European Luxury Brands Feel Pinch of China Slowdown
Burberry, Hugo Boss, and Swatch Group report challenges in China
European luxury consumer brands have started to feel the pinch of China’s economic weakness even as the 27-member bloc takes steps to reduce its dependency on the world’s second-largest economy.
Burberry, Hugo Boss, and Swatch Group reported challenges sales in China. British fashion brand Burberry said on July 15 that its sales dropped 21% in mainland China for the first quarter of fiscal year 2025. Germany’s Hugo Boss said the same day that the overall environment remained challenging in key markets such as China.
Swatch Group, the world's biggest watchmaker, reported on July 15 a steep drop in first-half sales and earnings as demand for luxury goods remained weak in China. The Swiss maker of Tissot, Longines and Omega watches, as well as Swatch watches, said net sales at current exchange rates dropped 14.3% overall to $3.85 billion in the January-June period.
Swatch “expects the Chinese market to remain challenging for the entire luxury goods industry until the end of the year,” it said in its first-half financial results statement.
The Stoxx luxury index, a stock market index that tracks the performance of the top European luxury goods companies, dropped 1.5% on July 15, the day that luxury brands like Burberry and Swatch announced their financial results. The index is up 5.90% year to date.
Economic Headwinds
The European Union Chamber of Commerce in China said in May that European companies operating in China are concerned that the slowdown will hurt their profitability. It also reported in its Business Confidence Survey that the outlook for doing business in China hit its lowest in the report's 20-year history.
China’s economy has taken a beating from a slowing property market, a decline in consumer spending and confidence, and a drop in foreign direct investment. Tensions with the US have hurt China, as Washington imposes tough trade restrictions on technology, markets, and capital.
The Chinese economy grew 4.7% in the second quarter from April to June, the slowest since the first quarter of 2023 and below forecasts of between 5% to 5.3%. The government expects economic growth of 5.0% for 2024, an ambitious target according to some analysts.
China's inbound foreign direct investment dropped 28.2% in the first five months of 2024 to 412.51 billion yuan ($56.7 billion)from the same period last year, dampening prospects for a turnaround. In the first half of 2024, property investment fell 10.1% from a year earlier and home sales by floor area declined by 19%.
Property Market Troubles
Investors and markets had expressed optimism at the start of 2023 that China would see a rapid economic recovery after the loosening of global COVID-19 restrictions and China’s strict Zero Covid policy. Instead, the government has been unable to manage a strong economic turnaround.
At the height of the COVID-19 pandemic in 2020, the Chinese government attempted to crack down on indebted real estate developers to reduce risk to the financial system. This effort pushed housing prices down and weaker companies defaulted.
It also led to the collapse of Evergrande after the developer inflated its revenue by $78 billion from 2019 to 2020. PricewaterhouseCoopers has cut staff across its China operation because of its role in its accounting services for Evergrande.
With a slowdown in the development of pre-paid homes, some homeowners stopped paying mortgages, increasing the perceived uncertainty of property investments. As of mid-2023, housing prices had fallen every month for more than a year and the declining value of homes seemed to negatively impact spending tendencies in China.
“A negative wealth effect from falling property and stock prices, as well as low wage growth amid various industries' cost cutting, is dragging consumption and causing a pivot from big-ticket purchases toward the basic 'eat, drink and play' theme consumption," Lynn Song, chief economist for Greater China at ING, said.
Forecasts Lowered
Goldman Sachs lowered on July 15 its forecast for China's 2024 gross domestic product to 4.9% from 5.0% after data showed that its economy had slowed in the second quarter.
"To counteract weak domestic demand, we believe more policy easing is necessary through the remainder of this year, especially on the fiscal and housing fronts," Goldman Sachs economists, led by Lisheng Wang, said. JP Morgan, which lowered its 2024 GDP forecast for China to 4.7% from 5.2%, said the country’s economy remains "fragile, unstable and uneven."
In February, the People’s Bank of China (PBOC) announced the biggest-ever cut to a key mortgage reference rate. Chinese lenders slashed their five-year loan prime rate by 25 basis points to 3.95%. The move aimed to allow more cities in China to reduce minimum mortgage rates for buyers.
Loans grew at the slowest pace on record in February, a reflection of the continued low borrowing demand. The PBOC is expected to maintain a loose monetary policy this year and push borrowing costs lower.
Third Plenum
Amid these economic challenges, China held its third plenum meeting from July 15-18 to focus on long-term economic reforms, presided over by Chinese President Xi Jinping, head of the party's Central Committee.
Following the end of the meeting, the government reiterated China’s commitment to a “new development philosophy,” focused on “high-quality economic development” driven by “all-around innovation” as well as reaching its 5% annual growth target by building a modern socialist country in all respects.”
The CCP has shown signs of shifting away from its previous emphasis on raw growth driven by infrastructure investments. But this may not be enough to help the country’s economy pick up pace, with internal and now external pressure causing additional uncertainty.
US, EU Pressure
In recent months, the US and EU have accused China of flooding global markets with cheap products to cope with industrial overcapacity.
EU Commission chief Ursula von der Leyen and French President Emmanuel Macron urged President Xi in May to ensure more balanced trade with Europe. Von der Leyen said at the talks in Paris that the European Union "cannot absorb massive over-production of Chinese industrial goods flooding its market."
The EU is looking to reduce its reliance on imports of critical raw materials from China under its Critical Raw Materials Act. The bloc sources 100% of its heavy rare earth elements from China.
The EU pressure to reduce its dependency on China amounts to greater economic uncertainty for European companies operating in China or reliant on Chinese consumers.
"European companies are confronted by growing uncertainties in China, in large part due to economic volatility and less predictable policy direction," Denis Depoux, global managing director of management consultancy Roland Berger said.