Why low interest rates do not stimulate investment
The average rate of return has hovered around 15% since 2015, according to the National Australia Bank business survey.
This despite the weighted average cost of capital – the average rate of
the return required by debt and equity investors when financing a business – falling from around 2 percentage points to 6% for BBB-rated non-financial companies.
Research by RBA economists Henry Edwards and Kevin Lane suggests that while business investment is less sensitive to changes in interest rates, monetary policy may need to be relaxed more than usual to induce a certain level. investment.
CEOs argue that the long-term nature of many projects means that interest rates need to be factored into business cycles.
“Survey data suggests that rates of return have remained high and well above the weighted average cost of capital (WACC) in recent years, as has the ex post return on invested capital for listed Australian companies,” said economists noted in a new RBA newsletter. article, Why are investment barrier rates so Tights?
“This rigidity contrasts sharply with the fall in interest rates.
“The proposed reasons include the perception that the yields available on potential projects are unrelated to the level of interest rates.
“Additionally, companies can avoid cutting interest rates to minimize the risk of regret, and some business leaders might view long-term interest rate cuts as temporary.”
RBA Governor Philip Lowe has urged companies to adjust to the new reality of low interest rates and reduce the returns they need to approve new investments.
But few business leaders are ready to budge on policy rates, arguing that while interest rates have fallen sharply, risks have increased and the long-term nature of many projects means that interest rates must be taken into account throughout economic cycles.
Low interest rates have also inflated asset prices, raising the price of existing assets that companies can acquire.
Investment by non-mining companies has gradually declined from around 7 percent of GDP to around 4.5 percent of GDP over the past 10 years.
The decline partly reflects the economy’s shift from capital-intensive manufacturing to more services.
Although low rates appear to have a limited direct effect on business investment, RBA researchers said monetary policy still affects investment through other channels.
“Lower interest rates stimulate investment through a variety of channels, including higher demand for products, higher after-interest cash flow and higher equity. “
Competitors do not invest
A lack of competition between firms may also have contributed to firms not lowering their rates of return and increasing their investments.
“There may be insufficient competitive pressure to reduce obstacle rates,” the RBA noted.
“Some companies noted that their competitors had not invested and that there had not been a lot of competitive pressure to reduce barrier rates.
“If there was more competition among firms to invest, or if competitors lowered barrier rates, then other firms would have a greater incentive to lower barrier rates and increase investment. “
Previous research by RBA chief economic analyst Bradley Jones suggests that companies’ perception of risk has increased since the global financial crisis, leading companies to place greater importance on the likelihood of downside extreme risk events.