Time for companies to start spending their surplus cash
Diane Coyle asks if Britain's miserly attitude to industrial investment is about to change Companies cling to high target rates of return The CBI's surveys suggest a strong pick-up is due
Friday 13 January 1995
This will be the year, according to most economic forecasters, when investment finally rebounds. It had better, if the forecasters are to avoid another blot on their tarnished reputations. Many see investment as the driving force behind economic growth of 3-3.5 per cent this year.
The Treasury, for example, predicts business investment will grow 10.75 per cent after a 2 per cent rise last year. It puts total growth in fixed investment, including housing and government investment, at 5.75 per cent, up from 3.75 per cent. Many priv a te economists have made similar predictions. Yet it is hard to avoid the suspicion that part of the reason for forecasting an investment boom this year is its absence so far.
A variety of explanations have been put forward, the most prominent being the notion that companies have clung to high target rates of return for investment projects rather than reducing them in acclamation of the new era of low and stable inflation. Surveys carried out last year by both the Bank of England and the Confederation of British Industry supported this theory.
Both surveys found that large numbers of firms target rates of return of more than 20 per cent or require excessively short payback periods for planned investments. The CBI remarked: "Some companies are clearly not convinced that the current low inflation rates will continue."
Some firms have made the adjustment, but these have mainly been big and financially sophisticated companies - such as Hanson, which announced last summer that lower inflation and interest rates had made it appropriate to lengthen the payback period. Others have been slow to follow.
Christopher Taylor, finance director of the engineering group Smiths Industries, argues that there are good institutional reasons for sticking to strict investment criteria. "Many companies would use a high target rate of return to force local managementto put forward a good strong case," he said. "In many of our projects there is a high level of risk which we often tackle with a high discount rate."
However, Mr Taylor does believe that a majority of British firms set hurdles that are too high, which makes them overlook projects that would be steady earners and take on high-risk projects instead.
A second reason for weak investment in the recovery has been the slow process of rebuilding company balance sheets after the borrowing binge of the late 1980s. In 1993 companies repaid £11.3bn in bank loans, and are likely to have repaid £2-3bn more in 1
994. Rights issues since 1991 have totalled nearly £30bn.
This financial restructuring left British businesses with a financial surplus of £4.8bn in the second quarter of 1994, the biggest on record, and a remarkable recovery from 1990's £23bn deficit.
Many economists argue that the corporate sector must now have enough cash to start spending it.
John Marsland, UK economist at UBS, said: "Companies' financial surplus in 1994 is unprecedented in the post-war period. It should encourage them to increase their investment spending."
Others are not so sure. Mark Brown, chief strategist at Hoare Govett, said: "They are awash with cash, but it will go to other things as well as capital expenditure." He expects another solid rise in dividends and an increase in takeover activity.
The third in the trio of excuses for the weakness of investment has been businesses' lack of confidence so far about demand and the absence of pressures on capacity. CBI surveys show that it is only recently that capacity shortages have begun to emerge, and that from a low base.
The prospects for a better year for investment in 1995 depend on how biting these shortages are and how confident firms are about their sales prospects. Sudhir Junankar, associate director of economics for the CBI, argues for a strong pick-up on the basis of survey evidence. The balance of firms expecting to raise investment spending was 16 per cent in the CBI's last quarterly industrial trends survey - the highest positive balance since April 1989.
Richard Freeman, chief economist at ICI, agrees. "Companies are taking old investment plans off the shelf and dusting them down," he said. The reason he gives is emerging capacity pressures, in the chemicals industry and others.
Sage, a small Newcastle software company, is investing internally and by takeover. Paul Walker, chief executive, said: "It demonstrates our confidence in both our business and the economy generally."
However, elsewhere in industry this year's outlook is not so rosy. A survey of more than 2,000 of its medium-sized business customers by Lloyds Bank, published this week, reported high order books and sales but weaker investment intentions compared with six months ago. Lloyds suggests that this reflects growing caution, with companies reckoning the economic cycle has turned.
Pressac, a Nottingham manufacturer of motor components, has invested heavily for the past three years in anticipation of higher demand, and is about to cut capital spending back in line with depreciation. Geoff White, chief executive, said: "We incorporated our anticipation of capacity needs when we made the investments."
The other rationale for £10m spent on new plant and equipment during the past three years was updating technology to improve productivity.
Cost-cutting has been a common theme in investment in the 1990s. Mr Taylor of Smiths Industries said: "If we need to cut costs, we would invest."
If business investment does not bounce back this year, the long-run consequences for Britain will be perturbing, to say the least. Manufacturing output is still lower than it was five years ago.
Britain invests a lower proportion of national output than other industrial countries, and earns a lower rate of return on capital - 11.5 per cent last year compared with an average of 16 per cent in the other OECD economies.
Mr Freeman of ICI said: "If the investment does not come through this year, we have not had the economic miracle everyone has been talking about." There is a lot at stake in those forecasts of an investment boom in 1995.
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