RDP 2013-13: Inventory Investment in Australia and the Global Financial Crisis 4. Inventory Investment and the 2008/09 Financial Crisis

4.1 Short-term Business Finance during the Global Financial Crisis

It has been well documented that total intermediated business credit in Australia fell sharply in 2008/09 (Black, Kirkwood and Shah Idil 2009). However, the extent to which the aggregate decline was due to a fall in short-term credit has not been documented. Moreover, it is not well-known how the availability and use of revolving credit lines changed during the crisis period.

If there was an adverse credit supply shock stemming from the banking sector in 2008/09 then we should observe three phenomena. First, short-term intermediated credit should have fallen and/or its price risen substantially. Second, borrowing firms should have substituted into trade credit from bank credit. Third, if the supply of new bank credit became constrained, firms should have drawn down their existing credit facilities. In other words, we should have observed a decline in the unused portion of existing credit lines.

Financial accounts data point to a relatively rapid run-up in the stock of short-term intermediated credit between 2005 and 2008 (top panel, Figure 2). Trade credit also rose rapidly over the late 1990s and early 2000s. Bank credit peaked in late 2008, coinciding with the collapse of Lehman Brothers, while trade credit also fell during the crisis period. Short-term intermediated credit has remained on a downward trajectory since then, while trade credit (as a share of GDP) has been broadly flat since the crisis. The sharp fall in bank credit in late 2008 may have reflected a deliberate decision by banks to pull back on risky lending. The subsequent rise in trade credit relative to intermediated credit may have reflected substitution effects. This is consistent with financial institutions tightening credit supply by more than trade creditors (bottom panel).

In aggregate, revolving business credit grew rapidly in the period preceding the crisis (Figure 3). However, the amount of revolving credit available to businesses fell sharply at the onset of the crisis and has continued to decline since that time. The amount of used revolving credit followed a similar pattern, except that it rose more rapidly in the period just before the crisis. The unused portion of credit lines broadly follows a procyclical pattern, indicating that firms draw down their facilities during downturns as liquidity problems emerge. Perhaps surprisingly, Australian businesses were using their credit lines most intensely in the period prior to the 2008/09 crisis.

4.2 Inventory Investment and the Business Cycle

Inventory investment is highly procyclical and, despite comprising a very small share of GDP (around 0.1 per cent), its high volatility means that it explains a large share of the variability in GDP (Flood and Lowe 1993). Indeed, declines in inventory investment typically contribute half of the peak-to-trough fall in GDP during recessions (e.g. Blinder and Maccini 1991; Ramey and West 1999; Benati and Lubik 2012). This was true of the economic slowdown in 2008/09, as well as the early 1980s and early 1990s recessions in Australia.

There are a couple of notable differences about the 2008/09 slowdown compared to the 1980s and 1990s recessions (Figure 4). First, both inventories and sales were rising rapidly in the period preceding the crisis in 2008/09, whereas the 1980s and 1990s recessions were characterised by a gradual slowing in the pace of inventory investment and sales as the economy cooled. Second, the post-crisis recovery in inventory investment in 2008/09 appears to have been more delayed than in the recessions. In the earlier recoveries, firms typically replenished stocks as sales picked up after a few quarters. But, following the latest slowdown, inventories continued to fall despite a recovery in sales. In fact, as of the June quarter 2013, inventories had still not reached the peak level observed in the September quarter 2008. The slower recovery in inventory investment may reflect a relatively high degree of uncertainty about the future course of demand. This is supported by the fact that there was only a mild recovery in sales, at least relative to the early 1980s recession. Alternatively, firms may be unable (or less willing) to replenish stocks because financing conditions remain tight.

Based on industry-level data, the decline in inventory investment in 2008/09 is explained by a reduction in manufacturing inventories and a fall in retail and wholesale stocks of motor vehicles (Figure 5). The large decline in motor vehicle inventories is notable given that motor vehicle dealerships are particularly dependent on the supply of short-term credit to support their inventory investments.

4.3 Floorplan Finance and the Motor Vehicle Industry

Floorplan (or bailment) finance is a type of short-term intermediated credit that is specifically designed to finance inventory investment and uses the underlying stocks as collateral. Floorplan finance is a small component of total business lending in Australia and is mainly used by motor vehicle wholesalers and retailers to purchase the stock of cars displayed on the showroom floors of motor vehicle dealers. The total floorplan finance market is estimated at around $8 billion, which is approximately the same value as the total stock of retail motor vehicle inventories in Australia.^[3]

Information on the floorplan finance market is relatively limited. However, we can glean some information about the state of the market during the crisis from the annual reports of the three publicly listed car dealers that were operating in Australia at the time (A.P. Eagers, Automotive Holdings Group and the Adtrans Group).^[4] Based on these listed company reports, there is a very close link between inventory investment and floorplan finance (Figure 6).

In the December quarter 2008, two large foreign motor vehicle financiers – GE Money Motor Solutions and General Motors Acceptance Corporation (GMAC) – ceased originating retail and wholesale motor vehicle loans in Australia as a result of the global financial crisis. This had a significant impact on the availability of floorplan finance, as the two finance companies provided finance for about 25 per cent of car dealerships (Parliament of Australia 2009). For the listed car dealers, inventory investment declined by 21 per cent while floorplan finance declined by 29 per cent over 2008/09.^[5]

The listed company reports also suggested that there was a relatively sharp increase in the cost of obtaining floorplan finance. The spread between the average floorplan financing rate and the 90-day bank bill rate rose by about 250 basis points over 2008/09. This is larger than the corresponding increase in the spread on the standard large business indicator rate, suggesting that there was a disproportionately large negative credit supply shock hitting the motor vehicle industry at the time.^[6]

The listed car dealers also noted in their annual reports that smaller car dealers were even more adversely affected by the tightening in credit conditions. For example, the Adtrans Group noted in September 2010:

As a result of the exit in 2008 of key industry financiers … many dealers who were financially struggling were unable to secure new finance deals and have accordingly been forced to exit the industry.KPMG 2010, p 82

There are several other pieces of evidence to suggest that tighter credit conditions contributed to the sharp drop in motor vehicle stocks during the crisis. First, the motor vehicle industry's share of total wholesale and retail sales fell significantly over 2008/09, but the industry's share of inventories fell even more sharply, suggesting that factors other than demand are likely to have contributed (Figure 7). Second, during this period, sales of motor vehicles fell relative to overall manufacturing sales, but motor vehicle prices rose relative to overall manufacturing prices (Figure 8). The combination of falling relative sales and rising relative prices suggests that the decline in motor vehicle production was, at least in part, due to supply-side factors, such as a tightening in credit conditions.

However, this analysis is based on correlations and the decline in inventories cannot be attributed to the causal impact of tighter credit conditions. For instance, the apparent sharp decline in floorplan finance may have been caused by local car dealers choosing to borrow less rather than being forced to borrow less.

Footnotes

The limited use of this type of financing outside of the motor vehicle industry is supported by the 2012 CPA Australia Asia-Pacific Small Business Survey (CPA Australia 2012). This survey indicates that less than 10 per cent of small firms have used inventory financing. Instead, small businesses are more likely to use credit cards (73 per cent), secured bank loans (41 per cent), bank overdrafts (40 per cent) and leases (36 per cent). [3]

Together, these three companies had a combined market capitalisation of about $700 million in 2008/09 and accounted for about 12 per cent of total motor vehicle sales. [4]

A tightening in credit conditions would have affected motor vehicle inventory investment through two channels. First, there would have been a direct effect as restrictions on the availability of wholesale finance forced car dealerships to scale back their investment in display stock. Second, there would have been an indirect effect as car dealerships could no longer sell retail finance, thereby constraining motor vehicle sales and hence the demand for inventories. [5]

In response to the withdrawal of the two finance companies, the Federal Government set up a car dealership financing special purpose vehicle (known as OzCar) to provide financing for domestic car dealers. OzCar commenced in September 2009 and provided temporary liquidity support, with funding from the major banks, to eligible participating car dealership financiers. This government program may have helped to restore liquidity to the floorplan finance market in 2009/10 but, given it was introduced in late 2009, it was unable to prevent the sharp decline in inventories in 2008/09. [6]