Why China cannot rely on consumers to spend their way out of the trade war
The nation’s consumers are pulling back on their spending on discretionary items as income growth slows and household debts rise
Mounting debt levels and rising uncertainty about the economic outlook appear to be weighing on the ability and willingness of China’s middle class to buy high-priced products, a change that may thwart Beijing’s expectation that consumer spending will offset trade war-related export losses and help maintain steady economic growth.
Chinese households appear to be scaling back their discretionary spending and following a new fashion of minimising luxury purchases, challenging Beijing’s narrative that China’s vast domestic market of a billion consumers is ready to open their wallets for better products and services.
Instead of a “consumption upgrade” – the phrase the government likes to use to describe Chinese consumers’ growing demand for high-quality and higher-priced cars, art and travel – many Chinese are taking the opposite approach. They are cutting conspicuous consumption – lavish spending to indicate social prestige – and are turning to cheaper substitutes.
Even as households have been borrowing more, data indicates they have been spending less. Banks’ outstanding loans to households jumped 19 per cent year on year in May and 18.8 per cent in June, but China’s overall retail sales growth rate dropped to a 15-year low of 8.5 per cent in May before rebounding slightly to 9 per cent in June.
Shen Weipeng is a 29-year-old trust manager in Beijing, working in one of the highest-paid vocations in China. His after-tax income last year was about 260,000 yuan (US$38,000).
He decided to cut his spending this year by replacing his favourite cocktail with water, cancelling a planned trip to Europe and sticking with his current mobile phone even though the screen is badly cracked.
Shen said he was trying to save money because he had a monthly mortgage payment of 11,000 yuan on his flat and was concerned about his income prospects, with the government’s crackdown on shadow banking having significantly reduced average incomes in the trust investment industry.
“I just have no better choice than to cut back on my spending,” he said. “My income was cut by about 30 per cent this year from a year earlier because of the broad downturn in my industry.”
Shen’s financial situation is not unusual in China, where discretionary spending is often limited by a large mortgage payment and confidence about future income has been undermined by a less optimistic economic outlook.
At the end of last year, total outstanding individual mortgage loans and borrowing from the public housing fund rose to 26.4 trillion yuan, meaning that housing-related loans made up 57 per cent of overall household debt, according to government data.
Considering that many Chinese use consumer loans to come up with the down payment on a house or to help pay their monthly mortgage bill, the weight of real estate debt on purchasing power is even heavier.
It is clear that total household debt in China is rising very quickly, mainly due to mortgage and other property-related loans.
Meanwhile, the ratio of rent to disposable income in Beijing and Shenzhen is 58 and 54 per cent respectively, according to data compiled by Chinese property service company E-House.
China’s household loans of all types – although mainly mortgages – amounted to 40.5 trillion yuan last year, with the ratio of household debt to gross domestic product rising to 49 per cent from 28 per cent in 2011. Fitch, the rating agency, said China’s household-debt-to-disposable-income ratio could hit 100 per cent by 2020, up from 82 per cent at the end of 2017.
Economist Christopher Balding, who has taught for the past nine years at Peking University’s HSBC School of Business in Shenzhen, has gone further. Writing for Nikkei Asian Review last month, he estimated that the country’s household-debt-to-income ratio reached 120 per cent in the past year, with an imbalance created by household debt growing at 20 per cent a year and disposable income rising at 9 per cent a year.
Qin Han, chief fixed-income analyst at Guotai Junan Securities, wrote in a research note last month about the recent emergence of the “consumption downgrade” phenomenon.
“Mortgages are an obstacle to consumption that cannot be avoided,” he said. “Rents are also significantly squeezing consumer spending.”
“The lipstick effect has emerged in China,” Li Xunlei, chief economist with Zhongtai Securities, told the South China Morning Post, referring to the phenomenon of consumers being more willing to buy less costly luxury goods instead of more expensive ones.
“The high household debt ratio has influenced consumer demand, especially leading to slower retail sales growth. To boost consumer spending, first the authorities need to raise disposable incomes, especially those of low and middle-income groups,” he said.
“The government should decrease investment in infrastructure and spend more on education, medical services and other public services.”
According to a report by the consultancy McKinsey published at the end of 2017, “Chinese consumers have good reasons to be cautious about the future, given the high debt ratios of the economy and households.”
Rapidly rising consumer debt is being accompanied by a worsening outlook for the economy, and thus incomes. China’s economic growth rate slowed to 6.7 per cent in the second quarter this year, from the first quarter’s 6.8 per cent, and is expected to slow further in the second half of the year due to the effects of the government’s drive to reduce debt levels and the trade war with the US.
In the first half of 2018, the rise in Chinese incomes slowed to 6.6 per cent adjusted for inflation, a growth rate slower than that of GDP, according to the National Bureau of Statistics. That compares with 8.3 per cent in the first half of 2014.
Since 2014, the median disposable income has been lower than the mean figure, meaning that the population with meaningful spending power has been shrinking. Urban consumer spending growth in the second quarter year on year was 4.7 per cent, the statistics bureau’s data showed, continuing a broad trend over recent years: it stood at 7.3 per cent in the first quarter of 2014.
“The slowdown in household income growth may be constraining some consumers’ spending power and expectations,” Liu Yunan, from China’s top economic planning agency the National Development and Reform Commission (NDRC), said at a press conference last week.
A number of articles on how to change one’s lifestyle to save money have gone viral on Chinese social media this year. “No afternoon tea, just use the time to diet,” one article advised. “No more taxis or ride hailing, buses and shared bikes will do. And no new clothes; after all, work uniforms should be fine.”
One question posted on Zhihu, the Chinese version of question-and-answer site Quora, about “how to downgrade consumption to survive 2018” has attracted more than 1,300 answers and 17.5 million views.
The responses offered suggestions such as “no food delivery, no milk tea and no electronics upgrades” as well as “cooking your own food, eating Lao Gan Ma chilli sauce (only 10 to 30 yuan) and pickled mustard”.
Zhao Yufang, a high-school teacher in northern China’s Hebei province, said she would not buy any new clothes unless Uniqlo had a sale. She also cancelled a trip to Cambodia.
Social welfare coverage is patchy: although 95 per cent of the population is covered by some form of public medical insurance, the coverage focuses mainly on basic medical care and excludes many life-saving cancer drugs or treatments.
This has resulted in heavy financial burdens for the families of many people with cancer, sometimes even dragging them into poverty.
It is common for people to save not only for health care but for old age, with debate surrounding whether the government pension system can cope with China’s rapidly ageing population.
The NDRC said last month it had approved a three-year action plan to boost consumer spending.
A weak performance in the country’s stock market – the benchmark Shanghai Composite Index has lost over 15 per cent so far this year – and a weaker yuan have not helped to shore up consumer confidence.
Weakness in retail sales is already clear even in an economy with a per capita GDP level rising towards the US$10,000 mark. For instance, Starbucks reported last quarter the first decline in its profitability in China in nine years.
British retailer Marks & Spencer tried to tap into China’s middle-class consumer market but was forced to pull out of the country in 2016 after years of disappointing sales.
If the situation continues, it would be bad news for foreign brands trying to ride the wave of consumerism in China.
Firms offering inexpensive products are thriving, however. The latest example is Pinduoduo, a three-year-old e-commerce platform that went public on the Nasdaq exchange last month.
Specialising in cheap goods to appeal to lower-income consumers, Pinduoduo claims to be the third-largest Chinese e-commerce player behind Alibaba and JD.com. Many of its products cost less than 10 yuan, including pyjamas and trainers.
Revenue for the Shanghai-based firm, whose website has nearly 300 million active users, more than tripled in 2017 to US$278 million, according to its filing to the US Securities and Exchange Commission – making it an early beneficiary of the seemingly changing habits of China’s cost-conscious consumers.