The Deloitte Research Monthly Outlook and Perspectives

Economy

Policies to Re-ignite the entrepreneurial spirit

The recovery that began in Q1 2023 appears to be losing momentum, prompting renewed demands for policy-driven reflation. Despite a currently benign inflation situation in China, comparisons are being drawn between Japan's economic situation after the bursting of the property bubble, and China's current one, which is being called a "balance-sheet recession" (a term coined by Richard Koo of the Nomura Research Institute). In Japan, after the property bubble burst, both businesses and consumers were so focused on restoring their damaged balance sheets that there was no appetite for investment. This necessitated government intervention and the Bank of Japan embarked on a lengthy period of ultra-loose monetary policy. However, this did not have the desired effect of kickstarting the economy, which remained sluggish. This prompts the question: should China follow Japan's path, especially given the near-negligible risk of inflation and the chances that an extended period of monetary easing could end up leading to a liquidity trap?

Figure: Extremely benign inflation in China

Source: Wind

July CPI (-0.3%) has reinforced the need of continued monetary easing. Price war in EV segment has accelerated the shift of consumer demand away from traditional vehicles. China’s surging exports of EVs indeed a reflection of a weaker domestic demand. Therefore, RMB’s renewed weakness of late, should be seen in the context of a bigger dose of monetary easing instead of a knee jerk policy reaction to declining exports (July exports decreased by 14.5% year on year).

Figure: Japan embarked on a multi-year journey of ultra-loose monetary policy

Source: Wind

We believe the best way forward is to have fiscal relief measures that stimulate final demand rather than a simple large-scale pump-priming of the economy. Amid rising youth unemployment and persistently decreasing PPI, significant infrastructure investment could potentially worsen overcapacity in the industrial sector without necessarily creating a substantial number of jobs. China’s economic situation today significantly differs from that of Japan’s in the past, especially with regard to adjustments following periods of rapid economic growth and asset inflation. Japan's property bubble was partially triggered by the post-Plaza Accord appreciation of the Yen. This led the BOJ to aggressively cut interest rates in a bid to curb the Yen's appreciation but they were unable to stop speculation in the property market.

The current struggles of China's property market are very different from Japan's in the 1990s in that China's extraordinary savings rates and the pent-up demand for better housing render a widespread property price crash improbable. China remains a developing country, unlike Japan, which was a fully mature economy before its property market downturn. Also, the PBOC's increased tolerance for a weaker RMB this year suggests China is unlikely to replicate Japan's mistakes regarding exchange rate policy. Given the increasing protectionism in the world economy and overcapacity in the manufacturing sector at home, an excessively strong RMB would only intensify the profit squeeze on companies.

China's Q2 GDP fell short of rather ambitious expectations primarily due to a broad investment slowdown. Nevertheless, China's stated growth target of "around 5%" remains attainable, assuming 2H growth remains around 4.6%. The focus is on shoring up the property market through targeted interventions. For example, on July 21, 2023, Premier Li Qiang advocated for redeveloping "urban villages"— clusters of substandard housing within large cities – and bringing them up to standard. This strategy is economically sound, as it both supports the real estate sector and benefits public health. While at present initial down payments for second flats in first-tier cities remain prohibitively high, at 70-80% of the selling price, in most second and third tier cities such restrictive policies have effectively been phased out due to a housing surplus and a stagnant number of transactions. Policymakers could feasibly reduce the property holding period from five years to three, potentially boosting market activity, although this policy option is not currently being considered. Despite the soaring housing prices over the years, demand in certain market segments such as areas where close to desirable resources of education and healthcare remains unsatisfied. Hence, pent-up demand and housing improvement were highlighted as the key factors for the health of the housing sector at a Politburo meeting chaired by President Xi Jinping on July 24, 2023.

Sectors closely tied to property development and local governments—which have accrued debt based on the assumption of continuously high housing prices—will likely face a balance-sheet recession. However, consumers and the central government still possess ample capacity for increased leverage. The challenge lies in discouraging consumers from precautionary savings and reigniting their entrepreneurial spirit. We anticipate the PBOC will guide interest rates lower and not react to exchange rate fluctuations. As the Fed approaches the end of its tightening cycle, the greenback—primarily bolstered by widening interest rate differentials and geopolitical tensions—could be vulnerable to profit-taking, thus easing the PBOC's balancing act. Lower interest rates will ease financial stress on local governments and debt-laden developers and while the latest Politburo meeting seems to indicate that there will be increased fiscal transfers from Beijing, enhancing private investment ultimately requires a fundamental shift in terms of capital access. In this regard, we believe changes in the IPO registration system could be a turning point. The move from IPO approval systems to registration systems has long been a policy objective. This reform would fundamentally alter firms' financing landscapes, potentially enabling many private enterprises previously lacking capital access to jumpstart their businesses. This liberalization could also extend to multinational corporations seeking to raise capital in China's domestic market, potentially strengthening the supply chain, which has been strained by geopolitical flashpoints.

Life Sciences & Healthcare

Standardization and Innovation send the Traditional Chinese Medicine Industry into high gear.

Since the release of the paper “Several Policy Measures on Accelerating the Characteristic Development of Traditional Chinese Medicine (TCM)” in 2021, the TCM industry has entered a phase of substantive development. To date, several of the recommendations in the document have been implemented providing a backbone of stable policy support for the development of the TCM industry. This led to increased investor interest in TCM but also a rise in costs. In June 2023 the first TCM volume-based procurement (VBP) was implemented, deepening regulatory control over TCM cost and pricing and further squeezing profits. While we believe that in the short run, industry growth will slow down under the pressure of pricing constraints and regulatory reform, significant potential exists for development and innovation in the TCM industry in the long run.

Sustained growth gets investors to gravitate towards the TCM Sector

Since the reforms, investor interest in the TCM sector has been rising as shown by the Shenwan (SW) TCM index (Figure 1) which has been inching up since mid-2021. It is also worth noting that since October 2022, the TCM sector has significantly outperformed the biopharmaceutical and chemical medicine sectors, becoming the most sought-after sector in the pharmaceutical field. Moreover, it is estimated that the main revenue of the TCM industry in China increased from RMB 516 billion in 2012 to nearly RMB 700 billion in 2021, largely due to a rapid expansion of market size.

Figure: Comparison of the SW Sub-industry Index for the A-share Pharmaceutical Sector

Sources: Wind, Deloitte Research

High-quality Development of the TCM industry: Survival of the fittest

In 2023, with the improvement of the safety and efficacy evaluation system and the release of the first-round of national TCM volume-based procurement (VBP) results, the TCM industry has been forced to upgrade and focus on achieving better quality control. But this transformation has not been without its teething problems and, in the immediate aftermath of the reforms, resulted in a slowdown in the TCM market's growth. There are several reasons for this:

On the supply side, a rise in the price of raw materials for TCM has increased costs. In 2020, The National Administration of TCM established TCM cultivation bases and a TCM germplasm resources bank. But despite this, the price of TCM raw materials jumped this year, primarily due to inflated prices by certain raw materials firms in anticipation of rising demand for TCM. This has resulted in greater cost pressure on downstream enterprises, thus affecting the market volume of TCM products, and highlighting the need for improved price and supply control in the TCM raw materials market. The government, on its side, has not been slow to react, announcing that by 2025 the administration plans to build over 4.38 million acres of authentic TCM production base to steadily enhance the supply of herbs and other materials for TCM. This will help reduce the cost of raw materials for the TCM enterprises, giving them the chance to focus on improving their quality control and marketing.

On the demand side, the introduction of the volume based procurement (VBP) system squeezed the profit margins of TCM enterprises. On June 21^st this year, the first-round of TCM VBP results were released, marking the start of the normalization of TCM VBP. The normalization will lead to a decrease in the price of TCM products, which will further squeeze the profit margin of the TCM enterprises. However, the volume-based procurement system will also stimulate innovation as TCM enterprises will have to increase investment in R&D to achieve distinct competitive advantages to strengthen their market positions.

Progressing Towards Standardization and Technology Upgrade

In February this year, the National Administration of Traditional Chinese Medicine announced that 2023 would be a year of striving for ‘high-quality development’. As part of this initiative, some players suggested that the government or the industry itself create an evaluation system to eliminate inferior TCM products. There are many advantages to having such a system. For one thing, it will motivate TCM enterprises to invest more in R&D and product development. Regulatory authorities need to fast track the establishment of a more comprehensive evaluation and management system for TCM as this will set standards and ensure further development of TCM enterprises.

Logistics

Three Growth Opportunities for China's Cross Border E-commerce

Benefiting from multiple factors such as changes in the global value chain, growth of online retail and government policy support, China's cross-border e-commerce exports are increasing rapidly. According to the General Administration of Customs, the import and export volume of cross-border e-commerce in the first half of 2023 has reached RMB 1.1 trillion, up 16% year-on-year, and is expected to reach RMB 2.46 trillion in  2024, up 19.9% year-on-year. Meanwhile, cross-border logistics is becoming an important engine of growth for cross-border e-commerce. Three opportunities for growth lie ahead for the industry.

Figure: China's cross-border e-commerce export volume and its year-on-year growth rate data and forecast, 2020-2024

Source: General Administration of Customs, Deloitte Research

• New market opportunities: the vast markets of Southeast Asia, the Middle East and Russia

Although Europe and the US remain the core markets for cross-border e-commerce exports, e-commerce trade in Southeast Asia, Russia and the Middle East is rising rapidly, bringing new vitality to the overall market. Thus, China's logistics companies are actively expanding in these overseas markets.

China and Southeast Asia: In June this year, the Regional Comprehensive Economic Partnership officially took effect in the Philippines, further reducing the cost of intra-regional trade. The growth rate of e-commerce transactions between China and the ASEAN is expected to continue to rise, with cross-border e-commerce transactions estimated to reach US$ 146 billion by 2025. In March of this year, J&T Express, the logistics company with the largest market share in Southeast Asia, officially launched its international B2B full-chain cross-border logistics service, providing a comprehensive cross-border logistics integration solution including collection, trunk transportation customs clearance, warehousing and delivery, and other key aspects. Relying on diverse international transportation modes such as air, sea and rail, J&T will help its clients open logistics and transportation chains from China to the world.

China and the Middle East: Cross-border e-commerce is the new frontier of the deepening economic and trade ties between China and the Arab world. It is also a key element of the Sino-Arab Digital Silk Road, a corridor of information flow that keeps BRI partners connected. As of early 2021, Chinese e-commerce platforms had already reached 80% of all Internet users in the GCC countries. On June 9, Cainiao Network officially opened an overseas warehouse in the United Arab Emirates, making Dubai the core node of its six Global Intelligent Logistics Backbone network hub node project (eHub). At present, Cainiao can achieve a 5–7-day delivery time in Israel, Saudi Arabia and a few other countries. By July Cainiao expected a shorter delivery time of 3-days on average within the UAE, with some deliveries achieving next-day delivery.

China and Russia: The two countries have been continuously strengthening customs cooperation and they established a cross-border e-commerce customs control mechanism to ensure trade safety and legitimacy. In terms of logistics and distribution, both sides are actively exploring the establishment of cross-border e-commerce logistics centers to improve the speed of goods distribution and to reduce costs. For example, in the city of Suifenhe, one of the important ports of China, the volume of China-Russia cross-border e-commerce trade reached RMB 600 million in 2022.

• New business model opportunities: the rise of the cross-border e-commerce full hosting model.

The fully-hosted model opens a direct channel from factories to overseas markets. In this model, merchants commit to  developing supply chain's potential and improving product's quality, while the platform focuses on the flow, operation, distribution, logistics, after-sales services and other links as both parties benefit from a bigger share of the overseas market.  This model is currently popular among many e-commerce companies. At present, AliExpress, SHEIN and Temu have already implemented the fully-hosted model, and TikTok and Southeast Asian platforms Lazada and Shopee will also launch it shortly.

Table: Five of the major cross-border e-commerce platforms used by Chinese sellers have entered the fully hosted model camp

Source: Public sources

Note: Green stands for the company that has already adopted the fully hosted model

The fully hosted model grew out of the understanding that a platform can play a much more important role in e-commerce than simply being a meeting place for merchant and customer. For, in fact, there is a great distance, physically amd mentally, between merchant and customer and many incredibly important decisions need to be made in order to create a good relationship between a business and its customer. A platform, because it knows the habits of both merchants and customers, can create tailor made logistics solutions for merchants. In the fully hosted model, the logistics function is crucial for the platform, requiring high logistics delivery capacity and service quality. As an innovation in the cross-border e-commerce logistics industry, the fully hosted model has a certain significance and influence, which can achieve higher sales and profits by streamlining the supply chain and improving operational efficiency. However, due to the complexity and cost constraints of cross-border e-commerce logistics, it is difficult for the platform to maintain complete and total control across the whole logistics link. Furthermore, merchants don’t always want to cede control and this model has given rise to disputes between merchants and the platform on the sharing of pricing rights, cargo rights, storage pressure sharing, and return penalties. So, ultimately, the fully hosted model is not a flawless solution.

• New Industrial Upgrading Opportunities: Supply Chain Optimization, M&A Integration and Technological Innovation

The cross-border e-commerce industry has the powerful attribute of integration, which can be innovatively integrated with various industries to evolve a much larger and richer ecosystem to serve the global market.

The cross-border e-commerce boasts its capability of integration to forge new business system and serve global market.

Currently, cross-border e-commerce is one of the main driving engines of growth in China's foreign trade.

As the logistics industry cannot be separated from cross border e-commerce, along with the development of cross-border e-commerce, the logistics industry is also moving to a higher level of efficiency. Platform enterprises with a head start in logistics management are taking the lead in reconfiguring the various elements of logistics management through industrial mergers and acquisitions and restructuring so as to achieve supply chain optimization and to get the whole industry to improve production efficiency and operational efficiency. Outstanding logistics enterprises, including logistics service providers and high-efficiency supply chain companies, are the backbone of industrial development, and are essential to the evolution and development of the economy.

On a more practical note, this year AliExpress will concentrate on contract fullfilment and efficiency, and along with Cainiao, will continue to increase investment in logistics capacity. This will include comprehensive expansion of the preferred warehouses at home and warehouses abroad, with a total area of more than 1 million square meters, and distribution centers covering more than 200 cities nationwide. SHEIN plans to invest $70 million in the next five years to continuously transform the traditional supply chain production model through technological advances. The international giant Amazon announced to strengthen its innovation business by investing $100 million in a new project "AWS¹ Generative AI Innovation Center" to conceive, design and launch new generative AI products and services. As it has already been stated, supply chain optimization, M&A integration and technological innovation will remain the three main drivers of growth in the logistics industry.

^{1 AWS：Amazon Web Services}

Automotive

The winning formular for China EV makers’ overseas adventure

After gaining a firm foothold in the domestic market, Chinese EV companies are falling over each other in their eagerness to reach the overseas market. In the first half of this year, exports of China-made new energy vehicles reached 0.8 million units, skyrocketing 105% year-on-year. Among which, western Europe and ASEAN countries make up the majority of China's total electric vehicle exports. Even excluding exports from foreign brands, this trend still remains valid as western Europe, ASEAN countries and the Middle East accounted for 60%, 20% and 10% of China NEV makers total exports, respectively.

This report will examine commonalities in the above-mentioned regions when it comes to the development of the EV industry, the strategies and approaches Chinese EV companies adopted when entering those regions, and the risks and challenges they are expected to face going forward.

The above-mentioned regions have some similarities in supporting EV industry build-up and increasing EV adoptions. They all have set up clear goals and comprehensive policy frameworks to nurture their domestic EV sector. They also have a promising domestic market for wider EV penetration. For instance, both EU and ASEAN countries have adopted a slew of policy instruments including financial subsides, taxation, government investment, public expenditure, and administrative regulations to support their local EV industry and push electric vehicle adoption. For example, in view of the 2035 ICE ban, most countries in the EU are postponing the phasing out of incentive packages for electric vehicles (they were supposed to have been phased out last year). These incentives include subsides, tax relief and other preferential policies towards EVs such as free parking, bus lanes and toll exemptions. They also incentivize charging operators to increase the density and spread of the charging network across the continent. Thailand, as an emerging market, has rolled out an ambitious plan for EV last year. The government, on the one hand, stimulated local demand for low-carbon vehicles through purchase subsidies and tax reliefs, and on the other hand, managed to attract global car companies to invest and build locally.

At present, Chinese EV companies primarily export vehicles to the target countries by selling wholesale to local dealership groups which then distribute locally. But with the introduction of incentive policies in these overseas countries, more and more Chinese EV makers are contemplating investing overseas. For example, BYD purchased land to build a factory in Thailand in 2022 which has a designed production capacity of 150,000 units annually. Cars produced at the plant will not only be sold locally but will also be exported to neighbouring ASEAN countries and other regions. Apart from local manufacturing, Chinese EV companies are also bringing their component suppliers to build factories locally. At the same time, Chinese car makers are extending their ecosystem network by forming close cooperations with local governments and various EV supply chain players to increase mutual trust and collaboration in local markets. For example, Great Wall Motors is cooperating with Thailand's National Electricity Authority and other departments to build charging stations, expand fast charging facilities and the like, and build a nationwide electric vehicle charging network.

Going forward, Chinese car companies will face mounting challenges brought about by more complex business environments and geopolitical uncertainties.

1. Geopolitical risks and trade conflicts: for example, imposition of additional tariffs on China-exported EVs or a sudden end to subsidies for new energy vehicles with no buffer period will result in huge fluctuations in sales.

2. Different rules and regulations: there are substantial differences from region to region in rules of market access and business operation, including tariffs, quality standards and environmental protection requirements. In addition, mature markets such as the EU have begun to adopt non-tariff barriers such as mandatory carbon footprint declaration and recycling requirements for key minerals. This will increase compliance barriers and costs for overseas companies.

3. Cultural differences and brand awareness: due to different cultures and customs, companies often experience setbacks when entering new markets. They are often surprised to learn that domestically popular products may not be well accepted in foreign markets. In addition, the lack of brand awareness is one of the biggest challenges facing Chinese EV companies. In the past few years, Chinese car companies have been less than successful in their numerous attempts at going overseas, leaving behind an inherent impression that Chinese products are unsafe and poor in quality in the minds of overseas consumers. 

To better prepare for future challenges, China’s EV makers should improve various capabilities, including but not limited to

1) Strengthening local R&D capabilities by gaining insights into local culture, consumer groups and consumption habits, and fine-tuning products that better meet local demand.

2) Establishing an extensive cooperation ecosystem to provide quality products and services for local consumers. In addition to marketing and sales, car companies also need to partner with local players for key user contacts such as charging, after-sales service, and connected vehicle services.

3) Enhancing compliance capabilities: including compliance on product development and business operation. For example, China EV makers need to plan in advance and take into account all the mandatory requirements when developing their products for a new market. They also need to ensure that they are following local labour laws and regulations to protect their corporate reputation, and to ensure the sustainable development of overseas business across the world.

Retail

Consumers want quality and value for money

The good news is that total retail sales of consumer goods in the first half of 2023 increased by 8.2% year-on-year, signalling a return to pre-pandemic growth rate levels. However, if one considers the low base impact of the same period last year, the compound growth rate of total retail sales was only 3.6% in H1 2023. Meanwhile, the year-on-year monthly growth rate fell from 12.7% in May to 3.1% in June. After the effect of the low base was taken into account, the growth rate diminished month on month. Hence, although a mild recovery may be the case for the overall consumer market, significant uncertainty remains. Overall, weak consumer confidence and high unemployment rates are the key factors affecting the current consumer recovery. On the one hand, the Consumer Confidence Index has not surpassed the strength baseline as it takes time for consumer confidence to rebound. On the other hand, the employment environment has yet to improve, especially with youth unemployment reaching a historical high of 21.3% in June, which also suppressed the consumption demand of young consumers.

Figure: Total retail sales, y-o-y growth

Source: National Bureau of Statistics

Uncertainty about the future has made consumers increasingly jittery and hence have become much more cautious in their consumption decisions. Merchants are responding by choosing to sell durable, mid-price range products which will appeal to this kind of consumer. "Cost-effectiveness" has become the buzzword in e-commerce platform marketing and promotion. As an important consumption node in the first half of the year, the June 18 shopping festival is often seen as a litmus test of current consumer trends and attitudes. Based on this year's June 18 consumer survey, we see that consumer preferences exhibit the following characteristics:

Firstly, consumers are choosing "good quality-but-low-price" products over high status, brand name products. Less confident about future earnings, they are gravitating towards "low-price" and "cost-effective" products. However, "low price" and "cost effectiveness" does not mean that they are willing to accept bad quality goods just because they are cheap. Consumers still maintain a high preference for quality products that can stand the test of time. According to the 2023 June 18 Consumer New Trend Insight Report, over 70% of respondents hope that the platform’s promotion, codenamed "billion dollar subsidy", will cover more well-known brand products.

Figure: Consumer attitudes towards major promotion measures such as the "billion dollar subsidy"

Source: June 18 online shopping festival consumer insight in 2023 Report

Secondly, the influence of interactive content such as live streaming on consumer shopping decisions has grown greatly. The rapid development of new consumer formats, models, and scenarios has accelerated the expansion of consumers' shopping methods and channels. Especially post-pandemic, new consumer media such as social media, live streaming, and short videos have rapidly increased in "popularity". Research data shows that brand store live streaming and influencer live streaming rooms have become an important shopping method for consumers, surpassing independent searches for products.

Figure: Share of Consumers' Shopping Methods during the June 18 period in 2023

Source: June 18 online shopping festival consumer insight in 2023 Report

In addition, there has been a shift in the age-group of online consumers as many older and more middle-aged people have begun to actively shop online, largely due to the pandemic. This year’s June 18 festival shows that the attractiveness of online shopping for the middle-aged and elderly segment of the population continues to increase. According to Questmobile data, consumers in their 70s are the fastest growing user group, their numbers increasing over 20%, either on e-commerce giants such as Taobao and Pinduoduo, or on content e-commerce such as Douyin, Kwai and Xiaohongshu.

Figure: Growth rate of new users of e-commerce apps during the June 18 period in 2023

Source: Questmobile

With the normalization of online shopping, business models of retailers in the post-pandemic era must also change accordingly. Consumer retail enterprises need to deepen their understanding of consumers and gain further insights into consumer preferences through digital technology. For example, as consumers now seem to want both "cost-effectiveness" and "quality", retail businesses should off more discount retail. At the same time, differentiated marketing strategies should also be developed for consumers of different age groups. In addition, merchants should also rely on consumer insights to accelerate product innovation, improve supply chain efficiency, and promote cost reduction and efficiency. These will make them more competitive in the digital marketplace.