A surge in business investment is coming, and it will likely put more pressure on Australia's already stretched economy.

For Australia, a business investment surge is coming – ready or not.

On August 26, the Australian Bureau of Statistics released the June quarter CAPEX survey, revealing for all to see that the business sector plans to lift investment spending in 2010/11 and to do so substantially – most particularly in the mining sector. That prospect was confirmed in the September quarter CAPEX survey released on Thursday. The RBA Governor in his Parliamentary Testimony described this as the "largest resource sector investment expansion in a century”.

The case for a business investment surge is compelling. The rest of the world is paying a lot more for our exports. So much so, that the terms of trade climbed almost 30 per cent over the last year to be at a 60 year high. This is at a time when there is a dramatic shift in global economic output. Ten years ago the advanced economies dominated the world economy, contributing around two thirds of global GDP. That share has fallen to just over half. In another ten years, it could be down to 40 per cent. The bulk of global output will be produced in the emerging economies.

RBA Assistant Governor Philip Lowe in a speech on September 16 highlighted the truly remarkable transformation that is occurring in Asia and how it is reshaping the global economy. To quote a few of the figures in his speech, over the past three decades, the proportion of the Chinese population living in urban centres has more than doubled to almost 45 per cent. The sheer number of people migrating to urban centres is unprecedented in human history – over the past 30 years, nearly 400 million Chinese citizens have moved to cities. There are now around 170 Chinese cities with more than a million residents, compared with only around 35 in Europe. And the urbanisation process still has a long way to run, with another 300 to 400 million people expected to move from the country to the city over the next 20 years. As people move to cities the demand for steel tends to rise. In China consumption of steel has more than quadrupled since 1997, with just over half of current consumption accounted for by the construction sector. India, which is also home to more than 20 per cent of the world’s population, is also urbanising. The process in India is for now more gradual and less advanced, with only around 30 per cent of the population urbanised.

The mining sector globally, aware of this structural shift, has bought into the emerging economy story in a major way. It is not surprising then that the outlook for business investment in Australia is very positive, both in 2010/11 and over the medium-term. The ABS September quarter CAPEX survey reported the 4th estimate of investment plans for the 2010/11 financial year as $124 billion. Applying average realisation ratios the 4th estimate suggests that CAPEX spending this financial year will be $128 billion. If so, that would be a substantial 21 per cent increase on the 2009/10 outcome. That’s not quite as great as the 28 per cent rise implied by the survey three months ago. Even so, it still represents a surge in CAPEX spending.

The mining sector alone plans to invest $55 billion in 2010/11. This is 57 per cent higher than the 2009/10 outcome of $35.2 billion – although, this, the fourth estimate, implies growth of 49 per cent. That’s because the final outcome in the CAPEX survey is, on average, only 94 per cent of the fourth estimate (indicating that mining companies tend to struggle to invest as much as they plan).

Delays in complex mining projects could see actual spending lower than implied by the CAPEX survey, with work pushed into 2011/12. We currently have factored into our forecasts a rise in real mining investment of a little under 25 per cent in 2010/11, an increase of $11 billion. That would directly add almost 1ppt to domestic demand growth and, allowing for import leakage, over half a percent to annual GDP growth. If anything, we may be too cautious with our forecast.

Projects in the LNG sector will be a major driver of this upswing. Work on the $43 billion LNG Gorgon project, which began at the end of 2009 and will take around four years, will be ramped up during 2010 and into 2011. The Federal Environment Minister, in a pivotal decision, on October 22, gave the go-ahead to two coal seam gas to LNG projects near Gladstone, Queensland. The reaction has been immediate. The BG Group announced on October 31 that it will begin construction immediately on a $15 billion venture. Santos has said it plans to commit to the first phase of its $16 billion project within this year. Origin Energy and Conoco Philip’s proposed $35 billion project has been given approval by the Queensland state government, with a decision by the Federal Minister pending. Beyond these four mega projects there is a long line of projects under consideration, as reported in the Access Economics Investment Monitor. The reported value of projects underway or in planning increased by $44 billion (6 per cent) to $770 billion in the September quarter 2010, to be up 12 per cent on a year ago.

So what of prospects for investment in the broader economy? No doubt the high Australian dollar, now trading around US98¢ – a touch above the July 2008 monthly average of US96¢ – will be a headwind for some sectors. Interest rate sensitive sectors will also be constrained to some extent by monetary policy, which has now edged into the contractionary zone.

Arguably, the outlook for manufacturing sector investment neatly addresses these concerns. The high Australian dollar and rising interest rates must mean that the manufacturing sector is looking to slash investment, right? That’s far from the case. There are strong linkages between mining and parts of manufacturing. Indeed, overall manufacturing investment intentions are positive, with the CAPEX survey pointing to 13 per cent growth in 2010/11. This linkage was also apparent in 2005/06, when mining CAPEX leapt by 72 per cent in real terms and manufacturing CAPEX increased by 18 per cent.

Given this positive outlook for manufacturing investment and other favourable fundamentals (limited spare capacity, healthy profit growth, business confidence and the reduced cost of imported capital goods) we're forecasting real business investment in the non-mining sector (which accounts for 75 per cent of total business investment in 2009/10) to rise by around 8 per cent over the year ahead. More generally, rising real incomes associated with strong growth in the resources sector will increase demand for a wide range of goods and services. Thinking outside the interest rate and exchange rate outlook debate, the mining investment boom will have a major impact not only on the broader economy but on social and political issues at the local and state government levels, as well as federally.

Competing demands for resources (land, water and labour) in an economy that is already operating with limited spare capacity will present major challenges for policy makers in coming years.

Andrew Hanlan is a Westpac senior economist.

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