In the last few months the Chinese Government has allowed the Chinese currency to appreciate, meaning the possibility of the country losing its low-labor-cost advantage and its export might. In this month's column we will discuss how RMB appreciation could impact some low value-added industries while conversely benefiting import-oriented industries.

One of the biggest impacts of the RMB appreciation is on the manufacturing of low-end products. Supposing that the manufacturing costs remain stable, foreign entrepreneurs have to pay a higher amount of U.S. dollars in order to purchase these products. However, the manufacturing cost has also increased over the last few months because of higher labor costs. For instance, in the city of Beijing, the government has increased the minimum wage by 20.8 percent since January 1, 2011. While the labor costs have had an effect countrywide, the increase is more pronounced in coastal and industrial cities such as Beijing, Shanghai and Guangzhou of Guangdong Province because of inflation and higher living costs. Therefore this double increase of both RMB value and manufacturing costs has seriously hurt some export-oriented operations.

In order to better understand these impacts, we can use the example of the toy manufacturing industry. In China, children's toys are usually manufactured with raw materials purchased in the domestic market. The rising manufacturing costs increase the purchasing price of the raw materials (for instance plastic or wooden parts), therefore the final selling price of toys increases as well. In addition to this, RMB appreciation makes the value of the toys higher if bought using U.S. dollars.

On the other hand, import-oriented industries could benefit from the RMB appreciation. Chinese companies, which import raw materials, components or machinery from abroad, would have more purchasing power and could take advantages of RMB appreciation. An example would be the LED lamps manufacturing industry. Over the past few years, China has become one of the biggest producers of LED lamps. As a hi-tech product, most of the manufacturers have to import their machinery and the LED components from abroad. In this case, like most other manufacturing sectors, the increasing labor costs and the RMB appreciation result in more expensive products (sold in U.S. dollars). However, manufacturers in this industry could benefit from their higher purchasing power to acquire better machines and components. This could help them to increase their productivity and product quality, thus, the impact of RMB appreciation and increasing manufacturing costs could be decreased.

Generally speaking, RMB appreciation could accelerate the upgrading phase of Chinese industries. Since importers and manufacturers would have a higher purchasing power, they could increase their acquisitions of new technologies and equipments. This would help them to produce higher value-added products and shift their market positions from low cost to high quality. Therefore, we could say that RMB appreciation not only would have negative effects on Chinese manufacturing, but could in fact help upgrade some industries.

With the increasing value of the RMB, foreign buyers have to find solutions in order to keep their purchasing costs low. One of the solutions is to change the purchasing currency from U.S. dollar to another currency. For instance, buyers located in Europe could choose euro as a transaction currency. Some special policies between China and other countries such as Argentina, allow importers to pay directly using RMB. These methods could help Chinese exporters and foreign buyers to avoid disadvantages caused by U.S. dollar exchange rate fluctuation.

Another solution is to agree on a fixed exchange rate on your purchasing contracts. For instance, foreign buyers could agree with their Chinese suppliers to fix the exchange rate on a specific amount for a defined period of time. This could help both exporters and buyers to avoid price changing for each order and schedule purchase in advance.

As explained in previous articles, the manufacturing costs are often lower in the western and central regions of China. Therefore, in order to cope with the increasing prices of Chinese products, foreign entrepreneurs could shift their manufacturing plants from coastal cities to less developed regions.

Column prepared by Milad Nouri, Managing Director, China Consultants International Limited