Private capital expenditure in Australia continues to decline and there is little sign of a turnaround in the coming year.
We always knew that capex would be impacted as the commodity boom started to shift into the more operational phase of the commodity cycle. The recently released National accounts show a continued decline in real capital expenditure (Private Gross Fixed Capital Formation) of -4%, subtracting -0.9% pts from the latest annual GDP growth. Most of that decline was driven by a fall in “engineering construction” as a result of this transition in the phase of the mining boom.
What was hoped for by the RBA was that a ‘rebalancing of growth’ could be engineered by lowering interest rates to stimulate non-mining investment and by weakening the AUD. We now have lower rates and the AUD has depreciated to levels that should improve our export competitiveness. Rather than see a continued pick-up in non-mining investment activity, the latest business capex expectations showed that capex intentions outside of Mining for the next financial year are also likely to fall. The quarterly Survey of Private Capital Expenditure (capex) showed that while mining capex is expected to fall by -37%, non-mining capex is also expected to fall by -5%. Overall, capex is expected to decline by 23% in 2015/16. At a total level, this is a fairly significant decline.
The issue in Australia is that the lack of investment growth to help take up the slack now left by lower mining investment highlights a lack of confidence in future growth. This quote from Glenn Stevens (RBA Governor) is as relevant today as it was a year ago:-
“…any plans for growth that might be in the top drawer remain hostage to uncertainty about the future pace of demand”
- Glenn Stevens Governor RBA, testimony to the Standing Committee on Economics, 20th Aug, 2014
And now, a year later:-
“The missing ingredient continues to be a lift in non-mining business investment, where we are still waiting for convincing signs of a pick-up”
- Philip Lowe, Deputy Governor RBA, Speech to the Committee for Economic Development of Australia (CEDA) 9th Sept, 2015
Just how bad is the situation with capex?
So far, we’ve had eight (8) consecutive quarters where total private capex has declined (annual % chg based on latest qtr versus the same qtr previous year).
Annual capex growth has gone from a high of +17% in 2011 to a -4% annual decline in the latest June 2015 data.
Source: ABS
From a long term perspective, declines in capex have been infrequent and part of a broader economic slow-down. The capex decline so far is low compared to historical standards, but expected capex for 2015/16 could be more in line with previous steeper declines.
The split between mining and non-mining capex is interesting.
Source: ABS
Whilst the value of mining capex has fallen sharply since 2013, it looks like non-mining capex has started to pick up at the same time – helped in part by lower interest rates and the falling dollar. That said, growth in non-mining capex has been, on average, lower since the end of the mining investment boom, growing at +3.3% on average (between Mar 2013 and June 15) than during the main investment boom years (2000-2012) when non-mining capex grew at +4.2% on average. More recently, while there was some acceleration in non-mining capex growth throughout 2014, that momentum has stalled during 2015.
What has contributed to the decline in private investment?
According to the latest GDP data, the single largest contributor to the decline in private capex is in non-dwelling construction. This is the single largest area of private capex spending, accounting for 35% in the latest quarter. Within non-dwelling construction, it has been engineering construction that has declined significantly – this is the type of large scale construction supporting the development of major mining projects. The contribution of non-dwelling construction to annual private capex growth has declined further in the latest quarter:-
Source: ABS
The only area that has made a more significant, and positive, contribution to private capex growth is Dwellings – which covers construction of new dwellings and additions/alterations to existing dwellings. But the contribution of dwelling construction to overall private capex growth has also slowed between the last two quarters. Again, not a great sign, given we’ve got record levels of lending for housing and very low interest rates. Construction of new dwellings accounted for 25% of private capex spending in the latest quarter.
The one piece of good news was in machinery and equipment expenditure. This is also one of the bigger areas of private capex, accounting for approx. 20% of private capex and was one of the few areas where contribution to overall capex growth improved.
So what does the future hold?
The June 2015 Capex Survey indicates more declines to come in 2015/16
As I’ve pointed out in previous posts, the Capex Survey is not a comprehensive representation of all new capital expenditure intentions in Australia. The dollar value of the capex intentions and actuals, represent just over 40% of the above more comprehensive investment element in GDP (Private Gross Fixed Capital Formation data used above). It still useful in providing some indication about the general direction of intended capex spending across a range of industries. Industries not included in the survey include agriculture, forestry and fishing, education, health and community services and capex on dwellings by households.
This latest survey for June 2015 covered actual capex for the full year 2014/15, as well as the latest forecast capex for the year 2015/16 called estimate 3. Estimate 3 contains a forward view of the next four quarters of capex – at this stage, the data for all next four quarters are estimates (no actuals yet).
For the full year 2014/15, actual capex included in the survey declined by 4.7%, or -$7.3b. Note that this is larger than the -2.6% in latest GDP data, when calculated in the same way.
Unfortunately, the latest forecast for capex in 2015/16 holds little hope that this will improve:-
Source: ABS, est 3 2015/16 not adjusted using realisation ratio
Estimate 3 for expected capex in 2015/16 signals a possible fall of -23% in spending, or a decline of -$39b. The chart above also highlights the concerning trend of this leading element.
It’s fair to say that these expectations have tended to ‘overshoot’ the final ‘actual’ to both the upside and the downside. So at worst case, actual capex will follow that lead, but is not likely to fall further than that.
The other concerning point from the capex survey is the composition of industries forecasting a decline in spending in the following year:-
Source: ABS, note realisation ratios used mining = 0.89, manufacturing = 1.07, other selected industries = 1.18, total = 1.0
The fall in mining capex has been expected for a quite a while. That said, the expected decline in 2015/16 is fairly large at -37% or -$28b.
The continued decline in capex for manufacturing is an ongoing issue. The high AUD hurt Australian manufacturers during the mining boom and the wind back of industry protection policies over the last several decades has seen the manufacturing sector shrink in size. No doubt globalization has also had an impact on the broader sector as much manufacturing has been outsourced to lower cost countries. The Australian dollar has now depreciated by close to 30% and capex still looks to remain depressed in the short-term. It won’t help that car manufacturing will also cease in Australia by 2017.
A lower AUD is no magic bullet as it will take time to rebuild export businesses and relationships. Manufacturers, and more immediately, service providers, in Australia that compete with imports may see a more immediate effect as the falling AUD filters through the supply chain. But only once there is consistent stronger growth, will capex businesses cases start to look more viable. The one downside to a weaker AUD is that import of capital equipment will become more expensive.
The one bright spot in the survey had been capex for “other selected industries”, which grew by +12% in 2014/15. Expected capex for ‘other selected industries’ is now forecast to decline by 5.3% in 2015/16. The ‘other selected industries’ accounts for a significant proportion of the value of capex in the survey and comprises key services industries. Growth in capex for this group had been stronger, relative to mining and manufacturing, over the last several years.
What does this mean for the Australian economy?
Usually, falling levels of capex are not a good sign for the economy. The fall in investment means that we will likely continue to see lower levels of growth in the economy. This could adversely impact employment, income and output growth.
One possibility is that the fall in mining investment will just be replaced by the increase in commodity exports as major mining projects start to come online. That has been a leading theory of the mining boom, but that’s not what has been happening recently. Part of the issue is that whilst export volumes have been rising, commodity prices have been falling. In nominal terms, net exports have detracted from GDP growth (on an annual basis) over the last five (5) consecutive quarters:-
Source: ABS
The other issue is that if global growth is slowing, then it’s more likely that demand (i.e. volume) for commodities will also fall because they are usually inputs into the production process.
Could housing construction fill the gap? There are still a few important headwinds. APRA is in the process of curbing investment loan growth, rightly recognising that the high proportion of mortgages on bank’s balance sheets represents a ‘concentration risk’ to the financial system. The residential dwelling construction component, whilst growing fast, is still not big enough to fill the potential gap left by mining. Putting aside any question of whether housing construction should fill the capex gap, growth in dwelling construction would need to accelerate from currently 23% to roughly over 40% (assuming that mining investment halves from here and all other components continue to grow at the current rate). With housing lending and household debt already at record highs, interest rates already very low and real wages and income stagnant at best, Australia would probably need to see greater levels of foreign investment in new dwelling projects for this to happen.
Could public infrastructure spending help fill the gap? This might not fill the entire gap, but at least well targeted investment on infrastructure projects would actually be good for the productive capacity of the economy in the future. The government has access to some very low interest rates, but it seems to lack any sense of urgency or leadership to get something done on both the infrastructure and reform fronts.
“A low exchange rate, low growth in wages and low interest rates are not the basis for sustained increases in investment and output. They can certainly help during the adjustment phase, but ultimately we will be better off if increased investment is driven by high expected returns rather than by the low cost of finance or low wages. This is why the focus on improving the climate for business investment is so important. There is no magic bullet here, but surely the investment climate would be improved through a strong focus by both business and government on innovation, productivity, human capital and entrepreneurship, topics that I have spoken about on previous occasions.”
- Deputy Governor of the Reserve Bank of Australia, Philip Lowe, Speech to the Committee for Economic Development of Australia (CEDA) 9th Sept 2015
Fundamentally, the missing ingredient is growth. This is why private capital investment growth is an important indicator. In a most simplistic way, it’s a sign that business is expecting growth – growth in sales, consumption and/or profits. Investment might take the form of new equipment to expand production or the introduction of a new technology/innovation to improve productivity. Either way, it’s about expanding the productive capacity at a firm-level in order to take advantage of growth opportunities – this is the cornerstone of economic, employment and productivity growth.
Meanwhile, in Australia…
“…firms are more focused on paying dividends than on investing in the future of their businesses or the country. At 91 per cent, the proportion of ASX-listed companies paying a dividend is now the highest on record, up from 83 per cent five years ago. Most of them increased the dividend in the latest year despite flat or falling profits”, Business Spectator, Too much Talk, Not Enough Action, 1st Sept 2015
The Macroeconomic Project 