Introduction

The South Korean economy faced a foreign exchange (FX) crisis again during the global financial crisis in 2008–09, a decade after it suffered from a similar disaster during the Asian Financial Crisis in 1997–98. For four months after the collapse of Lehman Brothers in September 2008, Korea saw a massive net outflow amounting to US$46.5 billion of loans held by banks, including domestic banks and foreign bank branches in Korea. The Korean economy virtually came to a “sudden stop” during the period (Rhee 2009).

This time around, Korea avoided seeking a rescue package from the International Monetary Fund (IMF), but survived the crisis thanks to the supply of foreign exchange and credit lines provided by emergency currency swap agreements with the United States, Japan, and China, totalling about US$80 billion. As the crisis was unfolding, the Korean won depreciated sharply, with the KRW-USD rate, which started at 937 in January 2008, rising to 1,200 at the end of September, and further shooting up to 1,500 towards the end of November 2008. It in fact depreciated even more than the currencies of Eastern European countries which actually received the IMF emergency rescue packages.

This Korean experience is puzzling, especially in view of the conventional perception that the country underwent one of the most successful IMF-sponsored reforms after the 1997–98 crisis and achieved “financial stability”. The debt- equity ratio of its corporate sector, which was over 400 per cent in 1997, was reduced to about 80 per cent in 2008, even lower than that of the United States. Its public finance was one the soundest among the OECD countries. Its FX reserves, nearly depleted in 1997, ballooned to US$240 billion at the beginning of 2008, making the country the sixth largest holder of foreign reserves in the world. The post-1998 Korean economy boasted “strong fundamentals” and it had hardly been expected that the country would face an FX crisis again.