Weak fixed investment growth is damaging the potential growth trajectory in Europe and the US. At this stage, though, we expect to see an improvement in developed market fixed investment relative to emerging markets.
In emerging markets the impact of rapid investment ranges from the benign (particularly for economies that still have low capital stock and are embarking on catch-up growth) to the systemically destabilising. Overall, the continued rapid expansion in emerging market fixed investment suggests that global rebalancing still has a long way to go.
We forecast fixed investment in China to be much more muted over the next decade than the previous one, which helps inform our below-consensus real GDP growth forecasts for the country.
We project Russia, Turkey, South Korea, Chile, Peru and Brazil to disappoint in terms of fixed investment over the next couple of years, while central Europe, Mexico, the Philippines, Indonesia, Malaysia, and the GCC have relatively bright outlooks.
Investment in capital, labour and technology is the key to sustainable long-term economic growth. With the global labour force continuing to expand, investment in fixed capital is vital to sustain growth in productivity, which is ultimately the source of wealth creation. Moreover, capital investment is a balancing act: too little can leave labour underutilised and firms unable to exploit new technologies, while too much can lead to malinvestment and excess capacity. With this in mind, the stark divergence in investment across developed and emerging markets is a telling sign of the tough economic challenges which lie ahead.
| EMs Lead The Charge |
|Global - Real Fixed Capital Formation Index, 1970=100|
As the chart above shows, global fixed investment has motored along at a healthy clip in the years following the 2008-2009 financial crisis, with growth rates around 4-5% a year. However, this masks considerable divergence between developed and emerging markets, with the former stagnating at a time when the latter is catching up fast. Chronic underinvestment is damaging the potential growth trajectory in Europe and the US, while in emerging markets the impact of rapid investment ranges from the benign (particularly for economies that still have low capital stocks and are embarking on catch-up growth) to the systemically destabilising (such as China, where years of heavy investment has led to excess capacity in industrial metals and property).
The DM-EM split is reflective of both structural and cyclical factors. On the structural front, the investment gap is partly the result of underdeveloped economies expanding and modernising low quality capital stock, which is a well-trodden path for accelerating economic development. However, it also reflects a fundamental savings imbalance which is synonymous with global trade asymmetries ( see our online service, Global Rebalancing: A Conflict Ridden Path). By forcing up savings, governments not only bolster domestic investment but can also create excessive savings which are exported abroad, resulting in entrenched current account surpluses that the rest of the world must absorb. The continued rapid expansion in emerging market fixed investment suggests that global trade rebalancing still has a long way to go.
| European Firms Still Holding Back |
|Eurozone - Gross Fixed Capital Formation, EURbn|
Cyclical factors are also at play. In the aftermath of the financial crisis, lingering demand uncertainty depressed investment as risk-averse firms cut costs, boosted margins and accumulated large cash piles. Periodic turmoil in the eurozone has further compounded the murky outlook for demand in the years following the global financial crisis, and has cast a long shadow over corporate investment. In an atmosphere of risk aversion, many firms in developed markets have held back from productive investment and have instead engaged in unproductive trades such as cash accumulation, low (or even negative) return bond holdings and property speculation, to the detriment of long-term economic growth. Cyclical factors have also turbocharged investment in emerging markets, which have benefited from DM demand malaise and a flood of money on the back of central bank measures to bolster domestic credit.
At this stage in the cycle, we expect to see an improvement in developed market fixed investment relative to emerging markets. With the eurozone crisis dying down (though not dying off altogether), private sector confidence is gradually recovering and the outlook for demand is more clear. This will presage a pickup in fixed investment over the medium term. Meanwhile, the transition towards tighter monetary policy in the US will drain some of the excess liquidity which has previously poured into fast growing emerging markets, and in turn dampen the capital spending spree. However, the structural trend of EM out-investing DM will dominate the cyclical turnaround. There is still scope for substantial convergence gains among the least developed emerging markets, and there is little to suggest that mercantilist growth models beloved by many fast growing EMs will be abandoned anytime soon.
Asia - Structural Change In Investment Trends To Offer Opportunities: The outlook for Asian fixed capital investment will vary by country over the next decade as several diverging trends unfold. The most important dynamic in our view will be the structural rebalancing of the Chinese economy, which will see the economic model change from investment-led growth towards greater private consumption. Fixed investment stands at 44% of GDP, and this will decline to 37% over the next 10 years as overcapacity weighs on the return on investment of new projects at a time when the government has made economic rebalancing a priority. As such, we forecast growth of fixed investment to be much more muted over the next decade than the previous one, which helps inform our below-consensus real GDP growth forecasts over the next few years. South Korea is another economy which will see investment as a share of GDP fall, from 27% to 23% over the 10-year forecast period. Indeed, the government ambitiously aims to boost private consumption by increasing employment levels to 70% as well as raising GDP per capita to US$40,000 over the next four years, which will help shift the growth model.
| Structural Changes Ahead |
|Asia - Fixed Investment, % of GDP|
However, we see substantial growth in fixed investment in countries such as the Philippines, Indonesia and Malaysia, all of which suffer from infrastructure deficits. In the Philippines, an increasingly stable political landscape and improving business environment will see investment pick up, particularly as the government increases the use of private public partnerships (PPP) in order to improve the financing and execution of projects. This will see the share of fixed investment rise from 20% of GDP to 26%. In Indonesia, the more recent protectionist inclinations will not last beyond the presidential elections in July as all parties recognise the need to attract foreign direct investment in order to plug the infrastructure gap. This, combined with government's 2011-2025 Master Plan for the Acceleration and Expansion of Indonesian Economic Development, will see the share of investment rise from 33% of GDP to 36% over the next decade. In Malaysia, we forecast that investment will rise from 27% of GDP to 30% over the next ten years, largely driven by the government's Economic Transformation Programme, which aims to attract US$444bn of investment between 2011 and 2020. According to the plan, 60% of the investment will be funded by the private sector, 32% from government-linked companies, and the remaining 8% directly from the government. A substantial portion of the projects will be heavily targeted towards the oil & gas sector.
Latin America - End Of Commodity Boom Paves The Way For Slower Fixed Investment Growth: Following a significant rebound in real fixed investment growth just after the global financial crisis, we have seen a notably slower pace of expansion in the last couple of years in several major Latin American economies, and we broadly expect this trend to continue in the coming quarters. This is underpinned by our view that the period of high commodity prices that drove robust gross fixed capital formation in places like Chile, Peru and Brazil is coming to an end. Indeed, we believe that slowing growth in China will feed through to weaker demand for metals and continue to place downside pressures on metals prices, paving the way for more moderate fixed investment growth in Latin America on aggregate. Mexico remains the major exception to this trend, as we expect that a growing manufacturing sector and key economic reforms, including the recent liberalisation of the energy sector, will drive stronger fixed investment in the coming years.
| Moderate Growth The Way Forward |
|Latin America - Selected Economies' Real Fixed Investment Growth, %|
We estimate that Mexico saw some of the slowest growth in real fixed investment out of major regional economies in recent years, averaging just 3.0% between 2010 and 2013, well below Brazil (7.1%), Chile (10.3%), Peru (12.2%), and Colombia (9.2%). However, we anticipate more robust growth going forward, as increased cost competitiveness with China in the manufacturing sector, and strong ties to a recovering US economy, will bolster foreign direct investment and prompt domestic firms to expand their existing operations. Moreover, reforms will bolster the country's business environment, while the liberalisation of the energy sector will invite significant foreign investment into hydrocarbons exploration and production, and drive the need for greater refining and export infrastructure. As such, we expect an uptick in fixed investment will help drive modestly stronger headline growth in Mexico in the coming years, in line with our average forecast of 3.7% between 2014 and 2017, up from 3.5% between 2010 and 2013.
Emerging Europe - Russia And Turkey To Underperform: Although gross fixed capital formation in Russia and Turkey withstood the economic downturn better than most other CEE economies (see chart below), we now expect fixed investment in both countries to underperform the region over the next few years. In both cases, elevated political instability will deter investment among foreign firms which are awaiting clarity on policy trajectory before expanding operations in the countries, with Turkey beset by corruption scandals and Russia at risk of economic sanctions after the recent annexation of the Crimea region of Ukraine.
| Resilience Of Turkey And Russia Unlikely To Last |
|Europe - GFCF, % GDP|
Central Europe however, stands to benefit from lower interest rates, relative political stability and an increasingly strong economic growth outlook. In particular, we are increasingly bullish towards fixed investment in Poland, with GFCF forecast to add 1.1pp to growth in 2014. Poland's Manufacturing purchasing managers index (PMI) reading rose to 55.9 in February, signalling the strongest overall improvement in over three years. Significantly, this is supporting the labour market, with the manufacturing sector posting a record rate of job creation in order to keep up with demand, and fixed investment should benefit as existing manufacturing capacity in used up over the coming quarters. Although the pickup in GFCF will be less pronounced in the Czech Republic, Hungary, Romania and Croatia, we nevertheless expect the outlook for fixed investment to brighten over the coming quarters. Robust and improving capacity utilisation rates should support GFCF as existing manufacturing output is used up. We are particularly bullish on Romanian and Hungarian manufacturing, where export-driven economic recoveries translated into robust industrial output growth of 9.9% year-on-year (y-o-y) and 6.1% y-o-y respectively in January 2014.
Although we are slightly less positive towards the Czech export story, a capacity utilisation rate of 80.5% indicates strong demand for additional capacity, underpinning our expectation that fixed investment will add 0.2pp to headline growth in 2014. Although competitiveness issues will prevent Croatia from exporting itself out of its economic malaise, we expect GFCF to improve slightly as investor sentiment is supported by the EU policy anchor and due to improved access to EU structural funds. Although this all broadly points towards an improving outlook for fixed investment in CEE over the coming quarters, we caution that the severe nature of the region's economic downturn will ensure that GFCF remains below pre-crisis levels for some time to come in most economies.
Sub-Saharan Africa - Increased Fixed Investment Needed To Build New Economies: Sub-Saharan Africa's dilapidated and fragmented infrastructure is perhaps the greatest obstacle to faster economic growth in the region. While higher investment spending - by both the public and the private sector - is having an effect, BMI does not believe that current expenditure will be sufficient to bridge the gap with other emerging economies. Low domestic borrowing rates and weak government finances mean that, taken as a whole, Sub-Saharan Africa directs a much smaller share of its output towards fixed capital formation than do emerging economies in other regions of the world. The African Development Bank estimates that the region must allocate an additional US$90bn to infrastructure spending each year in order to see a significant improvement. The power situation is particularly grim; the 48 countries of Sub-Saharan Africa combined generate less energy than Spain and output per capita is actually falling as populations expand.
| Falling Behind |
|Global - Fixed Capital Formation Spending, % of GDP (2014)|
Even so, BMI notes that capital investment varies significantly between African states, and some are seeing rapidly increasing expenditure. In some countries we predict that fixed investment spending will be the key driver of economic growth between 2014 and 2018, mostly in states that are currently experiencing resource-fuelled economic booms. This sort of economic growth necessitates huge capital expenditure as foreign investors construct massive mines, ports, railways, and oil wells. For example, the cost of developing Guinea's Simandou iron ore project could exceed US$20bn, a figure almost two and a half times larger than the country's GDP.
While such projects inflate headline growth in the short term, BMI notes that they do little to address crippling infrastructure deficiencies. Newly-built transport routes link mines to ports, avoiding population centres and leaving the broader economy unaffected. This missed opportunity has a huge economic cost; the World Bank estimates that upgrading Sub-Saharan Africa's infrastructure to match the level of Mauritius would boost annual per capita GDP growth by 2.2 percentage points.
Middle East And North Africa - Brightening Outlook For Fixed Investment: Across the Middle East and North Africa region the outlook for fixed investment is brightening, as the impact of increasing competitiveness and government spending drive growth. As has been the case in previous years, we highlight the Gulf Cooperation Council (GCC) as the key outperformer over the coming years as capital formation is set to be driven principally by the respective governments' infrastructure spending plans, particularly in Qatar, UAE and Saudi Arabia. The key laggard within the GCC will be Kuwait, which despite a more promising economic outlook will see political obtrusion remaining a drag on growth. Overall, we forecast the GCC (excluding Kuwait) to average 7.4% growth in fixed capital investment in 2014, with Kuwait seeing growth of 5.0%.
| Gulf And Morocco To Be Regional Winners |
|MENA - Real Fixed Investment Growth, %|