Investment

Negative outlook for GDP – Sept 2016

There are several concerning aspects to the Sept quarter decline in Australian GDP.

The main one is that this was not the result of an external shock forced upon our economy. It is a reflection of the state of our low growth economy and how vulnerable we are to quarterly gyrations in spending. On a broader level, investment spending continues to detract from overall growth. Even growth the strongest area of spending, household consumption spending, is starting to slow. Whilst there were a few bright spots, there is some evidence to suggest that this may not be the ‘one-off’ event.

Sept qtr GDP declines by -0.47% in real terms, annual growth slows to +1.76%

Over the longer term, real GDP growth has continued to trend lower and even more so since 2011:-

Source: ABS

There was little surprise in the contributors to the latest quarterly decline in GDP:-

Source: ABS

Public and private investment spending were the main contributors to the quarterly GDP decline. Private investment spending has been a drag on growth for several years now.

Net exports also made a negative contribution in the latest quarter. The net export result (exports less imports) was actually positive for the third quarter in a row, but that ‘surplus’ in real terms was smaller than in the previous quarter.

On the positive side, household consumption spending continued to contribute to overall GDP growth. Growth was not strong enough to offset the declines elsewhere and household consumption spending is continuing to slow.

Public and private investment spending is a drag on growth

The decline in private investment spending, due the end of the mining investment boom, continues. But it was also public investment, dwelling related construction investment and new non-dwelling building construction that drove the overall decline in investment spending in the latest quarter:-

Source: ABS

Most notable was the “improvement” in the latest quarter for private business investment which made a positive, albeit small, contribution to quarterly GDP growth. This was driven by three of the four areas –

  • There was a small improvement in investment spending on machinery and equipment – but total spend in real terms remains 16% below the peak
  • Cultivated biological resources (small) and intellectual property products both grew in the quarter

These areas off-set the 12% quarterly decline in the non-dwelling construction spending component of total business investment – this includes mining related engineering construction.

One thing caught my eye in the non-dwelling construction data. It was actually a speech by the Treasurer, Scott Morrison that led me to this. First the quote:-

“In this new data, though, released today, new building construction was also down 11.5 per cent for the quarter. That was impacted by some weather events during the course of the September quarter, as we know can affect these figures from quarter to quarter, when you break it down to that level. It was also the result of some larger projects coming to an end. But with such a change in both engineering and building construction, there could not have been a more important time to have passed legislation to restore the Australian Building and Construction Commission…” Australian Treasurer, Scott Morrison, 7th Dec 2016

The full transcript is available at http://sjm.ministers.treasury.gov.au/transcript/178-2016/

I was curious about the 11.5% decline in new building construction. Non-dwelling construction is one of five areas that is measured as a part of total private sector investment spending in Australia and accounted for approx. 30% of total private investment in the latest year to Sept 2016. New building construction falls under this category and while it isn’t the largest area of spending in non-dwelling construction, it might say something about sentiment. The following chart looks at the trend in private non-dwelling construction spending since Sept 1976:-

Source: ABS

What immediately stands out to me is the cyclical nature of new building investment spending over time. Note that this chart is in real dollars, so we can compare spending over time.

Splitting out new non-dwelling building construction strips away the overriding influence of engineering construction spending of the mining boom – that is when this cyclical trend becomes evident.

All of the obvious major declines in non-dwelling construction of new buildings correlate in time with our largest episodes of economic weakness: recessions of ’81 and the early 90’s, the dot-com bust in 2000 and the GFC in ’08. Which leads me to ask: is the decline in the Sept 16 quarter a warning that this is not just a ‘one-off’ in GDP decline? The decline doesn’t appear to be related to any mining slow down, as spending on non-dwelling buildings continued to grow while construction engineering (the mining element) started declining from the Dec 2013 quarter. Actual spending on new non-dwelling buildings only topped recently in the Dec 2015 quarter, but fell much harder in the Sept 2016 quarter. The deceleration in new credit for business at the same time, is also evidence that something may have shifted in the spending and investment patterns of business in Australia.

This is only one quarter of data. The forward looking nature of construction investment spending lends itself well as a proxy for business sentiment. At the very least, it is an interesting chart and it will be something that we will continue to monitor.

What is likely to change with regard to investment spending?

Public investment spending is likely to be subdued unless the government changes its focus on reducing spending to improve the budget deficit – but that focus is not likely to change:-

“Once borrowing for recurrent expenditure is under control, we will have more headroom to take on and deploy so-called good debt,” Scott Morrison, Australian Treasurer, 14 Dec 2016, in response to calls for the government to take advantage of low interest rates and boost investment spending on infrastructure.

Whilst private investment spending is still detracting from growth, the impact wasn’t as negative as in previous quarters:-

Source: ABS

But investment spending intentions are still lacklustre for the rest of the 2016/17 financial year. The latest capex survey (which doesn’t cover every industry – approx. 60% of the ‘value’ of private investment spending) highlights that non-mining investment spending will remain fairly flat, with only minor increases versus the year prior:-

Source: ABS

The overall -17% decline equates to approx. -$21B less investment spending versus the prior year.

As mentioned, the credit impulse for business shows a sharp deceleration in growth for business credit. This will need to reverse and turn positive before we anticipate improvement in business spending.

Household consumption is the key growth driver – but growth is slowing too

The strongest contributor to GDP growth remains household consumption expenditure. Household expenditure accounted for 57% of real GDP in the year to Sept 2016 – the single largest area of measured spending in the economy.

But quarterly growth in household consumption spending is continuing to slow.

In the latest quarter, household consumption spending in real terms grew by +0.44% – and has been slowing for the last 3 quarters. It is now at its slowest level of quarterly growth since 2012:-

Source: ABS

The state split of household expenditure provides some interesting insights into the growth shift among the states:-

Source: ABS, the HH Final Consumption Expenditure figures are sourced from the State Final Demand worksheets. The total of State Final Demand is more or less the equivalent of Domestic Final Demand (GDP less inventories, net exports and statistical error). The contribution figures are based on total state final demand.

On an annual basis, NSW and VIC accounted for the largest share of the total growth in household spending. But in the latest quarter, there has been a clear shift away from NSW, the single largest state driver. Growth in household spending in NSW has slowed fairly significantly over the last two quarters from +1.1% in Mar 2016 qtr to +0.08% in the Sept 16 qtr. On the positive side, household spending in QLD has accelerated higher in the latest quarter to be the strongest performing state.

The slower growth in household spending is not surprising when you consider the weaker labour market, record low wage growth and the deceleration in new private credit growth. If these three trends remain firmly in place, the expectation will be for continued lower growth in household spending.

National income growth – improving off the back of commodity prices

The growth in the Real Net National Disposable Income is the best indicator of changes in national income and annual growth is now up to +3.2%.

Source: ABS

Unfortunately, we can’t break this data series down into its income component parts, so we need to look at Gross National Income at current prices to see how this improvement has been shared throughout the economy.

In the last two quarters, it’s been the return of corporate profits (orange bars, chart below) from a negative to a positive contribution that has been a major driver of domestic income growth – this is not surprising given the improvement in the Terms of Trade (ToT).

In context of history, overall income growth is still extremely low (all four coloured stacked bars add up to the annual rate of growth in GNI in each quarter):-

Source: ABS

There has been a small improvement in the annual contribution of compensation of employees over the latest quarter (red bars). But at the same time, annual small bus profits (Gross Mixed Income) declined after a solid performance during 2015.

Hours worked grew in the Sept quarter GDP and the rate of growth is consistent with that reported by the monthly labour market reports. The latest GDP results show hours worked in the economy grew by +0.49% for the Sept qtr versus +0.41% for the Sept qtr using the latest month labour force data (Nov 16). The labour force data highlights that this is growth is driven by PT hours worked, which grew by +1.26% for the Sept qtr versus +0.24% growth in FT hours. This helps to explain why the contribution to of compensation of employees remains low.

The most concerning part of this report is the government response to it. The economy is clearly not getting better and we face more headwinds in the form of potentially higher interest rates and slowing growth in China (Chinese authorities are trying to deal with internal liquidity issues). Yet, no one seems to want to face the giant elephant in the room – our economic model, based on accelerating debt growth and house price growth is faltering. Not that it should be saved. This should be an opportunity to start the process of reform in our economy, to manage our country away from this debt-driven model – but this is not happening. We are falling behind in our standard of education and we have one of the poorest performing broadband networks in the world. We have tax incentives targeted at speculating on property rather than rewarding labour and entrepreneurship. This is hardly the stuff of the agile economy for the future.

Advertisements

Capex survey points to further falls in investment – Dec qtr 2015

The Australian capex survey results for the December quarter are disappointing on all levels. Capex remains firmly lower than last year, forecasts are for further declines in the next two quarters and the first view of 2017 looks like capex will continue to fall. There is one small bright point – actual December capex increased over September. This may be positive for the December quarter National Accounts. The reason for the increase can be traced back to activity in NSW and unfortunately, the forecasts by business suggest that it is not likely to continue.

Estimate 5 for capex in the 2015/16 financial year highlights that total capex is still expected to fall by -17% or $26.6b below last year

Expected capex for the full financial year to June 2016 is forecast to come in at $124b, which is 17% below last year. So far, the Sept plus Dec 15 capex actuals are tracking at -17.8% below the same two quarters last year in real terms and -15% in nominal terms.

The benefit of estimate 5 data is that it is made up of 50% actuals and 50% forecast. The forecast period now looks out over a shorter time frame (next 6 months) so is becoming a more accurate view of capex plans:-

Source: ABS

The decline in capex for this financial year, at estimate 5, is looking like it might reach levels not seen since the last recession in 1991/2.

It doesn’t matter whether you look at capex expectations by industry or asset type – ALL areas are contributing to the decline. But the decline is being led by Mining and Buildings and Structures:-

Source: ABS

The only positive in this is that expected capex in Manufacturing doesn’t look like it will decline as much as it did last year. Apart from that, capex in Other Selected Industries and Mining will fall faster than last year as well.

But are the actuals in the GDP results following the capex survey? The data is only up to the Sept qtr and for the moment, yes, private capital investment is following the lead of the capex survey. But we haven’t seen the larger falls in capex that the survey is forecasting. That said, capex has been slowing, then declining since 2012:-

Source: ABS

At estimate 5, we have two quarters of actuals and two quarters of forecasts for capex. The Dec quarter actuals came in higher than the Sept qtr actuals and this could be positive for GDP in the Dec qtr. I’ll come back to this in more detail shortly. But this means that the bigger falls in capex are forecast for the last two quarters of the 2015/16 financial year (which I’m calling ‘Half 2’ – H2 in the table below). From ABS 5625.01(a) and 5625.01(b):-

Actual Capex for H1 v Forecast Capex for H2 2015/16 Financial Year

Source: ABS, $ M, original, current prices

Across every industry, businesses are forecasting capex in the March and June 16 quarters to be between 15 and 20% below capex for the first half.

These forecasts for the March and June 16 quarters do not compare well with actual capex for the same quarters last year either:-

Actual Capex for Mar & Jun 2015 v Forecast Capex for Mar & Jun 2016

Source: ABS, $ M, original, current prices

I’ve outlined before that the Capex Survey (what this post is based on: ABS 5625) doesn’t cover all industries and tends to overstate the size of Mining. The industries that are excluded are: Agriculture, Forestry and Fishing (Division A), Public Administration and Safety (Division O), Education and Training (Division P), Health Care and Social Assistance (Division Q), Superannuation Funds (Class 6330).

The size of the capex change tends to be overstated in the survey compared to the actuals in the National Accounts, but are directionally in line. The Capex survey data is used in the development of the quarterly National Accounts.

The first look at expected capex for 2017 looks just as poor

“Non-mining business investment is forecast to pick up in the second half of the forecast period, reflecting the improvement in domestic demand”, RBA, Statement on Monetary Policy, February 2016

Estimate 1 for the next financial year 2016/17 was also released with the December data. This is a 100% forecast and is looking further out to the full financial year 2016/17, so its accuracy is lower than later estimates.

The view at estimate 1 tends to understate final capex. So adjusting the estimate using the 2016 realisation ratio for estimate 1 (which bumps up the estimate by 20%), we get our first capex estimate for 2017 of $99b. Let’s assume that 2015/16 capex spend comes in at the estimate 5 forecast of $124b. That means that estimate 1 is pointing to a further 20% fall in capex for 2016/17.

The falls in capex at estimate 1 are across the board as well:-

  • Mining – estimate 1 adjusted upward based on a +3% realisation ratio = $35b, which represents a further 33% decline on current forecast for mining capex of $53b in this 2015/16 financial year
  • Manufacturing – estimate 1 adjusted upward based on a +27% realisation ratio = $8.3b, which represents a further 1.1% decline on the current forecast for this financial year
  • Other Selected Industries – estimate 1 adjusted upward based on a +49% realisation ratio = $62b, which still represents a further 1.5% decline on the current forecast for this financial year

(The realisation ratios that I’ve used here are the larger of the last 5 years)

But according to the RBA in the latest Statement on Monetary Policy Feb 2016:-

“The ABS capital expenditure (Capex) survey of investment intentions and the Bank’s liaison point to a sharp fall in mining investment in 2015/16. The subtraction from GDP from lower mining investment is expected to peak this financial year.” RBA, Statement on Monetary Policy February 2016

Here’s hoping that the later estimates of the 2016/17 financial year capex improve, because so far, the falls for next year are looking just as bad as this year.

But actual capex in the survey INCREASED in the Dec quarter

It looked like there was a spot of good news in the capex survey data. Actual capex in the December quarter grew by +0.8% in real terms. A turnaround possibly? It unfortunately didn’t take long to see that this is all driven by one state – NSW, which contributed +1.97% points to the +0.8% quarterly increase in actual capex. The only other states to make a positive contribution to growth in the latest quarter were VIC and SA – and contribution to growth was small at best.

Source: ABS

But its nots looking like NSW is on a new investment trajectory either – the latest quarter of higher growth seems like a function of a lower result in the Sept qtr.

Source: ABS

Capex in NSW is still 8% below its 2011 peak in real terms and 4% below the Dec 14 quarter (same time last year).

Reverting to current prices, capex in NSW for the next two quarters is also forecast to be 18% lower than in the actuals in the Sept15/Dec15 quarters. NSW capex in Mar 16 + Jun 16 is forecast to be $11,051m versus the Sept 15/Dec 15 actuals of $13,544m. In other words capex in NSW is not likely to continue increasing in this financial year.

With capex falling and business continuing to forecast lower capex for 2017, the signs for the Australian economy are not good. While mining has mostly been leading the falls, the declines in capex are now evident many across the other industries – which suggests that the ‘transition’ has so far been tepid at best. Business remains wary of investing to increase capacity in light of overall lower growth.

GDP top-line looks better than it really is – Sept 2015

The GDP result for the September quarter came in ‘better than expected’. In real terms, the economy grew by 0.9% in the Sept qtr and +2.5% for the year. This is historically low growth, but given the scope of the adjustment currently underway in the Australian economy, it’s not a bad result.

This is a case though where the ‘better than expected’ top-line result isn’t representative of the underlying performance. Our latest growth figures were mostly the result of an unusually high contribution from net exports in the quarter. Investment spending continues to fall and household consumption spending was at best, on par with previous results and not really trending either way. The less-worse National income figures were due to Terms of Trade that didn’t decline as much in the Sept quarter.

Indicators of domestic activity show that the economy is continuing to languish. One measure of domestic activity known as Gross National Expenditure or GNE (which is just adding up the contribution of all consumption spending, investment spending and inventories), shows that growth was negative in the latest quarter:-

Source: ABS

There are several important points about the September quarter results.

Net exports made an unusually high quarterly contribution to GDP growth

…and the question is whether this latest quarter of net export contribution can be sustained. The analysis below is based on chain volume measures ie removing price effects. The situation would look different if you looked at nominal results.

The size of net exports in the Sept quarter was unusually large and was the combination of two factors 1) larger-than-normal growth in exports and 2) a corresponding contraction in imports.

To provide some historical context – the contribution of net exports to real GDP growth in the Sept 2015 qtr (last orange bar) was the fourth largest quarterly contribution since the start of this data series:-

Source: ABS

The chart above suggests that these ‘blowout’ quarters are infrequent, but not impossible, events. Net exports have been making a larger contribution to GDP growth since 2010.

Exports – Of the $4b growth in exports for the quarter, $3.9b of that was due to growth in goods exports. The biggest contributors to growth in goods exports for the quarter were non-monetary gold ($2.36b), metal ores ($1.24b) and then coal ($0.9b), in real terms. So actually, the largest contributor to our export growth for the quarter had nothing to do with mining. The size of the Sept quarter export growth for non-monetary gold was unusually large. But all it represented was a return to a fairly normal level of exports – it was actually the previous quarter fall that looks like the anomaly.

While there has been a slow-down in growth of our largest export, metal ores & minerals, volumes are still at all-time highs. The current level of contribution to growth is actually above just above average. At the time of writing, iron ore spot prices have now fallen below US$40/mt. The ongoing fall in prices is likely to result in a shake-out among higher cost producers, but the impact on our export volumes will be dependent on how low prices fall and how much Chinese economic growth slows (our largest export market). By all accounts, growth in China is expected to slow in 2016 and this will likely have adverse effects on our exports.

Despite the higher growth in the latest quarter, annual growth in coal exports have been negative over the last two quarters.

A significantly smaller amount of our export growth, $140m, was attributed to growth in services exports in real terms (source: ABS 5302.06). Growth in service exports have slowed in the last two quarters. There is no doubt that the growth in services exports has benefitted from the falling AUD, but the size of the sector for the moment is still small – approx. 20% of overall exports (in real terms). There is still much work required to further develop our service export industries and the Productivity Commission released a draft paper in August 2015 “Barriers to Growth in Services Exports” outlining the barriers and potential remedies.

It’s likely that we will continue to see higher than average contribution from exports (in real terms) to GDP growth in the near term, maybe just not to the same degree as this quarter.

Imports – Imports contracted by over $2b in real terms for the quarter. This is now not an unusual event, but the recent trend is somewhat unprecedented in the history of the data.

Goods imports peaked in June 2012 and are now 2% below that peak. Service imports peaked later in June 2013 – and are now 16% below that peak.

Source: ABS

Most of the decline in services imports can likely be attributed to the falling AUD. Since Sept 2013, price deflators (price index) for service imports increased by over 24% versus the Sept qtr 2015. The average quarterly change in the import price index during this time was +8%.

Not all of the decline in the import of goods can be attributed to the effect of the fall in currency. The import price deflator for goods also increased, but to a lesser degree averaging 2.3% since June 2012 (which is roughly around CPI levels). The areas that have contributed to the slowing in the import of goods is the area of capital goods. Since mid-2012, the import of capital goods has contracted by over 26%. This is mostly the result of the decline in mining investment spending, but is not limited to mining.

In the latest quarter, the largest part of this contraction was lower imports of Intermediate and Other Merchandise Goods for groups such as processed industrial supplies, iron & steel, lubricants and other parts for capital goods. While this could be just a quarterly aberration, there is an important point to this. What sits in these groups are inputs for industries such as car manufacturing. As this industry in particular starts to wind down in Australia, lower imports here could start to become the norm (but will be replaced by imports of finished product).

Demand for imported consumption goods continues to grow – food & beverage, household electrical, non-industrial transport (cars), textiles, clothing, footwear, and toys, books and leisure goods all grew in the latest quarter. Annual growth of imports of consumption goods is over 10%.

It may not be so unusual now to see further declines in imports and this will add to net exports.

Taking a step back though, the theory is that net exports are supposed to take over from where the mining investment boom left off. But it’s not likely that the spoils of an export boom are shared throughout the economy in the same way as an investment boom. Think wages, prices, employment, investment – all of these have been falling as we’ve moved into the more volume, cost and efficiency focused phase of the mining boom. The export boom still supports some level of local employment, government revenue and mostly corporate profits. But this is highly dependent on commodity prices. The Sept quarter was essentially a breather from the more aggressive falls in our major commodity prices – iron ore, coal (bulk commodity prices) and oil. The falls have now continued on in earnest – this will be reflected in the Dec data.

The decline in mining capex spending isn’t being offset by other investment spending

There has been a narrative that the housing construction boom can and will fill the gap left by mining investment.

As of the latest quarter, private dwelling investment spending contributed +0.5% pts to annual real GDP growth, whereas total private business investment detracted -1.5%pts from annual real GDP growth.

Source: ABS

Housing construction has at least taken up some of the slack left by lower mining investment, especially for employment.

According to GDP figures, we are well and truly into the housing construction ‘boom’. Currently, dwelling investment spending, including alterations and additions, is growing at over 10%:-

Source: ABS

In historical terms, this level of growth is just above average, but it has been accelerating since 2012.

There are many factors that weigh against the ongoing growth in the housing construction boom. Household debt (mortgages) is already at all-time highs, banks are tightening lending standards, negative wage growth, likely lower demand from foreign investors, slowing population growth and interest rates that have little room to power further growth. On the plus side, with prices starting to cool in some parts of the country, it could start to encourage those who have been priced out of the market (FHB’s).

There is no evidence to suggest that the growth generated by dwelling investment spending is or will be remotely close enough to filling the gap left by lower mining investment. It’s likely that we will continue to see further declines in overall investment spending. The latest capex survey highlighted that these declines were not limited to mining either. Manufacturing and services were also expected to see lower capex in the coming year. In fact the survey highlighted that some of the bigger falls in spending were to be expected from 2016, although the capex survey does tend to overstate the extent of capex changes.

Public sector activity lags

The falls in investment spending are not limited to the private sector, with public investment spending also detracting from GDP growth. The worrying element is the rhetoric of the new Treasurer who believes that we have a spending problem, not a revenue problem. It’s fully expected that the December MYEFO will highlight a further deterioration in the budget deficit and this will only add further pressure to the level of public spending.

Household consumption spending growth is trending along, but not accelerating

Household consumption spending is still the largest part of our GDP. Growth in household consumption spending has been fairly stable over the last year, but still well below the growth levels pre-GFC:-

Source: ABS

For the moment, household expenditure is neither accelerating nor decelerating. On an annual basis, the falls in investment spending (public & private gross fixed capital formation) were only just offset by growth in consumption spending – with GNE growing by 0.24%. But in the latest quarter, the growth in consumption spending, both public and private, is more than offset by the declines in investment spending resulting in GNE declining by 0.6% on a quarterly basis.

At least the slight improvement in Compensation of Employees in the last few quarters, and mortgage/house price growth, will continue to help underpin spending.

National income improved in the latest quarter

The analysis so far has focused on the economy in ‘real terms’ – removing the effect of price changes to understand the actual level of activity. But an important consideration is how much income we as a country generate from our productive activity. One of the more important determinants of our National income at the moment is movement in our terms of trade (ToT). As mentioned, the Sept quarter was a breather from the accelerating falls:-

Source: ABS

This is a slightly different view of movement in the ToT because I wanted to highlight that while the ToT still declined in the latest quarter, the level of that decline was smaller than in the June quarter. This was the result of more stable commodity prices during the September quarter.

Growth in the individual components of National income improved in the latest quarter, ‘saved’ partly by less-worse Terms of Trade falls and better labour market data. We still seem a long way from the income levels pre the ToT peak (2011):-

Source: ABS

Part of this recent improvement is not going to last, especially the improvement (or the less negative contribution) in the gross operating surplus of private non-financial corporations, given the ToT declines have continued to accelerate in the December quarter.

An interesting point is that Gross Mixed Income (GMI) is making a larger contribution to overall to income/nominal GDP growth and has been trending this way all year. “GMI” represents unincorporated enterprises. Could this be the result of a growing group of self-employed people?

What isn’t adding up is the labour market. The relationship between Gross National Expenditure and hours worked has a reasonable level of correlation over its history (r=0.65). In the last few quarters, growth of the two measures have diverged – hours worked continues to grow and GNE is slowing (in the quarterly data GNE is actually declining):-

Source: ABS

For the moment, labour market indicators show that the labour market is actually quite stable. Hopefully this means that GNE will follow hours worked.

As always, GDP is backward looking. As of early December, we are looking at renewed falls across commodity prices, continuing poor data out of China, a worsening budget situation and a housing market (Mel & Syd) that looks like it is starting to cool.

Capital expenditure in Australia continues to fall – Sept 2015

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

Capital Expenditure Survey June 2014

There are two important features of private capital investment in Australia at the moment. The first is the declining contribution of private investment to economic growth over the last three (3) quarters. The second is the unwind of mining capex growth which is currently underway. The two are related, of course. Over the last few years, monetary policy has been geared towards creating the financial environment to encourage a ‘re-balancing’ of private business investment towards non-Mining capex in order to off-set the much anticipated declines in Mining capex. The June survey of private capital expenditure shows that we are, to some degree, seeing growth in non-mining investment via construction, namely dwelling construction. The modest growth in the June quarter should have been no surprise because growth in new credit for business has been accelerating over the last year, as several previous posts have highlighted. But growth in new credit for business still remains well below pre and post GFC highs suggesting that business investment remains subdued. But is it really enough to say that a continued and increased emphasis on dwelling construction qualifies as a ‘re-balancing’ for the economy?

“When we look ahead, a key feature of the outlook, as everyone knows, is that the capital expenditure phase of the mining boom is winding down and the export phase is gearing up. The fall off in investment spending by resources companies has a long way to go yet, and it will probably accelerate in the coming year. This impending further fall is captivating most of the commentators right now. Meanwhile, growth in non-mining activity has been increasing. A recovery in dwelling investment is well underway, with spending in this area up by about eight per cent over the past year. Forward indicators for non-mining business investments suggest a modest improvement over the coming year, though intentions have so far remained somewhat tentative in this area.”

Glenn Stevens, Governor RBA, testimony to the Standing Committee on Economics, August 20, 2014

The survey of capital expenditure is not a complete picture of all sectors actual or expected investment intentions. It’s useful to understand what is included in the survey in order to understand the numbers. One way the survey measures capital expenditure and intentions is by ‘type of asset’, specifically, 1) Buildings and Structures and 2) Equipment, Plant and Machinery:-

Buildings and structures: Includes industrial and commercial buildings, houses, flats, home units, water and sewerage installations, lifts, heating, ventilating and similar equipment forming an integral part of buildings and structures, land development and construction site development, roads, bridges, wharves, harbours, railway lines, pipelines, power and telephone lines. Also includes mine development (e.g. construction of shafts in underground mines, preparation of mining and quarrying sites for open cut extraction and other developmental operations primarily for commencing or extending production). Excludes purchases of land, previously occupied buildings and speculatively built projects intended for sale before occupation. (Source: ABS)

Equipment, plant and machinery: Includes plant, machinery, vehicles, electrical apparatus, office equipment, furniture, fixtures and fittings not forming an integral part of buildings, durable containers, special tooling, etc. Also includes goods imported for the first time whether previously used outside Australia or not. (Source: ABS)

On a real value basis, the capex survey represents approx. 43% of the value (real) of Total Private Fixed Capital Formation (GFCF) and 60% of the Total Business Investment element of total private GFCF (full year at Mar 2014) in the National Accounts.

The other way the survey measures capital expenditure and intentions is by ‘industry’. The National Accounts estimates include capital expenditure by all private businesses including agriculture, forestry and fishing, education, and health and community services industries and capital expenditure on dwellings by households. Data for these sectors are excluded from the capex survey.

June Survey Results – Actual Private Capital Expenditure

Where possible, the figures used are ‘chain volumes’ to remove any price effects.

There is a significant difference in direction between the trend and the seasonally adjusted headline growth figure for the June quarter – I’ll present both throughout this post.

  • Seasonally adjusted, total capex grew by +1.1% (Jun ’14 v Mar ’14)
  • Using trend data, total capex declined -1.7%

Looking at both measures over time provides a better sense of how they move together and how the seasonally adjusted data tends to be a little more volatile.

Source: ABS

No matter which data you look at, trend or seasonally adjusted, there is a common theme at an industry level – Mining and Manufacturing continue respective recent declines and the growth trajectory continues for Other Selected Industries:-

Source: ABS

Below is a more detailed breakdown at industry level looking at both seasonally adjusted and trend data from the recent capex survey:-

Annual $’s M Annual % Chg Qtr % Chg
(Jun 14 v Mar 14)
Qtr Chg $’s M’s
Total Capex
Seasonally Adjusted
$153,413 -3.5% +1.1% +$399
Mining $86,824 -6.5% +0.2% +$42
Manufacturing $8,820 -6.8% -6% -$134
Other Selected Industries $57,769 +2.0% +3.4% +$491
Total CapexTrend $153,609 -3.8% -1.7% -$665
Industry View
Mining $87,207 -6.8% -4.1% -$872
Manufacturing $8,796 -8.5% -2.8% -$61
Other Selected Industries $57,591 +2.0% +1.8% +$263

Source: ABS

The impact of the decline in Mining capex over the last year is evident with total capex declining by -3.5% (seas adjusted). Only Other Selected Industries has been a positive contributor to capex over the last quarter and over the last year (looking at both measures), but this hasn’t been large enough (yet) to fill the gap left by the decline in mining investment (when using only the survey values).

Rebalancing underway?

There are two ways to drill down into the composition of growth in Other Selected Industries. The first is by breaking down Other Selected Industries into asset type. Using this view, its clear that Buildings and Structures have been the major driver of growth over the last four (4) quarters and growth continues to accelerate. Growth in Other Selected Industries – Equipment, Plant and Machinery remains lacklustre. The bigger of the two elements is Plant, Machinery & Equipment, but the majority of the growth in Other Selected Industries is coming from Buildings and Structures.

Source: ABS

The second view of Other Selected Industries is by industry type. Using this view shows that the main contributor to growth was from Construction.

Source: ABS

Cross referencing these results with the respective elements of the more complete view of Private GFCF in the National Accounts highlights the role that dwelling construction is playing overall. There has been a significant reversal between the growth in dwelling and the growth in non-dwelling construction & investment over the last two years. Note – I’ve used the ‘non-dwelling construction – new buildings’ element of the total ‘non-dwelling construction’ component of Private GFCF in order to remove the large influence from Mining in the construction engineering component.

The slowing growth in non-dwelling construction and the accelerating growth in dwelling construction over the last two (2) years, suggests that so far, ‘re-balancing’, or accelerating growth, has been focused on residential dwellings. Over the last year, GFCF dwellings has contributed twice the amount to total growth in Private GFCF than non-dwelling construction. Over the latest quarter (v. same qtr PY), that figure jumps to just over 7 times the contribution to GFCF growth. The circled area in the chart below highlights the shift in growth between the two elements:-

Source: ABS

The National Accounts breaks down investment spending into Dwellings (new and used dwellings and alternations and additions made by households) and Total Business Investment, which includes the non-dwelling construction.

In the recent past, total Private Business Investment has been the major driver of the historically high levels of investment growth – due to Mining. Over the last ten (10) quarters though, we’ve started to see the contribution of total private business investment to growth completely reverse. Its gone from driver of growth, to driver of decline in total Private GFCF (grey bars in the chart below):-

Source: ABS

Over the same last 3 quarters, you can see that the dwellings component (blue bars, above) has started to make a much larger, and growing, contribution to overall growth in Private GFCF.

Is the growth in ‘Other Selected Industries’ the start of the rebalancing that the RBA has been looking for?

The bigger question is whether this truly represents a rebalancing of investment for the future of Australia. This is a matter of opinion. Most of the growth in private sector credit is already going into residential mortgages (both owner occupier and investor) – so this private construction investment data seems to suggest that we are merely continuing to focus on residential dwellings. The upside is that new dwelling construction is likely to result in employment growth. But continued growth in residential dwellings will rely on continued acceleration in household debt – and there is some risk associated with that given that we are already close to historically high levels of household debt.

The issue remains that business investment has continued to make a negative contribution to growth over the last three (3)  quarters. If business investment on aggregate is not growing, and business is not increasing its productive capacity, then this will likely have important implications for the growing pool of underemployed people in the Australian economy (see latest post on employment). The economy is currently growing, but below the level required to start to absorb some of this growing underemployment.

“But the thing that is most needed now is something that monetary policy cannot directly cause. What I mean is we need more of the sort of so-called ‘animal spirit’, or confidence if you like, that is needed to support not just a repricing of the existing stock of assets, but the investment that adds to that stock of physical assets. There are some encouraging signs here, as you said, Chair. Nonetheless, if reports are to believed, many businesses remain intent on sustaining a flow of dividends and returning capital to shareholders and are somewhat less focused on implementing plans for growth. Any plans for growth that might be in the top drawer remain hostage to uncertainty about the future pace of demand. That is actually not a new phenomenon; it is in some respects pretty normal at this point of the cycle. There is always a period in which people can see that many of the conditions for expansion are in place but are not yet fully confident that it will happen. This is not confined to Australia: the gap between financial risk taking, and there is plenty of that in the world, and real economy risk taking is a gap that we observe around the world.”

Glenn Stevens, Governor RBA, testimony to the Standing Committee on Economics, August 20, 2014

Expected Capex 2014/15

We continue to pin our economic future on dwellings and so far, expected capex for the 2014/15 financial year sees little change in that direction. At June 2014, the survey shows that expected total capex will come in at approx. $14b lower than 2013/14 financial year. This figure has been adjusted using the realisation ratios.

Source: ABS

Taking a longer term view, this is how the growth of the 2014/15 financial year growth (decline) compares to the historical growth in total capex in the survey.

Source: ABS

There is no doubt that the major contributor to the year on year decline is the slow-down in Mining capex. The worrying element is that, based on the capex expectations, the recent growth in Other Selected Industries – Buildings and Structures is not forecast to accelerate in the 2014/15 period.

Note that some totals will not add to the full amount due to the application of realisation ratios.

Est 3 – Total 2014/15 Fin Year $M Realisation Ratio Adjusted 2014/15 Total 2013/14 Fin Year Actual Diff in $’s
Total Capex 145,158 0.99 143,706 157,869 -$14.1b
Total Mining 81,405 0.87 71,636 90,340 -$18.7b
Mining Buildings/Structures 70,758 0.89 62,974 80,911 -$17.9b
Mining Equip/Plant/Mach 10,646 0.86 9,155 94,29 -$0.3b
Total Manuf 8,032 0.96 7,710 9,201 -$1.5b
Manuf Buildings/Structures 2,607 0.87 2,268 2,675 -$0.4b
Manuf Equip/Plant/Mach 5,424 1.02 5,532 6,526 -$1b
Other Selected 55,722 1.15 64,080 58,328 +$5.7b
Other Sel Buildings/Structures 25,564 0.99 25,308 23,154 +$2.1b
Other Sel Equip/Plant/Mach 30,157 1.28 38,601 34,048 +$4.5b
Total Buildings & Structures 98,930 0.91 90,026 106,740 -$16b
Total Equip/Plant/Mach 46,228 1.12 51,775 51,129 -$0.6b

Source: ABS

The only forecast increase in capex for the 2014/15 financial year is for Buildings & Structures in Other Selected Industries in the table above (before the application of the realisation ratios). Based on the size and direction of these figures, it’s hard to see how the non-resources sector will in fact fill the gap created by the slow-down in Mining capex. It’s true that the survey isn’t the entire view of capex, but I wonder to what degree it’s indicative of the general direction of intentions and sentiment across the economy. We can only hope that the sectors not covered in the capex survey – agriculture, forestry and fishing, education, and health and community services – will take a far more optimistic and aggressive approach to capital investment in the coming year.

 

 

 

 

 

 

 

Growth in New Credit Continues to Accelerate in June 2014

Growth in new private sector credit has been accelerating for a year now. The largest component, housing, has gained most of the attention. But the more hidden star of the show has been the acceleration in growth of new credit for business. It’s an important point to focus on because it should be positive news regarding the Australian economy. Credit growth for business should lead to increased capital investment and all the benefits that come along with that – income, employment and economic growth. Yet private sector capex growth has not been a strong performer over the last few quarters, mostly due to the slowdown in growth of mining capex. The main question of this post, is whether this acceleration in the growth in new credit for business has, or will, likely end up driving growth in business investment – especially non-mining investment. Given the forward estimates for total capex (ex housing) in the 2014/15 financial year are still well below current levels, the answer is probably not to the degree needed at this stage.

The other important highlight in the June data is the reversal in the size of new credit growth between investor and owner occupier mortgages. The change was surprisingly large and, if it continues, highlights a potential shift in sentiment in the housing market. The overall continued acceleration of growth in new mortgage credit is likely to feed into ongoing house price growth.

Some clarification is required first. On this blog, I maintain a ‘credit impulse’ page which looks at the growth in new credit as a % of GDP. Growth in credit/debt is one of the major themes driving the Australian economy, along with mining and housing, so the tracking of the credit impulse is a useful indicator of activity in the economy. The data for this post and the credit impulse calculations are sourced from the same data – the stock of outstanding credit (RBA D02). As GDP is released quarterly, the credit impulse tracker is only updated at that time. In between these times, the ‘growth in new credit’ is used to gauge activity in the economy. The growth in new credit looks at second order changes or acceleration in credit growth in dollar terms. Read more here.

There are two significant highlights in the release of the June data by the RBA.

The first is the continued acceleration of growth in new credit for the business component of total private sector credit.

Chart 1

Source: RBA

The growth in new credit for business is now, for the first time in well over 18 months, one of the larger contributors to the overall growth in new private sector credit.

The growth in new credit for business could be an early indication that business is now willing to take on new debt to invest and/or expand. This is generally good news for economic growth. But it’s important to consider what this growth in new credit is being used for and which sectors are driving the growth in new credit in order to ascertain its potential impact on the economy.

As an aside, I generally place greater value on growth in business debt leading to productive capital investment than growth in debt for housing. Growth in new credit for housing does not tend to have the same impact on the economy where the majority of that credit growth is used to just transfer existing assets within the private sector for higher and higher prices. This type of credit growth potentially takes away from more productive forms of investment usually undertaken by business.

The stock of total outstanding credit for business is now only 2% below the peak reached pre-GFC in November 2008. The growth over the last 12 months (especially) is evident, as is the large increase in June 2014.

Chart 2

Source: RBA

The important assumption above is that this credit growth will lead to some form of productive business investment and/or expansion. This is usually part of the transmission mechanism that central banks rely upon when implementing a lower interest rate policy. But, despite the acceleration in growth in new credit for business over the last year, private capital expenditure growth has been poor of late.

Looking at the Mar ’14 GDP results, Private Gross Fixed Capital Formation (GFCF) made a -0.09% pt contribution to annual GDP growth of +3.53%. Breaking Private GFCF down into its component parts reveals the split between a negative contribution from Total Business Investment and a positive contribution from Dwellings & Ownership Transfer costs. This is consistent with the larger contribution from mortgage credit growth than business credit growth in the year leading up to the March quarter.

Chart 3

Source: ABS

The dwellings component is made up of ‘new & used dwellings’ most of which is new dwelling construction but also includes new additions and/or alterations to existing private dwellings. ‘Ownership transfer’ costs relate to all ownership transfer costs, not just for dwellings.

The main drivers of the negative contribution for Total Business Investment was non-dwelling construction and machinery & equipment, together contributing -0.67%pts to the decline in the Total Business Investment component. The Total Business Investment component has made a negative contribution to overall GDP growth for the last three (3) quarters and at a similar rate.

So will this current acceleration in the growth in new credit for business likely feed into growth in business investment? First consider which sectors have been driving this growth in new credit for business.

The RBA series – Bank Lending to Business – Total Credit Outstanding by Size & Sector (D7.3) provides some insight as to which sectors have been driving this growth in new credit for business over the last year. Note that the most recent data is only up until March 2014.

Over the last year, the single largest contributor to the growth in new credit for business was from the Finance & Insurance sector.

Chart 4

Source: RBA

Looking at the trend in the growth of new credit for business by major sector provides a further layer of insight. I’ve split the major sectors into two charts given the relative size of the dollar growth in new credit:-

A) The two largest sectors by share of total credit outstanding are Other (48%) and the Finance & Insurance sector (16%).

Chart 5

Source: RBA

The annual growth in new credit for Finance & Insurance has accelerated to $16b as of Mar 2014 – with the trend over the last 3 quarters to Mar ’14 clearly positive. Despite being the larger share of total bank lending to business outstanding, the growth in new credit for ‘Other’ remains negative and the upward trend no longer in place. Both are well below their recent highs which will likely have implications for the relative impact in the economy.

The question that this raises though, is to what degree will bank lending to the Finance & Insurance sector will lead to growth in capital investment? Finance and Insurance are service based industries, so large capital projects for these firms are likely to be IT or real estate based. According to the latest ABS capex survey (in current dollars), actual annual capex expenditure in the Finance & Insurance sector declined by 6.3% and the sector only accounts for a small proportion of the value of capex in the survey. More likely, this growth in new credit could find its way into the economy through these firms carrying out their core business of providing funding. Whether this ends up funding further housing speculation or more productive business investment remains to be seen.

B) The other major sectors of Agriculture, Mining, Manufacturing, Construction and Wholesale, Retail and Transport account for 36% of total outstanding credit of bank lending to business.

The size of the growth in new credit among these sectors is clearly much smaller than Finance & Insurance (again will have implications for the level of impact in the economy), but the important point to note is the recent acceleration of growth in new credit across most sectors. The direction is important, but the relative size of the growth is still small (which is why the credit impulse is so useful, as it expresses this growth as a % of GDP).

Chart 6

Source: RBA

The important point from this is to see whether this growth in new credit starts to show up in capex in these sectors. Given the continued acceleration of growth in new credit for the business sector (highlighted in chart 1, RBA D.02) between March and June 2014, there may be some upside surprise in private GFCF in the next few quarters GDP.

Looking at the Expected Capex survey from the ABS for March 2014, the small improvements in expected capital expenditure for manufacturing and ‘other selected industries’ are overshadowed by the sheer scale of the slow-down in mining.

Chart 7 – Total Capital Expenditure – actual and expected

Source: ABS 5625 – this survey isn’t a comprehensive over view of capex across all industry sectors – the ‘other selected industries’ does not include agriculture, forestry and fishing, education, and health and community services industries and capital expenditure on dwellings by households.

Firstly, looking at the remainder of the 2013/14 year above. Note that estimate 6 comprises actuals to March and estimates for the June qtr of the 13/14 financial year.

Total capital expenditure at estimate 6 represented a -2.5% decline on the previous estimate 5 at Dec 2013. The largest component of that decline was mining $-7,294m. At the same time manufacturing capex increased by 6.2% or $558m and ‘other selected industries also grew by 4.4% or $2,461m – was this growth driven by the recent growth in new credit? But the growth in capex in both these sectors was clearly overshadowed by the slow-down in mining. The upshot is that significant capex increases (and presumably credit) would be required by industries ex-mining in order to ‘re-balance’ growth as mining capex slows.

Looking further out to 2014/15, estimate 2 for total capital expenditure is set to decline by 15% from where estimate 6 currently stands. The biggest contributor to that decline is mining at -16% or -$15,418m. There is no evidence here to suggest that other sectors will be picking up the slack. For example, capital expenditure in manufacturing at estimate 2 for 2014/15 year is 29% or -$2,788m below where estimate 6 currently sits for the 2013/14 financial year. Other selected industries is similar, sitting at -13% or -$7,581m for the 2014/15 financial year.

The next capex survey for the June 2014 qtr is due for release by the ABS on 28th August 2014 (ABS 5625 Private New Capital Expenditure and Expected Expenditure) and this may shed some more light on whether this recent acceleration in credit growth between March and June has fed into incremental capital expenditure for the remainder of 2013/14 financial year.

Another more up to date indicator of potential capital expenditure is the import of capital goods (ABS 5368.08 – I’ve used trend data here in order to provide a guide on direction). The import of capital goods has declined by 5.5% year on year at June 2014 compared to an increase of 7.9% on the import of consumption goods. The month on month growth in import of capital goods suggests only a slight improvement via a slower rate of decline in the three months leading up to June 2014. In fact, the import of intermediate goods highlights that ‘other parts for capital goods’ has grown annually at over 6%, but the recent month on month data points to decline over the last five months.

The second highlight of the RBA June data was the dramatic shift in the size of the growth in new credit from investor to owner occupier mortgages.

Growth in new credit for housing investor mortgages has been the largest component of growth in total new private credit over the last year, despite the size of outstanding credit being half that for owner occupier activity. But in June, this trend reversed sharply, with growth in new credit for owner occupier mortgages increasing sharply;-

Chart 8

Source: RBA

Given that this has happened in one month, it’s unclear as to whether this is the start of a new trend. But if it is, it marks the start of a change in sentiment. Investor activity has been the key driver behind growth in housing debt and therefore house prices during this current interest rate easing cycle. It appears that owner occupiers were much slower to take advantage of lower interest rates to increase their debt load. Recently, several of the bigger banks have suggested that owner occupiers have used this opportunity to pay down mortgage debt at a faster rate. Full article here (source: SMH 27 July 2014). The data I use here is the stock of outstanding credit (the difference between monthly totals represents the addition of new debt to existing debt, less all debt that is paid down in the period), so a sudden increase in new credit growth could indicate that 1) owner occupier mortgages are now growing faster than households are paying down incremental mortgage debt or 2) that owner occupier households have slowed their faster rate of mortgage pay-down for some reason.

The growth in new credit for owner occupier mortgages only turned positive in May 2014, so the large increase in the June data is surprising. I will delve further into this issue in another post looking at the growth in housing finance and house prices in Australia.

It’s worthwhile pointing out that the growth in new credit for all mortgages is now higher than the pre GFC peak. This was not the case for growth in new business credit.

Chart 9

Source: RBA

Given the data shows the second order change, it means mortgage credit growth continues to accelerate in Australia. This ongoing acceleration suggests that house prices will, on aggregate, also continue to rise in the near term.

 

 

 

 

The credit impulse strengthens in March 2014

Credit data released by the RBA shows growth in Total Private Credit accelerating, as at March 2014.

This should be a positive sign for the economy – changes in spending in the economy depend on changes in income and changes in net new lending (source: http://www.debtdeflation.com). The components of this acceleration are also important indicators of where the economy may be headed and this is what I want to focus on in this post.

The main contributor to the acceleration in new credit continues to be investment housing credit. No surprise and no change. But the real news in this data is the ongoing turnaround in business credit. Whilst the size of the business credit impulse is still very small relative to the other credit components, it is now in positive territory. I’m far more enthusiastic about the improvement in the business credit impulse than the ongoing acceleration in housing credit growth. Schumpeter argues that there is a link between accelerating debt and accelerating incomes – if that debt has been used to fund entrepreneurial activity. In theory, that’s an investment in building the productive capacity of the economy, which is positive for growth in income and in employment. Certainly a part of the RBA’s intention with lowering interest rates has been to ‘rebalance’ investment towards the non-mining sectors. But business investment has been slow to respond and new credit for investment hasn’t grown on a large enough scale yet.

On the other hand, the change in monetary policy seemed to impact the speculative aspect of housing finance almost immediately. The majority of outstanding debt in Australia is related to housing and continued increases in house prices relies on accelerating housing lending/debt. Unfortunately, a large share of growth in new credit, and growth in household debt, continues to goes towards the transfer of ownership of houses in Australia.

Why is the credit impulse important?

The data released by the RBA is the stock of all outstanding credit which takes into account existing debt, new debt and debt paid down. More important than the growth in credit is the growth in new credit that is issued. Starting with a basic premise that borrowing equals spending, its new credit issued in an economy that partly drives new spending in the economy. The other source of new spending in the economy is growth in income – not covered in this post. Consider a simple example – if you borrow $10 each month for six months, total credit grows by $10 each month, but after month one, growth in new credit equals $0 or, in other words, there is constant growth in credit and therefore you only spend $10 each month. But if you borrow $10, then $15, then $25, then $40 and finally $60, then there is growth in credit and growth in new credit of $5, $10, $15 and $20. As a result, spending grows each month. So the importance of tracking the credit impulse is that it is one of two important sources of spending that will impact output and/or asset prices.

I first came across the credit impulse through the work of Professor Steve Keen in his quest is to build a more robust and accurate representation of the role of debt and money creation by financial intermediaries in the economy. In working through the impact of growth in new credit on aggregate demand, Professor Keen’s latest work suggests the impact of the credit impulse is also influenced by the velocity of money. His latest thinking:-

“[This formula corrects] a rule of thumb proposition that I have previously asserted, that aggregate demand is the sum of income plus the change in debt (Keen 2014; see also Krugman 2013b). The correct proposition is that, in a world in which the banking sector endogenously creates new money by creating new loans, aggregate demand in a given period is the sum of aggregate demand at the beginning of that period, plus the change in debt over the period multiplied by the velocity of money.”

Source: http://www.debtdeflation.com/blogs/2014/02/02/modeling-financial-instability/#sthash.p9qge3RN.dpuf

I have not gone into the velocity of money detail for this post. Whilst I have quite simply represented the growth in new credit, it’s a useful view of credit nonetheless.

To what degree does the growth in new credit drive growth in output versus growth in net change in the value of assets? I think this is a fairly fundamental question that faces our economy and it comes down to the source of the growth in new credit.

Total Private Credit

The usual way to present the credit impulse is as a % of GDP so that we can relate the size of the growth in new credit to the size of the economy. But given that March quarter GDP will not be released for another month, I’m opting to present this data instead in its dollar amount in order to understand the general direction of the growth in new credit. All the credit components – housing, business and personal are all expressed in dollars in this post, which will serve as the basis for comparison.

My proxy for the credit impulse – the growth in new credit – bottomed back in the June quarter 2013. Despite being in negative territory, the slope of the curve has been positive, meaning that the decline is getting smaller. Even a negative credit impulse with a positive sloping curve will have a positive impact.

The dollar growth in new credit for total private credit is approaching its two previous post-GFC highs, but is still well down on growth in the years leading up to the GFC:-

Source: RBA, The Macroeconomic Project

This gives you a sense of the relative size of the current growth and its potential impact on the economy. But for the impulse to become a larger proportion of GDP, it needs to grow faster than GDP (we’ll know this when GDP data is released). The current size of the growth in new credit at Mar 2014 is $26.6b, up from $17.7b in Feb 2014.

The question now becomes which of the main areas of total private credit have been driving growth in new credit?

The four components that make up total private credit (each with their share of total outstanding credit) are – owner occupier housing (40%), investor housing (20%), other personal (6%) and business (33%). Below is the growth in new credit across these four (4) components and total private credit over the last twelve months:-

Source: RBA, The Macroeconomic Project

There have been some large shifts in momentum over the last twelve months and a more positive shift in direction in the first quarter of 2014. The obvious one is the improvement in business credit – this has clearly had the greatest impact on the growth in new total private credit. But the actual dollar size of growth in new credit for business is still small relative to the other components (at Mar ’14). Growth in new investor mortgage credit is the largest of all components, which has also accelerated in the first quarter. Growth in new credit for owner occupier mortgage and personal credit are on par, but are, respectively, flat and decelerating.

Housing Credit – owner occupier and investor housing currently 60% of total private credit

Investor housing credit currently makes up the largest proportion of the growth in new credit. In March 2014, growth in new credit was $12b, up from $10.3b in Feb 2014, despite only currently representing 20% of outstanding total private credit. So approximately half of the current growth in new credit in the economy is for investor housing finance.

The growth in new credit for investor housing is close to reaching its second highest point of the last ten years.

Source: RBA, The Macroeconomic Project

This is only one part of mortgage credit. More broadly, the growth in new mortgage credit was $18.5b in March 2014, up from $16.9b in Feb 2014. This includes the change in new owner occupier housing credit of $6.6b in mar 2014, which was unchanged from $6.6b growth in Feb 2014. This signals a slowing in growth momentum for owner-occupier activity.

The slope of the curves look quite different between owner occupiers and investors – steep for investors and less steep for owner occupiers. The steeper curve suggests faster/larger growth in new credit for investor housing and this is consistent with what we have seen in other housing finance data.

Growth in new credit for owner occupiers has been somewhat more subdued and at March 2014, is about half that of growth in new credit for investor housing finance. Although the slope of the curve started to steepen in late 2013, the latest data suggests that the momentum is starting to slow.

Source: RBA, The Macroeconomic Project

The overall growth in total new mortgage credit remains strong and is obviously driven by investor activity.

So what can we expect as a result? Intuitively, you would expect accelerating housing credit growth to show up in asset values. As long as we have accelerating debt, it’s likely that we will continue to see house prices grow. Below is the mortgage credit impulse plotted with the annual growth in the residential property price index until Dec 2013. There is a reasonably strong correlation between the two (0.68).

Source: ABS, RBA, The Macroeconomic Project

Some of the accelerating growth in housing credit will show up in GDP, but to a smaller degree, in Private Fixed Capital Formation. This part of GDP captures the value of the creation of new assets only – new dwellings and new alterations and/or additions will add to GDP in that quarter. This currently accounts for just under 5% of GDP at Dec ’13. According to the latest housing finance data, purchase and construction of new dwellings has accounted for only 12% of total housing finance over the last year (ex-refinancing). Many of the current First Home Owners grants have focused on the purchase of new dwellings as it’s the creation of new assets that is likely to stimulate the economy more because jobs and income are created through new projects, rather than through transferring ownership of existing dwellings.

The transfer of ownership costs (legal etc.) are recorded as a part of GDP under Private GFCF- ownership transfer costs, but includes all ownership transfer costs, not just those on dwellings. This accounts for approx. 1.4% of GDP at Dec ’13.

Overall, the majority of total private debt relates to housing – debt which continues to accumulate, for what is essentially an unproductive asset. The downside to this is that this debt for the most part does not contribute to growing the future earning capacity of the economy, employing people, innovating or generating productivity gains.

Business Credit – 33% of Total Private Credit

The growth in new credit for business was the bright spot in this report. For the first time since the RBA lowered interest rates in late 2011, the growth in new credit for business has reached positive territory. Business investment is the single area most likely to generate income growth, employment, innovation and productivity gains for an economy.

Source: RBA, The Macroeconomic Project

The growth in new credit for business started to turn positive from mid-2013, but growth accelerated recently. In five months, growth in new credit for business has turned from a large negative to positive growth: Jan ’14 -$11.7B, Feb ’14 -$5.2B and Mar ’14 +$2.6b. Looking at the relative peaks over the last seven years (chart above), there is still a long way to go though.

Where is the growth in new credit for business likely to show up?

The labour market has been improving over the last several months – indicating at least progress on business expansion. There has been a shift from PT to more FT growth in jobs, although it appears that hours worked has not grown at the same rate. But this isn’t directly where growth in new credit is likely to show up.

This is more likely to show up in business investment. Over the last year, business investment has been slowing down and some forward indicators suggest that this will continue. One of the key objectives of the RBA in its easing stance has been to influence business investment and specifically to ‘rebalance’ investment towards non-resource sectors in light of the coming slow-down in mining investment. Recall that the first interest rate cut happened all the way back in Nov 2011.

Business investment and capex are measured in several ways. One way, is via the private new capital expenditure and expected expenditure survey (ABS 5625). This is not the equivalent of, or a complete view of the business investment component from GDP, but provides detail of expected capex expenditure, especially with regard to mining and manufacturing. You can read the full details of the inclusions and exclusions on the ABS website, but ‘all other selected industries’ excludes capital expenditure by all private businesses including units classified to agriculture, forestry and fishing, education, and health and community services industries and capital expenditure on dwellings by households.

The slow-down in mining capex is evident in the actual private capital expenditure data (ABS 5625):

Source: ABS 5625

I’ve opted for quarterly growth in this chart because I think it highlights the change in capex perfectly – “consistently slowing”:-

  • Mining capex growth has slowed since Sept 2011 and started to record quarterly declines from Dec 2012. At Dec 13, growth was -0.6% versus Sept qtr. 2013, a far cry from the high growth recorded in the mid-2000 and during 2010/early 2011. But this not the “mining capex cliff”.
  • Manufacturing capex growth peaked in Jun 2011 at 5.2% quarterly growth and since Mar 2012 has been in decline. Over the last year, the quarterly declines have become smaller, but capex spending continues to shrink – it’s not a drop off a cliff, but it’s a consistently lower value. At Dec 13, capex was -1.7% versus the prior quarter.
  • “All other selected industries” capex has been declining quarter on quarter since Jun 2011. There were two brief quarters of small growth in Jun and Sept 2013, but Dec was back to decline of -0.6% versus the prior quarter. As mentioned though, this is a not a complete representation of all other industries. See note above.

If you really want to know what the coming mining capex cliff will start to look like, then look no further. From the same ABS catalogue (5625):-

Source: ABS 5625

I’m referring to the 2013-2014 labelled graph above. The December ’13 quarter is marked ‘5’, which is half way through the 2013/14 financial year. Estimate 5 is made up of actual capital expenditure for the Sept and Dec ’13 quarters (as at the end of the Dec 13 quarter), plus the short term estimate for the Mar and Jun ’14 quarters. At this time, total capex for 2013/14 financial year is estimated to be $167,066m.

At the end of Dec ’13 quarter the first longer term estimate of capital expenditure is provided (E2) for the next financial year. This is the estimate marked ‘1’ for 2014- 2015 – and this is the estimate that has many spooked. Total capital expenditure is estimated at $124,880m, which is -17.4% lower than for the same period of 2013/14. The main reason for this lower estimate was a decrease in mining capex of -25.2%.

As mentioned, these estimates won’t add up to the investment data shown in the National Accounts – it’s a smaller view of what you would see in the GDP figures, but more detailed with regard to an ‘expectations’ view. The full explanation can be found on the ABS website.

So, looking at the more complete view of business investment from the latest GDP figures at Dec 2013 – this is what the quarterly growth in Private Gross Fixed Capital Formation (PGFC) for total private business investment looks like in the National accounts (ABS 5206.002):-

Source: ABS 5206.002

This includes all private business investments in non-dwelling construction, new machinery & equipment, cultivated biological resources and intellectual property. This represents approx. 17.1% of GDP at Dec ’13. I have excluded private fixed capital formation for new dwellings, new alterations to dwellings and ownership transfer costs – as this relates to mortgage activity.

Growth in total private business investment has been slowing since June 2011 and turned negative in the Sept 2013 quarter and the quarterly decline accelerated in Dec ’13. Given this consistent decline, it’s difficult to see that, based on the small size of the growth in new credit for business, that there will be a large turnaround in business investment at this stage.

Other data sources, such as the 2014 quarter one NAB Business Conditions report highlights a pickup in capex intentions in the coming twelve months, but at the same time points to ‘patchy’ investment intentions across the non-resources sectors.

Source: NAB

The latest NAB Business Conditions report for May 2014 (further out than the credit data I have presented here), suggests further gains in capex spending, but not enough to counter the falls in mining investment:-

Source: NAB

Given the size of the growth in new credit for business, I wouldn’t expect to see large improvements in business investment, but would at least expect a slowing of the decline for the March 2014 quarter GDP. There doesn’t yet appear to be high enough non-resources investment growth to counter the end of the mining investment phase.

Personal Credit – 6% of Total Private Credit

Over the first quarter of 2014, growth in new credit for total personal credit has been decelerating. Growth in new credit for personal lending reached a high of $11.6b in Oct 2013 and that growth has virtually halved since then to $5.4b at Mar 2014.

Source: RBA, The Macroeconomic Project

Total personal credit represents activity conducted with a bank on a non-business basis (excluding housing). This includes all manner of personal spending, so there isn’t one good place where you would expect this growth in new credit to impact output. It would likely be a combination of retail sales, new car sales and/or other discretionary spending etc.

Either way, growth in new credit for personal may be pointing to a slow-down in growth of the more discretionary spending categories (this is most likely where you’d find personal credit used).

Has this started showing up in Q1 retail sales? The month on month growth in retail sales has been slowing (sales remain high though), and whilst it does look like there is a correlation between the two measures, the correlation isn’t strong at all (0.23).

There was a stronger relationship between the actual personal credit impulse (as a % GDP) and the annual change in the Household Final Consumption Expenditure (HFCE) component of GDP (0.46) – at Dec ’13. The HFCE component of GDP is the single biggest part of GDP approx. 50%, so clearly spending that shows up here is ‘funded’ by a combination income as well as change in new credit.

Source: ABS, RBA, The Macroeconomic Project

It’s still not an ideal relationship/proxy, but does at least provide a very general view.

One thing to bear in mind is that a slowing in new personal credit growth could also reflect the current improved labour market conditions. It’s possible that income growth via increased labour market activity may counter any slowing in the growth of new personal credit. Using trend numbers for the first four months of this year we’ve seen +50k FT jobs (the first 4mths of 2013 was -11k FT jobs) and +22k PT jobs (the first 4mths of 2013 was +61k PT jobs) added. Unemployment has ‘only’ grown by 6.8K in the first 4mths of this year (versus 26.7k for the same time last year). This may have an impact on consumer discretionary spending, possibly cancelling out any slow-down in growth of new credit in personal spending for now.

Overall, the majority of the growth in new credit is going into housing – via investor activity. But it’s worth noting that growth in new credit for owner occupier housing appears to be slowing. For the moment, this is still likely to result in continued house price appreciation. Whilst business investment and expected capex, so far, looks like it will fall short of countering the drop in mining investment, the growth in new credit for business is an encouraging sign. But this needs to continue to accelerate in order to fuel business investment in new, productive activity in the economy. Business will likely expand investment if there is a strong growth business case. The continued high level of the Australian dollar, any potential impact of a slow-down in China and changes to fiscal policy are going to weigh on these business investment decisions.