China’s enigma: Consumers open their wallets as economy falters

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For years, the Chinese consumer has vexed the outside world. For every 10 yuan ($2.03) a family earns in disposable income, three are saved. And that newly created wealth hasn't yet been wrested from beneath the mattress. As they rode a scorching five-fold rise in their economy over the past decade, Chinese consumers actually boosted their saving rate by seven percentage points. Lengthy research has been devoted to decoding the "Chinese savings puzzle."

Now, things have become even more puzzling. As China's economy falters, its consumers are suddenly opening their wallets.

By the time this year is over, China's economy is expected to post its slowest growth in a quarter-century. In September, imports contracted 17 per cent, while growth in spending on fixed-asset investments was the slowest on record. And on Monday, China reported third-quarter GDP expansion of 6.9 per cent, below the national 7-per-cent target.

It comes as something of a surprise, then, that a new breed of free-spending Chinese are riding to their country's economic rescue.

With wages rising faster than the broader economy, consumers bought their way to 10.9-per-cent growth in September retail sales. Internet buyers were the hungriest of all, their spending up 36.2 per cent in the first nine months of the year. It's all enough to add 2.3 percentage points to the segment of the economy that is composed largely of the service sector and now accounts for 51.4 per cent of China's GDP. That shift is a mark of progress in Beijing's efforts to move away from smokestack industries toward a more modern economy.

It's also a signal that China's consumers are changing, their spending prompted by feelings of security in the widening reach of social safety nets, or by the very seeds of China's current economic frailty.

The weakness in housing has seen prices fall in numerous cities and devastated the manufacturers and developers whose heavy spending once drove the economy. Developers are building 12.6 per cent fewer square metres of housing this year than last. The secondary sector they occupy saw growth fall to 5.8 per cent in the third quarter, from 7.3 per cent last year.

But lower housing prices have also given consumers freedom to "be more relaxed," said Li Wei, a professor of economics at Cheung Kong Graduate School of Business in Beijing. "Why save up for a down payment when the price of housing will not rise as quickly as inflation?"

And why not, then, enjoy some of the fruits of past saving? "Chinese have made so many sacrifices in order to enjoy future consumption. And I think it's time for them to realize that future," Prof. Li said.

Their spending is providing enough of a new cushion to the tumble in other parts of the economy that HSBC economists Julia Wang and Jing Li saw in the third-quarter data "some signs of stabilization in the Chinese economy."

The data have, without doubt, underscored the darkening prospects for a country whose ebullience in recent years lifted the world – and whose current faltering has become a source of global anxiety.

"The deceleration in [the] manufacturing sector, especially in overcapacity industries, seems to have gained momentum in recent months," Haibin Zhu, China chief economist for JPMorgan, wrote in a research note.

Declines in prices for manufactured goods have come alongside a dramatic decrease in demand for diesel and electricity, which grew at just 3.6 and 1.9 per cent, respectively, in August, to generate "the lowest industrial production growth in a very long time," said Louis Kuijs, the head of Asia economics at Oxford Economics in Hong Kong.

And even with the slack that consumers are picking up, he said, "growth is gradually softening over time, which will probably continue, and that's really where we are for China."

The change relative to even just a year ago is striking. In the first nine months of 2014, real estate investments climbed 12.5 per cent; this year, 2.6 per cent. Twelve months ago, profits at large industrial enterprises rose 10 per cent; this year, 6.2 per cent. Last year, state-owned firms were still growing at a 5.2 per cent pace; this year, only 1.3 per cent. Fixed-asset investment in September was up just 6.8 per cent, compared to 16.1 per cent in the first nine months of last year.

Some of this year's numbers have been propped up, too, by the abnormal strength of a financial sector that has profited from volatility in Chinese markets.

"The financial sector contributed 1.4 percentage points to the GDP growth rate. In normal times, it is about 0.6 to 0.7 percentage points," said Changchun Hua, China economist with Nomura Securities Co. Ltd. Subtract that, and the third-quarter growth rate would "actually be around 6.3 per cent," he said – a key factor in looking ahead to the fourth quarter, when the excess contribution is expected to diminish.

China's leadership has argued that a slowdown is normal, particularly in the context of a worsening global financial picture. Given how big its economy has grown, the annual addition to national GDP at 7 per cent growth "still exceeds what was generated by double-digit growth several years ago," President Xi Jinping said in a written interview with Reuters published on the eve of his arrival in the U.K. for a state visit. He attributed China's problems to the "growing pains of shifting from old drivers of growth to new ones."

Part of that has included a slight rise in unemployment, which edged up to 5.2 per cent.

There is little doubt the transition poses risks for China.

"Striking a balance between reform and restructuring, and preventing an uncontrolled growth slowdown remains a principal challenge for the authorities," rating agency Fitch wrote in a research note Monday.

Others, however, say Beijing is already succeeding in vanquishing jitters.

"China's economic weakness may not be as dire as many observers think," wrote Chi Lo, the senior economist for Great China at PNB Paribas Investment Partners. He believes recent stimulus could spark an economic rebound. China, he said, "may well be at the bottom of this cycle."