Transcript of Question & Answer Session Business Investment in Australia

Dr Debelle, thanks for your presentation. My brief summary is that, the bank sees the business investment outlook as quite positive, the glass is more than half full. I say that because on Friday the Reserve Bank published its quarterly Statement on Monetary Policy, and in that statement, the Bank published forecasts showing that it thinks that the business investment with infrastructure investment and consumption is going to be strong enough to drive the unemployment rate gradually lower. So currently at 5.5%, and the Bank's outlook is over the next two years, it might edge down further. At the same time, the Reserve Bank has published an inflation forecast that has underlying inflation at 1.75%, and it's sort of flat to up, it's sort of edging up over the next two years to about 2%, which is the bottom of the Reserve Bank's 2-3% band. So, my question is on the policy outlook. Are we right to think that with the economy going okay, but inflation sort of low and stable and struggling to get back to 2% that the case for monetary tightening is weak, and so we're stuck with a record low cash rate for say the next six months, at least.

I wouldn't be quite that precise on the outlook for monetary policy, Rory, that's what you're paid to do, not me. I just get paid to think about it month by month. Yes, we do expect that increase in investment spending to keep going. I think the other thing which is the infrastructure spending upswing is well and truly there. It's pretty obvious, extremely obvious in this state and, as the (NSW) Treasurer said earlier, it's going to keep on going for a while yet. I think at least in that case, there are potentially positive spill-overs. One thing I think which is interesting to think about, and coming back to what you were talking about in terms of employment, is that businesses now appear to be willing to increase investment spending. Employment growth has actually been pretty strong as well. So, they're both hiring people and they're willing to increase investment spending and I think the missing part of the puzzle which partly comes from what you're talking about, inflation, is as the labour market gets a bit tighter, whether they're going to get around to the point of being willing to actually increase wages.

That partly comes back to what I was talking about earlier, is that for, I would say, most of the past decade, cost reduction has very much been at the top of mind for a lot of businesses. So while you've got that at the top of mind, you're not particularly interested in thinking about increasing wages. But, as you're starting to increase your investment spending, as you're starting to hire more people, that ultimately should start to absorb some of the excess capacity, and you might actually get to the point where you might have to actually think about paying someone a bit more to actually get them to walk in the door and we don't think we've quite got to that point yet, as we said on Friday. But, I think that if that business mindset is actually changing, maybe we do get there at some point, sooner rather than later.

But, at the same time, we've seen this dynamic play out all around the world. Cost reduction again, I think is very much at top of mind globally as well as locally, and it's taken a long time in the rest of the world for that mindset to change and for businesses to start being willing to increase wages. Hasn't changed, obviously, yet globally, and I suppose that's one of the risks. So, just as there may be positive upside from the infrastructure spending, there's still that negative, that risk on the downside that wages still increase a lot. They remain stubbornly lower a lot longer than we were anticipating, and at least that's what seems to have been the case globally; and the question is how relevant that is locally.

But I do think the fact that we're starting to see a change in mindset from the corporate sector around the willingness to invest, around the willingness to hire, gives you some hope that eventually we might get back into a world where we start to see those wage and price pressures emerge.

Thanks very much.

Australia is described as a variable rate economy. Could you just elaborate your thinking on vulnerability of Australia to external or internal shocks in relation to household debt levels?

From my point of view, the fact that we have variable rate mortgages has actually been a good buffer over most of our history, in a way that's not quite so true elsewhere in the world. So, I suppose, are we just going to jack up rates to see how the household sector lives with that? I don't think so. If rates were materially higher, then the household sector would have trouble servicing their mortgages. We know that, and I think you have to think about what the environment is that the rates are going to be going up in. It's going to be an environment where the economy is stronger, where nominal growth in the economy growth is stronger, where household incomes are actually rising. As I said, I personally don't see something where some set of circumstances where it just happens. So it will be in the context of nominal inflation and wage increases in the economy are stronger than they are now. I just don't see that shock which comes along which causes rates to go up in an environment where there's other things aren't the case. And that's been true pretty much throughout our history.

So I don't see any change in the dynamics in the economy now where suddenly there's just an exogenous increase. Upward pressure on rates isn't exogenous, it's endogenous, I suppose is another way of putting it. There's nothing which comes along, I don't think, which forces us to raise interest rates. We will do it because the circumstances in the economy warrant it, and as I said, that would be a world where we're looking at stronger nominal outcomes in the economy. I know it generates nice headlines to say well if interest rates were four percentage points higher than they are now, the household sector would struggle. So yes, if that happened today, indeed that would be the case. But, that's not the sort of scenario in which that sort of outcome is likely to occur. Monetary policy will be endogenous to the state of the economy, not exogenous.

Dr Debelle, thank you for the enlightening speech. You did say that, when you talked about signs of life in investment finally, the RBA, other central banks, UBS as well in various economies, have called a false storm before. How high is your confidence that business investment is picking up? And then related to that, you just linked the two, the other puzzle, the wages puzzle. We heard from the New South Wales Treasurer about all the investment that's going on in New South Wales and how low the unemployment rate is. But wages growth in New South Wales, despite having those very favourable characteristics, remains quite low. Is that a concern to you?

On the first, how confident? Provided the ABS doesn't revise the statistics from under us again, it's been growing for the past two years. It's not an issue of confidence, it is actually growing and we have reasonable expectation that it's going to continue to grow, not least of which because of the upswing in public investment has got a while to run yet. Probably not the right word to use, but there's quite a lot in the pipeline. There's actually not many pipes being built at the moment, it's mostly roads, but there is actually quite a lot in the pipeline. So, I think on that front, it gives us a reasonable amount of confidence.

It's not just New South Wales, it's actually evident pretty much in every state in Australia at the moment, and the Commonwealth is obviously facilitating, as well. So, Glenn Stevens, in particular, spent a lot of time banging on about infrastructure spending and you don't get much better circumstances than this to actually do it, and maybe it was related to him and Phil talking about it, or maybe they just got around to it themselves. But, we are actually seeing that now, pretty much right across the country. So, that part of the upswing in business investment I think is there. It's actually in the data, and it doesn't show any sign of going away any time soon.

One thing which we are picking up related to that, and related to what you said about what is happening in New South Wales, is there are some signs of pockets, and I would only call them pockets, where you are starting to see labour shortages and people actually thinking about paying higher wages and that is in areas related to particularly to infrastructure spending. And partly because you've got these large projects going on in different parts of the country, at the same time, that is, we are starting to see or hear some sign that's generating a little bit of labour shortage. But, so while that's generating labour shortage, not obviously spilling over into higher wages yet but it is at least crossing the radar screen in a way that it hasn't done for quite some time.

Whether that becomes more wide-spread than that, as we said on Friday, and as we've said any number of times, that remains one of the great uncertainties. As I said, it's not is a local story. It's as much a global story, no one has any particular good answer. There are economies where spare capacity in the labour market is much less or even non-existent than it is here. But, we don't see much sign of wage pressure in those countries yet and so, we're a little behind that, and it's a question of whether those same dynamics play out here, as played out elsewhere in the US, or in Japan, or UK, or Germany.

Dr Debelle, thanks for your thoughts. I wanted to ask your thoughts on macro prudential policy and the Bank's thoughts more broadly. How effective do you think it's been and what do you think is the sort of landscape going forward in that part of the economy?

I think most of the measures over the last few years have been designed to increase resilience, and I'd say in that respect, they probably have been effective. If you look most recently at the share, we were concerned about the large share of interest only loans in the economy, and so APRA introduced that cap on interest only loans, and that cap has now been met in the September quarter and that, I think, has increased the resilience of the borrowing in the economy. That's the filter that mostly I think is the one worth looking at all this through, is increasing the resilience of the economy, and I think measures which are being taken to date, I would say the answer is yes, and that's the same prism that I'd be thinking about things going forward. So, as I said, the measures today, I think have achieved that objective that it continually assess how things are going. But, so far, I think the direction of change has been good in that respect.

Dr Debelle, thank you. We heard from the Treasurer about the regulatory impediments to doing business in Australia. Any thoughts on the Bank on whether or not this is also affecting business investment?

I actually referenced this in my talk, but didn't actually talk about it. I think it was either put out by Commonwealth Treasury or all the Treasurers together, including the New South Wales Treasury, just last week or the week before, and it looks it exactly at that issue as to what are some of the impediments and what are some of the regulatory impediments? So, I direct you to have a look at that. And then I suppose not unrelated to that was that the Productivity Commission in the last week or two put out their five-yearly assessment, and they identify in a number of sectors of the economy, some of the potential regulatory impediments to business investment and hence, productivity. So, I would by no means profess to be an expert on that, so I would direct you do the people who are experts on that, which are the Productivity Commission. Gary Banks had this long list of stuff. It's not quite that long list, but all those things on Gary Banks's list are pretty much still there in the most recent Productivity Commission report as potential impediments to productivity growth in Australia and so, I would direct you to those who know this issue better than I, and both of those two things are worth having a read as to some of those potential impediments.

Thank you. You mentioned that a small, non-mining investment has not followed what the world's been doing. What are some of the other reasons why that hasn't been the case? You mentioned borrowing costs, but it seems to be really the crux of the issue why we haven't been seeing lot more investment over the last couple of years.

It's not so much borrowing costs, I think, as actually the availability of credit for that part; for the small business sector. So we've run a panel of small business, talking to them about access to credit for two decades now, and I chaired it for 10 years up until I took my current job. One of the things I think which is interesting about that is all of those people on our small business panel, it's a particularly biased sample. We actually get people who have basically won Telstra Small Business Awards. So they're actually good, and they have trouble getting finance, and you're thinking if these people are having trouble, they're very successful small business entrepreneurs, they are having trouble accessing finance, be it from banks or venture capital or other sources of finance. So, I always find it extraordinary that if these people are having trouble with well, what I think at least, are clearly successful businesses, with good prospects, and they're having trouble financing growth.

It's very much around that. So, it's not so much the availability of small business finance to sort of to keep running a business, it's very much around the availability of finance for growth. And I think that's basically the crux of the problem. They can run their business and they can get the finance to keep sustaining their business in its current state, but to move up to that next level, which has got uncertainty around it, they can't really project the cash flows because they are inherently uncertain in the future. That seems to be where the greatest impediment is for investment in that sector of the economy and it's in my talk. I didn't show it there.

These guys actually, the small businesses account for a pretty large chunk of overall investment spending in the economy. So it does matter for the aggregate story. So, I do think, a lot of it really does boil down to the availability of finance. It's not the absence of entrepreneurial spirit. It's the absence of entrepreneurial finance, I think, which has been the main factor holding that part of the economy back. In their case, I really do think it is that one single factor. They've got inherent uncertainty. They know that. They're comfortable in managing that. They're generally optimistic about the future, so that's not an impediment to growth. What it boils down to is basically the availability of finance and so, I think, in their case, there is just one primary explanation for the absence of investment spending.

Okay. I might leave it there.