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Kenya could lose out on a new trade deal with EU

Business Daily Africa, Nairobi

Kenya could lose out on a new trade deal with EU

Written by Gichinga Ndirangu

10 July 2007

Kenya is among 75 African, Caribbean and Pacific (ACP) countries currently engaged in negotiations with the EU for a new trade framework under the Economic Partnership Agreements (EPAs). As time is running fast, we need to examine the issues.

The treaty seeks to create a Free Trade Agreement (FTA) between the EU and ACP countries under which duties on most imports and exports will be eliminated or lowered by mutual agreement.

Kenya’s negotiations with the EU began five years ago and are expected to conclude at the end of this year. The country is negotiating under the Eastern and Southern Africa (ESA) group, which includes Rwanda, Burundi, Uganda, Comoros, Djibouti, Eritrea, Ethiopia, Madagascar, Malawi, Seychelles, Sudan, Zambia and Zimbabwe.

So far, Kenya’s trade with the EU has been based on preferential market access, this means that most of her exports - predominantly primary agricultural products - have attracted no tariffs. On the other hand, EU exports to ACP countries have attracted tariffs based on the applicable tariffs notified to the World Trade Organisation (WTO).

The new trade arrangement under EPAs will liberalise tariffs which means that African countries will need to eventually remove tariffs to EU imported goods creating a fully reciprocal trade agreement.

Kenya is expected to agree on a common tariff structure that could lower tariffs on at least 80 per cent of imports.

In addition, EPAs could create new binding rules targeting liberalisation in key areas such as investment, competition, government procurement, intellectual property and services. These measures are expected to have varying impacts on ACP economies..

The current paralysis at the WTO as a result of the collapse of trade talks in July 2006 has increased the urgency for the EU to conclude the negotiations and put ACP countries under tremendous pressure to beat the year-end deadline to conclude the talks.

Kenya largely exports primary agricultural products to the EU while importing mainly value-added goods such as machinery, electronic equipment, chemicals and vehicles.

A new trade regime with the EU is expected to impact on areas identified as key to Kenya’s trade strategy such as value-addition where EU imports will compete with local goods in key markets like Comesa.

The Kenya Institute of Public Policy Research and Analysis (KIPPRA) estimates a 15 per cent loss in Kenya’s regional trade under an EPA and concludes that “the EU stands to gain significantly in terms of expanded trade into EAC/COMESA”.

It warns that “with manufacture a large part of Kenya’s exports to the region, this will undermine the country’s trade in value-added goods and increase dependence on primary exports, narrow the range of products that Kenya currently trades in as well as the diversity of its trading partners.”

Yet, the government’s Economic Recovery Strategy for Wealth and Employment creation (ERSWEC) has identified priority areas for trade expansion as value-added production, boosting the competitiveness of domestic producers and diversification of export products and destinations.

In the past Kenya has liberalised trade mainly under the Bretton Woods structural adjustment programmes and in compliance with WTO rules which involved a dismantling of quantitative import restrictions and reduction of tariffs from an average 30 percent to under 18 percent for most products.

Under EPAs, Kenya will be expected to lower tariffs further on at least 60 per cent of its imports from the EU.

This could have negative consequences for Kenya in terms of lowering the level of government revenue collected from EU import duties by as much as 8-12 percent - higher than the government’s annual expenditure on health. Direct competition from EU products could threaten manufacturing firms involved in food processing, textiles, paper and printing which collectively employ over 100,000 people.

Since EPAs will not affect the continued use of subsidies which enable EU agricultural products to sell cheaply at below their true market value, Kenya’s agricultural sector could face unfair competition from subsidised EU products.

Products that could be potentially affected include wheat, rice, sugar, dairy, maize, meat and meat products. An FTA with the EU thus presents the potential to adversely affect key sectors which emphasises the need to negotiate for compensation and adequate protection measures to mitigate these potential impacts.

However, whilst some sectors of the economy could stand to from signing an EPA, others will definitely lose out if they do not sign a new trade deal by the end of 2007.

For 40 per cent of Kenya’s exports to the EU such as raw tea and coffee are zero rated under the Most Favoured Nation principle and will be unaffected whether or not an EPA is firmed up with the EU.

But for 60 percent of exports into the EU such as flowers, vegetables, fruit and fish a new trade regime, such as that which might be offered by an EPA, is necessary to secure the zero rated duty that these products have enjoyed under the Cotonou treaty preferential trade arrangement.
If a regime is not found that retains the zero duty into the EU then these products could face tariff hikes of between 2 to 24 percent if automatically shifted onto the global Generalised System of Preferences (GSP) scheme at the end of 2007.

Countries entitled to preferential trade schemes like the Everything But Arms (EBA) initiative such as Tanzania and Ethiopia or the GSP Plus (GSP+) scheme such as Colombia, Ecuador and Guatemala would become more competitive and could take a share of Kenya’s exports granted their zero duty access into the EU.

Kenya is facing tremendous pressure to sign an EPA by the end of 2007 both externally from the European Commission and internally from sectors which stand to lose out on zero-duty access after 2007 and in the absence of a trade deal that secures such access into the EU.

Yet Kenya could be entitled to join a preferential scheme such as GSP+ which would largely retain the existing preferential treatment for most of her exports to the EU market without threatening manufacturing growth in the future

Still, the potential benefit to Kenya of signing an EPA is primarily dependent on the deal addressing supply side constraints which are a major obstacle in increasing export volumes. Equally important is the extent to which the EU would be prepared to favourably liberalise areas of particular interest to Kenya’s value-added exports.

A change in existing tariff peaks could therefore provide incentives for Kenyan producers to diversify into value-addition of primary agricultural exports such as roasted and decaffeinated coffee which still attract a 7.5 and 9 percent tariff into the EU respectively.

It is also hoped that an EPA would simplify complex rules of origin and multiple non-tariff barriers to trade such as arbitrary health standards. The latter has significantly impacted on Kenya’s fish, flower and horticultural exports.

Between 1998 and 2001, for instance, a ban imposed on Kenyan fresh water fish exports to the EU necessitated a costly restructuring of the fish industry to comply with EU food and health standards resulting in the closure of more than half of the 14 fresh water factories on the coast of Lake Victoria.

However, it is unlikely that health standards could be changed for the ESA region alone, but rather that funding is made available to enhance internal capacity to meet EU standards.

Trade liberalisation under EPAs has potential advantages and downsides though it is the EU with more competitive industries that is, in the end, likely to benefit most from a reciprocal trade arrangement. An impact assessment carried out by the IMF estimated that Kenya could 65 percent of industry and a further 8 percent of government revenue under the proposed EPAs.

On its part, the European Commission’s own Sustainability Impact Assessment has projected greater loss to Kenya.

The assessment projected Kenya could lose 82 percent of total customs revenue under a reciprocal EPA with the EU that would translate into a 12 percent loss of government revenue.

A potentially sensitive area in the ongoing negotiations is tariff binding which is expected to cap further increases in tariffs above the agreed bound levels.
Kenya and other ACP countries could effectively lose their future flexibility to use tariff policy as a means of encouraging investment, production and protection of industries from EU competitors in order to enable industries mature and grow into value-added production.

This flexibility was used by the Kenya government in the early 1990’s to protect and revive the dairy industry from EU imports of powdered milk through a raise in tariffs from 35 to 60 percent. This sector now employs around 625,000 people directly and indirectly supports 3 million people. In practice governments can still protect local industries using other policy interventions, but the flexibility to raise tariffs can be an important tool in stimulating industrial development.

Since it is anticipated that ACP countries will be able to exclude about 20 percent of their trade with the EU from tariff liberalisation under the EPA, it is possible to protect the most sensitive or strategic sectors. However, Kenyan negotiators are unhappy with this and favour a more ambitious 40-60 per cent threshold - given the country’s desire to protect both agriculture and manufacturing. However, this is likely to be opposed by the EU.

Regardless of the final protection threshold offered within the EPA, future policy intervention outside protected sectors will be severely constrained Kenya and ACP countries must consider other options to the thorny problem of retaining export preferences with the EU.

Mr Ndirangu is a lawyer and policy analyst.