Challenges to China s Consumption-led Growth
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1 For professional investors 27 January Chi on China Challenges to China s Consumption-led Growth To improve is to change; to be perfect is to change often. Winston Churchill SUMMARY China has had some initial success in shifting its economic structure to services from manufacturing. However, it has made far less progress in boosting private consumption. A key reason for this macroeconomic disconnect between surging services and lagging consumption is the rise in urban savings, despite robust per capita income growth. This reflects not only a lack of consumer confidence but also a legacy of decades of lopsided growth that has favoured output growth at the expense of labour compensation. Relaxing the household budget constraint through banking reform, among other structural reforms, may be an effective medium-term policy to boost private spending. Sunrise sectors, such as consumer staples, services, healthcare and software should shape China s new consumption landscape. China s tertiary sector out-grew the secondary sector in 2013 (Chart 1), showing a clear progress on economic structural rebalancing. After bottoming at 36% of GDP in 2010, the share of consumption has risen to 38%, while that of investment has peaked (Chart 2). The gains in services, as reflected by the tertiary sector, have been particularly strong in wholesale and retail trade, finance and real estate. The shift towards services will continue, broadening out to healthcare, education, IT services, domestic tourism and leisure and transportation. China s tertiary sector is expected to grow towards 60% of GDP from about 50% now in the next decade.
2 Challenges to China s consumption-led growth 27 January The unwilling consumer However, it is unclear if this expenditure-switching process will deepen, as China s consumers have remained unwilling to spend. While the GDP share of the tertiary sector has risen by almost 6 percentage points since 2010, the share of consumption has only risen by 2 percentage points. This gap represents a yawning household savings rate. China s urban savings rate has been rising on the back of strong per-capita income growth in recent years. This reflects a preference for precautionary saving over discretionary spending (Chart 3), and is a rational response by the majority of Chinese households to their uncertain future, which is not supported by a reliable social safety net. Given China s demographic structure, under-developed financial market and weak welfare state, high precautionary saving is likely to persist in the medium-term.
3 Challenges to China s consumption-led growth 27 January Saving for retirement has become an overriding objective for most workers. In the past, the Confucian tradition of filial piety meant that children were proxy savings vehicles, as they were expected to support their ageing parents. However, after more than three decades of one-child policy, retirees now cannot expect much support from their children, many of whom subscribe less assiduously to the Confucian tradition. Meanwhile, the country lacks a strong pension system to pick up the slack. Some observers also argue that workers are increasing their savings due to longer life expectancy and surging medical costs. From a macroeconomic perspective, this does not yet seem to be a crucial factor constraining consumption, as the share of spending out of disposable income on medical costs has not risen despite the rise in the absolute amount of medical spending (Chart 4). Labour income has shrunk One crucial macroeconomic factor hurting consumption may be the fall in the share of GDP represented by labour income (Chart 5), despite years of robust economic growth (until recently). This has eroded private consumption power, and is likely the result of China s lopsided growth model and financial repression.
4 Challenges to China s consumption-led growth 27 January More than 35 years of distorted industrial policy has favoured investment over labour income growth and relied on wage suppression to subsidise output and exports. Financial repression has boosted investment and output growth at the expense of Chinese household savings by suppressing its real rate of return to almost zero. Macroeconomic policies cannot address structural woes Cheap capital and low labour cost might be good for output growth but they have hurt household consumption. Thus, the structural imbalance that China must address is really between the income share of labour and that of other factors of production in the economy. Macroeconomic policies cannot resolve this structural woe to boost consumption effectively. This is already seen in the lack of improvement in growth, inflation expectations and consumption since 2014, despite rounds of monetary and fiscal policy stimulus. Monetary easing may even backfire on consumption, as households may save more to preserve their purchasing power in the face of declining returns on their savings. This may help explain why China s CPI and PPI inflation rates have kept falling, despite monetary easing, which has boosted asset bubbles instead of consumption. However, this is not to say that China s effort to switch from investment-led to consumption-led growth will fail. The young generation today is keenly aware of their quality of life and more inclined to consume than their parents were. When they become the main agents in the Chinese economy, i.e. when they reach middle-age, their consumption should be a much stronger driver of GDP growth. A medium-term remedy Beijing could pursue a different set of consumption-boosting policies to make that transition happen. One possible measure is to relax the household budget constraint, which has kept China in a cash-based economy. China s consumption potential has been constrained by its excessive saving behaviour. The household sector is a net creditor in the economy, with net assets amounting to more than 8% of GDP. The gross household debt-to-gdp ratio was only about 7% of GDP (Chart 6), compared to a massive 95% in the US and 66% in Japan in 2015.
5 Challenges to China s consumption-led growth 27 January The personal loan industry in China is under-developed (Chart 7). In 2015, consumer loans accounted for less than 19% of total bank loans. The bulk of personal loans were in the form of mortgages, which accounted for only 14% of all loans (while it was more than 100% in the US). Only 5% of people over the age of 15 in China had mortgage debt, and 8.2% had credit cards, compared to more than 33% and 61%, respectively, in the US. It is clear that Chinese households have plenty of room for borrowing to boost consumption. By developing the personal loan business through financial liberalisation, Beijing can effectively relax the household budget constraint by enabling intertemporal choice by individuals to boost consumption. A lesson from the US In the US, Pittsburgh, Chattanooga and other so called rust-belt cities have strived to revive themselves through the structural rebalancing of their economies from sunset to sunrise industries. And they provide a useful lesson: the importance of building and empowering the middle class, which is the primary demand driver for services, from health care and education to retail and entertainment. By successfully transforming their local economies in a way that would attract middle-class consumers, they built and improved public
6 Challenges to China s consumption-led growth 27 January infrastructure, the social safety net and education provision, as well as adding amenities, reducing crime and creating job opportunities along the way. China s consumption landscape will be totally different in the future, with the country becoming a global buyer rather than the global seller it is today. But this will take years. To facilitate the transition to consumption-led growth, China needs more banking and structural reforms and needs to raise labour income s share of the economy. It should also empower the middle class and accelerate urbanisation. Consumer staples, services, telecommunications, healthcare, education and software are some of the main economic sectors that will be shaping China s future consumption. Chi Lo Senior Economist, BNPP IP
7 Challenges to China s consumption-led growth 27 January DISCLAIMER This material has been prepared by BNP Paribas Investment Partners Asia Limited* and is issued by BNP Paribas Investment Partners Singapore Limited ( BNPP IPS )** and BNP Paribas Investment Partners Asia Limited, members of BNP Paribas Investment Partners (BNPP IP)***. The content has not been reviewed by the Monetary Authority of Singapore ( MAS ) or the Hong Kong Securities and Futures Commission. This material is produced for information purposes only and does not constitute: 1. an offer to buy nor a solicitation to sell, nor shall it form the basis of or be relied upon in connection with any contract or commitment whatsoever; or 2. any investment advice. Opinions included in this material constitute the judgment of BNP Paribas Investment Partners Asia Limited or its relevant affiliate(s) at the time specified and may be subject to change without notice. BNP Paribas Investment Partners Singapore Limited and BNP Paribas Investment Partners Asia Limited are not obliged to update or alter the information or opinions contained within this material. Such opinions are not to be relied upon as authoritative or taken in substitution for the exercise of judgment by any recipient and are not intended to provide the sole basis of evaluation of any strategy or instrument discussed herein. The contents of this material are based upon sources of information believed to be reliable, but no warranty or declaration, either explicit or implicit, is given as to their accuracy or completeness. Investors should consult their own legal and tax advisors in respect of legal, accounting, domicile and tax advice prior to investing in the Financial Instrument(s) in order to make an independent determination of the suitability and consequences of an investment therein, if permitted. Please note that different types of investments, if contained within this material, involve varying degrees of risk and there can be no assurance that any specific investment may either be suitable, appropriate or profitable for a client or prospective client s investment portfolio. Investments involve risks. Investments in emerging markets involve above-average risk. Given the economic and market risks, there can be no assurance that the Financial Instrument(s) will achieve its/their investment objectives. Returns may be affected by, amongst other things, investment strategies or objectives of the Financial Instrument(s) and material market and economic conditions, including interest rates, market terms and general market conditions. The different strategies applied to the Financial Instrument(s) may have a significant effect on the results portrayed in this material. Past performance is not a guide to future performance and the value of the investments in Financial Instrument(s) may go down as well as up. Investors may not get back the amount they originally invested. Any reference to past performance of any market or instrument should not be taken as an indication of future performance. Neither BNP Paribas Investment Partners Singapore Limited, BNP Paribas Investment Partners Asia Limited nor any BNP Paribas Group company accepts any liability whatsoever for any loss arising, whether direct or indirect, from the use of any part of such information. A BNP Paribas Group company may, to the extent permitted by law, have acted upon or used the information contained herein, or where relevant the research or analysis on which it was based, before its publication. This material is for the use of the intended recipients only and may not be delivered or transmitted to any other person without the prior written consent of BNP Paribas Investment Partners Singapore Limited and BNP Paribas Investment Partners Asia Limited. Furthermore, any translation, adaptation or total or partial reproduction of this document, by any process whatsoever, in any country whatsoever, is prohibited unless BNP Paribas Investment Partners Singapore Limited and BNP Paribas Investment Partners Asia Limited has given its prior written consent. * BNP Paribas Investment Partners Asia Limited, 30/F Three Exchange Square, 8 Connaught Place, Central, Hong Kong. ** BNP Paribas Investment Partners Singapore Limited, 10 Collyer Quay, #15-01 Ocean Financial Centre, Singapore *** BNP Paribas Investment Partners is the global brand name of the BNP Paribas group s asset management services. The individual asset management entities within BNP Paribas Investment Partners if specified herein, are specified for information only and do not necessarily carry on business in your jurisdiction. For further information, please contact your locally licensed Investment Partner.
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