The latest Australian Bureau of Statistics (ABS) Capital Expenditure Survey revealed that business investment is likely to have fallen significantly in the March quarter, which has caused some alarm among commentators.
According to the survey, total real capital expenditure fell by 4.4%, with buildings and structures - which is heavily influenced by the mining sector - declining by 6.5%. Alternatively, expenditure on machinery and equipment decreased only slightly.
The so-called Capex survey is one of the main indicators of business investment in Australia. It’s currently of particular importance as it provides a signal of how well growth in the Australian economy is transitioning from mining to the non-mining sectors, and so its most recent weak figures are being closely scrutinised.
The Capex survey is a random sample of around 8,000 businesses each quarter. The ABS attempt to ensure the sample is representative across several dimensions, such as the size of the businesses and their industry.
The survey asks firms about both the actual investment that they did in the previous quarter and their investment expectations for the future.
Other sources of information
One of the reasons why the Capex survey is important is that it gives a timely read-ahead of the release of GDP in the National Accounts next week - of what business investment did in the most recent quarter. Relatively few other indicators exist for business investment, most notably business credit growth and surveys of sentiment. The Reserve Bank of Australia supplements these with an extensive business liaison program.
It’s worth noting, however, that the Capex survey does not perfectly translate into business investment in the National Accounts. There are issues about coverage which are particularly important for non-mining investment, for example, it excludes the health care sector.
The ABS produces other surveys, summarised in the Construction Work Done release, which also provide information on what investment did in the quarter. Here real engineering construction - much of which is mining - fell by 7.3%, whereas private non-residential building construction - admittedly a much smaller share of the economy - grew by 3.3%.
The investment outlook
The other main reason why the market pays considerable attention to Capex is its information on the investment outlook. By tracking successive surveys we can see how firms’ investment intentions change over time.
This survey contained the final estimate of investment intentions for 2014/15. These, for both mining and the non-mining economy, didn’t materially change, and point to a further fall in investment in the June quarter.
The main area of interest for the market, however, was firms’ investment intentions for 2015/16. These were weaker than many expected, with the outlook for mining investment being revised down, probably partially due to the current low commodity prices.
Investment intentions for the non-mining sector were broadly unchanged. Firms are surveyed up to eight to nine weeks after the end of the quarter, so it’s likely that many respondents did not know about the small business package in the federal budget and its measures to promote investment.
Interpreting the investment intentions from the Capex survey, however, is somewhat of an art form. Firms tend to underestimate their investment at long horizons, and subsequently get more accurate as time passes and more information becomes available, so the ABS produce realisation ratios.
These are the ratio of actual to expected expenditure in the history of the survey. These can then be applied to the most recent investment expectations - for example, a realisation ratio greater than one, which is typical for the early estimates, essentially amplifies any expected growth.
The art is knowing which realisation ratio to use. Should it be last year’s, or a moving average, or adjusted for the state of the business cycle? Voluminous work has been done on this, but one recent study suggests that simply taking the long-run average forecasts best. Even after all of these adjustments, the early estimates - such as those in this survey for 2015/16 - are not very reliable.
Transition in sources of growth
So, the recent Capex release suggests that the fall in mining investment in 2015/16 may be more sizeable. While that may mean there is a bigger gap for non-mining investment to fill, it is worth remembering that investment intentions in the non-mining sector did not materially change.
Outside of non-mining investment, evidence that the transition in sources of growth is underway remains. In particular, real residential construction work done increased by nearly 5% in the March quarter. More generally, the unemployment rate in April was 6.2%, a level it has fluctuated around for the last six months. Retail turnover volumes grew by a solid 0.7% in the March quarter.
Ultimately, a fall in mining investment will weigh on GDP growth in the March quarter, which is likely to be soft. However, the forces that will shape the Australian economy over the medium term remain qualitatively unchanged.