A Decent Credit Culture can Nurture China's Consumer Society

On the surface, nothing much has changed. China remains obsessed with investing - construction of factories and infrastructure accounted for 41 percent of gross domestic product (GDP) and about 50 percent of economic growth last year.

Moreover, its continuing high level of fixed-asset investment makes sense - building roads, water pipes, metro systems, telecoms networks and electronics factories is what a modernising country must do.

But the Communist Party leadership has decided that in the next decade hairdressers, accountants, karaoke bars, tour guides and movie directors will be the new pillars of economic performance. As investment growth slows and export markets endure unpredictable business cycles and protectionist moods, China will increasingly rely on consumption for job creation and income - the service industry is where most consumption occurs.

There is only one problem: Chinese people do not seem to want to consume, at least according to commonly cited data. Last year, national savings amounted to roughly 50 percent of GDP, which apparently means households are so afraid of hospital bills, school fees and the deposit on the new apartment they dream of that they save every penny they earn.

But that savings number hides something very critical. Chinese households save a lot, about 25 percent of their income. But as the World Bank says, what sets China apart from other developing countries is not that households save, but that enterprises do too.

Private consumption has been growing in real terms at about 10 percent a year for the past seven years. So getting Chinese households to spend more is not a hopeless mission. According to the credit card provider MasterCard, China's middle class will reach 100 million by 2010, each with disposable income of $5 590 (R38 200), and 7.5 million affluent people, each with $13 500 to spend. But why wait until 2010?

If a decent credit culture can be created, people can access tomorrow's income today and borrow money to buy a house, start a family and go on holiday, paying it back only when they are in their fifties. Consumer credit started in the late 1990s, with regulations allowing banks to offer home loans, now about 10 percent of total loans. According to a recent People's Bank survey, households in the 10 largest cities spend on average 35 percent of their monthly income on home loan repayments, which is comparable to other countries.

Loans to pay for education and buy a car are also possible, and 2 percent of households have credit cards. But there were no such households five years ago. Although debit cards are far more common, banks like China Merchants Bank have been aggressive in issuing real credit cards.

A key problem is that the payment system is not yet in place. UnionPay, the market leader, is expensive to install and many shops prefer cash to avoid tax. However, outstanding credit is growing, more than quadrupling in 2004 to 0.18 percent of GDP. But there are other obstacles to boosting consumption. First, banks have few means of checking creditworthiness.

Second, banks are vulnerable to non-repayment. The car loan market had a mini boom in 2003/04, but non-repayment over 50 percent forced banks to pull back. The difficulty of repossession and resale meant these bad loans had to be written off. A dark cloud also hangs over the home loan market.

A Supreme People's Court judgment in 2003 banned the repossession of homes that are a primary residence. A revision of that decision now permits banks to repossess homes, but only if they help arrange alternative lower-cost housing - an administrative nightmare, particularly if a lot of people default at the same time.

Third, consumers are generally not adept at dealing with interest rate risk. Nearly all home loans 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 rise in bank rates in April may boost greater public awareness of rate risk.

Finally, China needs to diversify financial products. Until recently, banks could offer only savings accounts. But structured deposits are becoming more popular. Securities investment funds now account for roughly 30 percent of stock market capitalization, but this is just 0.9 percent of GDP. 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.