International Construction Intelligence: Prospects for Global Construction

General Economic Overview

Experts continue to overestimate economic growth in the post-recession recovery. The downward revision of Gross Domestic Product (GDP) growth projections for 2016 repeats a pattern of the past few years. Since the continuing sluggish global recovery does not fit the pattern of previous expansions, a slow and gradual growth remains the expectation for the next couple of years.

Generally, we expect moderate global growth in developed countries for the next two-three years. Emerging and developing countries will perform slightly better, but slower than historical post-recession growth rates. Manufacturing investment trends to watch carefully are 'reshoring' manufacturing back to developed economies and the transfer of manufacturing from emerging to developing economies.

Stressed financial markets remain jittery amidst the governmental policies, political uncertainty, geopolitical tensions and ambiguous economic data. Debt remains a concern in many developing countries.

Commodities

Prices for construction related non-fuel commodities have trended downward for the past several years. Generally, this is good for manufacturing economies and bad for commodity export-based economies. This year the commodity prices began a slight rebound. As long as demand remains low, particularly in developing economies, broad significant price increases seem unlikely.

Generally, we expect moderate global growth in developed countries for the next two-three years.

Oil prices are rising and flirting with USD50/barrel after a prolonged period of below USD50/barrel. The lower prices hurt economic performance for oil producing nations, but especially curtail shale oil production. Uncertainty remains as to the future price levels for oil.

Demographics – the Economy and Construction Demand

The migration to urban areas continues with more than half of the world's population living in and around cities. This urbanization creates challenges, particularly for developing and emerging economies. Asian and African countries tend to have the higher rates of urbanization and the fastest growing cities are located there. Part of the challenge is providing the infrastructure to support rapidly expanding urbanization.

A second aspect of demographics to watch is the declining population in developed economies. Some western countries and Japan have been experiencing either near or below replacement fertility rates for some time. Stagnating population growth offers many challenges. The aging working population and declining birth population impedes economic growth. China's one child policy, revised last year, reflects an understanding of these issues. In the long-term, this trend will be an encumbrance for construction output.

Construction Industry – Global Perspective

The construction sector, which contributes more than 10 percent to global GDP, is generally improving. While long-term growth prospects are good, the short-term prospects reflect the gradual recovery of the general economy. The weakness of global trade reflects a slowing of consumption and lower commodity prices. The slow down stresses economies of countries focused on manufacturing or commodity exporting.

The construction sector, which contributes more than 10 percent to global GDP, is generally improving. 

Construction output should grow in 2016. Growth rates will remain low, but generally will be greater in the emerging economies compared to advanced economies. Rising interest rates will lower the appetite for new capital investments in the private sector. However, public sector construction output will likely rise. Infrastructure projects will be a major focus in the coming years, particularly in emerging and developing economies, while developed economies will face the need to overhaul existing infrastructure.

Americas Focus

The United States has experienced seven years of slow growth (below 2.5 percent) and more of the same is expected in the near-term. The Federal Reserve's reluctance to raise the interest rate is a sign of the fragile nature of the recovery. This prolonged lackluster performance shows how delicate, not only the United States recovery is, but also how the global recovery is. Employment is growing, but workforce participation remains a concern. Higher employment is contributing to GDP through increased domestic demand.

Gradual growth over the past six years has brought construction output to pre-recession levels in current dollars. On a constant dollar basis, more ground remains to be gained. The slow increase has enabled the industry to ramp up with the increased demand, with labor availability now becoming an issue.

Canada is experiencing very slow economic growth (below two percent). Unemployment remains high and construction output is likely to be slightly lower this year. The growth of the Mexican economy may be very similar to the United States. Manufacturing growth, which remains strong, is helping to buoy the overall construction output.

 Infrastructure projects will be a major focus in the coming years, particularly in emerging and developing economies...

The economy of Brazil remains in recession with no immediate prospects of recovery. Corruption scandals and political uncertainty add to the difficulty in reversing the recession. The flurry of construction activity to support the World Cup and the upcoming Olympic Games will be a memory as construction activity accompanies the economic recession.

Europe

The United Kingdom's GDP grew 2.2 percent in 2015. This contributed to positive indicators such as rising incomes and steady consumer spending. A tightening of labor supply is a concern. Growth was projected to be slightly lower this year prior to the Brexit vote, as perhaps a result of caution about the vote. It is too early to make any definitive predictions other than uncertainty about the details of how the British European Union exit may dampen capital investment.

The construction industry has shown resilience over the past few years, but recent data shows a trend toward lower production. This aligns with the overall expectations of lower economic growth for 2016.

Most Euro-area countries are expected to remain in low growth recovery for the next few years. Low investment and continuing high unemployment are among many factors impeding economic growth. Spain, following its economic crisis, was a bright spot for 2015 with 3.2 percent GDP growth. However, the outlook for 2016 is not as good. Generally, consumer spending is rising as there is some relief from high unemployment rates. Since GDP growth supports an expansion of construction output, expect low performance for the next few years. Construction output will remain below pre-recession highs.

The construction industry has shown resilience over the past few years, but recent data shows a trend toward lower production.

Low oil prices and sanctions contributed to a Russian financial crisis that began in 2014. Russia remains in a recession with little likelihood of a reversal in the near-term. GDP fell 3.7 percent last year, while the expectations are that it will contract in 2016 before turning positive in 2017. The marginal foreign investment driven construction will probably see some improvement this year.

Asia Pacific

The Asia Pacific region is difficult to overlook despite current economic struggles as it is the major construction market. China and India, economic powerhouses for Asia, are unlikely to see significant economic growth in 2016. GDP grew only at 6.9 percent in 2015 for China and 7.3 percent for India. China is facing some serious challenges that will further stagnate its growth in the near-term. India may be poised to at least maintain its current growth rate should reforms continue. Even with these slower growth rates, the construction markets are large and account for a big portion of global construction output.

Japan's economy continues to struggle to find a footing for growth and is unlikely to improve soon. GDP barely grew last year and much of the same is expected for this year. Construction output has mostly contracted during the last couple of decades, but output has shown weak growth in the past few years.

Parity Index - 2016 (US Base)

Using the Parity/Index

Americas

Europe

Pacific

These indices should only be used as a guide. Factors such as the ratio of imported to local materials, the specific location within the comparative countries and the relative construction supply and demand for each project can have a substantial effect on project cost. We would recommend that specific advice is sought before irrevocable decisions are taken.

Using the Parity/Index

Essentially, there are two approaches to using the parity/index to compare costs at different locations when one location involves the base country. Use the parity value to calculate costs in the national currency of each country. Use the index value to calculate the cost in the currency of the index base country.

Illustration 1 – Costs in a local currency

Assume you need to compare the cost of a proposed manufacturing facility in China with a similar recently completed project in the US, which cost USD 1,000/m2. Use the parity values from the Parity/Index table to calculate likely costs in Yuan (CNY).

Using the average parity value provides a most likely cost of CNY 3,180/m2.

This equates to USD 483/m2 (CNY 3,180 / 6.585; cost / exchange rate), meaning to build in China is approximately 52 percent less expensive than in the US. This example uses the exchange rate from the Parity/Index table. Parity allows easy use a different exchange rate to calculate China cost in USD. Introducing the exchange rate creates the result of using the index.

Illustration 2 – Costs in index base currency

Introducing the exchange rate with the parity calculation illustration clearly shows the relationship between parity and index. The index is simply the parity value restated through currency exchange into a single currency. It allows comparison in the base location currency in one step.

To ascertain the USD rate per square meter for a project in China simply use the index value from the Parity/Index table as follows. Note that the index is expressed in a percent format.

In the event a different exchange rate is required than used in the published index, say due to fluctuations in the currency markets or fixed internal company international exchange rates, start with the parity to adjust the index. The example below assumes a revised exchange rate of 6.70 CNY / USD, not the current rate of 6.14 used for the published index value.

If the costs are to be presented in the two currencies, the CNY cost would remain constant at CNY 3,180/m2 whilst the USD cost to build this project would be USD 471/m2 (US$1,000/m2 x 47.1%).

In summary, parity enables the identification of the cost for the same building in different locations in local currency whilst the index enables the direct comparison of costs for the same building in different locations in a single currency.