[Insight & Opinion] Financial Gridlock... Only Coordinated Measures with the Bank of Korea Can Contain the Crisis

Legoland Crisis Shakes Bond Market
Bank of Korea Also Has a Duty to Respond

"It’s chaos...!" I heard that South Korea’s corporate bond market is almost paralyzed. Even short-term bonds with high credit ratings are being offered at rock-bottom prices, yet buyers are nowhere to be found. Since the absurd situation last month when Gangwon Province avoided guaranteeing 205 billion won worth of bonds issued for the Legoland theme park project, the corporate bond market in South Korea, which is close to 500 trillion won, has plunged into a free fall.

To my recollection, even during the financial crisis, it was not this severe. Non-bank financial companies, which operate based on a credit system including short-term corporate bond circulation, are facing difficulties in raising funds and are forced to sell their relatively liquid, valuable assets such as government bonds at a loss, like swallowing bitter medicine.

The Gangwon Province issue is fundamentally different from an unavoidable moratorium declared by a debtor who lacks the ability to repay. It seems like a deliberate situation where, despite having the ability to repay, the debtor refuses to honor a guarantee contract they themselves signed when the project became difficult. The principle is that if it becomes difficult after guaranteeing, Gangwon Province itself should declare a moratorium. The market is unprepared for such unilateral contract breaches. The securities and financial market systems, which had been struggling to endure various difficulties amid recent sharp interest rate hikes, have now begun to fall into great turmoil triggered by this problem.

The lukewarm response from financial authorities was also puzzling. If they cannot trust guarantees from local governments, how can they trust those from financial institutions? Immediately after the Gangwon Province incident, they should have issued a clear warning that "if a guarantee contract was made, it must be honored," and swiftly implemented measures to prevent the widespread fallout from the massive amount of credit bonds issued domestically. When the fire rapidly spread and rumors of some companies’ insolvency despite profits erupted, the financial authorities issued a passive measure on the 21st that was like pouring a bucket of water on the fire, which only intensified market confusion.

Fortunately, on the 23rd, despite it being a holiday, financial authorities gathered in one place and announced a high-intensity measure capable of extinguishing the flames. The plan to establish a large-scale financial stabilization fund beyond market expectations is expected to have a significant effect. I believe the government does not need to intervene to help companies or financial institutions that go bankrupt due to poor management or investment. However, the government has a duty to thoroughly prevent companies that usually generate profits and manage risks properly from going bankrupt simply because the system was paralyzed for a short period. Just like traffic officers quickly appear to direct traffic when traffic lights break down causing chaos, financial market participants must have cheered seeing numerous “traffic officers” appear during this holiday to manage the crisis.

In the current situation, it is only natural that the Bank of Korea also has an obligation to present countermeasures. The Bank of Korea has recently been closing the floodgates of money supply to resolve the chronic household debt problem and real estate bubble in South Korea. This is a necessary policy. However, just as there must be measures in place for water shortages when closing a dam’s floodgates, there must always be contingency plans for cases where essential economic activities run dry of funds during monetary tightening. Now is the time to implement those contingency plans.

Measures such as the Bank of Korea’s repurchase agreement (RP) purchases and the Special Purpose Vehicle (SPV) for corporate liquidity support, which were actively implemented during the COVID-19 crisis a few years ago, should be combined with the current government’s measures to effectively extinguish the definite flames of financial system paralysis.

Seo Junsik, Professor of Economics, Soongsil University

This content was produced with the assistance of AI translation services.