Learning to use credit in China
The Chinese have a reputation of being adverse to credit, but all they really lack are suitable financial products like educational loans and home mortgages
By Stephen Green
Tuesday, Jul 25, 2006,Page 9
In the old days, when communist central planning suffocated China’s economy, fixed-asset investment was the regime’s measure of economic progress. The more tonnes of steel produced, slabs of concrete poured, and gallons of crude oil pumped out of the ground, the better. The consumption-based economy, to which the capitalist West had apparently succumbed, was written off as a paper tiger.
On the surface, nothing much has changed. China remains obsessed with investing — construction of factories and infrastructure accounted for 41 percent of GDP and around half of economic growth last year.
Moreover, the country’s continuing high levels of fixed-asset investment make sense — building roads, water pipes, metro systems, telecommunication networks, and electronics factories is what a vast and rapidly modernizing country must do.
But the Chinese Communist Party leadership has decided that in the next decade, hairdressers, accountants, karaoke hostesses, tour guides and movie directors will be the new pillars of economic performance. As investment growth slows and export markets endure their unpredictable business cycles and protectionist moods, China will increasingly rely upon consumption for the creation of jobs and income — and the service industry is where most consumption occurs.
Indeed, private consumption in China has been growing in real terms at an annual rate of around 10 percent for the last seven years.’
There is only one problem: Chinese people do not seem to want to consume, at least according to commonly cited data. National savings amounted to roughly 50 percent of GDP last year, which apparently means that households are so afraid of hospital bills, school fees and the down-payment on the new apartment they dream of that they save almost everything they earn.
But that savings number hides something very critical. Chinese households do save a lot, about one quarter of their income. But as Louis Kuijs of the World Bank has pointed out, what sets China apart from many other developing countries is not that households save uniquely high levels of their income, but that enterprises do. Indeed, private consumption in China has been growing in real terms at an annual rate of around 10 percent for the last seven years. This means that getting Chinese households to spend more is not a hopeless mission.
According to the credit card provider MasterCard, by 2010 China’s middle class will number 100 million, each able to indulge in discretionary spending of US$5,590. China will also have 7.5 million affluent people, each with US$13,500 to spend.
But why wait until 2010? If a decent credit culture can be created, people can have access to tomorrow’s income today. People in their twenties could borrow money to buy a house, start a family, and go on holiday, paying the money back when they are in their fifties and would much rather stay at home and enjoy their grandchildren.
Consumer credit began in China only in the late 1990s, with regulations allowing banks to offer mortgage loans, which now amount to about 10 percent of total loans.
According to a recent survey by the People’s Bank (the central bank), households in the 10 largest cities spend about 35 percent of their monthly income on average on mortgage repayments, which is comparable to other countries.
Loans for higher education and car purchases are now also possible, and 2 percent of households have credit cards, which is obviously still low compared to 75 percent in the US, but there were no such households just five years ago. Although debit cards remain far more common, banks like China Merchants Bank have been aggressive in issuing real credit cards.
A key problem with the credit card rollout is that the payment system is not yet in place. UnionPay, the market leader, is expensive for retailers to install, and many shops prefer cash to avoid tax. However, outstanding balances on credit cards are growing, more than quadrupling year-on-year in 2004, to 0.18 percent of GDP, according to the McKinsey consulting firm.
Several other obstacles must nonetheless be surmounted in order to boost consumption. First, Chinese banks still have few reliable means of checking borrowers’ credit worthiness, including their previous loans from other banks. Educational loans should be booming in urban and rural China, but banks do not know whom to lend to, so they are not.
Second, banks are vulnerable to non-repayment. The car loan market underwent a mini-boom in 2003 and 2004, but non-repayment rates in excess of 50 percent forced banks to pull back. The difficulty of repossession (where did the borrower park the car?) and sale (the used-car market is still in its infancy) meant that most of these bad loans had to be written off.
There is also a dark cloud over the mortgage market following a judgment by the Supreme People’s Court in 2003 that banned the repossession of homes that are a primary residence. A recent revision of that decision permits banks to repossess homes, but only if they help arrange alternative lower-cost housing — an administrative nightmare for lenders, particularly if a lot of people start defaulting at the same time.
Third, consumers are generally not adept at dealing with interest-rate risk. Nearly all mortgages have floating rates that vary with the five-year loan rate set by the People’s Bank. However, late last year, Everbright Bank and some others began offering fixed-rate mortgages. Take-up has been slow, but the surprise hike in April in bank rates may help to sow greater public awareness of interest-rate risk.
Finally, China needs a greater diversity of financial products. Until recently, banks could offer only simple savings accounts. But structured deposits — for example, deposits with a rate of return linked to the performance of the New York Stock Exchange — are becoming increasingly popular. Securities investment funds now account for roughly 30 percent of tradable stock market capitalization, although this represents only 0.9 percent of GDP, compared to more than 5 percent in India.
The economic significance of new financial products is likely to grow more rapidly as foreign banks enter the market. If China’s regulators issue the right licenses, the financial sector will play a key role in nurturing and sustaining the consumer society of tomorrow.
Stephen Green is a senior economist at Standard Chartered Bank in Shanghai.
Copyright: Project Syndicate