Asia's weapons of mass consumption Voice of Asia, January 2017

Asia’s major export markets, led by the United States, will boost this region’s growth in 2017. But Asia’s mega economies, China and India, have another line of defence: their cashed-up consumers.

That’s because, increasingly, consumer booms are powering Asia’s growth. A new, optimistic generation is taking its place in driving the direction of their economies: one that is technologically savvy, comfortable with the borderless consumerism of the global middle class, and yet imbued with the consumption-smoothing instincts of its parents and grandparents.

These new consumers are exactly what Asia and the world need. They’re inherently optimistic and incredibly open to innovation. They’ll make enthusiastic importers as well as formidably competitive exporters. And yet, like consumers everywhere, they will be a stabilizing force in their giant economies. That means they’re likely to play an anchor role for Asia’s prospects in 2017 almost regardless of other developments.

What more could Asia or the global economy ask for?

Increasingly, consumer booms are powering Asia’s growth.

Asia’s consumer is already a kingmaker

Two factors are sustaining China’s growth:

• Investment spending, primarily by state-owned enterprises
• Strong consumer spending, supported by the strength of the property market

Yet whereas the first growth driver may not prove sustainable, the second will: Strong consumers are here to stay. Indeed, that is a central aim of China’s policymakers, who are aware that their economy is underweight consumers, and who want consumer spending to take over from construction as the key growth driver of the future.

At the same time, India has emerged as the world’s fastest-growing mega-economy and has made strides in the face of headwinds of weak global growth and financial market volatility. The Indian economy, traditionally been powered by consumers, is set for another structural boost. Indeed, consumption is expected to continue its driving role in 2017 because of three fundamental factors:

• Rising wages (including for the public sector)
• A boost to rural incomes
• A structural push from taxation reform

Recent wage reforms have boosted the incomes of an aspirational population. However, it is the third factor that is expected to have the greatest impact. A major push to taxation reforms such as the rollout of a goods and services tax (GST) will improve consumer demand in the long run.

An Indian economy driven by domestic consumption is relatively sheltered from global disturbances

Over the past decade, India’s consumers have helped to underpin an enviable growth rate for their country. India has the world’s largest population of Millennials, with the typical Indian consumer being young, aspirational, technologically proficient, and enjoying the benefits of a fast-growing consumer market.

After experiencing the success of the first decade of the current century, many of India’s Millennials share an exuberance and a belief that good education and hard work can lead to a change in fortunes. The unshackling of consumer spending has also triggered a change in mind-set from a few decades ago, with higher spending no longer necessarily regarded as wasteful behaviour.

Even so, consumer spending as a share of the economy has been declining in India over recent decades, with India’s consumers now making up close to 60 percent of all spending in the economy. That is still relatively high for an emerging economy, with China’s consumption share less than 40 percent and Malaysia’s share just more than 50 percent. In comparison, the consumption share in Japan and the United States are 61 percent and 68 percent, respectively.

China’s consumers are gaining ground as the economy moves toward consumption-led growth

China’s economy has been slowing since the turn of the decade, but its consumers are still sprinting, with retail sales regularly clocking up double-digit gains in turnover.

There are many reasons for this resilience in retail amid a wider economic slowdown in China, but the most obvious are demographic:

• Those Chinese aged over 70 are big savers, and they have been all their lives. Prior to economic reform, salaries in Chinese cities had remained almost the same for nearly 30 years, and the habit of frugality became deeply ingrained.
• The story is only slightly different for those who are middle-aged. Their savings rates are also high, but they spend a lot of those savings on real estate. They strongly believe in helping the next generation to achieve a better standard of living, while looking after their own parents.
• Yet the young are very different. With almost three decades of double-digit growth behind them, they’ve happily embraced credit, consumption, and debt.

With those different patterns through the different generations, there’s a natural demographic tailwind to consumer spending in China.

However, the overall saving rate remains extremely high, at a remarkable 46 percent. That is partly to make up for the lack of an adequate social safety net—when the safety net is poor, the desire to save is stronger. Yet it is also cultural, born of a desire to provide children with a better life than their parents. This is true even in affluent Chinese societies such as Hong Kong and Taiwan.

The young, meanwhile, are optimistic about their future incomes, and that’s yet another reason why they are happy to consume more.

The upshot is a combination of soaring wealth, a nascent consumption boom, and a still relatively low share of consumer spending within the wider Chinese economy. Those are all the ingredients needed for a long-lived tailwind for China’s consumers—a tailwind that may well last for a generation.

These changes are already happening, and they are already important. The Millennials (those born between 1980 and 1995 and accounting for a quarter of the total population) are aggressively taking advantage of e-commerce and online retailing, with spending through those channels currently running at annual rates of close to CNY4 trillion in 2015.

The young are optimistic about their future incomes, and that’s yet another reason why they are happy to consume more.

However, there also is strong demand for more time-honoured forms of consumer spending. Economic history suggests that nations with per capita incomes between USD 5,000 and USD 10,000 experience an increase in demand for luxury items such as cars—and China is no exception.

Opportunities emerge for consumption growth in India

The last few years have also seen the rise of consumerism in India, with an increase in spend on durables such as electronics and automobiles, as well as on discretionary items such as travel and entertainment.

Indian households still save 22 percent of income, which shows that longer-term security goals are key but not important enough to stand in the way of India’s rampant consumerism. Indian retail markets are expected to expand rapidly to 2020 and beyond, lifting from USD 600 billion in 2015 to USD 1 trillion by 2020.¹

The big guns are firing up for the long haul

All the big drivers will play a role in this shift.

Half of all the growth in potential workforce in Asia over the next decade will occur in India. An empowered workforce with a next-generation mind-set and a high propensity to earn and spend is expected to provide a boost to India’s consumption story.

Strong wage gains have resulted in more disposable income in the hands of the urban middle class (forecasters see India growing faster than China over the next decade, and some of that outperformance will show up in wages). The government recently raised public-sector wages and pensions; this is usually a once-in-a-decade exercise in which history indicates that the first areas of impact are on consumer durables and nondurables. We expect a short-term boost to consumption driven by this impact.

One must not overlook the rural economy contribution. In 2014, rural India’s consumption expenditure outgrew urban India’s for the first time since 1991. The National Sample Survey Organisation indicates that from 2007–08 to 2011–12, rural per capita consumption expenditure grew at 16.7 percent compared with 15.6 percent in urban areas. Fifteen major states reported faster consumption growth in rural areas, albeit with notable exceptions.

One reason for this may be the minimum support prices and the rural employment guarantee initiatives that the government had previously introduced. The schemes have resulted in higher income for farmers, translating into higher rural spending.

Last but not least, attitudinal shifts driven by changing demographics, rise of the nuclear small family, and urban aspirations have ensured a change in consumption patterns. The post economic-liberalisation generation of the 1990s faces multiple consumption choices that their parents had never seen before. Consequently, they are happier to spend than their parents, and this has become the new norm.

And there’s evidence of these megatrends all around:

• Consumer confidence remains elevated, and India scored among the highest in the Nielsen Global Survey of consumer confidence.²
• India is one of Apple’s fastest-growing markets.³ The Economist suggests that three Indians first experience the Internet every second, and that the Indian market will see more than a billion people online by 2030.⁴
• India’s mobile phone subscriber base crossed the 1 billion mark in 2016, with more than 220 million smartphone users.⁵

That combination has led to the rapid expansion of online retailing, which is expected to account for 10 percent of total retail sales in 2018, up from 6.5 percent in 2013 and 3.5 percent in 2008.⁶ Amazon expects India to become its largest overseas market, surpassing industrialised nations such as Japan, Germany, and the United Kingdom.

That said, there are some immediate risks from the fallout of the government’s demonetisation move in late 2016. We believe that this slowdown is temporary and that consumption growth will be back on track by mid-2017.

Attitudinal shifts driven by changing demographics, rise of the nuclear small family, and urban aspirations have ensured a change in consumption patterns.

Another shot in the arm: Tax reform

But this is not the complete story. Moving beyond the structure of the economy, there are additional positives: The Indian government has responded to the boom by increasing access for foreign investors and reforming the taxation of consumption. It now permits foreign direct investors to acquire 100 percent ownership of online retailers, while foreign portfolio investors are permitted to buy up to 49 percent with certain conditions.

However, the more crucial reform is the new GST, which is to be introduced shortly. The key idea behind this tax is to broaden the tax base and lower overall taxation rates. The way implementation is being sought in India also presents an opportunity to enhance the ease of doing business in the country with the whole system being technology-driven.

The GST is likely to have differential impacts across sectors and will possibly lead to higher prices for services and possibly stable to lower prices for goods. Overall rates are likely to come down under the new regime, as the government is intending to keep four rate slabs depending on the nature of the item being taxed. The move to a GST is likely to increase consumption demand, as lower taxation would benefit producers who in turn—driven by competition—are likely to pass on some of the gains to consumers.

We expect a supply-side boost as well. India has traditionally been a supply-constrained economy, and a boost to the supply of goods and services could bring lower inflation and increased competitiveness. This could positively affect the real income of households and boost consumption.

China treading its own path, balancing risks and opportunities

China’s leaders might say that, for the present, just maintaining the present consumer share of their economy is challenging enough. In part that’s because China’s consumer boom is dependent on the government being able to keep sustaining the unsustainable—the over-investment, an overstretched housing market, and yawning debt—while it hurriedly builds a new, more viable consumer-driven service-based economy.

In particular, China’s property boom is proving difficult to manage. Banks, wary of lending to an industrial sector plagued with overcapacity, have regarded the housing sector a safer bet. Over the past year, housing prices have appreciated sharply in all of the major Chinese cities (17 percent for the 100 biggest cities, and 27 percent for first-tier cities).

• This has led nine cities, including Beijing, Shenzhen, Nanjing, Suzhou, and Xiamen, to impose restrictions on demand for housing. These restrictions include requiring deposits of up to 70 percent and bans on purchases of second homes.
• However, housing prices in many major cities were already so high that they were nearly unaffordable and may have hit a plateau. These high property prices are among the factors behind the continued capital outflows from China.
• At the same time, the number of still-unsold dwellings is putting financial pressure on local governments in smaller cities.

The central government has been encouraging banks to lend to home buyers in order to reduce the number of unsold apartments. It also hoped that the restrictions on home purchases in the first- and second-tier cities would see liquidity redirected to smaller cities’ oversupplied markets.

However, the increase in capital outflows suggests that the regulations might not work as neatly as that. If housing prices in first- and second-tier cities fall, then the most likely scenario is an even greater fall in prices in third- and fourth-tier cities. Local government finances would face severe challenges, and consumers would have to increase their savings to repair their balance sheets.

In other words, while the housing price boom has supported consumer spending in China, any unravelling of that boom could prove problematic for the consumer engine. In turn, that says the management of the exchange rate in 2017 also could have profound implications for the housing market, investment, and consumption.

As we argue in the first report in this series, further depreciation in the Chinese yuan will be desirable in 2017. If properly managed, the depreciation should, among other things, attract capital inflows to support the economy through its difficult transition.

However, the depreciation must be decisive. If the exchange rate is guided lower gradually, as was the case in 2016, more capital is likely to flow out of the country on expectations of a further decline in the exchange rate. In that situation, the use of capital controls to try to stabilise the exchange rate might only make things worse.

So despite the risks wrapped up in housing prices, there are short- and long-term options to boost consumer spending in China, aided by demographic tailwinds. We believe that the country’s consumption boom can be sustained given the scope for further reform and the state’s ability to spend. Given the right reforms, including reform of the state-owned enterprises, private investment could pick up on the back of eased restrictions and improved liquidity.

Further depreciation in the Chinese yuan will be desirable in 2017.

And there is more: The untapped rural consumer

In the long run, China could lift the consumer share of its economy significantly toward India’s 60 percent by empowering rural consumers and improving the social safety net. If the government could spend more on education and health care, then consumers would feel more confident and reduce their “rainy day” saving.

In addition, other government reforms could boost rural consumption significantly. Half of China’s population lives in the countryside, but rural consumption, which has been growing quickly in recent years, lags well behind urban consumption mainly because the “Hukou system” discriminates against rural migrant workers who have no access to many resources enjoyed by urban dwellers. Boosting fiscal spending on education and health care in rural areas is part of a short-term solution. And, in the medium to long term, farmers should be allowed to sell their land so that they can gain from the housing boom.

Looking ahead: China, India, and beyond

This report points to a range of reasons for confidence in the consumer outlook—short and longer term—in both China and India.

But Asia is much more than just China and India, and the basic conclusion that consumer resilience should stand this region in good stead in 2017 holds all the more true with a wider Asian lens. Indeed, economies such as Indonesia have equally seen a rapid pace of income growth and urbanisation over the last two decades in particular. Over the 10 years to 2015, the share of Indonesia’s population classified as either high-income or upper middle-income has risen from 15 percent to 60 percent, underscoring the consumption potential that the country offers into the future.⁷

Chances are, therefore, that Asia’s consumers are likely to play an anchor role for this region in 2017 almost regardless of other developments.