Economic update: A better economy = more confident firms


Go back a year and the consensus view was that the economic impact of the virus would be short. Certainly the economy was going to take a significant hit from the shutdown but then bounced back strongly once it re-opened. Forecasters turned more pessimistic following the Melbourne lockdown in July last year.

But it looks increasingly likely that any ‘scarring’ to the economy will be negligible. The economy has roared back to life, spurred on by very low interest rates and big budget deficits. Firms say they have not seen conditions like these for at least twenty years. Business investment is picking up strongly, powered by higher-than-expected capacity use and significant government incentives. Low interest rates means financing stronger investment is not a concern. Business credit growth is low, reflecting the large amount of saving that firms were able to sock away last year. But lending to firms has begun to grow.

And this is leading to more business investment

Firms are not only saying that they will invest more, they already are. Capex in the March quarter 2021 rose by over 6%. Much of that was plant and equipment (uncertainty about the future of the Office and physical shopping is weighing on non-residential investment). The need for more equipment has driven the pickup of imports of capital goods over the past 6-9 months. Car imports are on the rise.

With even bigger capex budgets likely for next year

Concern about a lack of business investment was an issue well before COVID. Back then, low capex spending was put down to an uncertain economic environment. The impact of technology and changes in consumer tastes also had an impact. For example, what long-term investments should the ‘traditional’ retail sector make when confronted by the rise of online shopping. The more capital-intensive sectors (such as manufacturing) have also become a smaller part of the economy.

More generally, investment spending is expected to rise strongly next year. A recent ABS survey suggested that firms might be increasing their investment spending by 15% next year, with particularly large increases projected in some services (including accommodation) and retail sectors.

This is all good news. And the big budget deficits and very low interest rates will make sure the economy is humming. But sustained strong economic growth will require widespread immunity to the virus (as we have been reminded by recent events in Victoria). A key question is when population growth will return to pre-COVID times? Another is what policy changes (if any) will be made to encourage stronger productivity growth?

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