The government has belatedly come up with a plan to prevent Korean construction companies and shipbuilders from getting in trouble by winning risky and unprofitable overseas contracts.
The Ministry of Strategy and Finance announced Tuesday that state-run financial institutions would be required to carry out a rigorous profitability test when they are requested by construction firms and shipbuilders to provide financing for large-scale overseas projects.
For this, the government plans to set up a profitability evaluation center within this year. It will be staffed with industry experts and officials from state-run institutions, including the Korea Development Bank, the Export-Import Bank of Korea, and Korea Trade Insurance Corp.
The evaluation center will analyze the profitability and risks of a project to determine whether it deserves government-backed financing. Projects that fail to pass the test will be denied financial support from state-run banks.
The plan is well advised. The government should have put in place such a system much earlier to prevent moral hazard, as companies benefiting from state-provided financing could be tempted to take excessive risks in the belief that the government would ultimately bail them out.
In the absence of such a mechanism, construction firms and shipbuilders recklessly won risky and unprofitable projects, only to incur huge losses.
The nation’s top three shipbuilders — Hyundai Heavy Industries, Samsung Heavy Industries and Daewoo Shipbuilding & Marine Engineering — recorded combined operating losses of more than 5 trillion won ($4.3 billion) in the second quarter alone.
In the third quarter, their balance sheets were expected to improve, but they posted another 2 trillion won in operating losses.
Most of these losses resulted from the oil and gas production offshore plant projects they obtained in recent years. Offshore plants were not a specialty of shipbuilders, but they sought to branch out into the new field to leverage their shipbuilding expertise.
This diversification effort itself was not to blame. The problem was that the shipbuilders recklessly attempted to win orders that were far beyond their limited capabilities. They underestimated the level of expertise required to build offshore plants.
Furthermore, they staged fierce competition among themselves to get plant orders, often quoting below-cost prices just to undercut their rivals.
The cost of such an imprudent practice is dear. The government has decided to pour 4 trillion won into Daewoo to restructure the distressed company. Hyundai and Samsung are undergoing painful restructuring processes on their own.
Many Korean construction companies also suffered large losses as a result of their ill-conceived attempts to win large-scale plant projects in the Middle East.
They should have accumulated experience in plant construction before taking on complex projects.
The government’s plan is expected to mitigate the moral hazard problem and curb the harmful practice of bidding for projects below cost to secure work or undercut compatriot rivals.
It is also expected to expedite corporate restructuring in the construction and shipbuilding industries. Financially distressed companies tend to chase risky and unprofitable projects to maintain cash flow.
But under the proposed system, they would find cash flow difficult to maintain, as government financing would no longer be available for unprofitable projects.
