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Special Topic: Outlook for investment

Investment is an important driver of both short-term GDP fluctuations and the economy’s long-run growth potential. This special topic looks at recent trends in business investment and assesses the risks arising from the ongoing economic downturn. In the short term, business investment is likely to suffer a sharp cyclical correction because of weak demand and the higher cost of capital goods. Lower borrowing costs are unlikely to outweigh the other negative factors. Investment is expected to recover from mid-2010 as the economy strengthens again.

Business investment the largest category …

Total investment is generally split into three categories according to the sector of the economy undertaking the investment: residential investment by households, investment by firms (including local authority and state-owned enterprises) and central government investment. Different factors influence the investment decisions of each of these three sectors. This topic focuses on business investment by firms, which is the largest category of investment.

Figure 11 – Real GDP and investment
Figure 11 - Real GDP and investment.
Source: Statistics NZ

… and one of the most volatile

Business investment is one of the most cyclical components of GDP (along with residential investment), making judgements about its growth in the short term important in forecasting the extent of the current recession (Figure 11). This volatility reflects the nature of investment decisions. Business investment has grown faster than real GDP in the past decade and consequently it has increased its share of total GDP from around 15% in 1998 to around 20% in mid-2008. Residential investment accounts for approximately 5% of GDP and central government investment approximately 2%.

Business confidence a major determinant …

The main determinants of business investment are current and expected demand for a firm’s outputs. The latest Quarterly Survey of Business Opinion (QSBO) showed that business confidence and firms’ own activity in the December 2008 quarter and their expectations for the March 2009 quarter were all at their lowest levels in seasonally adjusted terms since at least 1970. Capacity utilisation fell to its lowest level since mid-1999.

The weak outlook for activity, combined with limited ability to pass on large input cost increases because of the weak demand, led to a fall in expectations of profitability to its lowest level in 26 years. As a result, intentions to invest in plant and machinery fell to their lowest level since 1975. This survey series correlates well with investment in plant and machinery in the national accounts (Figure 12). These survey results (which were supported by the latest National Bank Business Outlook survey) point to a sharp fall in investment.

Figure 12 – Plant and machinery investment
Figure 12 - Plant and machinery investment.
Source: Statistics NZ

… along with the cost of capital goods …

The cost of investment goods is also relevant to investment decisions. Capital goods prices have increased by 2% - 4% per annum over the past five years as increases in the price of locally-sourced capital goods more than offset falls in the cost of imported capital items (Figure 13). The price of non-tradable capital goods (primarily building and land improvements) increased rapidly in the recent period as a result of the boom in construction, especially residential construction. However, the price of imported capital goods (eg, plant and equipment) fell in the early part of this decade and – until recently – grew more slowly than locally-sourced goods because of the appreciation of the New Zealand dollar. Recently, with the fall in the NZ dollar, the cost of plant and equipment, much of which is imported, has started to increase more rapidly. This trend is likely to continue and will constrain investment in imported capital equipment in the coming period.

Figure 13 – Capital goods price inflation
Figure 13 - Capital goods price inflation.
Source: Statistics NZ

… and the cost and availability of credit …

The cost and availability of finance are also relevant to investment decisions. Recent falls in interest rates have made it cheaper for New Zealand businesses to borrow, but the reduced availability of credit and tighter lending criteria may restrict credit growth. The increase in the annual growth in business sector credit from below 10% in August 2008 to more than 12% in January 2009 may reflect merely an increased need for working capital and refinancing of existing credit. Lower interest rates may encourage some firms to invest; for others, however, they are unlikely to outweigh the weak demand they face.

… as well as the availability of labour

The availability of labour is also relevant to investment decisions. Some investment is undertaken to make labour more productive (capital deepening) while some is in response to a shortage of labour. Until recently, firms found it increasingly difficult to hire both skilled and unskilled labour. However, that situation has changed recently with the fall in both domestic and external demand and the increase in unemployment (Figure 14). With labour the easiest to find since the 1990/91 recession, investment is expected to be lower in the future.

Figure 14 – Ease of finding labour
Figure 14 - Ease of finding labour.
Source: NZIER

Investment expected to decline sharply

Business investment is expected to contract sharply in the near term as a result of the factors discussed above. In our December Update, we forecast it to decline by 15% in the year to March 2010 and by 24% in the downside scenario. Business investment was weaker than we expected in the September quarter 2008 and we now expected it to follow a path similar to the downside scenario (Figure 15).

Figure 15 – Business investment forecasts
Figure 15 - Business investment forecasts.
Source: Statistics NZ, NZ Treasury
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