That means business can have confidence that the recovery phase will begin off the best possible base. That the Treasurer confirmed this week the October Budget will contain four-year forecasts, is a positive step towards helping businesses plan and feel more in control. It suggests the Government is working towards providing a longer roadmap for existing and new policies, structural reform and the economy (including some tax initiatives), in three months’ time.
What is becoming clear now, however, is that even when the economic cycle picks up, there is still structural adjustment that has to happen in the economy, which the Government flagged in this update. Some of that might have been on the cards whether the coronavirus had occurred or not. COVID-19 has certainly sped up trends towards working from home, online retail and structural reform around large issues such as energy transformation.
But it has also introduced new potential trends that will influence how Australia’s economy looks in the next decade – including diversified supply chains and advanced manufacturing. It may be that during the recovery phase companies opt for more expensive but robust supply chains. One possible adjustment could then be that companies will choose to be less profitable but more resilient.
Confidence will be critical, but we are also hearing that despite record low business interest rates, hurdle rates have not fallen as uncertainty has lifted the risk premium.
Hurdle rates for investments are a combination of the cost of capital and the return required for the risk of the project. When the economy is so uncertain, that risk premium rises, and in the current environment likely has more than offset the fall in business interest rates, making it harder to get investment projects off the ground.
Interestingly, one risk the Government has called out in its fiscal overview is to the global economic architecture, cautioning that “substantial increases in public and private debt …could lead to credit tightening and financial instability, slowing the pace of recovery.” Reducing the risk premium requires greater certainty about the future. As there is no equation as such for the risk premium, there’s an element of judgement, confidence plays an important part.
The October Budget is likely to include additional support for the economy, including infrastructure spending, tax measures to support and encourage investment, direct support for some sectors and further (although tapered) income support for households and businesses.
Stimulating Business Investment
Non-mining business investment was already weak before 2020 began, and the uncertainty around how the health and economic crisis will pan out is proving too great to be offset by the suite of stimulus made available in March.
Indeed, the Government’s own forecast is for non-mining business investment to be down 9 per cent for the 2020 financial year and is expected to be down 19.5 per cent by mid next year. Certainly, companies are facing tough times and company tax receipts are estimated to be down $25bn across this, and the previous financial year.
Business has been able to access ultra-low interest rates and policy supports for investment and borrowing put in place by the Federal Government, RBA and ASIC, but they haven’t. Policies are aimed at ensuring the supply of credit through the system, alongside incentives for lending to small and medium enterprises. The instant asset write-off and accelerated depreciation measures are aimed at boosting investment, while support for apprentices and trainees should support jobs.
RBA data shows businesses did crystallise more loans in March, with business credit up 3.1 per cent month on month due in large part to companies pre-emptively drawing down on existing credit lines. However, the latest RBA minutes notes that some of this has “since been repaid”, and its data for May shows credit contracted by 0.6 per cent, only the fourth monthly contraction in the past seven years.
At the same time, APRA data shows that business deposits at ADIs were up 14 per cent year on year in May suggesting that firms are shoring up cashflow rather than investing.