|North Korea’s External Debts: Trend and Characteristics|
North Korea should begin repaying South Korea’s food loans this year. The South provided food to the North on six occasions between 2000 and 2007, delivering a total of 2.4 million tons of rice and 200,000 tons of corn worth US$720 million. By June 7, Pyongyang is obligated to pay $5,830,000 for $88 million worth of food received in 2000. However, considering the North’s economic difficulties and strained relations between the two Koreas, payment is unlikely.
As the payment date approaches, concerns are growing among North Korea watchers about the overall state of the North’s debts to South Korea, the former Soviet Union, China, Japan, France, Germany, Britain and other countries. The scale of the North’s foreign debts is unclear as Pyongyang rarely provides economic data, particularly in the sensitive area of its external liabilities. Outsiders’ efforts to access correct figures have not been successful. This study aims to draw the outline of North Korea’s external debts, but the author should admit that his observation cannot but be partial and provisional because of the unavoidable scarcity of data and information.
Part II of this paper briefly reviews North Korea’s external economic relations during the 1970s, when the socialist state’s foreign debt problems initially surfaced about the middle of the decade. Part III reviews the debt increase in the following years. It tries to gauge the overall scale and delves into the background and causes of repayment problems. Part IV examines special conditions existing between the North and the respective lender nations.
II. North Korea’s External Economic Relations in the 1970s
1. Change in Economic Policies and Expansion of Trade with the West
North Korea’s external economic policies changed dramatically in the 1970s. The first sign was massive imports of machinery and plant facilities from advanced economies, including Japan, France, West Germany and Britain, beginning in 1972. What was surprising was that trade with these capitalist nations were made with loans.
As <Table 1> indicates, North Korea in the 1960s incurred foreign loans mostly from socialist states, but during the next decade, loans from capitalist states exceeded those from socialist countries. Between 1971 and 1980, North Korea borrowed $1,292 million from capitalist nations, an amount that exceeded all of foreign loans that it incurred in the 1960s.
The lending enabled trade between North Korea and the West to expand during the 1970s. Loans from OECD members were concentrated in the four-year period of 1972 through 1975 and they naturally led to rapid increases in trade with these countries. (Refer to <Table 2>.) Imports from the OECD members outpaced exports from them.
Trade with the OECD members increased drastically in 1972 and peaked in 1974, when the North’s imports from capitalist states, including developing countries, accounted for 53.7 percent of its total inbound goods, overtaking those from socialist states for the first time. Imports from the OECD declined rapidly after 1975.
Pyongyang’s expanded trade with the West produced huge trade deficits. (Refer to <Table 2> and <Table 3>.) During 1971-75, North Korea’s trade deficits with OECD nations totaled $1.05 billion and the trade gaps with socialist states amounted to $970 million. Thus, the deficit figures which were $242 million in 1961-65 and $400 million in 1966-70 ballooned to $1,932 million in 1971-75. The rapid increase of trade deficits led to the problem of heavy foreign debts.
Beginning in 1973, when the first global oil shock sharply increased petroleum prices, North Korea had to spend more for its imports than it earned from exports. While it was paying more for the imports of machinery and plant facilities, the prices of non-ferrous metals, including lead and zinc, which were the North’s main exports, nosedived. In addition, trade demand from Western industrialized nations fell. (Refer to <Table 3>.)
2. Background to Changes in External Economic Policy
North Korea’s expanded economic relations with the West in the early 1970s came amid détente between Cold War adversaries. Relations between the Eastern socialist bloc and the Western capitalist world rapidly improved with the so-called “ping pong diplomacy” between the United States and China, U.S. President Richard Nixon’s trip to Beijing in 1971 and his visit to Moscow the following year. East European countries, which had stagnant economies, took advantage of the détente by tapping capital from the West.
In the meantime, China opened its doors to former capitalist foes and North Korea followed suit, establishing diplomatic relations or exchanging trade offices with a number of European nations. Moreover, an overheated international financial market and lenders offered loans to the North in 1972 to early 1973.
North Korea was anxious to achieve its economic development goals under a six-year plan (1971-76), which it vainly tried to reach two years in advance. North Korean leaders realized that cooperation with socialist states alone did not guarantee success and were attracted to the advanced technologies of Western capitalist states.
In the meantime, dialogue with South Korea started in 1971 for the first time since the Korean War and the two Koreas issued a joint communiqué on July 4, 1972, pledging bilateral efforts toward peaceful reunification.
In 1972-1973, before the global oil crisis, the prices of gold, silver, lead, zinc and other export items of North Korea were rising and Pyongyang must have been confident of its payment capabilities. North Korean leaders had taken note of South Korea’s economic development through introduction of Western technologies. All these developments led North Korea into deciding to spur development with large-scale buildup of manufacturing plants with Western equipment and financing.
III. North Korea’s Foreign Debt Problems
1. Historical Review
North Korea’s foreign debt problem was exposed for the first time in 1974. In July that year, the North failed to make an initial down payment for steel products from Japan and the shipment was suspended. As the news was reported, North Korea’s other trading partners in Japan and Western Europe pressed Pyongyang for payment for their exports and some banks dispatched their representatives to Pyongyang to demand early settlement of its liabilities. To raise capital, the North issued bonds and obtained new loans but failed to elicit any significant support from the international financial community. Thus, in June 1975, North Korea began negotiating payment deferments with major creditor nations.
In July 1975, Euler Hermes, a leading credit insurer of West Germany, suspended its credit insurance for exports to North Korea, alerting the related businesses. About the same time, the Japanese Export-Import Bank refused to extend loans to North Korea and the Ministry of Trade and Industry virtually halted insurance for trade with the North. In May 1976, a British private consulting agency for North Korean trade was closed and European banks soon held official and unofficial meetings for joint pressure on the North for debt payments.
By 1977, North Korea had reached debt rescheduling agreements with Japan, Sweden, West Germany, France, Switzerland and Austria. In negotiations with West European lenders, North Korea demanded eased payment terms and replacement with new loans, and finally in July 1987, a group of about 140 European banks declared North Korea a default state. With Japan, North Korea obtained deferment of import payments for the third time in April 1983, but Pyongyang suspended payments in January 1984 under the excuse of political reasons.
North Korea’s loan default has continued and occasional negotiations between North Korean authorities and Western lenders’ group ended without clear results. After the dismantling of the Soviet Union in 1989-1991, Russia and North Korea discussed debt payments but the talks went nowhere. Summing up, North Korea has been unable to make interest payments, let alone paying off the principal, since the middle of 1984. Hence the accumulated interest has surpassed the total principal.
2. Overall Scale and Characteristics of North Korea’s External Debts
Because no official data is available on North Korea’s foreign debts as well as its major economic indices, including the gross national product, this study has to rely on estimates by international agencies. The South Korean government and the OECD released their estimates during the 1980s to the 1990s, but have not provided any officially recognized data since 2000.
During the 1970s, a number of overseas institutions sporadically produced provisional North Korean debt figures. The U.S. Congress, for example, reported that North Korea’s foreign debts amounted to $55 million in 1970, which soared to $725 million in 1974. The U.S. Central Intelligence Agency estimated that the North’s external debts stood at $2.4 billion as of the end of 1976, of which $1.4 billion was owed to capitalist states and the rest to socialist nations. The New York Times and the South Korean government estimated the North’s total debts at $2.3 billion, while the West German newspaper, Handelsblatt, reported the total amount reached $2 billion. Based on these figures, it may well be said that North Korea’s foreign debts in 1976 – two years after its debt repayment problems surfaced – amounted to somewhere between $2 billion and $2.4 billion.
Estimates became more complicated in the 1980s and 1990s. (Refer to <Table 4> and <Table 5>.) There were significant gaps between figures provided by the South Korean government and the OECD, for example. Seoul speculated that the North’s external debts grew from $2.23 billion in 1980 to $7.86 billion in 1990 and to $12.46 billion in 2000. The OECD figures were considerably lower with $4.88 billion for 1990 and $7.43 billion for 1998. According to the South Korean authorities, the North’s debts to capitalist countries ($2.80 billion) exceeded those to socialist states ($2.41 billion) in 1987 but the table turned two years later to show $2.74 billion owed to the West and $4.04 billion to the East.
Regarding North Korea’s external debts after 2000, only scattered and piecemeal data and estimates have been available. In 2008, Kwon Young-se, a lawmaker of the Grand National Party, claimed that North Korea owed a total of $18 billion in debts to about 30 foreign states including China, Russia and East European nations, attributing the figure to an unnamed intelligence agency. He said that the amount almost equaled North Korea’s GDP. On January 1, 2008, Bloomberg reported that the North’s total external debts amounted to $15 billion. Britain’s Financial Times on August 19, 2010 reported an estimate of $12 billion, of which two-thirds were concentrated in former socialist states.
It should be noted that any estimate of North Korea’s debts cannot but be provisional figures, considering that Pyongyang is still negotiating with lenders for write-offs and rescheduled payments. In addition, currency exchange and interest rates add to the flexibility of any estimates. One thing that is certain is that the scale of the North’s foreign debts continues to swell because of the huge amount of overdue interest.
North Korea’s repayment capabilities can be assessed by comparing its debt scale to its export volume or GNP, and then comparing these ratios with those of other nations. (Refer to <Table 6>.) In 1995 North Korea’s ratio of foreign debts against GNP was slightly above the average of low-income and lower-middle-income economies. But more noteworthy was the ratio between external debts and exports. The North, with a small export volume, shows an extremely high ratio, compared to other low-income countries and even to Mexico and Hungary, which have even higher debt-to-GNP ratios. The North’s debt-to-export ratio in 1995 was 10 times higher than the average of low-income and lower-middle-income economies. These figures clearly reveal the extremely worrisome status of North Korea’s debt repayment capabilities.
3. Background and Causes of North Korea’s External Debt Problem
North Korea has been under chronic trade deficits since the founding of the state. To determine why the country’s external debt problems emerged in the middle of the 1970s, it is necessary to take note of not only its trade volumes but current account and capital account figures as well as the overall international balance of payments.
<Table 7> provides clues to why North Korea had no external debt problems until the early 1970s. It is highly likely that North recorded current account surpluses during the 1950s, thanks to foreign grants that were abundant enough to cover its modest trade deficits. Grant-type aid was discontinued in the 1960s, but the return of Korean residents from Japan during those years must have meant a substantial amount of foreign capital brought into the North. This probably helped the North maintain surpluses in international payments. In the 1970s, however, the capital inflow from Japan declined, causing a depletion of foreign exchange reserves in North Korea.
There were several important reasons for North Korea’s swelling foreign debt problems in the middle of the 1970s. First, the unexpected oil shock increased import payments while export earnings dwindled. Second, North Korea’s foreign exchange reserves amounted to only $300 million to $400 million, with its gold reserve worth $56,740,000 and silver $63,140,000, according to available data. By 1973, the North already was asking Japan to accept iron ore instead of cash for import payments.
Third, trade deficits continued to expand as the North had few other products to export when demand for its non-ferrous metals declined. A typical underdeveloped economy, North Korea had extremely low export competitiveness as a result of its ill-advised macroeconomic and trade policies. With limited energy resources, insufficient capital and low technological capabilities, the North was forced to increase imports of capital goods and intermediary materials in an effort to pursue industrialization. Without considering the country’s overseas sales capabilities, North Korean authorities often decided to import expensive machinery and equipment for political reasons.
Efforts to increase exports met unsatisfactory results. The North was only able to sell some raw materials and half-processed products based on its relatively abundant natural resources. Export of manufactured goods was limited because of generally low product quality. In North Korea, where goods are chronically in low supply, producers did not have to care about quality; their focus was on meeting supply targets.
Fourth, foreign debts rapidly accumulated because North Korea neglected repayment of loans introduced in the early stages of economic development. North Korea received large-scale grant aid from abroad in the 1950s, but foreign credits increased rapidly as grant aid was discontinued and beginning in the 1970s most capital inflows were made through loans. The maturity of earlier loans approached while trade deficits swelled. New loans were incurred to pay overdue interest and principal and the overall scale of external debts snowballed.
IV. Particularities with Major Creditor States
1. North Korea’s Debts to Russia
1) Russia’s Loans to Developing Countries
Most borrowers from Russia are poor countries seeking debt rearrangements through the intervention of the World Bank, IMF, OECD and the Paris Club. As it joined the Paris Club in 1997, Russia follows the multilateral debt relief framework established by the organization of lending nations. For the ruble-denominated loans signed before January 1, 1992, the exchange rate of 0.6 ruble to the dollar will be applied, but Russia will make upfront discounts of 70 to 80 percent for these loans with the remaining liabilities to be paid in accordance with the “Naples conditions” providing further reduction by 50 to 67 percent on the basis of the present value of the debt instead of its nominal value.
Assuming North Korea joins international financial organizations and agrees to the IMF programs for economic reform, its debts to Russia will be subject to the debt relief formula of the Paris Club. Otherwise, North Korea could seek bilateral debt relief negotiations with Russia. If the debt rearrangement Russia made with Laos is benchmarked, the exchange rate will be 0.6 ruble to the dollar and a 70 percent discount will be given with a further cut of 20 percent on the basis of the present value. The result will be a reduction to 24 percent of the original amount. If the latest “Cologne terms” are applied, liabilities may be discounted down to 10 percent.
2) North Korea’s Debts to Russia
Throughout the 2000s, the two governments continued negotiations to reassess North Korea’s debts to the Soviet Union, but no clear-cut result was seen despite Moscow’s offer of drastic loan cuts. In December 2006, it was reported that Russian Deputy Finance Minister Sergei Storchak and his North Korean counterpart Kim Yong-gil agreed that the North’s debt to the former Soviet Union, amounting to 3.6 billion rubles, would be reappraised at $8 billion and an 80 percent discount on the amount would be given. Details were to be resolved before the third meeting of the Russia-North Korea Cooperation Committee for Trade, Economy, Science and Technology, scheduled to be held in March 2007.
However, the bilateral cooperation committee only reaffirmed the “principle of resolution through an adequate agreement,” indicating backpedalling on negotiations. At the latest fourth committee meeting, held in Pyongyang in September 2011, Russian Regional Development Minister Victor Basargin and the North’s External Trade Minister Li Yong-nam signed a 26-point agreement, but again no concrete accord was made on the North’s debts.
In addition to its 80 percent discount offer in 2006, Russia is reported to have proposed a 90 percent cut in the 2011 meeting. Deputy Finance Minister Storchak said in September last year that Russia would give a 90 percent relief for North Korea’s debts amounting to $11 billion and that the remaining 10 percent might be converted into investments in energy, medicine and other areas. When Russia signed an MOU with North Korea last August on the laying of a gas pipeline through the North Korean territory, it reportedly expressed intent to make a 90 percent debt relief for North Korea.
No final accord has been made, however. Basically, the problem is that North Korea is not willing to recognize Russia as the legitimate successor to the Soviet Union. Besides, there has been no agreement on the details of debt reassessment. Most importantly, North Korea seeks a political settlement of the debt issue while Russia does not intend to do so. In the third inter-governmental cooperation committee meeting in March 2007, the North Korean chief delegate said that his country was not capable of repaying the Russian credits and that the issue could be resolved through political decision.
As the two governments were unable to reach a final agreement on the amount of debts to pay, there are only Russian quotations, which ranged from a low of $8 billion to a high of $11 billion. The higher figure was mentioned by the deputy finance minister in August 2011, when Kim Jong-il was meeting Russian President Dmitri Medvedev in Ulan-Ude in eastern Siberia. Russian media explained that the amount of North Korean debts increased by $3 billion over the past five years because of overdue interest and penalties for failure to make payments.
Russia has the final say about the debt issue but many experts agree that Moscow’s “major decision” is not impossible, considering its ambitions to gain leadership position in Northeast Asia through grand energy and railway projects as well as the six-party negotiations for North Korea’s denuclearization.
2. North Korea’s Debts to China
The most outstanding fact about North Korea’s debts to China is that their overall scale and the moves between the two countries for their settlement have remained in almost complete secrecy. The South Korean authorities speculated in the late 1980s that the total amount could range from $580 million (in 1987) to $100 million (in 1989), but no such approximate estimate has ever been made since the 1990s.
Following the disintegration of the Soviet Union in 1991, China replaced the Soviets as the guardian of North Korea, and trade between the two countries spiked upward. While North Korea recorded large trade deficits, China is believed to have provided the North with significant amounts of aid in grants as well as credits. But no estimate is available about the overall scale of liabilities.
As the above table indicates, trade between North Korea and China increased dramatically in the 2000s, with the North recording large deficits each year without an exception. The North’s trade deficits during the decade aggregated at $6,106 million, which represented a 68.8 percent increase over the accumulated deficits in the preceding 10 years ($3,618 million). The figure even exceeded the total trade deficits recorded during the 50 years from 1951 to 2000 ($5,499 million). These large deficit figures raise the question of how the gap has been coped with. The natural answer is that the North must have incurred enormous amounts of debts to its neighboring guardian state.
Since the rupture of the socialist bloc, China is known to be providing its impoverished neighbor with various commodities on credit. About 500,000 tons of crude oil has been delivered annually to North Korea via a pipeline from Heilongjiang Province. International prices are applied to the oil shipments but North Korea has presumably been offered concessional credits for payment. In addition, North Korea receives considerable amounts of food from China annually, a large portion through commercial transactions and an unknown amount through grants and concessional credits.
It may well be assumed that the North’s accumulated debts have reached a high level, especially since the 2000s, but there is no way for outside observers to know how the two states are seeking ways to settle the liabilities. Since the North suffered economic difficulties and its reliance on China continued to deepen amid amicable relations throughout the 2000s, the unpaid debts may not be too serious a problem yet and political settlements are highly likely.
3. North Korea’s Debts to OECD Members
After North Korea’s external debt problem emerged in the mid-1970s, the alerted banks of the West formed creditor groups to make joint negotiations. In March 1977, 31 banks reached a rescheduling agreement with the North’s Choson (Korea) Trade Bank. North Korean authorities, however, fulfilled only a part of the agreement and repayment terms were virtually ignored. In 1987, a total of 140 banks again formed a creditor group represented by Britain’s Morgan Grenfell and the ANZ (Australia and New Zealand Banking Group), but negotiations fell apart because of North Korea’s lukewarm attitude.
After these failures, the OECD creditors took remedial steps to save themselves. They recognized their credits to North Korea as nonperforming loans and received compensations from export insurers and credit guarantors. The collected insurance money must be substantial in each member country but the whole amount has not been confirmed.
Externally, the OECD creditors filed suits against North Korea in August 1990 and in April 1992 with the International Court of Arbitration under the umbrella of the International Chamber of Commerce. The arbitration court ruled that the North should pay the requested interest and principal immediately but the ruling had no binding force.
Noteworthy was that the creditor banks, including ANZ, Morgan Grenfell and BNP (Banque Nationale de Paris), converted their credits to North Korea into bonds and began circulating them at low prices to recover their losses, though in only a small amount. Potential buyers of these bonds may calculate two possibilities: the bond price could rise when North Korea’s political and economic situations improve; and South Korea may repay the bonds when the two Koreas are reunited with the South taking over all outstanding liabilities of the North. Thus the South should find it hard to pay no heed to the North Korea bonds issued by the OECD banks.
4. North Korea’s Debts to Japan
North Korea’s failure to make import payments surfaced in Japan in 1974 and long-term delays over six months were reported in 1975. North Korea and Japan made debt rescheduling agreements in 1976, 1979 and 1983, but the North was unable to fulfill them. Especially in 1983 when Japan took economic sanctions against the North following the terror attack on South Korean presidential delegation in Yanggon (Rangoon), which was attributed to North Korean agents, Pyongyang retaliated with a halt to all payments to Japan.
Meanwhile, the two countries made official contacts occasionally to discuss debt problems. The Japan-North Korea Settlement Council was set up in 1977 to seek normalization of bilateral economic exchanges, including the North’s debt repayment. The Korea Trade Bank took charge of payments to Japanese general trading companies and other private businesses. Then in 1979, Japan established the East Asia Trading Institute for joint research on the expansion of economic exchange and study of industries and resources. Japanese members of the Japan-North Korea Settlement Council visited Pyongyang in 1987 and 1992 to discuss the debt issues with the Korea Trade Bank but they failed to find concrete solutions. Representatives of the East Asia Trading Institute also visited the North and heard Pyongyang wanted Tokyo to change its North Korea policies as a precondition for debt settlement.
In 1986, the Japanese government released export insurance funds to the general trading firms and other private exporters to cover a part of their losses. A total of 32 billion yen was released to about 30 companies in accordance with the Export Insurance Law. It was a move to relieve the difficulties of private exporters and help normalize trade with North Korea. The Japanese government thus took over a portion of the North’s liabilities and will try to settle them when the two countries normalize their relations.
South Korea and Japan set a precedent for comprehensive settlement of mutual claims and liabilities when they agreed on diplomatic normalization in 1965. Japan provided South Korea with $300 million in grants, $200 million in financial loans and another $300 million in commercial credits in addition to an unspecified sum of commercial loans. With the $300 million grant, South Korea’s debts to Japan, totaling $45,730,000 by that time, were cancelled.
When calculating the total amount of North Korea’s debts to Japan, it should be recalled that trade settlement between the two countries was made in West German marks until the mid-1970s. Under the yen-mark exchange rate in late 1976, when the two countries had their first debt rescheduling agreement, the principal of Japanese credits should have amounted to about 80 billion yen. North Korea repaid about 10 billion yen before it suspended payments to Japan in January 1984, with some 70 billion yen remaining in arrears. When interest is added to the principal, the total debts could exceed 100 billion yen, or could possibly amount to 200 billion yen depending on interest rates. By the present yen-dollar exchange rate (80 yen to the dollar), the North Korean debts could range between $1.2 billion and $2.4 billion. Given North Korea’s claims to Japan amount to around $10 billion, some 8 to 16 percent of it may go to offsetting the North’s debts to Japan.
The North Korean problem of external debts began surfacing in the mid-1970s and continued to worsen to reach a virtual default in the 1980s, with interests growing to exceed principals. If the oil shock in the early 1970s was a major external cause of the North’s debt problem, the communist state’s chronic trade deficits continued to undermine its repayment capabilities and aggravate the debt problem. The snowballing external debts obstructed international financial assistance and foreign investment, which are vital for economic recovery.
The overall scale of North Korea’s foreign debts is roughly estimated at $12 billion to $18 billion, which could be readjusted depending on debt relief negotiations with lenders. But overdue interests are to offset any cut in the amount of debts.
With Russia, there are the problems involving the application of ruble-dollar exchange rates and the scale of debt relief by the international standards. With OECD states, the North Korea bonds circulated by the creditor banks are among notable problems. Japan may seek to settle the North’s outstanding debts through diplomatic normalization with the regime in the future.
North Korea’s huge external debts pose a serious problem that cannot be overlooked as the two Koreas will eventually have to achieve reunification. But study on this important issue remains at the rudimentary stage with a critical lack of necessary data and information. The problem seems far more complicated than expected; it requires continued attention with in-depth research.
|[KDI Review of the North Korea Economy, March 2012,
published by the Korea Development Institute]