Defining China's challenges

In Chinese astrology, 2013 is the Year of the Snake. People born this year are thought to be highly attentive to detail and focused on their goals. That focus and discipline would also be useful for those doing business in China this year – James Walton, IGD’s chief economist explains how the challenges China faces are being redefined... 

China matters, whether you do business there or not

 The current Chinese national government, headed by Xi Jinping and Li Keqiang, took office in November 2012 and represents the fifth ‘generation’ of leadership since the founding of the People’s Republic in 1949.

Their appointment and initial public statements have attracted considerable interest in both mainstream and specialist media around the world, since China is increasingly influential in the diplomatic, economic and military spheres.

For the consumer goods industry, the policies of the Chinese government – and their success in implementing them – are of critical importance, even for businesses that do not have direct links to China. China has the potential to affect business operations in other countries in several ways:

• Creator
  • China is the world’s largest exporter of manufactured goods; in 2011, it accounted for 15% of all goods exported worldwide, ahead of Germany (10%), the USA (8%) and Japan (6%)¹
  • Since the reforms of the 1970’s, China has developed a manufacturing base that is diverse, capable and still (relatively) low-cost. This has transformed life for consumers around the world
  • A stroll around any town centre - or any hypermarket – will reveal just how reliant western shoppers have become on the power of Chinese manufacturing
• Customer
  • With volume demand in western markets depressed after years of economic and fiscal stress, western consumer goods businesses are increasingly turning to China as a source of growth
  • With its vast population, rapid urbanisation and growing individuall wealth, China offers perhaps the greatest consumer opportunity in history   
• Competitor
  • The burgeoning Chinese grocery market is being fought over by western suppliers and retailers, but indigenous competitors, such as China Resources Enterprise, are also active
  • Over time, Chinese consumer goods manufacturers and retailers may be expected to expand into other markets, either by organic means or via acquisition (although current regulations make it difficult for Chinese businesses to make overseas acquisitions) 
  • China is increasingly active in acquiring resources in other countries, including agricultural land and strategic materials - such as rare earth metals - a policy that may place China in direct competition with western interests
• Complication
  • China’s growing power has the potential to add complexity and uncertainty to business operations through its activity in currency and capital markets
  • In particular, China’s role as a buyer of government bonds gives it both economic and diplomatic leverage over other governments

The official view from within

On the surface, it would appear that the Xi-Li administration has inherited a fairly benign strategic situation and initial statements made by Mr Xi have been calculated to emphasise stability and continuity. 

A closer examination, however, reveals that the new leadership has a number of challenges to deal with, including: 

• Bad debt held by banks, often concealed by lack of transparency
• Boosting domestic demand to compensate for falling demand amongst traditional trading partners
• Confronting corruption in government and business
• Environmental degradation and access to resources
• Food safety and security
• Friction with other nations, especially over territory (e.g. Japan) and currency policy (e.g. the USA)
• Inflation, especially for basic foodstuffs
• Market reform and the privatisation of state-owned enterprises 
• Population ageing and the one-child policy
• Possible ‘bubbles’ in asset markets
• Reform of the ‘hukuo’ household registration system, which controls access to education and welfare
• Revitalising economic growth
• Sharing the benefits of economic growth more widely

A start has already been made on some of these issues – Mr Xi has made strong speeches on corruption² and on foreign policy matters³, demonstrating firmness and resolution.   

Of all the challenges, revitalising growth is perhaps the most urgent. China’s economic performance is still impressive by European or US standards, but a gradual slowdown over 2011 and 2012 did cause some concern. 

Growth strengthened in Q4 2012 and share values rose, suggesting confidence in the new leadership, but the mechanisms which delivered such impressive and consistent growth over recent years – inexpensive labour, low production cost, strong export demand – may now be fading. 

This leaves the Chinese government with the question of what to do next. This was recognised by the 18^th National Congress of the Communist Party of China, the meeting at which Mr Xi and Mr Li were appointed. The Congress indicated that current priorities for structural reform are: 

• Agriculture and land
• Industrialisation
• IT
• Urbanisation

The chart below shows how closely economic performance in China is connected with structural reform, as well as the recent slowdown in growth which has attracted such concern.

China GDP performance and economic reform

Source: Economic Research Service, US Dept of Agriculture / IGD Research, February 2013

The unofficial view from within

Research from the US-based Pew Institute offers a fascinating insight into unofficial concerns, the viewpoint of ordinary Chinese people. It also shows how these concerns have changed over time.

What Chinese people worry about

This data tells us a number of things:

• Very few of these issues seem to have improved over time - most have got worse over the last 5 years, rather than better
• Inflation is a major worry, especially for food and drink – many older Chinese people have memories of severe hunger and food is an important political issue
  • There has been a clear step-up in concern over food safety, medicine safety and quality of goods generally as a result of safety scandals, such as  melamine in milk products

The latter item helps to explain why western brands have achieved such popularity in China – they are seen as a guarantee of quality and consistency.

What it all means for consumer goods businesses

Despite current economic concerns, China is likely to remain a major – perhaps the major – global growth market for consumer goods businesses in the years ahead. 

Grocery retail sales in China were worth US$1,121bn in 2012, making China the biggest grocery market in the world, well ahead of the next largest, the USA, where sales were worth US$951bn⁴. 

This value has been reached primarily due to the number of Chinese consumers – about 1.4bn-  since spend-per-person remains low by European standards, about US$827 per person in 2012 compared with US$3,013 for the USA. 

Looking ahead, spend-per-person may be expected to rise, reflecting a range of influences: 

• Changes in diet, with greater consumption of animal products and processed foods
• Growing affluence, with desire for more luxurious food and drink
• Retail development, with modern retailers able to offer a wider range of goods
• The benefits of growth spreading to less well-off workers
• Urbanisation, with self-sufficient rural workers becoming urban food store customers

These drivers must be weighed against a number of limiting factors, especially the maturity of some retail locations and growing retail competition. 

Maintaining growth momentum in long-developed markets within China such as  Beijing and Shanghai,  will be just as important as developing newer areas. 

The convenience and online formats will be important in driving further growth in areas where hypermarkets are well-established. Western businesses with experience in these areas may find that their knowledge is much in demand. 

Overall, however, the growth potential of Chinese grocery will likely continue to attract investment from both indigenous and foreign operators for some time to come. 

Rapid market growth, however, raises a number of risks which consumer goods businesses will need to grapple with, whether or not they decide to do business in China, primarily: 

• Greater difficulty in sourcing non-food products  such as clothing and electronics inexpensively from China – switching to another source is possible, but not easy, since China has well-established networks for supplying the necessary components, packaging, services etc
• Rising, volatile prices for food, fossil fuels and other vital commodities, due to Chinese demand and limited global supply (access to supplies may also be an issue)
• Sudden changes in the cost of credit and the values of currency as the Chinese government intervenes in markets

Further Material

Subscribers to IGD’s Retail Analysis service can find additional analysis on China, including:

• China hub page
• Special Analysis - Asia In Focus, Issue 2
• Store visits

Sources:

(1) Statistics Database, World Trade Organisation, value basis, data for 2011, accessed February 2013
(2) New York Times, 19^th November 2012
(3) New York Times, 29^th January 2013
(4) Retail Analysis Database, IGD Research, data is for 2012, accessed February 2013