YANGTZE RIVER DELTA TEXTILE MAKERS FEAR RMB APPRECIATION

UNCLAS SECTION 01 OF 04 SHANGHAI 000029

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NSC FOR MCCORMICK AND TONG

E.O. 12958: N/A
TAGS: KTEX EFIN ETRD EAGR PGOV ELAB SENV CH
SUBJECT: YANGTZE RIVER DELTA TEXTILE MAKERS FEAR RMB APPRECIATION

REF: A. 05 SHANGHAI 798

B. 07 SHANGHAI 813

C. 07 BEIJING 7554 and previous

D. 07 BEIJING 7652

SHANGHAI 00000029 001.2 OF 004


(U) This cable is sensitive but unclassified and for official
use only. Not for distribution outside of USG channels or via
the internet.


1. (SBU) Summary: Chinese textile manufacturers in the Yangtze
River Delta (YRD) say that they face significant challenges that
threaten their businesses in the coming year. Their main
concern is the ongoing renminbi (RMB) appreciation that makes
their exports more expensive and less competitive. New
environmental standards and increased government concern about
pollution mean that textile factories must implement costly
mitigation plans. At the same time, Chinese textile
manufacturers must cope with increased work-force costs
associated with inflation and a new labor contract law. In 2008
and 2009, as much as 20 percent of the YRD's textile production
capacity will be forced to close, according to a successful YRD
textile company's estimate. These cuts will negatively impact
the economic livelihood of the tens of millions of low-wage
workers and farmers who work directly and indirectly in China's
textile industry. End summary.


2. (SBU) Econoff met separately with three major textile
manufacturers in the Yangtze River Delta (YRD),one of China's
main textile producing and exporting regions. These companies
included Wuxi Jinmao Ltd. General Manager Yang Nan on January
17; and, Chenfeng Group Ltd. President Yin Guoxin and Orient
International Holding Company Vice President Zhong Weimin on
January 18. Econoff also met with Donghua University Institute
of Textile Economics Professor Gu Qingliang on January 15.
Donghua University was founded in 1951 as the China Textile
University and describes itself as the largest textile
university in the world. Accompanying Econoff to these meetings
was a two-member United States International Trade Commission
delegation.

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"RMB Appreciation to Close 20 Percent of Textile Output"
-------------- --------------


3. (SBU) Donghua University's Gu noted that due to fierce
competition within China, China's textile industry has engaged
in a race to the bottom in terms of price. As China's textile
industry is dominated by companies engaged in the processing
trade and exports, it is especially vulnerable to currency
valuation changes.


4. (SBU) Each textile manufacturer with whom Econoff met said
that the rate and pace of RMB appreciation is their biggest
concern. (Note: The RMB has appreciated more than 14 percent
against the dollar since July 2005. In the past three months
the pace of RMB appreciation has picked up dramatically, and is
now appreciating at an annualized rate of more than 10. End
note.) Wuxi Jinmao's Yang said he closely follows RMB
appreciation predictions and he expects at least 10 percent
appreciation in 2008. "Frankly speaking, no textile company in
China has ten percent margin left to give," he said. Yang
expects that by 2009, China's textile production capacity will
be reduced by 20 percent as individual factories and
manufacturers close due to pressure from RMB appreciation on
their bottom lines. Only those that can create new products and
innovate will survive.


5. (SBU) Chenfeng's Yin separately agreed with Yang's gloomy
outlook for Chinese textile manufacturers in 2008. "This year
will be a pressure year," he said. On average, Chinese textile
exporters had profit margins that were less than 3 percent in

2007. "How can we survive a more expensive RMB?" he asked.
"There will be real problems in 2008."

SHANGHAI 00000029 002.2 OF 004




6. (SBU) Orient International's Zhong also expected that there
would be a significant reduction in Chinese exports of textiles
in 2008. RMB appreciation accounts for more than 50 percent of
increased textile costs in China. "No one will stay in a
no-profit business," he said. Chinese textile manufacturers do
not take advantage of the limited financial product choices they
have to help them hedge against currency unpredictability.
"These types of products cost money and we Chinese love to
gamble," said Zhong. "We would rather gamble that the price is
lower in 90 days than pay someone else to accept that risk."

-------------- --
More Expensive Clothes? Blame Both Governments
-------------- --


7. (SBU) When United State retailers come to his office to
bargain for a cheaper price, Wuxi Jinmao's Yang tells them that
they should be negotiating with their own government in
Washington, which Yang blames for driving up the exchange rate
and hence cost of his textiles. Yang said that he sees a
conflict between the needs of U.S. consumers for inexpensive
clothes and a U.S. policy that he believes makes imported
clothes more expensive for Americans.


8. (SBU) Chenfeng's Yin, on the other hand, blames the Chinese
Government. Where ten years ago, Chinese export policies
"really supported textile exporters," now, due to trade friction
from Europe and the United States, "it seems that the government
does not support us." In fact, the government has gone from
supporting China's textile exporters to actively opposing them.
Yin noted that this lack of support is apparent at every level
of interaction with the government. He cited recent examples of
hassles with Chinese Customs during the export process that he
insists would never have happened ten years ago. Chinese RMB
appreciation is another policy that is severely hurting his
industry, but the Chinese Government "doesn't care."


9. (SBU) Orient International's Zhong separately noted that
Chinese textile manufacturers had "gotten very accustomed to the
17 percent value added tax rebate on exports." With its
elimination last year by the Chinese Government, textile
manufacturers are really struggling.

-------------- ---
Seeking Price Stability by Importing U.S. Cotton
-------------- ---


10. (SBU) Wuxi Jinmao's Yang said that his company exported
about USD 90 million worth of fabric and apparel to the United
States in 2007. Since the bulk of his export earnings are
priced in dollars, one way that his company has attempted to
lend a measure of price stability and predictability to their
input costs is to import cotton, priced in USD, from the United
States. In 2007 they imported about USD 20 million worth of
American cotton and anticipate they will import at least that
much in 2008. This was a change from the past when they used
mainly domestically-sourced cotton to avoid dealing with what
Yang called cumbersome foreign exchange transaction processes
requiring governmental approvals.

--------------
...And By Moving Factories Overseas
--------------


11. (SBU) Each of the three textile manufacturers said that they
were also moving some of their factory production to lower cost
countries in Asia. They specifically noted Cambodia, Vietnam,
the Philippines, and Bangladesh as countries where they are
expanding operations. In these cases, the Chinese parent
company would assemble all of the material for a single order
(fabric, thread, buttons, accessories, etc.) and package them in

SHANGHAI 00000029 003.2 OF 004


a container to be shipped out of China. This order would then
be assembled by garment workers in the factory abroad. Wuxi
Jinmao's Yang noted that despite the lower labor cost available
in countries like Vietnam and Cambodia, China's higher
productivity and speed of delivery to customers means that it is
still usually cheaper to produce in China.

--------------
Higher Environmental Standards = Higher Costs
--------------


12. (SBU) China's environmental protection requirements have
become stricter and this is raising textile manufacturer's
raising costs. The Central Government is increasingly concerned
with the effects of pollution on China's water supply and that
so much of China's water supply is no longer potable, said
Chengfeng's Yin. Wuxi Jinmao's Yang said that prior to 2007,
the old standard for discharged waste was 500 biochemical oxygen
demand (BOD). In the wake of the 2007 Lake Tai pollution crisis
(Ref B),factories in Jiangsu Province are now required to
conform to a 300 BOD standard.


13. (SBU) Factories that do not meet this new standard can be
shut down, and more than one thousand companies in the Lake Tai
watershed were shut down last year, said Yang. Textile
factories must be fitted with waste-water treatment equipment
and more modern production and dyeing technologies to meet these
higher standards. This further adds to increased unit costs for
textile manufacturers.

-------------- --------------
Chinese Inflation and New Labor Law Also Increase Costs
-------------- --------------


14. (SBU) Chenfeng's Yin claimed that Chinese official
statistics approximate that as many as 100 million Chinese are
employed by the textile industry, including both up- and
down-stream operations such as cotton farming and logistics.
Most of these employees are from the less-educated and more
marginalized peasant class and migrant workers. China's
increasing inflation rate (Ref C) hits these most vulnerable
populations the hardest since so much of their income is used to
pay for food and clothing, said Yin. In the face of inflation,
textile companies must increase wages for their employees and
pay more for manufacturing inputs such as cotton and energy.


15. (SBU) Yin also noted that his own company chose to lay off
600 workers as a result of the new Labor Contract Law took
effect on January 1, 2008 (Ref D). Due to the provisions of
this law, his company would have been forced to make these 600
employees "permanent" employees since they had either worked at
the company for ten years or had signed more than two contracts
with the company. Since a company's ability to dismiss
permanent employees has become much more difficult under the
Labor Contract Law, Chenfeng and other textile manufacturers
felt compelled to release some of their longer-serving, more
experienced workforce in order to contain future costs. Even
so, such workforce manipulation is not cost-free; Yin said that
training new employees incurs costs and newly trained employees
often are not as productive as the employees they have replaced.
(Comment: Press reports have also noted or alleged similar
jettisoning of long-term employees in other types of Chinese
industries in the run-up to the Labor Contract Law's entry into
force on January 1. End comment.)

--------------
Seeking Lower Costs By Moving West and North
--------------


16. (SBU) Rising costs and rising wages in the YRD is leading
some textile manufacturers to move factories westward. Wuxi
Jinmao's Yang said that ten years ago all of his factories were

SHANGHAI 00000029 004.2 OF 004


in Wuxi, a city not far from Shanghai in the lower part of
Jiangsu Province. Five years ago Wuxi Jinmao opened factories
in a poorer part of northern Jiangsu. Now they are opening
factories in neighboring (and even poorer) Anhui Province.
However, due to the relative complexity of assembling garments
-- a shirt has as many as 30 separate component parts -- Yang
believes that management needs to be close by to insure high
standards and quality control. For his company, this means the
factory must be within three hours drive of Wuxi. Given the
region's improving highway network, this geographic circle is
widening, he added.


17. (SBU) Another important factor in textile manufacturing is
that it requires a relatively skilled labor force. As migrant
workers, who are often recruited from poorer geographic areas
(first northern Jiangsu Province and now Anhui Province) learn
the skills and return home, the textile company can then "follow
the workers." This is what Wuxi Jinmao did in establishing some
of its newer plants.


18. (SBU) However, Chenfeng's Yin noted that moving textile
factories to the less-developed interior of China does not make
much sense since benefits from lower labor and production costs
are offset by increased logistics and transportation costs and
reduced proximity to markets and company management.

--------------
Comment: What is the Opposite of Subsidy?
--------------


19. (SBU) Given the competitive nature of the global textile
trade, it is not surprising that textile manufacturers in China
are expressing concern about how hard it is to stay profitable.
The challenges that textile manufacturers in the Yangtze River
Delta currently face are exacerbated by the fact that much of
the industry developed during a time of direct and indirect
government support in the form of rebates of value-added taxes,
multi-year corporate tax holidays and other investment
inducements as localities sought new job creators, as well as a
fixed, non-market based exchange-rate. As Chinese textile
production soared and competition drove profit margins down, the
profitability of many textile companies became increasingly
dependent upon VAT rebates and export competitiveness
facilitated by the fixed exchange rate. Mounting labor and
environmental protection costs, higher RMB appreciation, and the
removal of structural supports have had the effect of a
"negative subsidy." Stress in the textile industry will be
transmitted directly to the millions of migrant workers and
farmers who are employed by it. Whether due to increased RMB
appreciation, increased labor and input costs, or long-overdue
attention to environmental protection, increased production
costs for textiles in the Yangtze River Delta will likely be
passed on to U.S. consumers clothes imported from China.
JARRETT