They say South Korea's economy may contract by as much as five per cent this year, unemployment will grow much worse and the banking system could collapse under the sheer weight of bad debt and a domino effect of corporate bankruptcies. "We have seen clear signs of severe recession taking hold in Korea in recent months," said Stephen Marvin, head of research at Ssangyong Investment and Securities in Seoul.

Industrial production plunged 11 per cent year-on-year in March -- but an extraordinary 45 per cent quarter-on-quarter.

Factories operated at around 65 per cent of capacity in March, which means unemployment -- already at a 12-year high of 6.5 per cent in March -- is likely to soar as plants startshutting down. "Disguised unemployment in Korea may be 25 per cent or more," said Dave Carbon, market strategist for Pacific Asset Management in Singapore. "The eventual outcome is clear. Either layoffs grow or firms go bankrupt and layoffs grow."

Economists are scrambling to revise their projections for gross domestic product. The government and the International Monetary Fund are expecting a one per cent decline in gross domestic product against 5.5 per cent growth last year.

Marvin at Ssangyong Securities projects the economy will shrink by five per cent. Rob Subarraman, regional economist at Lehman Brothers in Tokyo, is also predicting a five per cent drop in GDP. But Richard Samuelson, head of research at SBC Warburg Dillon Reed, is forecasting a 1.9 per cent drop and Mark Neale at Dresdner Kleinwort Benson is forecasting a one per cent fall. Much of the concern is over the growing mountain of bad debt in the banking system.

Finance minister Lee Kyu-sung said last week bad debts in the financialsystem had reached a staggering 120 trillion won ($83 billion), and half may have to be written off.

Lee Hun-jai, chairman of the Financial Supervisory Commission (FSC) that supervises the financial system, said financial sector reform will cost 81 trillion won over five years.

Half of it has to come from the government, he said. "More large bankruptcies are inevitable and the banking system will come under increasing pressure," Marvin said. "We will likely experience a full-blown financial crisis, a breakdown in the financial system, in the next few months."

The bearish view was reinforced last week when Moody's Investors Service lowered the long-term debt rating of 19 Korean banks. But FSC Chairman Lee says the situation is manageable. "I clearly say there will not be any crisis in June," Lee said in an interview.

"There will be some effort by the financial companies to negotiate with business firms to extend the terms to longer terms," he said. The International Monetary Fund's Asia Pacificdirector, Hubert Neiss, also dismisses talk of a new crisis. "I don't expect another crisis," Neiss said in an interview. "I think the government is able, and all interested parties are willing, to deal with the next difficult phase."

That phase involves massive debt rescheduling talks between banks and companies and means some banks and weak firms will have to exit the scene, he added. Marvin and others estimate corporate debt at more than a half-trillion won, or roughly 120 per cent of GDP.

"Monthly interest payments alone are 6.0 billion dollars. That means total interest payments this year will be more than half of total exports last year," Marvin said. "So a substantial portion of this debt must be written off, which means banks, foreign and domestic, have to book substantial losses." Dresdner Kleinwort Benson, in a recent report, predicted nearly 15 per cent of quoted stocks, mainly the smaller ones, could go bankrupt by the end of this year. More than 10,000 companies went out of business in thefirst quarter of this year, official figures show.

With bank debt drying up and share prices in the doldrums, corporations are looking for money on the bond market. Securities dealers say companies have offered 3.0 trillion won a month in new issues this year against 2.5 trillion last year.