COVID-19 Extends Australia's Capex Decline

Economist's View

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This week the Australian Bureau of Statistics (ABS) released data on private sector capital expenditure for the September quarter. As expected, real private capital expenditure declined again, falling 3%. The decline follows a 5.9% fall in the second quarter, leaving capex 13.8% lower than the same quarter last year, and points to another quarter of weaker business investment in the Q3 national accounts to be released next week.

Capital expenditure (‘capex’), and business investment more broadly, have been a weak spot in the Australian economy for some time. This was the 7th straight quarterly decline in capex in the data. Real private capital expenditure has been trending steadily lower since mid-2018, though the COVID-induced recession has extended and magnified this trend.

In the September quarter, the weakness was seen consistently in spending on buildings and structures as well as on equipment and machinery. Real expenditure on buildings and structures fell 3.7% in the quarter to be 15% down over the last year. Equipment and machinery capex declined 2.2% in Q3 (following a 7.9% fall in Q2) to be 12.3% down over the last year.

Expenditure on buildings and structures has been trending lower since the end of 2017. While equipment and machinery had staged a recovery up to 2018, it has also been on a steady decline since mid last year. Expenditure in both categories remains well below spending peaks seen during the heights of the mining investment boom over 2012 to 2014.

Unsurprisingly, the September quarter’s decline in capex was led by Victoria, falling 7.7% in the quarter (the most of any state or territory) and 23.7% over the last year, as the state entered its strict lockdown in the quarter. Victoria’s Q3 performance was slightly milder than the June quarter however, when capex fell 7.9%. Expenditure on building and structures has been particularly weak in Victoria, falling over 11% in both Q2 and Q3. All other states and territories experienced capex declines in the September quarter, and in year-ended terms New South Wales isn’t far behind Victoria at ‑21% y/y, with the September quarter’s 3.7% decline following a 10.2% fall in Q2.

The other major states who had milder outbreaks and lockdowns and stricter border closures have tended to have less severe declines in capex. Capital spending fell 3.7% in South Australia in Q3, though is only down 8.5% from a year earlier, and spending in Queensland fell just 0.7% in the quarter, though is 13.7% lower over the year. With the strongest border restrictions and an earlier lifting of restrictions, Western Australia has been the standout. Capex in the state fell 1.4% in Q3, but WA is the only state or territory where expenditure remains higher over the year, at 4.8% y/y.

Capex fell 1% in the manufacturing industry and 3.3% in other selected industries, which includes services industries and construction. However, there were promising signs in some of the services industries that are turning around as the economy reopens, and saw strong growth in capital spending in the September quarter. Capex in the wholesale trade industry rose 10.6% in the quarter, driven by investment in machinery and equipment, and capex in ‘other selected services’, which includes accommodation and food services, rebounded with 20.2% growth, (though is still down -30.1% from a year earlier). Interestingly, the retail trade industry has seen continued growth in capital expenditure through the whole pandemic period, with shifts to online shopping and delivery of goods, and alterations to make stores COVID-safe, likely contributing to greater spending.

Mining capital expenditure declined 3.1% in the September quarter following a 1.2% fall in Q2. This came after mining investment had returned to growth over the previous year following a long period of contraction. Mining capex is now 2.8% lower than a year earlier, which is surprising given capex is higher over the year in WA. Indeed, a closer look at the data reveals that the weakness in mining capex has been driven by other states, and mining capex in WA is actually higher over the year; not surprising given the strength in iron ore and gold prices and the number of large mining capex programs known to be underway in the state.

With capex continuing to trend down and only a few bright spots in the data, what are the prospects for a sustained turnaround? Capital expenditure intentions for the 2020/21 financial year in the quarter’s survey (the 4th estimate of 2020/21 intentions) improved from the previous survey, but nonetheless remain subdued, down 10% from the same estimate from the previous year. So while the outlook for investment for the 2020/21 year is not quite as weak what was expected last quarter, it is still a downbeat picture. However, these intentions reflected the plans of businesses largely made before the positive developments seen more recently, such as the reopening of Victoria, further easing from the RBA, better than expected employment data, and encouraging progress of vaccines.

With interest rates low and business confidence recovering, we should be near the bottom of the capex decline, and expenditure should return to growth in the coming quarters. An investment recovery is likely to be patchy in the near term as businesses may remain hesitant to lift their capital expenditure in force until there is more certainty around widespread vaccination and border controls. Once this occurs however, with the RBA committing to low interest rates for years ahead and the federal government offering generous tax incentives for investment expenditure, we expect a strong rebound in business investment to follow.

Table 1: Financial market movements: 19 - 26 November 2020

Source: Bloomberg