22/06/2024 3:31 PM


Piece of That Fashion

How Concerned Should Fashion Be About Chinese Stagflation? | China Decoded, BoF Professional

Many international fashion and beauty companies have looked to China for sales salvation during the Covid-19 pandemic and the country has largely delivered.

In recent quarters, luxury names, beauty brands and sportswear players running the gamut from LVMH to L’Oréal to Lululemon, have reported outstanding growth in the world’s second-largest economy.

The growth has been driven by two key factors: first, China’s swift nationwide quashing of the Covid-19 outbreak in the early months of 2020 and second, millions of local consumers — some of whom resorting to shopping at home rather than spending abroad as they would have before travel restrictions kicked in; others investing in health and wellness amid pandemic-induced lifestyle changes — ramping their already-robust spending.

Then there’s the third big factor: China’s broader positive economic trajectory. The country was, after all, the only major economy to achieve growth in 2020, with GDP rising 2.3 percent and data points ranging from retail sales to manufacturing activity looking strong in the second half.

But a different narrative is unfolding in 2021, one that could lead the economy into stagflation — when a country experiences both a slowing or stagnating economic growth and rising inflation. It’s a potentially painful situation that should give pause to companies whose growth plans hinge on a robust Chinese economy.

Kelvin Wong of CMC Markets said key indicators in recent months suggest the country could be shifting gears, in ways that could make a big dent in consumer demand amid rising prices and slowing economy driving up unemployment and lower wage growth if it carries on over the medium to long-term.

“[S]lower growth and higher prices tend to lead to a stagflation environment and, if entrenched, it may be challenging for counter-cyclical fiscal and monetary policies to reverse [stagflation’s] adverse effects,” Wong said.

The Stagflation Scenario

Concerns have been rumbling for several months now that the country may sooner rather than later find its economy in a deep stagnation or a stagflation scenario. While GDP forecasts set for the year are still looking respectable relative to other big economies — OECD estimates from May forecast China’s GDP to grow 8.5 percent this year, compared to 6.9 percent growth for the US — there are worrying pressure points.

A case in point are the official and private business surveys suggesting a weakening in key economic drivers. The latest data from the country’s National Bureau of Statistics (NBS) showed that China’s official manufacturing Purchasing Managers Index (PMI, a measure based on monthly industry surveys) fell to 50.1 in August from 50.4 in July, which is still above the 50-point mark that separates growth from contraction. However, the official non-manufacturing PMI in August was 47.5, well down from July’s 53.3. This marks the first decline since February 2020, when the country was in the grips of the Covid-19 outbreak.

“The latest surveys suggest that China’s economy contracted [in August] as virus disruptions weighed heavily on services activity,” Julian Evans-Pritchard, senior China economist at Capital Economics, wrote in a note. “Industry also continued to come off the boil as supply chain bottlenecks worsened and demand softened.”

Though, Evans-Pritchard noted, the fall in the services sector was largely due to an outbreak of the highly contagious Delta variant of Covid-19 that began in late July, disrupting tourism and the person-to-person service sector, weakness in China’s domestic consumption was already noticeable for months.

High production costs could be squeezing corporate profit margins, especially those selling directly to consumers.

Another consideration is China’s recent “Covid Zero” strategy. Under the policy, outbreaks of the virus are stamped out with lockdowns and travel restrictions, creating supply chain pressures and fuelling freight rate hikes, which are at record levels and a source of inflation. In August, the world’s third-busiest port, in the eastern Chinese city of Ningbo, was partially shut when a worker tested positive for Covid-19. It was the second major Chinese port shutdown in a matter of months.

Keeping producer price inflation under control has proven elusive for policy makers in China. The producer price index for the country’s industrial sector for July recorded a 9 percent year-on-year change, its seventh consecutive monthly increase. At a state council meeting in May, chaired by Premier Li Keqiang, the need for policy action to prevent spillover into consumer prices was emphasised, though no concrete plan has been disclosed. Economists are now warning that high production costs could be squeezing corporate profit margins, especially those selling directly to consumers.

And though China’s official urban unemployment rate was 5.1 percent in July, Wong questioned whether that might be painting an “over-optimistic” picture of the labour market, particularly since the country’s significant population of migrant workers are not included in that rate. As for young people aged between 16 and 24, their jobless rate was 16.2 percent in July.

The full repercussions on fashion and retail companies, in China and beyond, remains to be seen. But freight and other rising costs — including for cotton and other raw materials — mean that companies must decide whether and by how much to pass on the price inflation to consumers, at a time when demand appears to be diminishing. Unlike international brands such as Crocs, Michael Kors and Ralph Lauren, Chinese brands have yet to signal in their recent earnings reports their intention to raise prices.

Indeed, consumer prices have remained relatively muted, though core consumer inflation (excluding food and energy costs) rose 1.3 percent in July, the highest rate in 18 months, Wong of CMC Markets explained, indicating that “producers may have started to pass on the higher cost of production to consumers.”

Uneven Impact

While international luxury companies such as Chanel, Prada, Balenciaga and Louis Vuitton seem to be able to raise prices at regular intervals without denting consumer desire for their products, other global brands responding to price pressures in their supply chains will need to have a good case to pass higher costs to Chinese consumers.

Unlike international brands, Chinese brands have yet to signal in their recent earnings reports their intention to raise prices.

“I think what we are continuing to see is that within the mid-market or upper mid-market, foreign brands are facing a variety of challenges in maintaining and growing market share,” said Ben Cavender, managing director of China Market Research Group. He added that success for non-Chinese companies might be found in “smaller niche brands that are seen as being the best of their specific category or where they are seen as offering brand heritage or an interesting designer or interesting concept that will still get domestic consumers to open their wallets.”

Put another way, regardless of whether a brand raises prices in China as a result of inflationary pressures, it likely won’t be the price alone that influence consumers’ decisions to make a purchase.

This said, with a greater proportion of Chinese consumers feeling pessimistic about their economic futures post-pandemic, it stands to reason that this will cause at least some consumers to start tightening their belts. Particularly for discretionary categories like fashion, that means even a whiff of stagflation casts ominous clouds.



Lu Han had been a brand ambassador for Audemars Piguet since 2018. Lu Han Studio Official Weibo.

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