Opinion: Plenty of Reasons to Be Pessimistic About Consumption

* Weighing on consumption growth are residential expenditures, health care costs, and decline of disposal income

* Overall weakness of consumption is already having an adverse effect on the commodities market

After much discussion of how China is “upgrading” to an economy based on consumption in recent years, consumption growth appears to have stalled. Rather than being a blip in an upward trajectory, there are plenty of reasons to think that lower consumption growth will become the new normal.

Total consumer goods sales grew 9.3% year-on-year in the first half of 2018, the lowest level since 2014. The figures make for even bleaker reading when adjusted for external factors affecting pricing, which brings the actual growth rate down to 7.6%, the lowest since 2000. Growth in consumer goods such as food products, clothes, and other everyday items has remained roughly in line with last year’s growth, while the growth rate of cars, sports and entertainment goods has fallen sharply.

Some economists question whether retail sales can tell us much about the country’s actual economic situation because the indicator doesn’t include the consumption of services, which continues to rise. It is possible then that retail sales underestimate real consumption rates. What’s more, total consumer spending data showed a rebound in the second quarter.

Yet it is hard to reach an optimistic conclusion about the direction of consumer spending. For one thing, more than 20% of household consumption is taken up by residential costs, with 4% going on water and electricity bills and the rest going to rental costs. Residential expenditures grew by 11% in the first half of 2018, substantially above the 6.8% growth in overall expenditures. Such consumption does not have the same positive effect on other sectors of the economy seen when other services or commodities are consumed, as it essentially means more money is transferred from low-income groups through rent to high-income groups, which contributes less to consumption.

Spending on health care is another key contributor to the household consumption growth rate, rising by more than 18% in the first half of the year. However, this is likely related to price increases brought about by health care sector reforms last year, and does not necessarily reflect an actual increase in demand. If housing and medical care are taken out of the picture, the other areas that contribute to consumer spending only grew at 4.4% in the first half of 2018, down from 4.7% last year.

Thirdly, the ratio of household expenditures to disposable income has continued to decline since the second half of 2015, reaching a new low in the first half of this year. This suggests that the propensity to consume is also on the decline. Altogether, all these signs point toward consumption weakness being a real problem.

Why did consumption become so weak? There are short-, medium- and long-term reasons.

In the short term, the growth in consumption of goods like furniture, home appliances and cars in the last two to three years has been closely linked to the increased growth in real estate sales. Yet with the reduction in the money supply since the second half of 2017 and tighter regulation of the real estate market in first- and second-tier cities, the rate at which real estate sales had been growing has dropped significantly, dragging down related consumption with it.

On top of this, the household expenditure growth rate depends on the income growth rate. Yet the nominal gross domestic product (GDP) growth rate has dropped from 11% in the fourth quarter of last year to 9.8% in the second quarter of this year. In step with this, income growth rate has fallen from 8.3% to 7.8%, having a knock-on effect on household consumption.

In the medium term, the growing debt burden in the residential sector is also weighing on consumption. The ratio of debt to GDP in the residential sector has risen from around 30% in 2015 to over 50% today. The ratio of residential debt to annual disposal income has reached 110% for urban and rural residents alike, exceeding levels seen in the U.S. While “balance sheet risks” on the wider economy from such debt ratios are still low, it is nevertheless having an effect on individuals’ cash flows as more income is sucked up by mortgage repayments.

In the long term, fundamental demographic changes are weighing on consumption. China has seen two “baby booms” in recent history, one in the decade from 1960, and the other between 1985 and 1990. The generation born in the first boom is now over 50 years old and is unlikely to add much more in terms of major purchases such as houses or cars. Those born in the second boom are now in their 30s, and although they will still add to consumption in the future, their numbers are fewer than those born in the first boom, and the level of demand they will bring remains uncertain. Ultimately, even if per capita GDP continues to grow in the future, such growth will be partially offset by the declining population. The average annual consumption growth rate of 13% we have seen for the last 20 years will be history.

The overall weakness of consumption is already having an effect on the commodities market. For example, the prices of types of copper associated with consumer goods has fallen since the start of the year by between 10% and 15% while metals associated with investment have risen by 20%.

Xu Xiaoqing is the director of macro strategy at Dunhe Asset Management Co. Ltd.

Translated by Ke Dawei (daweike@caixin.com)

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