Recent economic data coming out of China has observers wondering about the momentum of the country's transition to a consumption-driven economic model. However, according to Mike Shiao, CIO Asia ex Japan at Invesco, the outlook remains bright for Chinese consumption growth, with lower-tier cities becoming one of its key drivers.
"Like its economy, China's consumption landscape has been diversifying over the past few decades," Shiao says. "The growth engine that once relied on China's largest cities for fuel now needs more input from other sources." China's lower-tier cities can serve as such a source of growth as favourable demographics, rapid income growth, a faster pace of urbanisation, improved accessibility and connectivity, and low product penetration combine to release pent-up demand beyond China's main urban centres.
In all, private consumption in China amounted to roughly USD 5 trillion at the end of 2017. That is more than 10% of total global consumption and makes China's consumer market the world's second largest. Yet, the market's potential is far from being fully exploited. Data show that China still lags other major economies in terms of the contribution of private consumption to gross domestic product (GDP). In 2017, the share of China's GDP attributable to domestic consumption stood at 39.1%, compared to 68% in the US, 62.2% in India and 55.8% in the European Union (according to the latest data for each country taken from CEIC as of January 2019).
At the same time, real incomes in China are expected to continue rising thanks to sustained strong economic growth and supportive government policies. The strong growth of Chinese workers' real incomes has been a key factor behind the rapid growth of China's consumer sector over the past few years. "These trends highlight that the forces that have helped create one of the world's largest consumer markets are set to continue," Shiao notes. "What we think will be different, however, are the dynamics of expansion in China's consumer sector: lower-tier cities are fast emerging as another key dynamo in China's consumption engine."
Ever since China embarked on economic reforms four decades ago, its largest cities have led the country's economic development. These tier-1 cities, including Beijing and Shanghai, have grown to become centres of urbanisation and development. Improvements in infrastructure in these cities support growing industries and in turn, nurture employment opportunities. The inhabitants of these cities have seen their incomes rise rapidly, which has propelled the consumer sector's growth. Now, salaries in these upper-tier cities have reached high-income status based on the World Bank's definition in 2017 of USD 12,236 per capita.
Today, China's domestic consumption is likely to find additional much-needed momentum from the emergence of its lower-tier cities. Defined as those in the second tier and below (prefecture and county-level urban centres), these cities, which include places like Chengdu and Nanjing, are riding beneficial trends that are turning them into sources of fuel for China's next stage of consumption growth. Indeed, like economic growth, consumption growth in lower-tier cities has been outstripping that of tier-1 cities recently, thanks also to better transport and communication infrastructure, which is making it easier for residents of these cities to jump onto the consumption bandwagon.
With these driving factors in place, companies will find a ready consumer base for their products in lower-tier cities, according to Shiao. Similar to their top-tier peers, residents from lower-tier cities are increasingly looking for premium products and healthier, higher-quality alternatives as well as exploring varied experiences, a trend which is likely to benefit online travel agencies, among others. "We believe this trend will serve to attract astute consumer companies into China's smaller cities," Shiao says. "Their efforts, together with the consumer market's steady growth in top-tier cities, will help maintain the momentum of the Chinese consumer sector as it leads China's economic growth."
Mike Shiao is CIO Asia ex Japan at Invesco