Depressionberg’s capex collapse upon us

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Via Deloitte:

The Australian economy is expected to fall into a deep recession in 2020. A number of decisions taken to protect the health of Australians, such as limits on mass gatherings and social distancing, have also necessarily hurt the economy. There have been widespread job losses in Australia, consumer confidence has fallen to its lowest point in three decades and the latest data saw the largest decline in business confidence on record.

Releasing the latest edition of Deloitte Access Economics’ quarterly Investment Monitor, Deloitte Access Economics partner and report lead author, Stephen Smith, said: “During tougher economic times, businesses have greater ability to wind back their spending compared to consumers. And that is exactly what is expected, with the total amount of private business investment set to fall by more than one third in 2020.”

“The underlying fundamentals for a recovery in private business investment will remain soft for some time to come, and so it is imperative that businesses are encouraged to be courageous.”

The following chart uses the Investment Monitor database to estimate the impact of potential project delays and cancellations on construction activity. The base case refers to Deloitte Access Economics’ forecasts of the most likely outcome for investment over the coming years, compared to a scenario where additional delays are imposed, and a scenario where additional delays occur alongside project cancellations. Under both scenarios Australia ends up with an even lower level of private investment spending in the coming years.

Value of new private sector engineering and non-residential investment

Smith said that while stimulus measures announced to date include some changes that will directly support business investment, more will be needed. And with business confidence at record lows it is likely that governments will have to lead by example in the near term.

“There is already a large pipeline of publicly funded infrastructure work underway and in planning across Australia. The current pipeline of public infrastructure investment remains dominated by a series of large road and rail projects, most of which are in Sydney and Melbourne.

Major road and rail projects1

“The continuity of the existing pipeline is essential to Australia’s recovery from the 2020 recession. But there are a series of challenges. First, infrastructure is mostly a state responsibility, and COVID-19 is placing additional pressure on already strained state finances. And second, there are concerns about the construction industry’s ability to deliver the existing pipeline of infrastructure projects, let alone a larger and more urgent pipeline.

“Against this backdrop it will be crucial that spending is well-directed. There will be a temptation for governments to pursue large nation-building projects as a way of stimulating the economy, but the focus should instead be on improvements to existing infrastructure and smaller developments. These types of investment tend to generate the largest relative economic returns, while smaller scale projects are also easier for contractors to commence quickly and to deliver on-time and on-budget.

“It will be important for governments to focus on the potential impact on productivity when selecting projects. Despite the time-sensitive nature of the looming stimulus effort, every step should be taken to ensure rigorous cost-benefit analyses are conducted to help guide project selection.

“There is also an opportunity to make changes to the way projects are developed and financed. This could include removing barriers for private investment, improving the management of project risks, providing access to a wider range of funding sources (e.g. asset recycling) and investigating funding models that shift the burden away from taxpayers towards those who benefit directly from the new investment (e.g. user pricing).

“These proposed reforms are not new, but in responding to COVID-19 governments have a rare opportunity to make changes that help drive productivity and improvements to the living standards of Australians in the long-term.”

Key figures for the March quarter include:

  • The value of projects in the database rose by $3.0 billion to $768.9 billion – a 0.4% increase from the previous quarter
  • The value of definite projects (those under construction or committed) increased by $3.0 billion over the quarter. Despite a number of projects being completed over the March quarter, definite activity is 7.8% higher over the year.
  • The value of planned projects (those under consideration or possible) remained flat over the quarter, but continues to sit at a seven-year high.

There has also been a dramatic shift in investment activity away from states in Australia’s north and west to those in the east and south. At the height of the mining boom there were $300 billion worth of projects listed as either under construction or committed in Queensland, Western Australia and the Northern Territory (the north and west), compared with less than $100 billion in New South Wales, Victoria, South Australia, Tasmania and the Australian Capital Territory (the east and south). Since then the value of projects in Australia’s north and west has fallen by $232 billion, while projects in the east and west have increased by $72 billion – a more than $300 billion shift in activity. The past year has seen an increase in definite activity in the north and west as several mining projects commenced construction, but few commencements are expected in 2020.

Honestly, this is madness. Why are we talking about at a corporate tax cut in this environment? Put the money straight into public investment.

We have been warning of this capex collapse for years. Now it has come at the worst possible time.

Letting capex collapse to 2004 levels (or 1990s in the bear case) amid the virus bust should cost Josh Depressionberg his job.

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About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.