Drive to Reduce Corruption Dampens Luxury Goods Consumption in China

11 Jun, 2015 by Dwarka Lakhan

The Chinese still have an affinity for luxury goods but the government’s drive to stamp out corruption has put a damper on demand. “Froth and extravagance are no more” states an Exane BNP Paribas report (China 3.0 – Luxury Goods: Chinese Luxury comes of Age, June 8, 2015.)

The report notes that two major factors are negatively affecting the dynamics of luxury goods demand in Greater China: (1) the drive to stamp out corruption by the Chinese administration; and (2) conspicuous “in your face” consumption of luxury goods and “gifting” to gain favors from public officials

The Washington-based Global Financial Integrity Group estimates that US$1.1 trillion flowed out of China illegally between 2002 and 2011.

Since assuming power in 2012, China’s President Xi Jinping has launched a sweeping anti-corruption campaign that transcends all segments of the Chinese population, including those living abroad. It has also ensnared executives working for foreign and Chinese companies, and placed tens of thousands of government officials under investigation.

The Beijing Declaration on Fighting Corruption has been signed by the 21 members of the Asia-Pacific Economic Cooperation (APEC), which comprises Pacific Rim member economies that promotes free trade throughout the region.

The declaration reaffirms APEC members’ commitment to denying safe haven to those engaged in corruption, including through extradition, mutual legal assistance and return of proceeds of corruption. It also seeks to expedite international cooperation in the prevention, investigation, prosecution and punishment of offences and makes reference to the use of existing multilateral UN conventions as well as establishing new bilateral extradition treaties and mutual assistance agreements.

APEC has also set up an informal network for sharing information and best practices to fight corruption.

Incidentally, China does not have bilateral extradition treaties with the United States, Canada or Australia – the three most popular destinations for suspected economic criminals. However, China is signatory to a number of multilateral treaties containing extradition obligations to which Australia, Canada and the US are also party.

The government’s anti-corruption drive has resulted in a sharp drop in luxury goods sales in Hong Kong (-15% to -25% year over year) as mainland Chinese consumers are not feeling welcome anymore and due to adverse FX restrictions, according to the Exane BNP Paribas report.

The decline in demand for luxury goods is expected to negatively affect sales for a number of items, states the report. Among them are high-end watches which are specifically hit, with sales down by approximately 60% from their 2012 peak. Sales of cognac is also on the decline while very-high-end car sales – the realm of “second generation” rich Chinese – are a fraction of what they were in 2011 and will continue to decline. High-end watches and cognac are reported to be two primary items used to gain favors from government officials prior to the anti-corruption drive.

In addition, gaming revenues and luxury goods sales in Macau are shrinking, as rich Chinese keep a low profile, while luxury hospitality venues throughout mainland China have downsized or closed.

The government believes that Macau casinos are a prime source of money flowing out of China and has made the casinos a prime target through its Operation Fox Hunt anti-corruption efforts. So far, dozens of individuals from some 40 countries around the world have returned to China, either voluntarily or otherwise to face corruption charges.

While luxury goods demand is moderating in China, it is shifting elsewhere, states the report. It identifies three factors which are at play. (1) Rich Chinese consumers have moved abroad, with some high-end brands indicating that up to 2/3 of their VIP clients are simply no longer in Asia. (2) Rich Chinese consumers have moved on by moderating spending on luxury products in favor of experiences and services such as travel, education, health, food, home, etc; and (3) Chinese middle class consumers, for whom price is an important purchase driver, seek every opportunity to buy luxury products at cheaper prices – during travel abroad and through the internet.

In spite of the decline in demand, the report notes that the love affair of Chinese middle class consumers with luxury goods is still very strong. Luxury sales growth today is driven primarily by a greater proportion of the Chinese affluent population getting into the market.

For this reason, premium mass market and aspirational luxury goods brands continue to experience strong growth. Demand is reported to be stronger among consumers in second and third tier cities who are the latest to be exposed to luxury goods purchase opportunities, states the report.

Dwarka Lakhan

Dwarka Lakhan is a pioneer in emerging markets journalism in Canada. His first emerging markets article, “Africa Joins Ranks of the Emerging,” appeared in Investment Executive, Canada’s leading newspaper for financial advisors, in September 1994. Since then he has written hundreds of articles on the full spectrum of emerging markets and has conducted more than two thousand interviews with emerging and frontier markets investment professionals.