THE ECB’s 1.1tn euro quantitative easing programme was designed to spark capital expenditure and boost growth in Europe. But, despite cheap credit and low interest rates, many corporations say it is still too early to spend.

Without a revival in corporate spending, Europe is at risk of entering a vicious cycle where low economic growth begets weak corporate investment, which then begets weak productivity and lower growth.

Disappointing growth is among the reasons why the ECB is now considering beefing up its 1.1tn euro QE package, with Mario Draghi, its president, opening the door to more bond buying should global market tremors threaten Europe’s still-fragile recovery.

Yet the evidence that more aggressive action will boost corporate spending is mixed. Executives at Siemens, which revealed last month its 200m euro investment in a wind turbine plant at Cuxhaven, say it had nothing to do with QE or low interest rates.

“Those [jobs] were not created because interest rates are low,” Ralf Thomas, Siemens’ chief financial officer, says. “Investments are driven far more by assumptions around growth, potential profit and technological barriers to entry, rather than movements in interest rates. We don’t decide to spend more just because interest rates are lower for a couple of years.”

Quantitative easing appears to have lowered the cost of borrowing for smaller businesses and helped spur demand for lending from companies. But interviews with senior European business leaders highlight the challenges facing the ECB as it seeks to create an environment where confidence and ready access to capital can spur investment.

“There is no stimulation from cheap money to invest more,” says Kurt Bock, chief executive of BASF, the German chemical group. “We orientate [our spending] towards growth prospects . . . and in Europe those growth prospects are modest.”

The central bankers didn’t anticipate that the lags would prove so stubborn and last this long

This mood reflects a broader debate among central bankers about just how much influence their policies — such as setting low interest rates — can have on investment decisions.

But Mr Draghi insisted earlier this month that the ECB programme was effective. “I would say that our accommodative monetary policy is being passed through to the rest of the economy,” he said, adding that credit conditions were improving in stressed countries like Spain and Italy, as well as France. “Its cost has gone down.”

Cash piles: Corporate investment collapsed in Europe following the 2008 crisis as companies paid off their debts and hoarded cash. And although it picked up briefly in 2010-11, lately it has stagnated in France and Germany — in spite of rising exports linked to the weak euro and healthy corporate profits. Standard & Poor’s last month predicted that global capital expenditure would fall more than 10pc this year, largely due to contraction in energy and mining.

Cash piles at European non-financial companies have swelled to $1.1tn — more than 40pc higher than in 2008, according to Moody’s.

Policymakers view the collapse in investment as one of the barriers to a strong global recovery of the sort that would allow central banks to raise rates from rock-bottom levels.

Andy Haldane, chief economist at the Bank of England, argues that “the main reason world growth has been subpar is because businesses have not been investing sufficiently”.

This was not supposed to be the case. Below-par investment was the sort of problem that central bankers’ aggressive response to the crisis could fix. Many now question whether monetary policymakers can have much impact on investment.

“While central bankers knew there would be a lag between their unconventional measures and the resulting boost in financial asset prices feeding through to real economic activity, they didn’t anticipate that the lags would prove so stubborn and last this long,” says Mohamed El-Erian, chief economic adviser to Allianz. “There are four reasons why, acting on their own, central banks have not delivered high and inclusive growth.

“First, the west had invested in the wrong growth model, overemphasising finance rather than real investment. Second, national and regional inequality matters as it drives a wedge between the ability and willingness to spend. Third, firms don’t invest when there is excessive indebtedness. Fourth, if the architecture is incomplete — as it is in the eurozone — this in itself undermines economic recovery and lift off.”

The experience of the US, which began QE earlier, is far from encouraging. It has pushed up stock prices but US companies have often used cheap debt to fund share buybacks and higher dividends rather than hire more employees or expand their businesses.

With interest rates near zero in the US, Europe and Japan, there is a widespread assumption that any company worth its salt should be able to find profitable projects to back. But that does not appear to be happening, and part of the reason why, may lie in how corporate boards give approval for new investment in the first place.

Before authorising a new project, a company looks at how much it can expect to earn on the investment and compares that with its weighted average cost of capital (WACC), which represents the combined cost of the interest payments on its debt and the return that equity investors demand.

The price of money: In Europe, blue-chip companies have recently issued debt at negligible rates: French utility Engie, formerly GDF Suez, sold a zero-coupon corporate bond in March, for example. But that does not mean that money has become almost free. The cost of equity has remained quite high for public companies, in part because of volatility and uncertainty in financial markets. The so-called equity risk premium tends to move in the opposite direction to interest rates, partly offsetting the impact of the falling cost of debt.

Public companies usually fund themselves with proportionately more equity than debt, and therefore their overall cost of capital has not declined much since the crisis.

“The influence of [low] interest rates is limited,” says Wolfgang Schaefer, chief financial officer at Continental, the German car parts supplier. “The equity risk premium has increased over the last three or four years, so the WACC has slightly increased for the automotive industry, which goes against people’s gut feeling.”

To provide leeway for various risks, companies usually require that the return on investment exceeds their cost of capital by several percentage points. These investment ‘hurdle rates’ are typically above 10pc, and often between 15 and 20pc.

“A low cost of debt doesn’t mean a low hurdle rate,” says Marc Zenner, co-head of corporate advisory at JPMorgan. “It’s a slow process from QE and cheap money to getting firms to invest more.”

Indeed, corporate boards rarely adjust the hurdle rate, meaning the impact of lower borrowing costs is not immediately passed on.

Richard Dobbs, director at the McKinsey Global Institute, the consultancy’s research arm, says he has “yet to come across a corporation that has adjusted their hurdle rate or WACC to reflect the fact that we’ve had QE.

“Executives seem to think something funny is going on in the bond market. They’re getting these very low rates, but don’t think their true cost of capital has changed,” he says. “So we’re not seeing an uptick in investment because of QE.”

Companies are able to lower their cost of capital by funding themselves with a higher proportion of debt compared to equity. Indeed, US corporate debt issuance has enjoyed the strongest ever start to a year, spurred by a surge in multibillion-dollar mergers and acquisition deals. But in Europe, companies are still reluctant to take on more debt.

“Even large companies have not heavily taken on more money from the bond markets. It seems that they don’t want to have too much debt on their balance sheets,” says Stefan Schoeniger, partner at KPMG in Hamburg.

“Companies are not substituting debt for equity or using cheap debt to fund capex and investments at the moment as would be expected in light of low interest rates.”

Wolfgang Buechele, chief executive of Linde, the German industrial gas and plant engineering company explains why. “Cheap money is easily available and quite a few of the investors ask quite straightforwardly: ‘why don’t you re-leverage the company and pay an extra dividend?’

“But I said very clearly ‘no’, because if tomorrow the economy is shaken up you are the first ones to claim: why did you do that? We are obliged to run a stable balance sheet, rather than embarking on opportunistic possibilities that might not be beneficial in the long run.”

Making projects pay: Some companies complain it has become harder to find investment projects that meet their required level of profit in the current environment.

Ingo Bertram, a senior manager at KPMG, explains that “if companies with a lower cost of capital decide to invest more, that raises competition [for investment] so the returns are then not as large as expected. That’s the other side of the equation. If the cost of capital reflects the low interest rate environment, then so will the cash flows.”

Bernd Scheifele, chief executive of HeidelbergCement, the cement maker, says: “The problem in a world of zero interest rates is that it’s very difficult to find projects where you can still earn the WACC within a foreseeable future.”

Bill Gross, the bond investor now at Janus Capital, argues that access to very cheap credit has also provided life support to companies that would otherwise fail, hindering the emergence of more innovative rivals. “Low interest rates are not the cure — they are part of the problem,” he wrote last month.

Despite the efforts of central bankers, businesses remain nervous about their growth prospects and uncertain about investment returns. Low investment therefore reflects low business demand and an excess of capacity in some sectors, such as the steel and oil industries.

“Expecting companies to invest more when they already have too much capacity is not the answer,” says Mr Dobbs.

Policymakers argue they cannot change this low-growth, low-investment paradigm alone. Addressing the Federal Reserve’s 2014 Jackson Hole meeting, Mr Draghi stressed that “no amount of fiscal or monetary accommodation . . . can compensate for the necessary structural reforms in the euro area”. Since then the European Commission, the EU’s executive arm, announced a 315bn euros investment plan to promote spending on infrastructure and innovation, and the 28-member bloc is pushing ahead with plans for a capital markets union.

Published in Dawn, Business & Finance weekly, September 14th, 2015

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