TRALAC - Trade Law Centre

SACU-US Negotiations: Issues Around Rules of Origin

Monday, 11 August 2003

Source: Financial Mail

Southern African Customs Union (SACU) negotiators will have to tread carefully in their talks with the US on the issue of rules of origin as they apply to trade in clothing and textiles.

SACU - SA, Botswana, Lesotho, Swaziland and Namibia - and the United States are negotiating the removal of barriers to trade in goods and services. The talks began in May and resume this month.

As tariffs and quota-based trade barriers have reduced in line with the World Trade Organisation (WTO) guidelines, rules of origin have become an important feature of international trade in clothing and textiles. These rules are used to establish the "economic nationality" of goods and provide a framework within which the origin of goods, being not only the source they are shipped from but also where they are have been produced, is determined.

Rules of origin are often highly technical and can pose significant challenges to exporters.

These rules prevent a clothing manufacturer from using inputs (fabric, yarn and thread) from certain countries as they risk losing eligibility for preferential treatment. This implies that if clothing manufacturers want to gain market access in a country where specific rules of origin apply, the manufacturer may be forced to use inputs that may not be the cheapest available.

Cost efficiency for such a manufacturer is compromised by these rules, and the competitiveness of such exports is reduced.

The clothing and textile industries are important to the SA economy. The two industries have sales of more than R20 billion per year and together employ 100 000 people. Their combined exports in 2002 amounted to R7,2 billion and imports to R8,7 billion.

Under the proposed trade agreement between SACU and the US, preferential access to the US market is likely to be extended to include the textiles sector.

New rules of origin will need to be negotiated, which may be more advantageous to the clothing sector than is currently the case under the African Growth & Opportunities Act (AGOA).

Agoa removes US import tariffs on a large number of goods from 38 qualifying African countries.

It is likely that in the SACU-US trade talks, SA will push for at least a double-transformation rule.

Double transformation refers to two distinct stages of production. Specifically, while imported yarn may be used, the conversion of that yarn to fabric and from fabric to clothing must take place within the country's borders.

The clothing rules of origin under the EU-SA trade, development & co-operation agreement (TDCA) signed in 2000, and AGOA, tie the domestic textile industry into the clothing production process. Any weaknesses in the textiles sector, in terms of price, quality, availability or logistics, can thus have a marked impact on the success of the clothing sector in export markets.

Clothing exports to the US have increased significantly since 2000 (SA became eligible to export clothing duty-free under AGOA only in March 2001).

Yet restrictive rules of origin are perhaps a factor why during 2002, for example, only 42% of SA's clothing exports to the US were shipped under AGOA (despite much higher levels of exports). Only a modest change is evident from export data for the five months to May 2003. The rest entered the US under normal WTO rules, indicating that the benefits of Agoa to clothing manufacturers may not be enough to encourage firms to forgo the use of cheap textile imports from third countries.

A shortage of locally produced fabrics is also frequently cited as a deterrent to complying with Agoa's stringent rules of origin. This shortage comes about because SA's export credit schemes apparently make it more lucrative for textile companies to sell fabric to Mauritian producers (for use in their Agoa exports) than supplying the local clothing sector.

Rules of origin are clearly a double-edged sword for SA. On the one hand, they may be severely restricting the clothing industry's competitiveness in the EU and US export markets, even though the industry is still managing to grow exports to the US.

The price differential between local and imported fabrics is large enough to drag down the competitive standing of the clothing industry. Yet at the same time, the rules of origin have perhaps to some extent been the saving grace for the domestic textile industry.

A single stage transformation, as is the requirement that most other African countries face for exports under Agoa, would in all likelihood lead to a rapid detachment from the local textile industry. This could severely harm the industry and threaten thousands of jobs.

Both the US and the EU are important markets for SA clothing. The US in particular is SA's single most important destination for clothing exports, having grown rapidly over the years.

But stringent rules of origin, both under the TDCA for access to the EU, and under Agoa for access to the US, may be undermining the competitiveness of SA's exports of clothing. Preferential access is granted to goods deemed to be originating in SA, or, under Agoa, originating in the region.

Under the TDCA, SA's clothing exports to the EU are still subject to tariffs. The EU began removing tariffs on SA manufactured clothing in 2000 in equal increments either over a three-year or a six-year period (depending on the exact product category). This means that effective tariffs on clothing have already been reduced by more than half. To benefit from this preferential treatment, though, goods must have been produced (or deemed to be originating) in SA. This is where the rules of origin come into play: to "originate" in SA, an item of clothing needs to undergo a "double transformation" here.

To an extent, goods produced in the BNLS countries (Botswana, Namibia, Lesotho and Swaziland) can be deemed to be made in SA if the final stages of production took place here. This provision is subject to further conditions.

All clothing exports under the TDCA must in addition be accompanied by an "EUR.1 movement certificate" whereby exporters warrant the authenticity of the product's stated origin.

Under AGOA, rules of origin applicable to SA are even more stringent. Countries must be "certified" by the US to export clothing under AGOA, an "origin certificate" must accompany shipments, and the producer must keep all documentation for at least five years (this provision is policed by US teams stationed in SA).

AGOA in effect requires a "triple transformation", though its application is somewhat broadened by requiring that the transformation take place within any of the AGOA countries. Eligible clothing exports thus have to be manufactured from yarn produced in either an AGOA country, or from the US.

Lesser-developed countries (as determined under AGOA) are exempted from this rule until September 2004. This means that only the garment assembly has to be carried out in these countries. Textile inputs may be sourced either regionally or from third countries.

This exemption is making clothing producers in African countries like Lesotho, Swaziland, Kenya and Madagascar highly competitive as the benefits of low-priced inputs are carried through to the final product. A number of firms in SA (particularly in northern KwaZulu Natal and the Qwaqwa area) have relocated to Lesotho to take advantage of the preferential access to the US market.

The mobility of clothing firms is particularly important in the context of the time-bound preferences that these lesser-developed countries enjoy under AGOA. When these special preferences expire, clothing firms may move to another country offering other benefits such as lower costs.

It's probably too late to integrate the clothing industries of SA and neighbouring countries to make it a more internationally competitive network.

However, the SA government and the private sector can work together to at least improve efficiencies in terms of customs clearance and documentation, port logistics and general administrative bureaucracies affecting exporters.

These ancillary issues are critical co-determinants of an industry's international competitiveness, particularly for export penetration of the highly demanding US and European markets. Poor infrastructure and delays in customs clearance can affect, for example, the ability of SA clothing companies to meet the lead times - from order to delivery - set by the EU and US customers.

(Eckart Naumann)