Luxury comes of age in China

As demand for luxury property in China reaches historic highs – prices in Hong Kong have surged by more than 50 per cent since early 2009 – so too has the demand for high-end shopping malls and the luxury goods sold within.

Producers of luxury goods have enjoyed many years of impressive growth in demand for their products in the emerging market. However, a number of commentators have been raising the possibility of a ‘hard landing’ for the Chinese economy while Chinese officials tempered economic growth targets.

Therefore, given the changing nature of the Chinese economy, or at least the perception thereof, a re-examination of the prospects for the luxury sector within China seems timely.

On closer examination of likely economic trends and, most importantly, the earnings reports of companies involved in distributing discretionary or non-essential consumer products, the conclusion is that the long-term growth within the sector continues unabated. One is also reassured by the manner in which key producers have adapted their product range to local tastes and market circumstances.

Recently China’s authorities have started to steer opinion makers (and its citizens) towards a lower target for economic growth. During the 11th National Peoples’ Congress, Chinese premier Wen Jiabao revised the nation’s growth target down from 8 per cent to 7.5 per cent. This announcement prompted various forecasters to reduce global growth estimates but, on reflection, the significance of a reduced growth target seems limited: China has a record of consistently exceeding its growth targets.

Also, Chinese officials are explicitly targeting an increase in consumption as a proportion of GDP, aiming to raise it to 45 per cent of GDP by 2015 from today’s level of 35 per cent. Based on 2011 figures from the IMF, this would represent an increase of $2.2trn (£1.4trn) in just four years.

In the context of this “consumption policy”, it is not surprising that lowering taxes on luxury goods is on the political agenda.

Luxury goods taxes vary significantly between products, ranging from 30 per cent for handbags to 20 per cent for apparel and 10 per cent for jewellery.

Policymakers would have noticed that mainland Chinese residents are avoiding luxury taxes by shopping in Hong Kong but also that shopping tourism to Europe and the US has been increasing dramatically.

A reduction of luxury goods taxes will have two effects: purchases will move towards mainland shops, while there could be downwards pressures on prices in line with lower taxation. Nevertheless, on balance, one can expect a boost to the profitability in the sector.

Companies with a comprehensive Chinese distribution base are likely to be disproportionate beneficiaries. This would include BMW, Coach, Estée Lauder, LVMH, PPR (which owns Gucci), Prada, Richemont (which owns Cartier), Swatch and Tiffany.