WEEKEND ECONOMIST: A rocky rebalancing

Despite a recent uptick in business and consumer confidence, mining investment is still approaching its peak. And non-mining sectors seem unlikely to be able to pick up the slack.

A rotation of the growth drivers of the Australian economy is set to emerge over the next one to two years. A peak in mining investment is looming, creating the need for other sectors such as housing construction and non-mining business investment to strengthen.

The precise timing of this rebalancing and the smoothness of the transition remains particularly uncertain.
We see the risk that business investment by non-mining sectors will continue to be relatively subdued in the near-term and will be slow to respond to a likely strengthening of household demand during 2013 and 2014. This adds to the risks of a growth gap.

The Australian Bureau of Statistics survey of business investment plans, the Capex Survey, is to be published next Thursday. This update will provide some further guidance on growth prospects and will be a key input into considerations by the Reserve Bank board at their March meeting.

September 2012 capex survey, a recap

Investment plans for 2012-13 were scaled back significantly in the September capex survey, driven by the mining sector. The survey, released on November 29, was conducted over the October-November period.

Mining was responding to the squeeze from higher costs and lower global commodity prices. In the lead up to this survey, there were announcements that some key potential projects were to be either delayed or shelved (for example, the Olympic Dam expansion).

Of note, spot iron ore prices slumped from $135 in mid-July to a low of $87 early in September. A recovery was underway by the time of the ABS survey, with prices at $104 by end September, rising to $120 by late October, followed by a consolidation.

Mining capex plans for 2012-13 were reduced to $109 billion at Estimate 4, down from Estimate 3 of $119 billion. Applying realisation ratios (i.e. the average 'slippage' between final outcomes and reported spending plans), Estimate 4 implies capex of $97 billion for the full 2012-13 year, an increase of 18 per cent on 2011-12 but a downgrade from the 33 per cent increase suggested by Estimate 3.

Of note, actual mining capex in the initial quarter of the 2012-13 year was $24.7 billion, $99 billion annualised. Hence, at face value, the survey implies that mining investment is set to decline over the remaining quarters of 2012-13. Mining investment hitting a peak in the September quarter 2012 is earlier than suggested by other information. The pipeline of work on mining projects already under construction points to further upside. Our central case forecast is for total private infrastructure activity to advance over the first half of 2013 and then begin to decline over the second half of the year.

December 2012 capex survey

The December quarter capex survey will include the fifth estimate of plans for 2012-13. In addition, an initial estimate of plans for 2013-14 will be available. This will be the first of six estimates, ahead of the actual figure, available late in August 2014. The December survey was conducted over January-February.

Between surveys some positives have emerged. An improvement in global economic conditions and sentiment is apparent. Associated with this, commodity prices are off their lows. Notably, iron ore was trading at $145 in mid-January. Against this, the mining sector's recently refound focus on cost control appears to have been sustained into 2013.

Private business surveys, some insights

The NAB business survey potentially provides some insights into the upcoming capex survey. The quarterly NAB survey includes a question on capex plans for the next 12 months, a series which tends to lead actual capex spending by about two quarters.

The December quarter NAB survey is a little dated, having been in the field from November 19 to December 7. Capex plans for the next 12 months were relatively subdued, moderating to a net balance of 10, below the historic average for this series of 21.

Such a reading points to near-term downside for actual capex.

By industry, the December quarter NAB survey reported weak and sharply lower capex plans for mining, ongoing weakness for manufacturing and ongoing soft plans for the services sectors. The more recent January monthly survey, in the field from January 25 to February 4, revealed that overall business confidence and conditions improved modestly. It seems unlikely that these changes were sufficient to greatly alter investment plans.

Low capacity utilisation levels provide an explanation for soft investment across the broader economy. While the Australian economy continues to expand, the pace of growth beyond mining investment has been sub-par. In this environment of soft demand capacity utilisation levels have moderated, following a recovery during the second half of 2009 and during 2010.

Utilisation slipped below average levels in mid 2012. This is consistent with a loss of momentum in the economy, reflective of a number of domestic and global factors. The initial read on capacity utilisation in 2013, from the January monthly business survey, was softer again.

Compounding the fundamentals of current subdued demand and excess capacity is an air of uncertainty. It is notable that commercial finance trended lower over recent months, associated with a loss of business confidence.

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Scenarios

Here we consider a few scenarios for Estimate 1 of 2013-14. At the outset there are a few key caveats:

(1) The 2012-13 starting point is unknown. Any surprises for 2012-13 will impact our interpretation of 2013-14 plans.

We suspect that plans for 2012-13 will be broadly as reported three months ago. However, we do see upside risks to 2012-13 intentions. As noted previously, Estimate 4 of mining intentions are weaker than suggested by the existing pipeline of construction work.

Estimate 4 for 2012-13 implied growth of 7 per cent on 2011-12. For Estimate 5 to imply 7 per cent growth and a final outcome of $169 billion would require a print of $179 billion (upgraded from $173.4 billion).

(2) The industry mix of investment plans is of significance.

The calculation is affected by the mix because average realisation ratios differ by industry and we calculate the total from the sum of the three industry figures. Moreover, our interpretation of the survey will reflect a consideration of both mining and non-mining investment prospects.

Also note, prior Estimates are subject to revision.

(3) Our calculations are based on historic average realisation ratios, a 3 year average for mining and a 10 year average for manufacturing and services. Ratios between estimates and the final outcome differ from year to year. Accordingly, interpreting thissurvey requires a degree of qualitative judgement.

To repeat: the following scenarios are based on an expectation that Estimate 5 for 2012-13 will be $179 billion, implying a final outcome for 2012-13 of about $166 billion. To the extent that there is any upside surprise to Estimate 5 for 2012-13 then Estimate 1 for 2013-14 will need to be marked higher in each of the following scenarios.

Scenario 1, 2013-14 – a smooth rebalancing of growth

Estimate 1 of $150 billion.
Implies an outcome of $170 billion, growth of 2.5 per cent
Mining: flat
Manufacturing & services: growth of 6 per cent

Note: the capex survey substantially under-estimates investment by the services sector. A healthy rise in services investment would provide a more substantial boost to business investment as measured in the national accounts.
Also note, these figures are in nominal terms. Inflation for capex spending is negligible at present, running at only 1 per cent annual for mining and just 0.6 per cent annual for the aggregate.

Scenario 2, 2013-14 – a resilient result

Estimate 1 of $147 billion.
Implies an outcome of $166 billion, and a flat outcome
Mining: a decline of 2 per cent
Manufacturing & services: growth of 3 per cent

The Reserve Bank would arguably be encouraged by such a reading. This could be interpreted as a modest pace of decline in mining investment and tentative evidence of a pending modest improvement in investment across the broader economy.

Scenario 3, 2013-14 – no rebalancing of growth

Estimate 1 of $143 billion.
Implies an outcome of $162 billion, and a decline of 2 per cent
Mining: a decline of 4 per cent
Manufacturing & services: flat

Such an outcome and such a mix would add to concerns of a potential growth gap. This would confirm that mining investment is no longer adding to growth but was instead subtracting. Additionally, there would be no evidence that the non-mining sectors are about to fill the gap.

Scenario 4, 2013-14 – a particularly weak result

Estimate 1 of $140 billion.
Implies an outcome of $158 billion, and a decline of 5 per cent
Mining: a decline of 6 per cent Manufacturing & services: falls of 3 per cent Investment declining on a broad-based front would be cause for concern.

With fiscal policy contractionary and the currency stubbornly high, monetary policy would have more work to do.

Andrew Hanlan is a senior economist at Westpac.

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