China's Rebalancing Act: How Much Do Consumers Stand to Gain?Published: January 06, 2010 in Knowledge@Wharton
After a tough grind through the Year of the Ox, it's easy to see why China is looking forward to the beginning of the Year of the Tiger in February. Thanks in large part to the Chinese government's ability to keep the world's third-largest economy moving over the past 12 months with a massive, two-year, RMB 4 trillion ($585 billion) stimulus program, most analysts expect robust growth in the year ahead.
The government reacted swiftly to the global economic crisis by launching its stimulus program back in November 2008. Now, it is reaping the rewards. "With a larger than expected impact from the stimulus, China's GDP growth target, which seemed difficult to attain early in 2009, is now in the bag," wrote Louis Kuijs of the World Bank in a blog shortly after the government announced that real GDP growth rose to 8.9% year on year in the third quarter.
What's not as clear is where the country goes from here. True, analysts are predicting a bullish 9.6% annual rise in GDP for 2010, up from 8.5% for all of 2009. But that will be no small feat, particularly as the stimulus package begins to contribute less and less to that growth. In fact, sustaining growth now could be even more challenging than revving it up during the downturn. The key, say experts from the World Bank, Wharton and elsewhere, is for China to make a break with past expansionary policies and rebalance the economy in a way that reduces the country's overreliance on exports and manufacturing while increasing its focus on private consumption.
The Ones to Watch
If the past is anything to go by, however, getting China's consumers to spend is easier said than done. As a report from research firm Euromonitor International notes, in U.S. dollar terms, China's consumer market lags those of the U.S., Japan and much of Europe, with private consumption just over one third of GDP in 2008. China is also a country of savers: The average Chinese household saved 31.6% of its disposable income in 2008 -- nearly 10 times the 3.4% savings rate for U.S. households. But that is changing, albeit slowly, says Euromonitor: Consumer spending rose from $1.6 trillion in 2008 to $1.7 trillion in 2009, and is expected to reach $1.9 trillion in 2010.
It certainly helps that consumer confidence in China is more robust than it has been in a long time. A survey by The Nielsen Company found that consumer confidence in China in the third quarter of 2009 reached its highest level since mid-2007, particularly among individuals living in the country's tier-two cities, while nearly 60% of Chinese consumers polled describe local job prospects as "good" or "excellent" for the next 12 months, 14% higher than in the previous quarter. Another recent survey -- by Shanghai-based China Market Research Group (CMR) -- found that 80% of consumers believe the economy will accelerate over the next three years.
Even rural Chinese -- hard-hit by factory closures in 2009 and left behind economically as urban China has prospered -- are feeling fairly confident, according to Shaun Rein, president of CMR. A big part of the reason, he says, is that some of the stimulus program is benefiting them directly, including rebates and subsidies on white goods, such as dishwashers and air conditioners, and cuts in sales taxes for small cars -- which, according to the World Bank, helped the auto sector grow by a third in the first nine months of 2009 compared to the previous year.
Strong domestic demand has buoyed import volumes, and the current account surplus may fall from 10% in 2008 to 5.5% of GDP in 2009 and 4% in 2010, even with import prices down sharply, the World Bank reports. In addition, China's manufacturing expanded at the fastest pace in 20 months in late December, according to a report from Bloomberg, citing a manufacturing index released regularly by the Beijing-based National Bureau of Statistics and the Federation of Logistics and Purchasing. In a similar vein, a report published in late 2009 by Barclays Capital estimates that Chinese manufacturing output has risen more than 30% since January 2008, while that of Japan, Europe and the U.S. declined more than 10%.
Foreign companies are also benefiting from the reinvigorated domestic economy and growing consumer confidence. For proof, look no further than the humble TV. While the rural stimulus program encouraging consumers to buy old-fashioned cathode ray tube television sets backfired because of low traction, sales of flat-screen TVs -- both local and foreign made -- have been booming. Samsung Electronics, a South Korean company with extensive operations in China, posted a record 29% rise in sales in the third quarter of 2009, which its executives ascribe partly to China's growing consumer electronics market. Rival flat-screen TV and appliance producer LG also gained 15%. By 2012, the country's LCD TV market is expected to grow to 40 million units annually, making it larger than the U.S. market. "If you cannot succeed in the China market, you cannot succeed in the world," Keun-Hee Park, president of Samsung China, told reporters in Chengdu late last year.
From TVs to luxury goods, the one enticing segment of the consumer market that both foreign and local companies will continue to target heavily is the country's younger generation. According to China's national census bureau, there are roughly 200 million 15- to 24-year-olds in China -- about two-thirds the size of the entire U.S. population. Although the older generation saves up to 60% of their income, a CMR survey of 5,000 consumers ranging from 18 to 32 years old found that very few are saving. "They're just so optimistic about their futures," says Rein.
The optimism may be warranted. As the country's growth gets back on track, GDP per capita is expected to be $4,000 this year, up from $3,000 in 2008 and just $800 10 years ago, according to government statistics. But that is only part of the story, some analysts note: Statisticians rely on reported income -- a number that is often considerably less than what people take home, since government figures don't include such benefits as company cars and under-the-table earnings.
Why Wallets Could Snap Shut
However, even among China's younger big-spenders, a number of factors could dampen consumption in 2010. One of them is youth unemployment, particularly among university graduates -- 16% of whom were unemployed as of last month, according to government statistics.
Socially, the government's biggest concern is generating more jobs, according to Wharton management professor Marshall Meyer. Xinhua, the Chinese press service, recently reported that the People's Liberation Army is aiming to recruit up to 130,000 university graduates this winter, based on promises that the government will pay off their student loans and give them preference for government jobs after two years of service.
The rural unemployed are another group about which the government is concerned. The official registered urban unemployment rate tends to hover around 4%, according to the China Labor Statistical Yearbook for 2008. However, that number does not include rural migrants. Research by the China Economic Monitoring and Analysis Center, conducted in February 2009, found that 20 million workers -- or 15.3% of migrant workers -- had returned to their rural homes without jobs in 2008. "The government is willing to flood the country with cash to make and retain jobs since both [urban and rural citizens] are capable of making a lot of trouble," Meyer notes. "Didn't Mao say, 'The countryside surrounds the city'?"
Another factor that could weigh on domestic consumption is inflation. In much of 2009, households benefited from negative inflation, which boosted their purchasing power. This will likely change next year with inflation expected to turn positive again, according to the World Bank.
Although inflation may be negligible in 2010, just three years ago the government faced the risk of hyperinflation brought on by major increases in the price of food. (Hyperinflation occurs when inflation runs more than 30% a year for three consecutive years, with the currency rapidly losing its value, often because of a large increase in the money supply.) Overall, consumer prices rose 6.9%, according to government figures, propelled by a dramatic rise in the price of such staples as pork (more than 55% year on year) and cooking oil (more than 35%).
In the press and elsewhere, concern has been growing that this scenario could be repeated. Hu Shuli, a well-known investigative journalist and editor of Century Weekly, ran a recent cover story in that publication questioning whether inflation is much higher than the consumer price index numbers indicate. "Hyperinflation [would put] China's emerging middle class at risk," Meyer notes. "These folks' savings for education, medical care and retirement are almost entirely in cash, sometimes in the bank, sometimes under the mattress. They would be wiped out by double-digit inflation."
However, other China watchers downplay the threat. Franklin Allen, a professor of finance at Wharton, estimates the likelihood of inflation reaching between 10% and 20% to be around one in five. "I would be very surprised if it went above 30%," he says. Analysts at Morgan Stanley, the global brokerage and investment bank, now forecast a 2.5% increase in the consumer price index, against 10% growth in GDP -- what it calls "a Goldilocks scenario" of high growth and low inflation.
Real Estate Bubble?
A third factor that could give consumers the jitters is the real estate sector. Many believe that the sector is a bubble just waiting to burst. (See "Deconstructing China's Property Market: What's Behind the Bubbles?") In the first 10 months of 2009, according to the State Statistics Bureau, the volume of sales for all types of property was nearly 80% higher than the same period the previous year.
In terms of commercial real estate, a report from real estate services firm Jones Lang LaSalle says that rentals and capital values in most major office markets are "now closer to their long-term levels" and will turn the corner by the end of 2010 if they haven't done so already. Office rents in Shanghai, for example, seem to have hit bottom after falling as much as 45% in 2008, according to Michael Klibaner, national director and head of research in Shanghai for Jones Lang LaSalle. "When you look out your window, you see there are a load of buildings [being built] ... but a lot of that space is already spoken for." One of the major drivers, in Klibaner's view: Regional banks. Bank of Beijing and Bank of Ningbo, for example, are moving to Shanghai in response to Beijing's recent announcement that it intended to make Shanghai a global financial capital.
On the residential side, overseas investors were responsible for more than half the country's high-end housing sales until a few years ago. Today, the home-grown nouveau riche account for most of the luxury home transactions. Interest rate cuts and lower deposit requirements were among the measures introduced by the government over the past year to stimulate the domestic property market.
The excessive easing of credit has a lot to do with the sector's growth. Total financing for all real estate developers grew some 43% in the first 10 months of the year, to RMB 4.4 trillion. Mortgage lending jumped by a whopping 120%, to more than RMB 616 billion, and lending to property developers rose by 50% to more than RMB 911 billion. Now, Klibaner says the government wants to slow the growth with new loan caps and the enforcement of laws that limit residential property stimulation.
Health Care vs. Highways
Despite any efforts to rebalance the economy domestically, more needs to be done, including allowing the renminbi to appreciate against the U.S. dollar and harnessing energy consumption, experts say.
Social programs also need more attention. The World Bank notes that the high costs of health care, education and pensions will continue to eat into disposable income until government measures -- such as plans unveiled last year to provide most of the population with basic medical insurance -- kick in. A large part of the government's focus in the past 12 months, however, has been to create new jobs via new infrastructure projects to stimulate the economy. Less than 4% of the stimulus package is going towards education and 10% to social welfare, compared with 38% for public infrastructure.
"The government's coffers have been opened, with most of the cash going into fixed asset investment [such as infrastructure and real estate], and the cranes and concrete mixers are working overtime," says Meyer.
He adds that the one-child policy has made China a rapidly aging society. To keep advancing, he notes, this vast, graying country -- whose citizens aged 60 and above make up some 10% of its population of 1.3 billion -- needs to invest more in people than infrastructure. Unfortunately, such long-term investments can take a decade or more to have an impact on national economic growth, and could be politically difficult to orchestrate. "Such reforms in China would be about an order of magnitude more difficult than health care reform in the U.S., given vested interests."
John Zhang, a professor of marketing at Wharton, says that the government realizes it needs to create a consumer-driven economy that lets farmers and blue-collar workers share the economic gains with the rest of the country. "For that reason, in the coming years, there will be lots of new initiatives and policies in city building, infrastructure investments, income tax reforms, social safety net investments and, most importantly, wage increase mechanisms. A demand-driven economy works only if the vast majority of consumers in China hold money bags."