RMB appreciation will have a major short-term impact on exporters' profits. If the RMB appreciates too quickly, the rate of profit in labor-intensive industries will fall dramatically and some will face bankruptcy.

This is the conclusion of a simulation of the effect of RMB appreciation on China's labor intensive industries, carried out by chambers of commerce representing the textile, mechanical and electrical products, and light industry sectors.

Many experts are pessimistic about the results. They say that if the RMB rises too much too quickly, industries will suffer. But others caution that the results should not be exaggerated.

3% revaluation means 50% drop in profits

According to the Export and Import Chamber for Mechanical and Electrical Products, if the RMB appreciates by three percent within a short time, the profits of home appliance, automobile and mobile phone enterprises could fall by 30-50 percent. Many small and medium-sized companies will face bankruptcy.

Mechanical and electrical products account for about 60 percent of China's exports. Although those products have a big market share, profit margins are low and Chinese companies, who for the most part do not own the core technology, having limited pricing power. If the RMB exchange rate rises, companies will need a long time to digest the consequences.

According to the Textile Import and Export Chamber, if the RMB appreciates one percent, profits will fall one percent. Since average net profits of textile companies are only between 3 and 5 percent, revaluation would deal a major blow to the industry. It is unlikely that exchange rate losses could be mitigated by negotiating with clients or improving supply management.

In light industry, big companies make 5 percent gross profit on exports but for small and medium-sized companies the rate is only around 2 percent. In the crockery industry, the companies could absorb only a one percent RMB appreciation before seeing their profits eaten up altogether.

Rapid revaluation bad for industrial upgrading

The structural upgrading of labor intensive industries will require a long time. A rapid rise of the exchange rate would impact the upgrading of these industries or even throw it into reverse.

According to a report by the Export and Import Chamber for Mechanical and Electrical Products, a frequently fluctuating exchange rate will encourage companies to stick to low-end processing and assembly to avoid exchange rate losses.

And as import costs fall, demand from processing firms for high end electrical components elements will be further strengthened. Though this might temporarily boost exports, it is bad for the long term development of the industry, especially the development of local brands, technological upgrading and structural adjustment.

The task facing China's manufacturing industry is to prevent traditional labor-intensive industry from disappearing on the one hand, while catching up with developed countries on the other hand. Labor-intensive industry will be needed for a long time in China to promote the development of the western and central regions and provide employment to those without higher education.

But labor intensive industry would not be the worst hit by RMB appreciation, according to Mei Xinyu, a researcher from the Ministry of Commerce. Exporters of power stations, ships, railway and communications equipment face the highest risk due to their long production circle. Exchange rate losses during 2007 and 2008 cut the profits of these industries by 30 to 40 percent.

Raising the exchange rate will also have an impact on employment by forcing companies to freeze wages.

But some experts think the impact of the RMB exchange rate should not be exaggerated.

According to Zhang Ming, vice director of the Research Section of International Finance, Institute of World Economics and Politics, under the Chinese Academy of Social Sciences, overall export income fluctuates much more than prices, which means the determining factor for China's exports is international demand, not the RMB exchange rate.

Processing trade accounts for half of China's overseas trade. The appreciation of the RMB increases export prices on the one hand, but reduces costs of imported raw materials and intermediate products on the other. Therefore, its impact on the company profits is limited.

Between 2006 and 2008, as the RMB appreciated more than 20 percent, China retained its market share in garments, shoes and hats. This shows that the adaptability of China's export industry should not be underrated, said Zhang.

Senior research fellow at China Construction Bank, Zhao Qingming, said although the pricing power of China's export companies is weak, that is not to say they do not have any. He said China's companies have the capacity to adapt to RMB appreciation by adjusting prices.