Is the Cost of Capital Expenditures Becoming Unaffordable?

Capital Expenditures

Capital expenditure (CapEx) refers to the financial investment made by businesses to acquire, enhance, and maintain physical assets like buildings and machinery. These projects often necessitate thorough planning because once initiated, they tend to be expensive, protracted, and difficult to halt. The willingness of a company to undertake capital expenditures can serve as an indication of its future economic prospects. For instance, if a retail business holds a pessimistic outlook regarding future product demand, it may be less inclined to invest in opening a new storefront.

Capital expenditures play a vital role in driving the long-term growth of the majority of firms. By investing in capital today, businesses can enhance their future output. Given the substantial influence of capital expenditures on individual enterprises and the overall economy, it becomes crucial for policymakers to have a real-time understanding of how firms are adapting their capital investment strategies.

In their regular monthly surveys conducted in the Fifth District, the Federal Reserve Bank of Richmond frequently inquires whether firms have made any modifications to their current and projected capital expenditures. Furthermore, as part of the Q1 2023 CFO Survey, they specifically queried firms about their expectations regarding capital expenditures. Their findings reveal that companies are slowing down their pace of capital investment. Over the course of their business surveys, the proportion of firms reporting month-over-month increases in capital expenditures has been declining since April 2022.

The decline in Manufacturing and Services Capital Expenditures since 2022

In the latter half of 2022, analysts have noted a decrease in the capital expenditures indexes for both manufacturing and services sectors. Presently, these indexes are hovering around 0, marking their lowest levels since the summer of 2020. These indexes are computed by subtracting the percentage of firms reporting a decrease in capital expenditures from the percentage reporting an increase. While the declining indexes indicate a general retreat in capital investments by firms, a more nuanced understanding can be gained by examining the changes in the proportions of firms reporting “increased,” “decreased,” or “stayed the same.”

Richmond Fed Capital Expenditures Indexes

Between March and April, the non-seasonally adjusted portion of firms reporting “increased” capital expenditures declined from 22 percent to 13 percent, while the percentage reporting no change increased from 63 percent to 75 percent. This suggests that the recent drops in the capital expenditures indexes are primarily driven by a growing inclination among firms to maintain a steady level of capital spending rather than increase it. One possible interpretation is a diminishing eagerness among Fifth District firms to embark on new capital investment projects. This observation is not entirely unexpected, given the backdrop of rising interest rates (which play a significant role in assessing the cost of capital borrowing and investment) and prevailing economic uncertainties surrounding future demand.

Confirmation of Reduced Capital Investments by Firms

Supporting evidence for the notion of firms scaling back on capital investments can be found in research published as part of the Q1 2023 CFO Survey. The study revealed that while the percentage of firms intending to engage in capital investment over the next six months remained relatively steady since 2020, the anticipated growth rate of capital expenditures during that period exhibited a significant decline, starting from the latter half of 2022. In other words, the same number of firms expressed plans for capital expenditures in 2023, but the projected investment amount has notably decreased.

Capital Expenditures

Additionally, the survey identified the primary reasons cited by firms that do not intend to invest in capital over the next six months. The most commonly mentioned factors were “no need to expand capacity,” “need to preserve cash,” and “uncertainty.” However, a noteworthy increase was observed in the percentage of firms, rising from 15 percent in the second half of 2022 to 25 percent, who attributed their decision to unfavorable financing conditions. These findings align with the notion that rising interest rates and broad economic uncertainties are influential factors shaping firms’ decisions to postpone new capital investments.

Capital Expenditures

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