The retail sector in China should hold up nicely in the coming year, even against the backdrop of slowing economic growth and a continuing antigraft campaign, according to market watchers. But in Asia’s other major economy — Japan — the recessionary environment is giving retailers pause.

This story first appeared in the January 5, 2015 issue of WWD. Subscribe Today.

China’s anticorruption measures over the past 18 months have put a dent in luxury sales worldwide, while slower economic growth at home has stoked concern about consumer spending. China’s gross domestic product in the third quarter grew at its slowest pace in five years, making it likely the country will miss its annual growth target of 7.5 percent.

Yet lower economic growth doesn’t necessarily mean reduced retail spending, said Julian Evans-Pritchard, China economist at Capital Economics in Singapore, because “much of the slowdown has been due to slowing investment rather than slowing consumption.”

Income growth has held up “quite well” as the Chinese economy has been shifting into the service sector, which is more labor-intensive. The job losses that some have been expecting haven’t materialized and urban job growth, at 10.7 million as of the end of September 2014, has been better than expected.

“It’s been sort of a misinterpretation that slowing growth means fewer employment opportunities and job losses, but the service sector has picked up,” Evans-Pritchard said. Further aiding consumer spending are falling foreign oil prices, which have been giving households more disposable income, he added. “I think it’s quite positive for most retail sales,” he said.

Luxury sales are another story and market watchers say the outlook continues to be difficult.

Aaron Fischer, analyst at CLSA in Hong Kong, said he remains cautious on luxury, not only because of anticorruption measures, but also because customers have become more knowledgeable and particular about brands. The analyst forecasts 10 percent year-over-year growth in luxury spending, which is “not too bad,” but is a big drop from three years ago when some brands saw 100 percent year-over-year growth.

The luxury goods sector has become a lot more “complicated.” Three years ago, the “power brands” outperformed, he said, now customers are looking for more unique products. “There isn’t the same level of brand loyalty as in other markets, and that makes it harder to retain customers,” he said.

The key trend for luxury brands is to offer products at reasonable price points, Fischer explained, noting that during a recent conference call, Prada talked about offering handbags at a variety of price levels. “We tend to favor a wider range of price points. One company we like because of its wide offering is [Hong Kong-based jeweler] Chow Tai Fook. Income levels [in China] are still quite low. Most can’t go and spend 3,000 euros [$3,650 at current exchange] on a handbag.”

Chinese spending power is good news for Hong Kong, which has long been a prime shopping destination for Mainland Chinese tourists. CLSA said it is “very bullish” on Chinese tourist demand and expects outbound departures from China to grow at an 11 percent compound annual growth rate, reaching 200 million by 2020. Hong Kong is facing more competition, though, as Mainland Chinese go further abroad and the city is losing market share at a faster pace than expected. The strength of the Hong Kong dollar, which is pegged to the U.S. dollar against the Japanese yen and Korean won, is also not helping, as it could encourage Hong Kong and Chinese consumers to go to Japan or Korea to shop.

But while Chinese consumer spending is holding up, the outlook for textile and apparel manufacturers is less rosy. Chinese manufacturers have been struggling with rising labor and materials costs and losing market share to cheaper factories in Southeast Asia. (See story, this page.) To adapt, Chinese manufacturers have been trying to move up the value chain and improve efficiency, but with limited results.

“If [the Chinese government] continues to raise wages 15 to 20 percent every year, in five years’ time, China cannot be competitive. If you move further [upstream] you need fewer workers, but the population is not shrinking like in other countries. It’s a wait-and-see game. We can’t sustain cost increases,” said Roger Lee, chief executive officer of TAL Group.

TAL, which produces 30 million shirts a year, has kept headcount in China steady at about 8,000 people, but has been expanding in Vietnam, where costs are lower.

As for Japan, retailers might be breathing a sigh of relief that a second sales-tax hike has been postponed until 2017, but they are still expressing caution about consumers’ spending habits in a recessionary environment. On the upside, tourists are flocking to the country and embarking on shopping sprees. That trend is likely to continue, particularly if the yen remains weak.

Miyako Sekimoto, fashion director for Matsuya’s Ginza store, estimated that sales to foreign tourists make up an average of 12 to 20 percent of each department store’s business in Tokyo. Foreign visitor arrivals to Japan between January and November rose 28.2 percent on the year to 12.18 million, according to preliminary figures from the Japan National Tourism Organization. South Korea, China and Taiwan were the three biggest source regions for tourists every month.

Sekimoto said tourist spending at Matsuya compensated for weaker sales to Japanese consumers. Ultimately the store’s sales ended the year up about 10 percent from the previous year, she said.

“Many department stores are trying to catch foreign people,” she said, adding that foreign tourists tend to target high-end European luxury brands like Prada, Christian Dior and Saint Laurent Paris. “They buy a lot, you know, they don’t buy only one piece.”

As for nontourist shoppers, retailers expressed caution about their prospects with the increasingly selective and budget-conscious Japanese consumer. Prime Minister Shinzo Abe pushed through a controversial sales-tax increase in April with the aim of generating funds to pay down the country’s formidable debt pile. The tax hike, which lifted the rate from 5 to 8 percent, dented consumer spending more than anticipated and precipitated Japan’s fall back into a recession as of the third quarter. Abe postponed a second tax increase in the hopes that Japan’s economy would recover. That second rise — originally slated for October 2015 and now scheduled to take effect in April 2017 — would lift the tax rate up to 10 percent. Abe’s Liberal Democratic Party handily won a snap election in December, but observers have said the victory was overshadowed by low voter turnout, and it reflected the lack of a compelling alternative from opposition parties, rather than a rousing show of support for Abe or his economic policies.

Goldman Sachs economist Naohiko Baba noted that Japan’s real wages continue to shrink and warned about an “ongoing deterioration in consumer sentiment indices” under Abe’s stewardship.

“We think real incomes will get a boost from April 2015 as the [year-over-year] inflationary impact of the tax hike drops out of the picture. Incomes could benefit further if spring wage hikes are higher than last year. However, we believe serious efforts to lift productivity are essential for wages to keep rising. We look to the government to deliver tangibles from its growth strategy, including far-reaching measures to address demographic challenges,” Baba wrote in a research note last month.

Matsuya’s Sekimoto noted that European brands have started to raise their Japanese prices on certain items to counterbalance the weak yen and she expects more of that in the coming year.

“If I think only about Japanese consumption, I can’t be optimistic,” she said.

A spokesman for Sogo and Seibu department stores said Japanese consumers are thinking about “ethical” spending that fits their income levels. “Because disposable income has decreased, I think people will become very smart about choosing things carefully when they shop,” he said. “It’s not that people are not interested in things, but the feeling of wanting to buy things that you really like, or things that meet high expectations, is getting stronger,” he said.

Noting an ongoing trend rather than a recent development, Sekimoto said Japanese consumers are showing more interest in spending money on lifestyle pursuits, hobbies and beauty products rather than fashion.

“People have more options to spend their money,” she said.

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