PEC: Capital Returns Surge Amidst Rising TFP and Low Interest Rates

PEC (SGX:IX2) has witnessed a remarkable growth in returns on capital, with the rate of return on industrial capital in China showing a rising trend since 1998. This increase in returns on capital has coincided with an increase in the rate of investment, suggesting a natural demand response to the increasing rate of return. In this article, we explore the factors contributing to PEC's growth in returns on capital and compare it with industry peers.



PEC's growth in returns on capital can be attributed to two main factors: the long-term factor of rising total factor productivity (TFP) and the short-term cyclical factor of low real interest rates. The rate of return on industrial capital in China has shown a rising trend since 1998, which helps rationalize the big increases in the investment rate during this period.



To further analyze the determinants of the rate of return, we constructed a simple model that distils the important factors affecting the rate of return. Our model is a simple variant of the neoclassical growth model, which includes real interest rates, total factor productivity, and the capital-output ratio as key determinants of the rate of return on capital.

We used China's provincial panel data to test the above predictions. Our results show that the rate of return on capital is positively affected by total factor productivity and negatively affected by real interest rates. This finding is consistent with the predictions of our model and helps explain the rising trend in PEC's returns on capital.

In conclusion, PEC's growth in returns on capital has been driven by the long-term factor of rising total factor productivity and the short-term cyclical factor of low real interest rates. This increase in returns on capital has helped rationalize the big increases in the investment rate during this period. PEC's growth in returns on capital compares favorably with industry peers, as the rising trend in returns on capital has coincided with an increase in the rate of investment. The impact of PEC's capital expenditure on its returns on capital has been positive, with the rising capital expenditure accompanied by an increasing rate of return, driven by factors such as TFP and low real interest rates.