CBA: Get ready for higher business investment in 2018

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There is hope yet for higher business investment next year with several factors that can catalyse spending by non-mining companies improving.

Business conditions and confidence are high and balance sheets have improved due to stronger profits. Capacity utilisation has lifted and the factory floor has aged, according to Commonwealth Bank of Australia.

Other factors that can spur investment include improving conditions in the manufacturing sector and the “strong pipeline” of infrastructure projects, said CBA, which is factoring in a pick up in non-mining investment next year after a subdued 2017.

Non-mining business investment as a proportion of GDP is near the lowest since 2013 and remains the missing ingredient in the transition from mining to non-mining led growth. A pick up in such investment would also boost productivity, which is essential for maintaining growth in the face of an ageing population and a potentially slower population growth rate.

The following factors point to hope ahead, according to CBA.

Business conditions and confidence: Survey measures of business conditions and confidence have generally been on an upward trend for several years now. Business conditions are at their highest level since the global financial crisis. Business confidence is the highest since 2010. Both are well above long run averages.

Capacity utilisation: Capacity utilisation is rising. Research from the RBA finds that goods-related industries plus transport tend to be more capital intensive than services-related industries. So high levels of capital utilisation in the goods plus transport industries are more likely to result in additions to capital stock. Capacity utilisation has trended higher in recent years for these more capital intensive industries and is now around its long run average. This has historically been consistent with a higher level of non-mining business investment than is the case now.

Revival in the manufacturing sector: There is somewhat of a revival going on in the manufacturing sector. Employment in manufacturing has picked up. Exports have risen too and are not too far below their pre-GFC levels. A lower and relatively stable Australian dollar in recent years has helped. RBA research shows that a 10% depreciation in the real exchange rate will boost manufacturing exports by more than 15% three years later.

Public infrastructure spending: Increased public infrastructure spending can “crowd in” private business investment. Private sector businesses also provide inputs into the building of infrastructure so stronger demand can enable these businesses to expand. Australia is about to go through an infrastructure boom. The State governments have ramped up infrastructure spending. In particular there are many large transport infrastructure projects underway in NSW and Victoria. The federal government is also planning on a large infrastructure spend. The latest Budget includes $75 billion in transport spending over the next ten years.

CBA says a lacklustre outlook for consumer spending amid weak wages, high household debt and high expectations for investment return could pose a hurdle to any revival.

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