There Goes The Credit Impulse: Why Chinese Consumption Is On The Verge Of Collapse

Recently we discussed how in addition to the widely manipulated Chinese GDP data, new concerns had emerged about official data involving Chinese industrial profits, because while China’s National Bureau of Statistics has traditionally reported positive year-on-year growth rates in percentage terms, growth in absolute yuan terms has been negative. This deviation, which barely happened in the past, has reinforced scepticism over the quality of Chinese “data” and fueled fresh suspicion that the NBS generates data outcomes that match the policy goals of the Chinese government leadership instead of reflecting the true state of the economy.

More recently, similar worries have been noted over China’s consumption data, which have been sending what Goldman politely calls “mixed signals lately”, and which a more cynical take would dub “massaged”, if not outright fabricated. Which, with China’s economy increasingly turning into a consumption-driven model like that of the US, is a problem if economists, analysts and investors are unable to get an accurate grasp on consumption trends in the world’s second largest economy.

The problem in a nutshell: NBS retail sales slowed in Q2 and also in July, while NBS household consumption expenditure and GDP final consumption contribution (quarterly data) rebounded relatively strongly in Q2. Other widely observed consumption data include 100 major retailers’ sales, with the data painting a bearish picture in recent months and showing negative year-over-year growth in July.

This, as Goldman notes in a Saturday report, has led many investors to ask: where does the divergence come from and how has consumption been growing in reality?

Goldman then spills a lot of digital ink to offer various politically correct explanations for why the government’s stronger data may be accurate, although even the bank is not fully able to justify the variation between government data, and private reported data from 100 major retailers, whose sales growth has been a lot weaker than the official NBS goods retail sales report.

Specifically, the bank notes that when plotted against listed department store revenues, the 100 major retailers’ sales move relatively closely with listed companies’ data. In fact, as shown in the chart below, the retail sales reported by China’s 100 major retailers has been flat at best over the past 4 years, and most recently, has sunk into contraction.

One possible explanation for this stark divergence between the “too pessimistic” private vs optimistic public retail sales data is that the the former does not capture the consumers’ shift to online stores for purchases.

Online sales showed much faster goods consumption growth – NBS online goods retail sales data and package delivery data (our proxy for online goods sales) both suggest online goods sales have probably been growing at close to 30% yoy so far this year, in contrast to the negative year-over-year growth recorded in the offline goods sales channel.

Assuming the truth is somewhere in the middle, something which Goldman has attempted to do with its own proprietary Chinese goods consumption tracker, still shows a sharp decline in annual sales growth on a Y/Y basis, hardly encouraging for an economy that hopes to becomes less reliant on fixed asset investment and transition into a consumption driven model.

Which brings us to the core of the report: what is behind the slowdown in China’s goods consumption – this key driver of Chinese GDP – and what is the outlook going forward.

As Goldman explains, there are multiple reasons behind the softer goods consumption trend – unfavorable wealth effects from the property and equity market, income-related drags such as fewer subsidies from shanty town redevelopment plans, but the biggest driver is the slower growth of consumer credit, and higher debt service burdens due to larger mortgages and greater consumer credit.

Of these, the bank estimates that the key catalyst explaining the slowdown in Q2 consumption is the fading credit impulse and higher debt service costs, and that these could further shave goods consumption growth later this year. As for the culprit, the most likely suspect is Beijing’s recent crackdown on Chinese P2P lending: recall that one month ago we reported that as part of China’s crackdown on peer-2-peer online lending which had grown at a blistering pace heading into 2018 only to suffer a waterfall of defaults, social unrest had broken out in some parts of the nation as China scrambled to avoid the bursting of yet another credit bubble.

So where does that leave us? Well, as Goldman writes, the trend of softer goods consumption may continue as loans via P2P platforms are now more than 10% of consumer credit (this includes all loans via P2P in consumer credit, while P2P loans could also be invested in corporate bonds and property markets), and recent P2P defaults have prompted large-scale redemptions by investors (P2P loans outstanding amount shrank from 1.3 trillion RMB in June to around 900bn RMB in August, based on WIND data) as investors perceive higher risks and regulations tightened.

This has resulted in a sharp consumer deleveraging, and loss of purchasing power, as ordinary Chinese found one relatively easy debt channel shuttered.

Factoring in this slowdown and assuming other categories of consumer credit continue to grow at the speed seen in 1H 2018, overall net credit flows (as a share of disposable income) would slow even more in 2H 2018.

How much more?

When combing with the lagged effects from the recent slower consumer credit growth, Goldman estimates that the fading credit impulse and associated debt service costs will shave goods consumption growth by a whopping 3% in 2H 2018, resulting some time in late 2018 and early 2019 in the most negative print since the financial crisis. This, as shown in the chart below, would lead to the fastest slowdown in Chinese consumption this decade.

Needless to say, such a sharp contraction in consumption would lead to broad, adverse spillover effects affecting everything from China’s GDP (which would be severely impacted), to China’s reflationary impulse which has been so critical for the past decade, and which would go into reverse, sparking another global deflationary shockwave and sharply lower interest rates.

What is most concerning is the timing: all of this is set to take place just as Trump’s $1.5 trillion fiscal stimulus reaches its one year anniversary (i.e. the base effect fades), and what until now has been a sugar high for the economy on a Y/Y growth basis, will result in contraction absent another round of fiscal stimulus. It would also impact global asset prices and markets, many of which are already suffering from sharp, “rolling bear market” selloffs as a result of emerging market turmoil which has so far spared the US.

In short, and as always: keep an eye on China’s collapsing credit impulse for hints on what happens next going into 2019, a year in which many economists and pundits believe the US recession will finally make a repeat appearance.

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