Tuesday 02 December 2014
The business investment outlook
The rebalancing of Australia's economy back towards the non-mining sectors will be the major economic challenge for the next few years
The rebalancing of Australia's economy back towards the non-mining sectors, which account for more than 90% of activity and more than 97% of jobs, is the major economic challenge over the next few years. New data on business investment plans show that the transition from the mining boom to non-mining growth has begun, but is a long way from complete.
The latest capital expenditure (capex) survey shows that firms remain on track to cut their investment spending this financial year. Capex intentions survey data points to a 6.4% fall in investment on the 2013/14 level. The downswing phase of the mining investment boom is the major drag. Mining firms expect to reduce the level of investment by 15.8% in financial year (FY) 2014/15, spending $16 billion less than FY2013/14. Analysis by the Reserve Bank of Australia (RBA) based on the known investment pipeline and liaison with mining companies suggests that further 20% decline is likely in FY2015/16.
Key to the success of the investment transition, and the economy overall, is the trajectory for non-mining sectors. The data suggests that non-mining investment recovery is likely to fall short in 2014/15. The latest reading suggests that non-mining firms expect to lift capex by 4.9% in FY2014/15. However, the $3.3 billion increase in spending will fill less than a quarter of the investment hole left by the mining sector.
A much larger increase in investment will be required to offset the anticipated decline in mining investment spending in FY2015/16. Unfortunately, we won't know the exact size of the decline in mining investment, and whether the non-mining sector's investment spend is sufficient to offset it, until early 2015 when the first survey is published in February. Based on the RBA's outlook, non-mining capex would need to rise by a further 22% in FY2015/16, to a record $86.5 billion.
Such a large increase would be unprecedented. However, there are other areas of non-mining investment that are not covered by the capex survey that could make a contribution. The proportion of non-mining capex included in the capex survey is just under half of total non-mining investment.
Investment by sectors of the economy such as agriculture, education, aged care, and health are excluded from the data. For these sectors, the monthly non-residential building approvals is the only survey that provides a regular forward-looking indicator of investment. However, this only counts building works that have been approved. While the construction of buildings is an important component of investment spending by these sectors, other components - namely the purchase of machinery and equipment – are not available on a timely basis.
While only partial, non-residential building approvals remain an important indicator. Unfortunately, approvals have declined steadily, with rates of decline consistent with the falls following the onset of the global financial crisis.
This weakness in non-residential approvals was cited by the RBA as a factor which drove them to cut their outlook for business investment in the November Statement on Monetary Policy. The RBA kept their growth outlook for the economy unchanged, despite lowering their forecast for the Australian dollar ($A) from $US0.93 to $US0.86. The weaker non-residential construction picture led to the benefits the RBA expected from a more favourable currency being offset by continued stagnation in the non-mining growth transition.
It is clear from the lacklustre non-mining business investment picture that an increase in confidence or further substantive declines in the currency will be needed to achieve the desired growth rebalancing in the economy. We have been highlighting for some time that there are other risks in the economy that could prevent both of these outcomes from being realised.
On the currency front, the actions of the European Central Bank and Bank of Japan could see increased demand for $A assets. This, along with further portfolio rebalancing by Asian central banks could mute downward moves in the $A.
On the confidence front, further declines in iron ore and energy prices are going to negatively impact the Government's revenue forecasts. If the revenue downgrades are matched with additional spending cuts there is a chance that consumer and business confidence could be further eroded.
How the economy's four Cs - currency, commodities, confidence and capex - play out over 2015 will be the determining factor of whether this period of interest rate stability continues, or the balance is tipped in favour of further rate cuts.