Mining and manufacturing investment is set to fall sharply in the 2014-15 financial year but the outlook for the economy appears to have improved. Though there remains considerable uncertainty and significant risks in the form of iron ore and China, it appears likely that the non-mining sector will provide enough support to keep the Australian economy growing at a solid (if unspectacular) pace over the next couple of years.
New capital expenditure fell by 4.2 per cent in the March quarter, weaker than market expectations of a more modest decline, to be 5 per cent lower over the year. This followed a similarly weak result in the December quarter.
The fall in capital expenditure was driven by an 8.7 per cent decline in mining investment, which has now fallen by 13 per cent over the past six months. Manufacturing and other (mostly services) investment rose by 1.7 per cent and 2.1 per cent respectively in the quarter. The quarter marks a rare reprieve for manufacturing investment, which has declined by 38 per cent over the past two-and-a-half years.
Capital expenditure was predictably weak in states that rely on the mining sector. Spending was down by 11 per cent in Queensland and 2.1 per cent in Western Australia. The biggest surprise was the 40 per cent decline in capital expenditure in the Northern Territory, which subtracted 2.1 percentage points from total capital expenditure growth in the quarter.
Spending in New South Wales rose by 7.6 per cent in the March quarter, which partially offset the weakness elsewhere. Expenditure in Victoria was down by 1 per cent.
Of more interest is the outlook for investment, particularly given the significant risk that mining investment poses for the Australian economy.
Each quarter the ABS asks businesses their investment intentions for the future. This is the sixth quarter where businesses have been asked about the 2013-2014 financial year and the second where they were asked about the 2014-2015 financial year. There are seven quarters of estimates for each financial year.
Nominal capital expenditure intentions for 2013-2014 fell moderately compared with three months ago and, based on historical realisation ratios, it is likely that capital expenditure over 2013-2014 will fall slightly compared with the previous financial year.
Of more interest are the investment intentions for the 2014-15 financial year. Though there are dangerous signs within the forecasts, the outlook is actually better than expected and suggests that the economy continues to rebalance towards non-mining drivers of growth.
Based on realisation ratios over the past five years -- which basically show the relationship between investment intentions and actual investment -- it appears as though capital expenditure will decline by around 5 to 6 per cent in the 2014-15 financial year. This is a significant improvement on the 10 per cent decline that appeared likely three months ago.
Obviously the data is highly sensitive to the realisation ratio used and there remains considerable uncertainty surrounding the eventual drop-off. For example, if investment in the 2014-15 financial year follows the same path as the 2012-13 financial year, then investment would decline by about 16 to 17 per cent.
However, despite the uncertainty, I feel more confident about the state of the Australian economy than I did yesterday.
Mining investment is still expected to take a big hit, with investment set to decline by around 15 per cent in the 2014-15 financial year. The risks to that outlook are certainly on the downside, particularly with the iron ore price declining significantly and continued speculation regarding the Chinese economy. I expect the eventual realisation ratio for 2014-15 to be a bit lower than the 5-year average I used to derive my estimates.
Investment intentions for the manufacturing sector are simply dreadful and suggest that nominal investment in 2014-15 could be at its lowest level in around 25 years. We really are seeing the end of the manufacturing sector as we know it and, with investment set to be so low, there really is no light at the end of the tunnel.
On the upside, investment intentions for the services sector appear to be quite strong and suggest that the economy continues to rebalance. Investment for the services sector is expected to rise by around 11 to 12 per cent in the 2014-15 financial year.
On the whole, this is good news for the Australian economy. The collapse in mining investment appears as though it will be spread out and the non-mining sector is showing tentative signs that it can keep the Australian economy growing at a solid pace. The risks are probably to the downside, particularly given the recent weakness in the iron ore price and speculation regarding the Australian economy.
For the Reserve Bank of Australia, this means it is unlikely to drop rates again in the foreseeable future. Any decision to drop rates would be centred on mining and non-mining investment and today’s data indicates that investment over the next couple of years may be a bit stronger than was widely anticipated.