Poised to invest in productivity gains and emerging market opportunities

TORONTO, March 30 /CNW/ - Canadian businesses are poised to take the reins from government and consumers as the leading source of growth in the Canadian economy, finds a new report from CIBC World Markets Inc.

While governments, both federal and provincial, are now singing a tune of restraint and consumers are cutting back on spending growth, Canadian businesses are set to ramp up investments in new plant and equipment with a focus on expanding export opportunities.

"By any measure, the current recovery in capital spending is impressive," says Avery Shenfeld, chief economist at CIBC. "The real return on capital employed is rising and is now currently at just under six per cent-a full point above its long term average, and return on equity is now above 12 per cent."

The report notes that all three of Canada's heavy hitters of capital investment, the oil sands, utilities and the manufacturing sector, are expected to add significantly to capacity, ensuring that business investment remains a consistent source of support for the domestic economy, not just in 2011 but also in the coming years.

While the strong loonie is hurting exports from Canada's manufacturing sector, Mr. Shenfeld notes that the stronger currency is also playing a role in spurring investment in the sector.

"There has been a lot of discussion regarding the disappointing productivity numbers, but the reality is that we are seeing a much tighter correlation between the value of the dollar and purchases of machinery and equipment from abroad. The surge in imports of machinery and equipment has clearly been facilitated by a strengthening Canadian dollar. We expect the loonie's strength to persist over the longer term, which should help boost investments going forward in sectors that can remain competitive."

Capacity utilization in the manufacturing sector is now at 81 per cent, a record six points above that of the rest of the economy, and fast approaching pre-recession levels. With improving capacity use and rates of return on capital employed in the sector approaching a 10-year high, Mr. Shenfeld expects business investment in manufacturing to rise strongly in 2011.

In the U.S., businesses are also seeing increases in capital budgets, in part due to improved opportunities for American exports. The U.S. dollar is relatively cheap against many of its trading partners, and the market share of American goods abroad is likely to benefit. Capital spending to meet that demand will be an important source of growth.

"Canada's exports will tap into some of the resulting improvement in the U.S. economy, particularly for companies that can hitch themselves to the U.S. supply chains for products ultimately destined for higher growth economies overseas," says Mr. Shenfeld. "A strong Canadian dollar will remain a challenge for exporters, but we expect the improving global economy to generate increased opportunities over the next few years."

For Canada's small and medium-sized enterprises (SMEs), Mr. Shenfeld believes many of them will have to think more globally to grow. Recent trends in SMEs' trade activity and international comparisons suggest that Canadian SMEs have not responded to globalization in a way that optimizes their long-term growth potential and their contribution to the Canadian economy as a whole.

Only nine per cent of Canadian SMEs are engaged in exporting activity, a number that is probably overstated as it includes companies that export sporadically and not as an integral part of their business model. It also appears that, despite globalization, the relative number of SMEs that engage in export activity in Canada is on a decline.

The report finds that strong growth in emerging markets and increased opportunities to participate in global supply chains due to the growing export focus of the U.S. economy provide Canadian SMEs with an opportunity to reverse this trend. Currently, only an estimated three per cent of SMEs' revenues and five per cent of jobs are directly linked to trade with emerging markets.

"This is where we see the most significant near-term opportunity for Canadian SMEs given the projected increase of outsourcing activity in the U.S.," adds Mr. Shenfeld.

Firms that have been successful in penetrating foreign markets also tend to have senior managers with international experience. "Given the rising number of new immigrants from emerging markets in general, and China and South Asia in particular, there is a clear opportunity to capitalize on this trend," notes the report.

The complete CIBC World Markets report is available at: http://research.cibcwm.com/economic_public/download/sr-20110330.pdf

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