For longer term perspective, I will be buyers of domestic consumption names - CLSA

“If you ask me if the US dollar is going to hold its purchasing power fully at the level of 2011, 5 years, 10 years from now, I will tell you it will not” Warren Buffet

It is interesting to note that China posted a US7.3bn trade deficit, the biggest monthly trade deficit in the past 7 years. Although it is expected only to be a temporary blip, the overall trend is something that cannot be ignored. China trade surplus for 2010 was $183bn, down slightly from 2009 and sharply off peak of $296 in 2008. The function of this trend is stemmed by a slightly strengthening RMB but more importantly China (as well as many EMs in the region) shift to focus/stimulate domestic consumption (all those luxury goods = higher imports here) as they realize export to the west model is not sustainable.

A shrinking surplus has many far reaching implications. Most importantly, it implies less money available to buy US treasuries eventually sending yields much higher to attract buyers. Sure a bounce of the dollar is possible, but a weaker dollar is structural (just keep printing) as it is really the only democratically acceptable solution to reduce debt (by inflating).

At the same time Japan is also embarking their latest and biggest QE program. In the aftermath of the earthquake, the BOJ’s massive liquidity stimulus and intervention in the bond market is equivalent to their own QE2 relative to the size of their economy. No doubt this added liquidity is likely going to exert higher inflation pressures in a global context together with US dollar liquidity and emerging market demand pressures.

One of our NY colleague Lucy Chuah wrote an interesting angle on the psychological effect of a strong Rupiah/weak dollar. Most Indonesians think in US$. This is the inevitable outcome when out local currency has been depreciating for a long time. If you are acutely aware every day that you are worse off in Rupiah terms, you will adopt certain behaviour such as depositing your USD offshore, pricing your goods in USD first then only the Rupiah (more inflation), and watching your spending because your staples will cost more tomorrow.

Not only an appreciating Rupiah is positive for the corporate profit line (because of the dollarized cost structure). It is equally or even more positive for people's psychology: Indonesians will start to keep/bring back money on-shore, inflation will be tempered, and there will be a sense of being more well-off.

An appreciating Sing dollar does not have the same impact on consumer behaviour because Singaporeans are used to it. The impact on the Indo consumer is massive because of not just higher purchasing power but also the fact that we start from a much lower base. When you are from low income bracket going towards middle class, your propensity to spend is high. Every extra Rupiah of wealth you have, you are going to spend 90% of it. When you are rich like the Japanese households, your propensity to spend is very low. So every extra Yen of wealth you have you are going to SAVE most of that. The impact of an appreciating currency is not the same between countries with low income per capita and hi income per capita.

Lastly, the Central Bank stated today that strong Rupiah will be a good formula to curb inflation threat. Central Bank (BI) stated Indonesia’s inflation rate is still manageable despite 19% increase in money circulation in 1Q due to strong rupiah. Every 1% appreciation of Rupiah helps ease headline inflation by 0.06-0.1%. So far, 3.5% gain in Rupiah has helped reduce the inflation rate by 0.35%.

For longer term perspective, I will be buyers of domestic consumption names.