By far the biggest negative economic news in recent months was the shock slump in business investment expectations in the Australian Bureau of Statistics (ABS) March 2015 quarter capital expenditure survey. This note looks at the relationship between the survey and the actual level of business investment subsequently revealed in the national accounts. The note suggests that while we should be reasonably confident business investment will be weak next financial year, it is still, at this stage, by no means clear if it will be dire enough to produce a recession.
THE MARCH 2015 QUARTER CAPEX SHOCK
The ABS capital expenditure survey reports on business capital spending for the current quarter, as well as progressive updates on expected spending for the current and following financial year.
As seen in the chart below, the March 2015 survey’s 2nd estimate of business capital spending for next financial year was a steep 25% lower than the comparable 2nd estimate for this financial year, as stated in the March 2014 quarter survey. This marks the largest percentage decline in a 2nd estimate spending survey report from a previous year, since the survey began in the late 1980s.
Does that mean business investment is set to slump, potentially pushing the economy into recession?
Not necessarily. Although there is a broad relationship between 2nd estimate survey measures and actual business investment for the relevant financial year, the relationship is still fairly loose.
This view reflects a number of factors. For starters, the official capital expenditure survey does not cover the agricultural, health and education sectors. While only accounting for around 10% of business investment in the national accounts, these sectors have collectively tended to grow at a strong pace in recent years. Secondly, the survey’s estimates exclude other areas of capital spending such as intellectual property and mineral and petroleum exploration, which collectively account for around 25% of business investment within the national accounts. Last but not least, being only the second, and therefore relatively early, estimate of capital spending for the coming financial year, the survey estimates are still capable of substantial revision. Corporate Australia has been known to revise its investment intentions quite notably over time.
As seen in the chart below, there have been two previous occasions when the 2nd survey estimate of investment spending fell by 20% relative to the previous year’s estimate. In the 1991-92 recession year the estimate proved to be a timely warning, as actual investment fell by 10% that year. In 1999-2000, however, the 2nd estimate slump proved overly pessimistic, as investment intentions were subsequently revised up and actual investment rose by 5.5% that year.
Note, moreover, that despite the differences in coverage, the relationship between surveyed investment and actual (national accounts) investment gets tighter as the financial year unfolds. Indeed, statistical analysis suggest the annual percent change in the final (7th) survey estimate of investment spending can explain 80% of changes in the national accounts measure of investment spending.
All up, the current very weak reading for expected investment does not necessarily mean that actual investment will be weak in 2015-16, as 1999-2000 demonstrated. That said, unless investment expectations are revised up strongly over the coming year, the outlook would be very dire, as the survey estimates tend to be a reliable indicator of actual national account investment changes despite the differences in coverage between these measures.
Given a still high $A and pockets of excess supply in the non-residential construction sector, our base case is that investment intentions will be not revised up significantly over the coming year – leaving the investment outlook still weak. Either way, this analysis underlines the importance of keeping a close track of the ABS investment surveys as the coming year unfolds.