. That's the way of the capital markets. No amount of fancy footwork from Wall Street is going to change it.