Unleashing animal spirits

  • By Elizabeth Fry
Guy Debelle

Reserve Bank of Australia deputy governor Guy Debelle has blamed an absence of "animal spirits” for the lack of investment by companies since the global financial meltdown.

Speaking at the UBS Australasia Conference in Sydney on Tuesday, Debelle said the long-lasting paucity of business investment spending has been an ongoing theme in the global economy since the financial crisis.

This, despite the favorable conditions such as low borrowing rates, strong corporate balance sheets and solid profitability.

In Australia, the story has been quite different, he told the audience.

First, he argued, there has not been a lack of investment in Australia over the past decade. Indeed, it has been close to the opposite, with investment reaching a multi-decade peak.

“Mining investment was strong because expectations for future demand were high and there wasn't that much uncertainty around that expectation,” he said.

Weak demand

Outside of mining though, he argued there has been a disappointingly low level of investment spending.

In a speech, Debelle said research finds that much of the weakness in global investment since the crisis can be explained by slower economic growth.

“Expectations of weak future conditions are plausibly restraining business investment even more than current conditions," he added.

Similarly, he went on to say, there is some evidence that weaker corporate sentiment is holding back investment for both US and Australian companies, using estimates of corporate sentiment based on the share of ‘negative’ words in each company's annual report.

"Until recently, Bank liaison pointed to businesses being reluctant to invest until they saw a sustained pick-up in demand.

"More recently, though, investment intentions in business surveys and the Bank’s liaison contacts have increased alongside improved expectations for demand.This is true in Australia, but particularly so in other countries, most prominently in the US."

Firms risk averse

While Debelle pointed to weak aggregate demand as being the obvious candidate to explain the post-crisis behaviour of investment, that argument does not stack up here.

"However, when we look at this in Australia, while the explanation clearly has a lot of attraction, there is less clear-cut evidence for non-mining business investment.

“Investment spending in the non-mining sector has been even weaker than predicted by our standard aggregate model."

Moreover, he added, firm-level data found that corporate investment has been consistently weaker than would be predicted.

"Investment could be held back if firms have become more risk averse or if they have reassessed the likelihood of bad outcomes," he told conference attendees.

"While it is difficult to differentiate between these two, there are some signs that suggest that one or both have changed post-crisis."

Short-term thinking

According to Debelle, Bank liaison suggests some managers are less willing to take risks, and have tightened investment criteria since the crisis.

The official told the audience that companies have reduced their gearing and increased their cash holdings, and hurdle rates remain relatively high despite falls in borrowing rates.

"There are some indications that the stock market is rewarding cost reduction rather than investment spending where the payoffs are multi-year rather than immediate.

"That is, the risk aversion may be coming more from shareholders than a company's executive or board.

"There appears to be a desire to have 'excess' capital returned to shareholders through buybacks and dividends, rather than utilising that capital for investment with uncertain returns."

Central bank analysis is suggesting to Debelle that the capital intensity of industries varies substantially within each of the goods and services sectors. 

"That is, the decline in the investment share of output is largely due to changes in investment within industries, rather than changes in the sectoral composition of output."

Signs of life

That said, of late, there have been signs of life in investment spending outside the resources sector, the deputy governor explained to the audience.

Debelle also said there are signs of that dynamic changing around the world and in Australia.

“With any luck, it will be sustained.

"This will be timely for the Australian economy as the mining investment story draws to its close."