This briefing comes from Korea View, a weekly newsletter published by the Korea Economic Institute. Korea View aims to cover developments that reveal trends on the Korean Peninsula but receive little attention in the United States. If you would like to sign up, please find the online form here.

What Happened

• President Moon pledged to support the bio-health industry in his five-year plan.
• In October, South Korea’s Financial Services Commission (FSC) warned investors entering the bio-health sector to be prudent.
• The FSC strengthened investigations into potentially fraudulent bio-tech companies last week.

Implications: Financial regulator’s warning to investors in the bio-health sector suggests that the government’s concern with market instability overshadows desire to rally private investment to this innovative industry. While the government has been forward-leaning on the sector’s potential for growth, the warning comes on the heels of scandals involving companies’ exaggerated disclosure of information related to clinical development, as well as insider trading allegations. There are concerns that the FSC’s public statement may dampen private investments to this innovative sector. Nonetheless, the government appears to have calculated that small losses today may be less costly than a bigger crisis down the road.

Context: Scandals have already caused market volatility in the bio-health sector. Samsung Biologics, the country’s biggest pharmaceutical company, committed accounting fraud and is currently under investigation. Meanwhile, Kolon TissueGene intentionally falsified its documents to win a license. Revelation of this criminal behavior led to the suspension of transactions involving this medicine. Sillajen was accused of insider trading and spooked investors panicked when the company’s executive dumped $7.4 million-worth of of the stocks.

Korea View was edited by Yong Kwon with the help of Soojin Hwang, Hyoshin Kim, and Rachel Kirsch.

Picture from Wikimedia Commons 

By Troy Stangarone

In trying to sell Kim Jong-un on giving up his nuclear program, the United States and South Korea have tried to entice North Korea with the promise of a better economic future. As part of this push, the Trump administration has suggested that the U.S. private sector, along with China, South Korea, and Japan, will provide financial assistance to North Korea. However, it has also been made clear that no U.S. tax dollars will be used as an economic inducement for North Korea.

While the refusal to provide aid is in line with President Donald Trump’s desire to ensure that greater costs are born by other states, there is a practical reason why the United States will not provide significant aid to North Korea. The administration is limited in its ability to provide economic assistance.

When Congress legislates sanctions on foreign countries, it generally includes a provision in the legislation that allows an administration to waive the sanctions if it determines that doing so in the national interest. Most of the U.S. sanctions on North Korea contain national interest waivers, but in most cases they do not to apply to the prohibitions on providing aid to the regime in Pyongyang.

In recent years, Congress has inserted specific language into the annual appropriations legislation explicitly forbidding the use of funds for North Korea. These restrictions include credits, loans, or guarantees by the Export-Import Bank. While there are exceptions for humanitarian aid and some other circumstances, it is unlikely that Congress will change course and remove the prohibitions in the near future.

While the administration could request Congress grant it an exception to the prohibitions on aid or to remove them permanently, it would also need to persuade Congress to appropriate the necessary funds. Doing so could be challenging. If the United States intends to provide security assurances to the North Korean regime through a treaty in the U.S. Senate, as has been suggested by Secretary Pompeo, persuading Congress to also waive sanctions on aid will be dependent upon progress on the nuclear issue, and perhaps other issues. Even if the administration can secure an agreement with North Korea on the nuclear issue that would gain the support of two-thirds of the Senate that would be needed for passage of a treaty, Congress may be reluctant to appropriate funds for North Korea if progress is not made on issues that could include North Korea’s chemical and biological weapons programs, its cyber activities, and human rights.

The history of the Agreed Framework suggests that even if Congress agrees to appropriate funds there will be limits. As part of the Agreed Framework, the United States committed to providing 500,000 metric tons of heavy fuel oil a year until a light water reactor was completed. The Clinton administration had promised Congress that the costs would not exceed $30 million a year, and when they did the needed extra funds were not forthcoming. In the case of the Agreed Framework, the funds were designed to serve as a bridge to a new energy resource for North Korea. While it is reasonable to expect that if a deal is struck Congress might appropriate funds for dismantlement of North Korea’s nuclear program, funding that is focused on economic development as opposed to dismantlement is unlikely.

Practically speaking, the Trump administration does not have the authority to provide economic assistance to North Korea and is unlikely to seek it from Congress. It goes against Trump’s broader philosophy and is something Congress would most likely be reluctant to provide. While North Korea will need assistance in developing its economy, there is unlikely to be political support in the United States in the near future for economic aid for North Korea.

Troy Stangarone is the Senior Director for Congressional Affairs and Trade at the Korea Economic Institute of America. The views expressed here are the author’s alone.

Photo by Pictures of Money on flickr Creative Commons.

By Phil Eskeland

(“That’s Where the Money Is.”[1])

Last week, the House of Representatives and the Senate overwhelming passed and sent to President Trump’s desk a new sanctions bill for his expected signature. The bill originally focused on Russia and Iran when it was first adopted by the Senate, but was expanded after bipartisan, bicameral negotiations to include sanctions provisions against North Korea as well.  With all the talk in Washington about the inability of different sides to work together, few issues unite more U.S. public policymakers on both sides of the political spectrum than getting tougher on North Korea.  Last May, the House of Representatives passed the Korea Interdiction and Modernization of Sanctions Act (H.R. 1644) by another overwhelming bipartisan vote of 419 to 1.  Essentially, this new sanctions bill – Countering America’s Adversaries through Sanctions Act (H.R. 3364) – takes almost every word from the House-passed North Korea sanctions bill to include it as part of Title III.

Much of the attention to this legislation has been directed at the first title of the bill affecting Russia.  The debate has primarily focused Congressional limitations on the flexibility given to the Executive Branch to implement the bill.  In the past, most sanctions-related legislation grants the President some discretion to waive or delay the imposition of sanctions, because the U.S. government may need flexibility in diplomacy and cannot wait for Congress to pass a bill to amend or end sanctions.  If there was any constraints on the Executive Branch, it was usually done when there was divided government (i.e., the Republican Congress passed the Helms-Burton Act in 1996, when Democrat President Bill Clinton was in office, that placed into statutory law many of the presidential Executive Orders affecting U.S. trade with Cuba, and thus cannot be unilaterally lifted or altered by the President without the consent of Congress).  It is interesting to observe a Republican Congress reasserting itself as a co-equal branch of government by imposing a series of constraints on the ability of a Republican president to unilaterally waive part of the sanctions against Russia.

However, any additional Congressional limitations on the President’s ability to waive or delay the imposition of these new sanctions do not affect the provisions of the bill dealing with North Korea, despite a last-minute effort by some Senate Republicans.  Nonetheless, the primary purpose of Title III of H.R. 3364 is to close loopholes and target new areas to deprive the North Korean regime of the money it needs to operate.  The fundamental philosophy behind the effort is to “cut off the Kim Jong Un regime’s access to hard cash” and “to restrict North Korea’s ability to engage in illicit trade.”

How does this bill accomplish these goals?  First, the legislation mandates sanctions against foreign persons who engage in five activities that have been identified as major revenue-generating activities for the North Korean regime – high-value metals or minerals, such as gold and “rare earths;” military-use fuel; vessel services; insurance for these vessels; and correspondent accounts, which are used in foreign currency exchanges to convert U.S. dollars into North Korean won.

Second, H.R. 3364 increases the discretionary authority of the U.S. government to impose sanctions on persons who engage in one or more of 11 different activities that generate revenue for North Korea, including those who import North Korean coal, iron, or iron ore above the limits set by the United Nations (U.N.) Security Council resolutions; who buys textiles or fishing rights from North Korea; who transfers bulk cash or precious metals or gemstones to North Korea; who facilitates the on-line commercial activities of North Korea, such as on-line gambling; who purchases agricultural products from North Korea; and who are engaged in the use of overseas North Korean laborers.

Third, there is a provision closing one loophole in the international financial system that would prohibit North Korea’s use of indirect correspondent accounts.  These accounts temporarily use U.S. dollars when converting one foreign currency into another, such as North Korean won.  The aim of this provision is to further cut off North Korea from the U.S. financial system and restrict the ability of the DPRK to conduct business with other nations.

Fourth, the legislation curtails certain types of foreign aid to countries that buy or sell North Korea military equipment in the effort to dry up another source of revenue to the regime.  Nations will have a choice: buy North Korean conventional weapons or receive U.S. foreign aid to help their people.

Fifth, H.R. 3364 augments sanctions that target revenue generated from North Korea overseas laborers who work under inhumane conditions.  It would ban the importation into the U.S. of any product made by these laborers.  The bill would also sanction foreign individuals who employ North Korean laborers.

The legislation also ensures that humanitarian aid destined for North Korea is not affected by heightened U.S. sanctions.  However, H.R. 3364 did not retain a provision in the original House version that contained an exemption for planning family reunification meetings with relatives in North Korea, including those from the Korean-American community meaning that family reunions will still be subject to sanctions.  In addition, the bill contains a reward for informants who report violations of financial sanctions on North Korea, in the hopes of increasing the government’s ability to enforce these sanctions.  Finally, it requires a report from the Administration within 90 days after the bill becomes law on the efficacy of putting North Korea back on the State Sponsors of Terrorism list. The debate over reinstating North Korea on the list was revitalized in light of the assassination of King Jong Nam, the exiled half-brother of the ruling leader of North Korea, at the Kuala Lumpur international airport in Malaysia using the VX nerve agent, a banned chemical weapon.

H.R. 3364 should not be seen as an end-goal, but as part of a continuing process of ratcheting up pressure on North Korea to denuclearize.  As this bill is implemented, North Korea will find new ways to evade sanctions.  Further legislation or action by other nations and the U.N. Security Council may be required to further clamp down on these loopholes.  However, the question remains unresolved if heightened sanctions from both the U.S. and the international community will produce the desired outcome – a nuclear-free Korean Peninsula – particularly before North Korea acquires the ability to launch a nuclear warhead on top of an intercontinental ballistic missile (ICBM) capable of reaching the mainland of the United States.   Sanctions are only as strong as its weakest link.  Thus, North Korea’s main trading partner, China, needs to do much more if it is to live up to its rhetoric that “they will strive for the complete, verifiable and irreversible denuclearization of the Korean Peninsula.”

By Patrick Niceforo

Late last year, the Bank of Korea (BoK), South Korea’s central bank, announced its plans for a “Cashless Society,” which first and foremost means getting rid of coins by 2020. A proposed method for gradually removing coins from circulation is encouraging travelers in South Korea to deposit their change onto their T-Money cards, electronic travel passes that are used to pay for metro and bus fares. But while the BoK has reduced its annual expenditure on coin production by 200 million won from 2015 to 2016, it could do more. Similar to Canada ceasing production of its penny, South Korea could simply stop minting its equivalent of a penny, the 10 won coin.

The BoK issues won banknotes in denominations of 50,000, 10,000, 5,000, and 1,000 and won coins in denominations of 500, 100, 50, and 10. According to a recent study, only 8.5 percent of 10 won coins are in circulation, with the remainder sitting in jars or private safes in peoples’ homes.  As of last year, the cost of producing the 10 won coin (0.009 USD) was reportedly twice its face value at 20 won (0.018 USD). Other sources such as KNN and Asia Economy, however, have estimated the cost of production to be as high as 40 won (0.036 USD).

Besides the fact that it costs more to mint a 10 won coin than it is actually worth, the coin’s value is so low that it has little, if any, purchasing power. At the current exchange rate, the 10 won coin is worth slightly less than an American penny. As a result, its only real use is when one needs exact change, which is rare since just 20% of financial transactions involve cash. Furthermore, given the coin’s low value, most coin-operated devices such vending and laundry machines do not even accept it.

In addition to Canada, many other countries such as Brazil, Australia, Finland, Israel, and Malaysia have removed their equivalent of a penny from circulation, primarily because inflation rendered the coin virtually useless. To compensate, many penniless countries round prices to the nearest 5 or 10 cents. South Korea could easily implement similar policies, especially since prices in Korea already include sales tax. In other words, consumers who pay with cash in South Korea can easily calculate how much one or more item costs before reaching the cash register since their final price is whatever is listed on the labels. Getting rid of the 10 won coin will not only make Koreans’ wallets lighter, it will actually expedite cash transactions.

It does seem like South Korea is naturally moving further away from physical currency, with more Koreans starting to use smartphone apps in lieu of credit cards. Nonetheless, achieving a cashless society could take some time, especially since cash discounts are common in the informal sector. Moreover, the gifting of cash is a cultural tradition in South Korea at weddings and during certain holidays. A small and cost effective step consistent with a cashless society policy could be to cease minting the 10 won coin. Many other countries have already removed the penny from circulation for these same reasons. Perhaps South Korea should, too.

Patrick Niceforo is a graduate student at the Middlebury Institute of International Studies and an intern at KEI. The views expressed here are the authors’ alone.

Image from YunHo Lee’s photostream on flickr Creative Commons. 

 By Kyle Ferrier

The Federal Reserve’s move to increase its benchmark interest rate hardly came as a surprise. Though the March 15 rate increase is only the third since the Global Financial Crisis of 2008, it is the second in three months and we are likely to see at least two more incremental rises this year. Janet Yellen and company’s decision to cool a strengthening economy and the expectation that they will continue to do so this year will certainly irk President Trump. Higher interest rates will dampen the effectiveness of his promised stimulus package and, vis-à-vis a stronger dollar, make U.S. exports more expensive. While the latter will further complicate Korea’s relationship with Trump over the bilateral balance of trade, the biggest challenge to Korea stemming from the Fed rate rises will hit closer to home.

As the Fed’s key interest rate converges with the Bank of Korea’s (BOK) we should expect to see a weaker won, or at the very least constraints on its appreciation. Though the won strengthened immediately in response to the Fed’s rate increase, this can largely be attributed to the less hawkish wording in the Fed’s decision than anticipated. Currency volatility aside, a weaker won encompasses several benefits to a struggling South Korean economy. A cheaper won makes domestic consumption less expensive—aiding fiscal stimulus measures, though tempered by higher import costs—and helps struggling export-oriented companies. However, if the Fed does follow through on the additional two interest rate increases, it could force the BOK to raise its benchmark rate sooner than it might be ready to, exposing critical risks in the economy. The most concerning of which is household debt.

In 2015, Korea ranked 9^th out of the 35 OECD countries in household debt. Korean household debt has continued to reach new heights since then, with the most recent statistic of $1.15 trillion up 11.7 percent from last year and representing nearly 90 percent of GDP. Though other advanced economies rank ahead of Korea—a group that is led by Denmark, the Netherlands, and Norway—which households own how much of the debt is of particular concern for Korea.

Earlier this month the Financial Supervisory Service (FSS), Korea’s top financial watchdog, stated it has entered an “emergency response mode” after revealing the growth in household debt is primarily originating from nonbank lenders. These institutions tend to issue loans with higher rates to homes with lower incomes and credit, i.e. those which are more likely to default once interest rates rise. Only about 8 percent of households are considered marginalized—meaning at least 40 percent of disposable income is used to pay off loans—yet they hold an outsized 32.7 percent of the total debt. A one percent increase in the interest rate would add on around $22 billion in debt to these marginalized homes as well as create an additional 69,000 marginalized households. Government efforts to encourage less risky amortized loans, requiring monthly principal and interest payments as opposed to amortized loans which are interest only, have had limited success. Sixty percent of mortgages are non-amortizing and another sixty percent utilize floating rates, both of which are not mutually exclusive.

The danger to the Korean economy from household debt has hardly come out of left field. Oversized debt is not only a risk, it is a drag on sluggish domestic demand plaguing the economy. Seoul seems to recognize tackling the issue would kill two birds with one stone, but past efforts to curb household debt have been derailed in favor of short-term gains. President Park’s attempts to curtail debt growth early in her administration were undercut by a series of rate reductions starting in August 2014 and seemed to take a back seat to short-term growth thereafter. Perhaps the most notable example is the government disregarding IMF suggestions to cap debt in favor of safeguarding growth in the construction industry, essentially kicking the can down the road. With interest rates on the rise in the U.S., Seoul may now be running out of pavement much faster than it was expecting.

The benchmark U.S. and Korean interest rates will be the same by the end of the year if the Fed raises rates two more times by 0.25% and the BOK holds at its current rate. The prospect of this parity alone would be too distressing for the BOK to tolerate, but market forces in the interim should force their hand well in advance. If the Fed stays on course, all signs point to at least one BOK rate increase this year, though more would not be surprising to maintain some distance ahead of the U.S. The new Korean administration will inherit an economic dilemma that creative solutions alone cannot resolve. Past presidents may have sacrificed long-term stability for short-term gains, but the winner of the election in May must realize they will not have such an option.

Kyle Ferrier is the Director of Academic Affairs and Research at the Korea Economic Institute of America. The views expressed here are the author’s alone.

Photo from Ervins Strauhmanis’s photostream on flickr Creative Commons.

By Kyle Ferrier

This year’s G-20 summit in Antalya, Turkey may best remembered for the inclusion of non-economic issues in response to the terror attacks in Paris and the migrant crisis in Europe, but the final agreement also reflects the work of officials from participating governments since late last year.  In a previous post I outlined how the rotating G-20 presidency permits countries to shape the agenda and discussed how South Korea’s inclusion of development during its 2010 presidency continues to be a significant contribution. In addition to development, South Korea added global financial safety nets to the agenda, but comparing progress on the two issues reveals stark contrasts. Whereas advancement on development issues can be monitored annually, advancements on global financial safety nets have proven to be more elusive, yet a breakthrough in the area is important to shore up global economic stability.

Addressing global financial safety nets in Seoul not only indicated global demand for reform, but reflected South Korea’s history with the IMF. After South Korean markets crashed in November 1998 the IMF offered $60 billion in loans to the Kim administration to immediately stabilize the domestic economy, which also included conditions to increase the economy’s competitiveness. These conditionalities, such as those on labor market flexibility, caused painful structural reforms and were so unpopular that the possibility of a new loan from the IMF continues to be politically untenable in South Korea. When the departure of nearly $50 billion from domestic markets during the Global Financial Crisis (GFC) of 2008 left the country on the verge of a liquidity crisis, the Bank of Korea undertook a $30 billion bilateral swap agreement (BSA) with the Fed rather than drawing from an IMF facility or the IMF-linked Chiang Mai Initiative (CMI). Although this agreement with the Fed expired on February 1, 2010, later that year South Korea attempted to elevate the role of these central bank agreements in Seoul.

 Despite the inability of its most ambitious policy proposal to gain momentum, South Korea’s addition of financial safety nets to G-20 talks led to some initial successes. Wanting to make bilateral currency swaps more permanent and to decrease the involvement of the IMF in times of financial crisis, the Lee Myung-bak administration introduced a global swap regime, which it argued would reduce the need for reserve accumulation through a central bank swap regime similar to the lines of credit extended by the Fed during the GFC. The unclear management of moral hazard and the inevitable burden placed on the Fed as the issuer of the global reserve currency ultimately prevented the proposal from being adopted. However, the 2010 Seoul summit did lead to the enhancement of the IMF’s Flexible Credit Line (FCL), aimed for countries with strong fundamentals in a cash crunch, and the introduction of the Precautionary Credit Line (PCL), designed for countries with sound fundamentals but moderate vulnerabilities. The PCL would then be supplanted at the Cannes summit of 2011 by the Precautionary and Liquidity Line (PLL) to have a more flexible qualification process than its predecessor.

 Since its approval by the IMF Board of Governors in December of 2010, implementation of the IMF Quota and Governance Reform has unequivocally been the most pressing agenda item pertaining to global financial safety nets. While it was approved in the IMF with overwhelming support, the reform package doubling IMF lending capacity and shifting the weighted-voting representation in the institution continues to be stalled in the U.S. Congress, with little prospect for ratification.  The concluding communiqués of G-20 summits from 2011 to 2013 all broadly stated member country commitment to quota reform, but representatives did little to hide their exasperation at Brisbane in 2014, stating, “we are deeply disappointed” with the delay and made specific reference to the U.S. as the last remaining holdout.  To put this in perspective, the only other time “deeply” is used in the document is in reference to concerns about the Ebola outbreak in East Africa. The year’s communiqué from the G-20 Finance Ministers and Central Bank Governors Meeting used the same language to express disappointment with the U.S. Because the demand for the ex-ante arrangements providing liquidity in times of financial crisis is not being met at the multilateral level, countries have increasingly looked to bilateral and regional agreements for emergency currency supply.

 The G-20 has facilitated talks on the collaboration between Regional Financing Arrangements (RFAs) and the IMF, yet there has been little discussion regarding how to manage a rising number BSAs. Until the 2013 G-20 summit in St. Petersburg, RFA-IMF cooperation was a key component of the agenda on global financial safety nets, but in 2012 the development of the CMI into the CMI Multilateralization (CMIM) and the introduction of the European Stability Mechanism (ESM) as well as strengthened communication networks with the IMF for both institutions obviated the need for more substantive work on this issue in the G-20. Though this represents a significant achievement for the G-20, the rise of BSAs since the global financial crisis represents a potential challenge for the IMF and RFAs as BSAs inherently lack conditionality and in some cases can offer greater access to emergency liquidity.

Since 2008 China has signed the most of these such agreements with over thirty RMB-denominated BSAs, but unlike Fed swaps, which were a reaction to an emergency situation, these BSAs are part of a long-term policy to internationalize the RMB. Several of these agreements are with CMIM countries, including South Korea, Hong Kong, Malaysia, Singapore, Thailand, and Indonesia. The values of all of these agreements are significantly higher than the IMF de-linked funds accessible in the CMIM with the continued potential for their increase as was demonstrated last week with Indonesia. Though the swaps may not be in the more widely-used USD and are merely intended to facilitate trade, they can readily be converted into USD in emergency situations as demonstrated by the examples of both Argentina and Pakistan.  Additional BSAs within CMIM membership include the USD-denominated ones by the Bank of Japan with Singapore, the Philippines, and Indonesia as well as a local currency agreement between the Bank of Korea and Indonesia. How to best incorporate BSAs within the existing financial stability regime at a time of stalled progress in the IMF should be of global concern, but of particular importance for South Korea and other CMIM members. Some experts have even begun to question the relevancy of the RFA in light of the BSAs.

 Though pushing through IMF reforms is unlikely to be removed from the G-20 agenda, the Antalya G-20 summit may very well have been the final one in which the 2010 IMF Quota and Governance Reform was discussed. IMF rules state that there must be a General Review of Quotas by December 15, 2015 and there have already been new proposals to enhance IMF legitimacy and efficiency that are also aimed to be either more palatable for Congress or which could bypass Congress altogether.

 Regardless of whether a completely revamped quota system is adopted or countries reaffirm their commitment to a system more or less similar to the one proposed in 2010, 2016 may mark a watershed year for global financial safety nets in both the G-20 and the IMF. Moreover, China’s presidency of the G-20 next year makes the prominence of global financial safety nets on the agenda all the more likely since it is the IMF member with the most to gain from an IMF quota adjustment. As BSAs continue to rise in importance as tools for financial stability, China’s presidency may also provide an ideal opportunity to address the relationship of these bilateral currency agreements to RFAs and the IMF. Despite the lack of progress on global financial safety nets, their persistence on the G-20 agenda is representative of their lasting importance.   They may yet prove to be as fruitful a contribution from South Korea as was Korea’s championing of the development agenda.

Kyle Ferrier is the Director of Academic Affairs and Research at the Korea Economic Institute of America. The views expressed here are the author’s alone.

Photo from Fr Lawrence Lew, O.P.’s photostream on flickr Creative Commons.