Plastic nation

China is in the midst of a transition from a cash-only society to 'buy now – pay later.' The domestic banks are issuing credit cards at a tremendous rate and card usage is growing as fast as the spending power of the young, upwardly mobile, urban population.

The shift to credit payment for consumer goods and services has big implications for the entire economy and is seen as a panacea for a host of ills. The government sees credit as a way of loosening the grip of the masses on their savings and speeding up China's shift from an economy driven by government-funded infrastructure projects to one based more on consumer spending. Domestic banks still struggling under a mountain of bad debt see consumer credit lines as a quick route to profitability, while foreign banks and credit card issuing operators like Visa and Mastercard eagerly anticipate a share of the prize.

For any foreign company with an interest in China's 1.3 billion potential consumers, the prospect of the average citizen gaining access to revolving credit is tantalizing. But it pays to put things in perspective. Goldman Sachs expects only "a handful or two of foreign banks to garner a collective 5 percent to 10 percent share" of the potential US$7 billion- US$9 billion consumer banking market in due course – hardly a full-scale foreign invasion.

The credit consumers
China's middle class, defined as those earning US$5,000 per year and above, is predicted to grow from an estimated 60 million people in 2002 to 160 million by 2010. By that time, China – or at least its major eastern urban centers – will have been transformed from the cash economy of only yesterday to one dominated by credit cards and electronic transactions. It should be remembered that the concept of credit as understood in developed nations was only introduced to China in 1996.

Already the numbers look very promising. Card transactions in China last year grew 38 percent year-on-year to RMB 11.6 trillion while direct card consumption (point of sales transactions) soared 46 percent year-on-year to RMB 187.5 billion, not more than 4 percent of the country's total retail sales of RMB 4 trillion.

What those impressive figures mask is a largely unsophisticated card market. The number of cards in use in China in June was 569 million, but 544 million of them were straight debit cards. A further 23 million (often referred to as 'quasi-credit' cards) are essentially debit cards with an overdraft function of no more than RMB 5,000. Only two million cards would be considered 'real' credit cards outside China.

Of these unsecured, revolving credit cards, half are RMB denominated and the other half (known as 'international' cards) are capable of being used for foreign currency (mostly US$ or HK$) transactions. Only 2 percent of consumer spending in China is done with these real credit cards compared to about 30 percent in other Asian economies like South Korea.

The root of the confusion as to what constitutes a 'real' credit card dates back to the 1980s when banks in China began issuing debit cards with overdraft facilities and calling them credit cards. It was only very recently that real credit cards began to be issued.

Barely seven years old
When credit cards first appeared in the US in the 1950s, China was in the midst of such excesses as the Great Leap Forward. When the notion of consumer credit as known elsewhere was introduced to China in 1996, the main motive of the government was to reduce the burden of state assigned housing by encouraging China's urban population to buy their own homes. Most consumer credit today is still made up of home loans, although auto-financing is growing strongly. In the first eight months of this year, new car and home loans reached RMB 500 billion, almost double the growth rate a year earlier. For banks in China, consumer credit is a very attractive business compared with corporate banking. This becomes apparent when you consider that the delinquency ratio on mortgage loans for the country, according to a Goldman Sachs report, is only an estimated 1 – 1.5 percent versus double-digit delinquency ratios for commercial and corporate loans.

Not only is the risk low, the potential is only just beginning to be realized. Total consumer credit grew from zero at yearend 1996 to RMB 699 billion at year-end 2001 (of which RMB 560 billion was mortgage loans), but consumer debt still amounted to only 6.7 percent of China's total loans, and only 7.3 percent of China's annual GDP. By comparison the consumer debt-to-GDP ratio is 63.4 percent for Hong Kong, 66.9 percent for Korea, and 42.6 percent for Taiwan.

Goldman Sachs expects China's consumer debt market to rise to at least 30 percent of GDP (or more than RMB 3 trillion at today's level) over the next five to 10 years, providing enormous profits for the struggling domestic banking sector as well as foreign competitors.

The future is plastic
The government has introduced policies to slow the growth in the home loan sector in order to help head off a potential property bubble and, while it recently allowed some non-bank organizations to offer auto-financing with promises that foreign automakers could also be allowed to compete as early as next year, the government continues to warn of overheating in the automobile manufacturing industry.

In contrast, the growth of the consumer credit card market is seen as fundamental to the government's plan to generate and sustain consumer-led GDP growth, and the development of the industry features very prominently in the current Five-Year Plan. Private consumption in China still makes up only 49 percent of China's GDP versus 64 percent in Taiwan and 70 percent in the US, and the development of consumer credit is seen as a fast track to increasing the ratio. So the government is doing everything in its power to accelerate the transition from cash to credit, including allowing foreign players into the market – in a regulated and orderly fashion, of course.

Lining up for the prize
Foreign banks such as Citibank, HSBC, and Standard Chartered are all poised to enter the market, according to Godfrey Kong, Senior Manager of HSBC's credit card department in China. The foreign players are attracted by the same things that lure foreign businesses in every industry to China – the largest potential consumer market in the world and an extremely primitive industry infrastructure just waiting to be developed.

The foreign banks are currently somewhat disillusioned after hopes were raised at the end of 2002 that they would soon be allowed to issue foreign currency credit cards. A year later, and it is now believed to be "sometime next year".

"We are still waiting for legislation to be announced before we can apply for licenses and when that will happen no one knows," Kong said.

Under China's WTO commitments, by 2006 foreign banks will be freed from all geographical and customer restrictions and be allowed to conduct full RMB business, including issuing local-currency denominated credit cards.

HSBC and rivals such as Citibank are not sitting idly in the meantime. HSBC is using its 8 percent share in Shanghai Bank to reach a cooperative deal in which the local bank issues cards for the foreign lender. Most other banks are preparing to enter the market as soon as they are able.

While maintaining restrictions on foreign banks, the government is actively encouraging domestic banks to ramp up their credit card services. The country's first credit bureau, Shanghai's Credit Information Services (SCIS), has been set up to provide credit information on borrowers in the city, and in March 2002 China UnionPay (CUP) was set up as a fledgling domestic competitor to Mastercard and Visa. CUP now links major banks and payment systems in China's principal cities and aims to connect all payment systems throughout China by 2005.

So far, all Mastercard and Visa cards in China have been issued by Chinese banks. Mastercard-branded cards have a twothirds share of the quasi-credit card market but Visa has captured about 74 percent of the smaller real credit card market. In the third quarter of this year, the number of Visa international currency revolving credit cards in circulation rose from 860,000 to 1,080,000 – a 25 percent increase in just three months and a 100 percent increase from a year earlier, according to Albert Shiung, Visa's Vice President and General Manager in China.

That is phenomenal growth, but considering the miniscule number of real cards in circulation in proportion to the population, Shiung said this number could be expected to grow even faster in the future. He pointed out that the US has over a billion credit cards, or about four or five per person, while even in Hong Kong the ratio is about two for every person.

This year, the State Administration of Foreign Exchange (SAFE) changed regulations to allow consumers to make credit card purchases in foreign currencies and pay back the debt in RMB. This led to a surge in the issuing of dual-currency cards, especially by China Merchants Bank which recognized the potential early and aggressively marketed this new product. The number of these cards has already reached 600,000 and is expected to increase exponentially.

Probably one of the most significant effects of these new cards is that it allows Chinese consumers to buy products online from international shopping websites which generally charge in US dollars.

Currently only 2 percent of China's merchants accept any kind of bank or credit card and for every RMB 100 of card transactions only RMB 1.5 involves a point of sale transaction with bankcards primarily being used to withdraw cash over the counter or from ATMs. But increased competition and the steadily rising number of foreigners in China are spurring a speed-up in network construction across the country.

Educating consumers to owe
Rebecca Zhao is a young professional working in a foreign firm in Shanghai who got her first real revolving, dual-currency credit card just one month ago.

"I'm getting ready to use it for shopping in Hong Kong," said Zhao. For her, it is a novelty that will make her first trip off the Mainland a more convenient experience. She has no intention of using it for daily purchases at home or to run up large amounts of debt, even debt she can afford to pay back.

Statistics from a study by the School of Management at Fudan University in Shanghai show that an estimated 38.6 percent of real credit cards issued in China are used less than once a month and while in Taiwan the average debt per credit card is about US$300 dollars, in China the debt is only about US$20 per card.

Visa's Albert Shiung sees raising consumer awareness and changing consumer behavior as the biggest challenges facing the development of the credit card industry in China. "The concept of spending first and paying later is one that consumers in China will have to be taught. Remember that China has never even had personal checking," he said.

He said that as with any undeveloped credit card industry, the China market would not be profitable for at least three to five years until economies of scale begin to pick up and the volume of cards reaches viable levels. But even then, credit card operators would focus only on the four richest urban centers of Shanghai, Beijing, Guangzhou and Shenzhen.

Per capita GDP for the whole of China last year was a little over US$900, well below the magical US$5,000 level of the major cities. Not surprisingly, credit card usage varies considerably depending on location. For example, over 70 percent of credit card holders in Guangzhou use their card at least seven times a month compared with only 30 percent in Shenyang.

In credit, as with most aspects of China's economy, it is the affluent east- ern cities that will lead the way. But the direction and trends are clear from the historical examples of comparative economies such as Hong Kong, Taiwan and Singapore. Fifteen years ago, Taiwan residents were saving about 40 percent of their income – exactly the same as the observed rate in China today. Nowadays, with the deep penetration of credit cards on the island, the savings rate has dropped to about 20 percent. Analysts believe it is reasonable to expect the same trend on the Mainland, and in a much shorter time span. "There is an enormous potential market here," said HSBC's Godfrey Kong. "It won't be long until China runs on credit instead of cash."