HONG KONG, China's rapid economic expansion is a boon for the Hong Kong economy but not for many of the territory's small manufacturers, who are struggling with rising costs in China that could drive them out of business. "We read in the papers every day that property prices are rising and everything in Hong Kong is going well but it's a misleading picture. Services and tourism are doing well but not manufacturing," SAId Mark Foo, managing director of Amrex (Hong Kong) Ltd, which makes household appliances at a factory in Zhongshan in China's southern Guangdong province.Hong Kong exports rallied 16 percent last year as global demand for goods from China surged,underpinning the territory's economy, which grew by 8.1 percent in 2004 and is set for another 4.5-5.5 percent expansion this year, according to the government.But soaring raw material prices coupled with rising labour and production costs in China are squeezing Hong Kong exporters' profit margins.According to the latest Hong Kong purchasing managers' index survey, Hong Kong companies' input costs rose for a 19th consecutive month in March, with inflation far outpacing rises in output prices. At Amrex, which makes cooling fans for French supermarket chain Auchan and other clients, profit margins have slumped to 2-3 percent from 10 percent a few years ago as plastic prices hAVE soared 80 percent in the past year. Foo SAId he would be more than happy if he could maintain margins of 2-3 percent this year. As a small company generating US$20 million annual turnover, Amrex has few economies of scale and little bargaining power with its suppliers amid voracious demand for raw materials on the mainland. "In China, when the oil price goes up suppliers will put up raw material prices within days but it takes 2-3 months for them to come down," Foo SAId. CURRENCY RISK The past year has been especially difficult for the company as China has slashed exporters' tax rebates and in Zhongshan cut electricity supply in a bid to curb factory output and cool the mainland's overheating economy. As a result, Amrex has had to reduce production to five days a week from seven but intensifying competition for workers as foreign companies move into the area means all 300 staff at its plant are still on seven days' pay.A revaluation of China's currency meanwhile could erode profit margins altogether. "Rising raw material prices and a yuan revaluation are my biggest headaches," SAId Foo. As the company's costs are in yuan but its sales are in Hong Kong and U.S. dollars, a three percent appreciation of the yuan would wipe out its profit. The financial pressures faced by Foo and many other small manufacturers in China contrast with the heady profits of bigger companies like Hong Kong power tool maker Techtronic Industries Co Ltd <0669.HK>, which is a major supplier for U.S. do-it-yourself chain Home Depot Inc and last week announced a 39 percent surge in profits. It also marks a turnaround from 20 or even 10 years ago when Hong Kong entrepreneurs got rich quickly by shifting production across the border, pouring much of their wealth back into Hong Kong property and other assets. "Today it's about maintaining your lifestyle not enriching it," SAId Foo, 37, who set up Amrex in 1996. To offset tightening margins he says he needs to expand production by 35-40 percent this year and has looked at factories in his native Malaysia and in Vietnam, where labour costs are much lower than in China and suppliers would be more open to bargaining. Maintaining cash flow would also be easier, Foo SAId. In China, capital controls restrict the company to withdrawing 100,000 yuan (US$12,000) a day from local banks. Realistically though, for all its disadvantages, the convenience of China means Amrex is unlikely to leAVE. "China is inefficient and it's hard to make a profit but at the end of the day it's the only place where I can access all the raw materials I need," he SAId.