CBA - why has non-mining capex not picked up? No reference to obstacles in raising finance to grow

For the past few years, economists and policymakers have assumed that a lift in non-mining business investment was forthcoming. A trawl through RBA documents and speeches shows that policy officials have been anticipating a lift in non-mining investment for a few years. And yet despite incredibly low interest rates and a significantly lower AUD, the lift remains elusive. It has felt a lot like waiting for Godot. Fortunately, however, there has been a greater than expected pickup in services activity which has generated a fall in the unemployment rate despite weak non-mining capex. This has supported the economy and employment growth over the past two years. But for the productive capacity of the economy to lift over the longer term, a lift in business investment outside of the resources sector.

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In this note we ask the question why non-mining business investment has been so weak.

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…it may be the case that expectations of future demand are too low to justify a lift in investment…

Capacity utilisation, as measured in the NAB Business survey, implies that throughout most of the past few years capacity utilisation in Australia has been below its long run average. This goes some way to explaining why business investment has been weak. And also why inflation has been low…

Australia’s manufacturing industry suffered greatly because of the first and second stages of the mining boom…

The problem, of course, for the manufacturing sector is that when the currency depreciates to more ‘normal’ levels, it’s not that easy to crank up manufacturing investment and output… the high fixed cost component of manufacturing means for firms that are forced to close, recommencing operations is often not an option…

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The hurdle rate is too high. Firms generally use Discounted Cash Flow (DCF) analysis (or a version of it) to estimate the attractiveness of discretionary capital investment. But a range of evidence indicates that hurdle rates are often much higher than the weighted average cost of capital (WACC)…

The ‘stickiness’ of business hurdle rates is in stark contracts to valuation methods employed by property investors…The fall in borrowing rates over the past few years gave rise to a big increase in investor activity in the housing market. Dwelling prices rose quite sharply as interest rates fell…

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Monetary policy has been overburdened for too long… Indeed, record low interest rates have been assumed to be the panacea to get non-mining investment going. But monetary policy can only do so much. The interest rate lever can help smooth out the business cycle. But it cannot do anything to change the more entrenched and structural impediments to growth which are primarily related to the inefficient allocation of resources.

In Australia, for example, policies should be developed that encourage and channel capital into projects that improve the productive capacity of the economy over the long run. Establishing an efficient taxation system that incentivises innovation and productive investment is one area that could help lift business investment…

Public infrastructure investment is also important. For example, greater investment in transport infrastructure will improve the productive capacity of the economy. And it supports private investment rather than crowding it out. At a time when the yield curve is at historic lows, there must be no shortage of viable projects where the costs of finance is less than the social rate of return…

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Australian investors love dividends! And the pressure on companies to maintain or lift dividends in a low interest rate environment has intensified because deposit rates are so low. There is a risk that the pressure on companies to increase dividends has been paid for by cutting back on capital investment…

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What can we expect in 2016?.. the leading indicators suggest that non-mining business investment growth is likely to remain weak over 2016. The latest capex survey suggested that non-mining capex would fall over 2015/16… [although] there are limitations with the capex survey…

Notwithstanding the soft capex survey, the latest credit aggregates offer a glimmer of hope on the outlook for non-mining investment. Business credit growth has been lifting which is an early sign of a lift in capital expenditure…