China’s economy is grappling with the significant challenge of weak consumer demand. Data from second-quarter GDP growth show that gross capital formation, final consumption expenditure, and net exports contributed 1.9, 2.2, and 0.6 percentage points to economic growth, respectively.
Notably, the role of consumption in driving economic growth has waned, declining by 1.7 percentage points from the first quarter. This slowdown first emerged in the second quarter of last year and has been falling since.
From January to August of this year, total retail sales increased by only 3.4 percent year-on-year, a 0.1 percentage point decline from the January-to-July growth rate.
Although the consumer price index (CPI), rose by 0.6 percent year-on-year and 0.4 percent month-on-month in August, the year-on-year growth for the first eight months was only 0.2 percent.
A noteworthy trend is that since March, the CPI growth rate in urban areas has consistently been lower than in rural areas. This further confirmed the relatively weak purchasing power of urban residents and the persistent sluggishness of the consumer market.
The insufficient demand is also evident in the decline in capacity utilization. In the second quarter, China’s capacity utilization rate dropped to 74.9 percent, which is noticeably lower than the pre-pandemic average of around 77 percent and lags behind that of international levels.
The root cause lies in the slow growth of household incomes, which is a key factor limiting consumption growth. In the first half, the per capita disposable income growth rate for urban residents was only 4.5 percent, significantly lower than the GDP growth rate for the same period.
Therefore, raising household incomes and driving consumption motivation is crucial to addressing the primary economic contradiction.
To boost consumer spending, tax reforms must be deepened. First, it is necessary to raise the personal income tax threshold. Currently, China’s personal income tax threshold is set at 5,000 yuan ($712). If we raise this threshold from 5,000 yuan to 8,000 yuan, it is estimated that the annual tax revenue could decrease by about 30 billion yuan, which makes up for just 0.17 percent of the total tax revenue last year and would have minimal impact on overall fiscal health.
But this change could yield significant socioeconomic benefits. It would directly benefit middle and lower-income earners by substantially increasing their disposable income, as this group is more sensitive to income changes, and any additional income is likely to be quickly spent.
Second, individuals with an annual income of below 350,000 yuan are the backbone of the consumer market, and their spending power plays a crucial role in driving economic growth. Thus, lowering the personal income tax rate for this income group could be considered.
If the tax rate for those who earn 100,000 to 200,000 yuan a year were reduced to 5 percent from 10 percent, and the rate for the 200,000 to 350,000 yuan were reduced to 15 percent from 20 percent, it is estimated that annual tax revenue could decrease by around 100 billion yuan.
Third, there is still ample room for fiscal policy to stimulate demand. In July, China launched measures to promote large-scale equipment upgrades and the replacement of old consumer goods with new ones.
The measure includes an allocation of about 300 billion yuan in long-term special government bonds to facilitate this process, with approximately 150 billion yuan earmarked for local governments to support the replacement of old consumer goods.
Similar fiscal policies could be expanded to emerging sectors like telecommunications, electronic devices, and green products. Additionally, greater support can be launched to ensure the policy genuinely benefits a broader range of consumers.
Fourth, it is also important to boost local governments’ incentives to promote consumer spending. Moving the consumption tax collection to local authorities is a significant move of China’s fiscal reform, which will profoundly impact local government revenue and local economies.
Traditionally, the consumption tax is collected at the production stage, which has weakened the incentives of local governments to promote consumption. For example, with goods like tobacco and alcohol, even if these items are consumed in different regions, the tax is collected at the production site, making it difficult for the local government where consumption occurs to benefit directly.
With such efforts, local governments will have a direct right in collecting consumption taxes, which will significantly enhance their motivation to stimulate and support their local consumer markets.
In addition, more efforts should be made to maximize financial support for consumer spending.
First, it is expected that the country could lower interest rates on existing mortgages to boost household purchasing power. China has implemented such adjustments twice before, in 2008 and 2023, both of which effectively promoted economic recovery and growth.
Adjusting existing loan interest rates is not an easy task. Factors such as loan duration, interest rate levels, and market changes, make it challenging to precisely quantify the difference between rates on existing loans and new loans.
But a broad consensus is that lowering interest rates on existing loans could directly ease borrowers’ repayment burdens, thereby unlocking consumer spending potential.
For example, if a household’s monthly mortgage payment decreases from 2,000 yuan to 1,500 yuan, the extra 500 yuan could be redirected toward consumption.
Currently, interest rates on new loans have dropped significantly but rates on existing loans remain high, resulting in a substantial gap between the two. Given the relatively low deposit interest rates and higher rates on existing loans, many borrowers are opting to repay their loans early.
Against this backdrop, calls for reducing interest rates on existing loans have intensified. Such a move would not only reduce consumers’ repayment burdens and stimulate spending, but also curb the trend of early loan repayments, partially offsetting the loss of interest income for banks.
However, multiple factors should be considered when implementing this policy. With banks accounting for over 90 percent of China’s financial sector assets, their stable operation is also crucial to the financial market’s stability and the real economy’s healthy development.
Therefore, while discussing the reduction of interest rates on existing loans, it’s essential to fully understand the banking system’s unique challenges and constraints, including its capacity to absorb changes, manage risk and support the real economy.
Currently, banks’ net interest margins have dropped to a historic low of about 1.54 percent, indicating substantial pressure on profitability.
While exploring new drivers of consumer growth, innovation in consumer finance products has also become essential.
Aside from mortgage loans, consumer loans accounted for 24.7 percent of household debt in China in 2023, compared to 30 percent in the United States, which showed both structural differences in consumption and the potential for growth in non-housing consumer loans in China.
By leveraging big data analytics, financial institutions can more accurately identify consumer needs and design products that better align with public expectations. This approach not only broadens the reach of consumer credit, but also taps into deeper consumer demand, helping to unlock spending potential.
A high-level meeting on July 30 provided us with clear direction — China enhancing the consumption ability and willingness of middle and lower-income earners is crucial to expanding domestic demand and promoting economic circulation.
Service consumption, as a key driver of consumption expansion and upgrading, plays an important role in improving people’s quality of life and fostering social harmony.
Financial institutions should actively respond to policy guidance, increasing support to these areas through innovative financial products and optimized services, thereby offering consumers more convenient and efficient financing solutions to help accelerate the development of the service consumption market.
Achieving steady growth in the consumer market is not an overnight process. It requires coordinated efforts on both the demand and supply sides.
On the demand side, fiscal and monetary policies must be implemented precisely to raise household income levels and boost consumer confidence.
On the supply side, continuous optimization of industrial structures, enhancement of product and service quality, and diversification of consumer offerings are needed to meet the increasingly varied consumer demand.
To conclude, only when supply and demand work together in a positive cycle can the consumer market stabilize and move toward higher-quality development.
The writer is a professor at China Europe International Business School and former director-general of the PBOC’s statistics and analysis department.
The views do not necessarily reflect those of China Daily.