China's initiatives to stimulate the consumer sector are heading in different directions. On the one hand, the government is deploying subsidies to encourage upgrades to new, energy-efficient products. On the other, it has been tapering support for the electric vehicle (EV) sector to encourage market efficiencies. S&P Global Ratings anticipates these policies will have a small positive net effect.

Demand for consumer electronics is accelerating as incentives roll out. Meanwhile, EVs' growing share of China's auto market will help drive sales. Despite this, we are cautious about strength in consumption growth, because we expect faster growth for services than for products.

In addition, declining demand for internal combustion engine vehicles will offset some growth in sales of EVs. We see increasing product competitiveness of EV and battery producers helping them continue to expand exports in the next one to two years. Localized operations overseas will likely deliver more sustainable growth in the long run.

We wrote about the Chinese government's stimulus measures in a recent report, "What Are The Credit Implications Of China's Various Programs To Support Growth?" published March 27, 2024, and held a webcast on the topic on April 11, 2024. This follow-up article focuses mostly on the design and effect on consumption of government programs targeting consumer appliances and EVs. The questions below are ones that participants raised in our recent webcast.

Frequently Asked Questions

Will China's consumption in coming years look different to that in other markets?

China's consumers are increasing the share of their wallets they allocate to services rather than products. This is similar to the trend in the U.S. As a result, service categories such as restaurants, food delivery, travel, and cinemas are doing well. Many service categories had double-digit growth in China last year. That momentum continued in the first quarter of 2024.

Meanwhile, the outlook for products is a more mixed bag. We see polarization of demand in many product categories, from nondurables like dairy and beer to durables like apparel and electronics. At the same time consumers as a group are both trading down to lower-cost, higher-value alternatives and trading up to indulge in higher quality or premium products. They are turning away from midrange products, which have the toughest outlook both in terms of lower demand and greater competition.

In EVs, we think China's domestic consumption will grow 15%-20% annually in 2024 and 2025, from above 30% last year. This reflects a continuous shift in consumer preference to EVs from gasoline vehicles thanks to improving product functionality and charging infrastructure. We expect EV penetration to approach 40% in China by 2025, from over 30% in 2023.

In the global market, while momentum weakened a bit in the U.S. and Europe in recent quarters, we view the shift to electrification as irreversible in the long term. By 2025, we expect EV penetration of 25%-30% in Europe and 15% in the U.S.

What's the main objective of China's efforts to stimulate consumption? Are there any signs that these are working and when might we see a turnaround?

The objective is to boost consumer confidence battered by hits to domestic equity and property markets. Confidence has picked up a little so far this year but is nonetheless still quite far from its recent peak in February 2022.

While China has traditionally focused stimulus more on infrastructure-related investments, it has also launched consumption-focused incentives. One major success is in Hainan. Supportive policies in recent years helped lift sales at the island's offshore duty-free shops. They jumped to over Chinese renminbi (RMB) 60 billion in 2021 from under RMB20 billion in 2019.

In 2022 and 2023, sales fell due to COVID-19 and remediation of problems in cross-border "daigou" trade. But judging from planned capital expenditures for development projects, the island should continue to attract domestic visitors and spending.

As to when consumption will turn around, we maintain our view that in 2024 China's retail sales will expand slightly less than GDP. We project annual consumption growth of 4%-6% for the next few years. The era of rapid 7%-10% annual growth is largely behind us.

How does the program to encourage trade-ins of home appliances differ from previous ones to boost sales, and will it bring a bonanza to retailers or manufacturers?

It's very different to past programs. Those addressed much lower penetration of home appliances in rural areas. The latest program aims to shorten replacement cycles in both cities and rural areas.

A program in 2008 addressed uneven growth in the use of home appliances between cities and rural areas. This was notable despite rapid overall GDP growth, with rural areas lagging in overall economic momentum and therefore living standards. For example, less than 25% of rural households had refrigerators compared with over 90% of households in cities. The rural population was also outsize at 50%-60% of the total population.

This time, the aim is to boost overall national demand and progress green goals. Many of the three billion appliances that the government estimates to be in use across China are not energy efficient. Local governments have been rolling out incentives to trade up and we see a pickup in electronics sales. Retailers and manufacturers are building supply chain and service capabilities to support trade-ins of old products.

Overall, we don't anticipate a repeat of the 30% growth in electronic home appliances in 2008. We foresee about 4%-6% growth this year compared with shrinking sales in this category over in the past two years. We also expect the replacement cycle to continue to shorten and product selling prices to rise with product upgrades. At the same time, weak property market transactions will hinder the pace of growth, in our view.

Are Chinese EV makers more cost efficient than U.S. and European makers? And is this the main reason China's EV exports have grown significantly?

Chinese EV makers have cost advantages over U.S. and European makers, given China's well-established supply chain from upstream materials to batteries and other components. They also have lower energy and labor costs.

Apart from cost advantage, improving product functionality also supports Chinese EVs' increasing competitiveness. This includes improving battery performance, longer driving range, better software capability, and improving infotainment systems.

How does the Chinese government's support for EV or EV battery sectors differ from that in the U.S.?

In our view, Chinese government support for the EV sector is similar to government support in the U.S., for example via the Inflation Reduction Act (IRA). The IRA grants tax credits to consumers and production credits to EV battery producers. There are also differences. For example, China's subsidies are fading while the U.S.'s have increased under the IRA. Moreover, U.S. support seems at least partly aimed at deterring the entrance of Chinese players or imports from China.

Chinese support in summary:

• The Chinese central government's support for the EV sector has mainly included purchase subsidies for consumers and purchase tax exemptions; both have helped increase consumer acceptance of EVs.
• Central government purchase subsidies stopped at the end of 2022. Some EV producers qualify for favorable income tax treatment if classified as high-tech companies (this benefit exists in other sectors as well).
• Some local governments still provide purchase subsidies as well as subsidies to EV producers when they set up factories.
• China in 2019 phased out an EV battery whitelist containing only Chinese suppliers. This had protected them from foreign competition because only EVs with batteries produced by suppliers on the list were eligible for central government purchase subsidies at the time.
• Overall, the government has gradually wound down supportive measures to encourage a more market-oriented EV industry.

Key differences between Chinese and U.S. support include:

• China's 10% purchase tax exemption for EVs is capped at about US$4,200 in 2024-2025 and will halve to a maximum of US$2,100 in 2026-2027. This compares with US$7,500 tax credits in the U.S. valid till December 2032 under the IRA.
• In China, purchase tax exemptions are available to buyers of qualified imported EVs such as Tesla Model S and Model X made in the U.S. Whereas U.S. buyers would not qualify for a tax credit if the EV's final assembly is not in North America or the EV battery is manufactured by a foreign entity in any of four countries of "concern." China is one of those countries and the only one strong at EV and EV battery production.

With China having invested substantially in its EV sector and its production capacity still growing, what's the implication for the domestic and international EV market?

China brands are becoming more dominant. The country's EV production and sales have grown substantially in recent years thanks to rapidly developing supply chains and improving product offerings. In 2023, China produced 9.1 million electric passenger vehicles. It sold 7.7 million units domestically and exported 1.2 million units thanks to cost advantages and improving product functionality. So, EV sales have essentially kept pace with production.

Of the 1.2 million EVs exported, Chinese brands accounted for only 60%-65%. Tesla's Shanghai factory alone accounted for over a quarter of exports, according to media reports, with other international brands making up the difference.

Export destinations included Europe, Asia, Latin America, and beyond. In Europe, Chinese brands have a small share of the EV market. As trade hurdles rise for Chinese EV makers eying exports, the domestic market remains the main battleground for such entities.

We're also seeing Chinese carmakers set up production facilities in markets including Southeast Asia and Europe with the approval of foreign governments. Localized production will level the playing field with other producers. However, Chinese firms will take time to increase brand awareness and gain trust of local retailers and consumers.

In China, by contrast, the government has gradually removed restrictions on operations of foreign carmakers and battery suppliers in recent years. Foreign brands account for 40%-50% of China's domestic passenger vehicle market. German producers alone control more than a fifth of the market. Japanese brands account for about 15%.

What's the outlook for China's EV battery exports and for makers' expansion overseas?

We think export momentum for EV batteries will remain robust in 2024 after growing 87% last year. This is due to continued electrification globally and China's dominant position in EV battery production. But the growth rate may moderate as EV growth slows in major markets.

Producers such as Contemporary Amperex Technology Co. Ltd. (BBB+/Positive/--), Gotion High-tech Co. Ltd., and Eve Energy Co. Ltd. have expanded or are in the process of expanding to Europe by setting up manufacturing plants in countries such as Germany and Hungary. They're likely to continue to gain share in Europe.

Meanwhile, the producers will remain cautious in their actions to expand into the U.S., given restrictions under the IRA. Instead of building plants there, some are partnering with local automakers through technology licensing agreements.

Editor: Leeroy Betti

Related Research

What Are The Credit Implications Of China's Various Programs To Support Growth? March 27, 2024