Tuesday, April 7, 2015

7/4/15: IMF WEO on Global Investment Slump: Part 2: It's Demand, Not Supply ..

IMF released Chapter 4 of the April 2015 World Economic Outlook update. The chapter covers the issue of lagging growth in private investment (http://www.imf.org/external/pubs/ft/weo/2015/01/pdf/c4.pdf).

IMF findings focus on 5 questions:

  1. "Is there a global slump in private investment?"
  2. "Is the sharp slump in advanced economy private investment due just to weakness in housing, or is it broader?"
  3. "How much of the slump in business investment reflects weakness in economic activity?"
  4. "Which businesses have cut back more on investment? What does this imply about which channels—beyond output—have been relevant in explaining weak investment?"
  5. "Is there a disconnect between financial markets and firms’ investment decisions?"


I covered chapter’s main findings for questions 1-2 in the earlier post here: http://trueeconomics.blogspot.ie/2015/04/7415-imf-weo-on-global-investment-slump.html

Now, onto the remaining questions and the core conclusions:

Q3: "The overall weakness in economic activity since the crisis appears to be the primary restraint on business investment in the advanced economies. In surveys, businesses often cite low demand as the dominant factor. Historical precedent indicates that business investment has deviated little, if at all, from what could be expected given the weakness in economic activity in recent years. …Although the proximate cause of lower firm investment appears to be weak economic activity, this itself is due to many factors. And it is worth acknowledging that, as explained in Chapter 3 [of the WEO], a large share of the output loss compared with pre-crisis trends can now be seen as permanent."

Here's a handy chart showing as much:

Figure 4.6. Real Business Investment and Output Relative to Forecasts: Historical Recessions versus Global Financial Crisis (Percent deviation from forecasts in the year of recession, unless noted otherwise; years on x-axis, unless noted otherwise)




Q4: "Beyond weak economic activity, there is some evidence that financial constraints and policy uncertainty play an independent role in retarding investment in some economies, including euro area economies with high borrowing spreads during the 2010–11 sovereign debt crisis. …In particular, firms in sectors that rely more on external funds, such as pharmaceuticals, have seen a larger fall in investment than other firms since the crisis. This finding is consistent with the view that a weak financial system and weak firm balance sheets have constrained investment. Regarding the effect of uncertainty, firms whose stock prices typically respond more to measures of aggregate uncertainty have cut back more on investment in recent years, even after the role of weak sales is accounted for."

Here is an interesting set of charts documenting that financial and policy factors played more significant role in depressing investment in the euro area 'peripheral' states:

Figure 4.10. Selected Euro Area Economies: Accelerator Model—Role of Financial Constraints and Policy Uncertainty (Log index).




Note: in Ireland's case, financial constraints (quality of firms' balance sheets) is the only explanatory factor beyond demand side of the economy for investment collapse in 2013-present, as uncertainty (blue line) strongly diverged from the actual investment dynamics.


Q5: "Finally, regarding the apparent disconnect between buoyant stock market performance and relatively restrained investment growth in some economies, the chapter finds that this too is not unusual. In line with much existing research, it finds that the relationship between market valuations and business investment is positive but weak. Nevertheless, there is some evidence that stock market performance is a leading indicator of future investment, implying that if stock markets remain buoyant, business investment could pick up."

Conclusions

  • So IMF finds no need for any systemic the supply-side adjustments on capital/credit side.
  • It finds no imbalances in the capital markets and finds that demand is the main driver for collapse in investment. 
Where is the need for more 'integration' of the capital markets that the EU is pushing forward as the main tool for addressing low investment levels? Where is the need for more bank credit to support investment? Ah, right, nowhere to be seen…

Meanwhile, the IMF does note the role of debt overhang (legacy debts) in corporate sector as one of the drivers for the current investment slump. "Although this chapter does not further investigate the separate roles of weak firm balance sheets and impaired credit supply, a growing number of studies do so and suggest that both channels have been relevant." In particular, "For example, Kalemli-Ozcan, Laeven, and Moreno (forthcoming) investigate the separate roles of weak corporate balance sheets, corporate debt overhang, and weak bank balance sheets in hindering investment in Europe in recent years using a firm-level data set on small and medium-sized enterprises in which each firm is matched to its bank. They find that all three of these factors have inhibited investment in small firms but that corporate debt overhang (defined by the long-term debt-to-earnings ratio) has been the most
important."

Thus, once again, how likely is it that low cost and abundant credit supply unleashed onto SMEs - as our policymakers in Ireland and the EU are dreaming day after day - will be able to repair investment collapse? Err… not likely.

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