Addendum to Volume 1. Analysis of Regional and Preferential Trade Arrangements DRAFT. Madagascar. Diagnostic Trade Integration Study

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1 Addendum to Volume 1 DRAFT Analysis of Regional and Preferential Trade Arrangements Madagascar Diagnostic Trade Integration Study August 15,

2 INTRODUCTION For Madagascar, given the very small size of its domestic market and low income per capita, international trade has to play an important role in its strategy to stimulate growth and alleviate poverty. Yet, as an island relatively far from OECD markets increasing exports constitutes a significant challenge. A series of reforms since the early nineties, such as the creation of the Export Processing Zone (EPZ), the rationalization and liberalization of tariffs and the decision to join the World Trade Organization (WTO) in 1995, have been behind the boost of exports that have underpinned growth and poverty reduction. Although this trend was abruptly halted in 2001 due to the political crisis undergone by the country, the latest statistics seem to indicate a recovery of export-led growth. Madagascar diversifying export base suggests potential for a broader-based increase of its foreign trade. Nonetheless, the current export expansion, largely driven by a few sectors and made possible to a large extend by the advantages obtained through unilateral preferences granted by OECD countries, has not resulted in the substantial foreign direct investment (FDI) necessary to establish a solid basis for growth in an economy with a low domestic savings rate. At present, Madagascar participates in two regional economic arrangements; COMESA and IOC while it is considering joining another one SADC, both with complex and sometimes potentially conflicting rules, including preferential trade liberalization, rules of origin and regional cooperation in a number of areas (regulatory and other). At the same time, the country is one of the main beneficiaries of the preferential agreements granted by the US and the EU, namely AGOA and EBA. During the next few years important changes in the international and regional trade environment will create significant trade opportunities for the future, but also will pose a number of challenges for trade policy design and implementation. The current multilateral trade negotiations that opened in Doha, the forthcoming EPAs negotiations with the EU, the establishment of the COMESA Customs Union, the end of the exception to the AGOA regulation for LDCs, the expiration of the MFA in 2005, are all examples of the upcoming agenda. These are all complex issues that demand the preparation of a comprehensive strategy, which will set the priorities and identify the costs and benefits of its participation in the different fora, in terms of their economic efficiency, the cost of its implementation and their budgetary implications. Until recently, very little attention has been devoted in Madagascar to discuss the position of the country in the various regional trade agreements. Significant publicsector capacity constraints have largely forestalled any active involvement of the Government in the regional or multilateral negotiations. Little coordination between ministries and with the private sector has also played a role in the lack of any serious debate on international and regional trade policy issues. Fortunately, the new Government of Madagascar seems to have understood the importance and urgency of the forthcoming agenda. The EU and COMESA recently organized two workshops on regional integration with high attendance from various ministries and private sector 2

3 representatives. More importantly, the Government has set up a inter ministerial Task Force with four objectives: (i) analyse status of programs on regional integration and trade, (ii) work out a master plan of activities, (iii) put in place a communication system with all stakeholders, notably business, universities and NGOs, and (iv) co-ordinate all activities related to integration and trade. The task force will be led by the Vice-Prime Minister and will encompass representatives from the main ministers, private sector, NGOs and academia. While the establishment of the Task Force is clearly a solid step in the good direction, it still remains to be decided how will it operate, how often will it meet and which will be the role of the different participants. Given the little human capacity available at the ministerial level, the main challenge will lie in achieving effective co-operation and co-ordination between the numerous ministries involved - specially between the International Trade Ministry and Foreign Affairs and with the private sector, so as to render it into a real forum for debate and policy decisions. Simultaneously, the Ministry of Trade has set up an inter-ministerial Steering Committee to implement the agenda stemming from the Integrated Framework program. To ensure coordination, all the representatives attending the Task Force will also be seating in the IF Steering Committee. There is a danger that the creation of two parallel forums with partly similar agendas and members will disperse the attention and take up scarce administrative resources. It would therefore be advisable that the IF Steering Committee become a specific working group under the umbrella of the Task Force. The purpose of this paper is to analyze Madagascar current and potential regional trade agreements in order to highlight its benefits and constraints and identify policy options that the government and the Task Force may want to consider in formulating a global and regional trade strategy. The chapter is organized as follows: firstly, we examine the main African regional trade agreements to which Madagascar is part or could have an interest in. The next section will look at three market access initiatives that are impacting the trade relations between Madagascar and the two main OECD markets: AGOA, EBA and EPAs. The last section presents the main conclusions and policy recommendations. 3

4 1 ANALYSIS OF REGIONAL ECONOMIC ARRANGEMENTS 1.1 COMESA Madagascar has been a member 1 of the Common Market for Eastern and Southern Africa (COMESA)since COMESA was initiated in Kampala in 1993 as the successor organization of the Preferential Trading Area (PTA) for Eastern and Southern Africa, which was founded in COMESA s main agenda is to deepen and broaden the integration process among member states through:! The complete elimination of internal tariff and non tariff barriers and, in a second phase, the adoption of a Common External Tariff (CET).! Free movement of labor and capital.! Harmonization of product standards, especially sanitary and phytosanitary standards.! Fiscal harmonization, particularly for VAT and excise duties.! Cooperation on intellectual property and investment laws, and ultimately, a monetary union. In October , nine COMESA members established a Free Trade Area 2. The remaining countries are expected to join the FTA in the next couple of years; currently, they grant preferential access to products from other members, ranging from 10 percent for (?) Ethiopia to 90 percent for (?) Burundi. COMESA members have also agreed to move to a customs union by 2004, which includes the establishment of a Common External Tariff. COMESA has recently reviewed and simplified its rules of origin so that now the criteria to obtain origin are: products whole produced; 35 per cent value added on foreign inputs; value of imported content less than 60 per cent of the value of the final good or; change of tariff heading. All goods eligible for preferential tariff treatment must be accompanied by a COMESA Certificate of Origin, completed, stamped, and authenticated by the authorized signatories in the country of origin. 1 The twenty members are: Angola, Burundi, Comoros, the Democratic Republic of Congo, Djibouti, Egypt, Eritrea, Ethiopia (6,130), Kenya (10,255), Madagascar, Malawi, Mauritius, Namibia (3,298), Rwanda (1,814), Seychelles (568), Sudan (8,378), Swaziland), Uganda, Zambia (3,201) and Zimbabwe (7,137). 2 Djibouti, Egypt, Kenya, Madagascar, Malawi, Mauritius, Sudan, Zambia and Zimbabwe 4

5 One of the areas where COMESA is most active is in trade facilitation, where a number of important programs are being implemented with the objective of simplifying trade and lower the costs of doing business. They include:! Harmonized road traffic charges: introduced in 1991 and implemented in at least 10 countries.! Harmonized axle load limits: operational in 16 countries.! Carrier license and transit plates: nine countries had introduced this programme since 1998.! Road transit custom declaration document: in operation since 1986.! Advance Cargo Information System: a computerized system that tracks the movement of cargo and transport equipment through ports, railways, roads, and lakes.! Yellow card scheme: a vehicle insurance scheme that covers third party liability and medical expenses, operational in 12 countries.! Customs bond guarantee scheme: meant to eliminate avoidable administrative and financial costs associated with national customs bond guarantees for transit traffic.! Harmonization of customs systems through the implementation of Automated System for Customs Data and Management (ASYCUDA) and EUROTRACE. The objective of ASYCUDA/EUROTRACE is to enable faster clearance of goods by customs and to generate accurate, reliable, and timely trade and customs revenue and statistics.! Simplification and harmonization of trade documents and procedures: the COMESA customs declaration document is to be used for clearance of exports, imports, transit, and warehousing, replacing all declaration forms being used by member states.! Trade information services: facilitate trade through computerized databases, trade directories, trade inquiries, and monthly bulletins. Progress is being made to expand its capacity and consolidate its services for regional networking. According to the COMESA Secretariat, the recent trade liberalization has already had an impact on trade flows. Intra-zone transportation costs are estimated to have dropped on average by as much as 25 percent (COMESA 2002), and intra COMESA trade in 2001 was estimated at US$ 3.43 billion (Figure 1), representing an increase of 33 percent over 2000 intra-comesa total trade estimates. 3 3 The figures quoted exclude Tanzania, which ceased to be a member of COMESA in

6 FIGURE 1 TRENDS IN INTRA COMESA TRADE Billions, US$ Years Exports Imports Source: COMESA Secretariat Trade Between Madagascar And COMESA Madagascar s total trade with COMESA countries has been growing steadily since the early 1990s. Exports to COMESA have increased from 18 millions US$ in 1991 to near 40 millions in 2001, while imports rose from 7.7 millions to 80 Millions during the same period. However, more than 90 percent of this trade is conducted with Mauritius, which means that, excluding this country, Madagascar total trade with the other 18 th COMESA partners in 2001 barely amounted to 2.6 million dollars of exports and 3.4 millions of imports, representing less than 1 percent of its foreign trade. As indicated, Madagascar s main partner in COMESA is Mauritius, which has been one of the big gainers from liberalization of the region s trade. Mauritius intra-comesa exports more than doubled between 1994 and 2001, reaching US$105 million. This growth likely reflects increased vertical trade (particularly in textiles) as Mauritius companies outsource the most labor-intensive parts of their value chain to subcontractors in neighboring low labor cost countries like Madagascar. This form of intra-industry trade, which may take a variety of contractual arrangements (subcontracting; cut, make and trim [CMT]; or intra-firm trade), is one of the largest sources of gains from trade and is undoubtedly one of the engines of the growth in Madagascar s EPZ. It seems, however that much of the outsourcing of labor-intensive 6

7 activities to firms in Madagascar s EPZ is being generated by preferential access under AGOA or EBA, with the ultimate goal of exporting the final products to the US or EU markets. Thus, in this case vertical trade between neighbouring partners in semifinished products is driven by preferential access to OECD markets (a North-South agreement) rather than by regional trade liberalization. Other than with Mauritius, Madagascar s trade with the rest of COMESA is minimal. Interviews carried out in Madagascar with private and public sector representatives suggest that numerous barriers, both formal and informal, to regional trade persist. Transport costs, little market knowledge, language differences, and lack of tradition are the factors most mentioned to explain the minimal trade with COMESA countries. Yet, even though it is not evident that Madagascar s foreign trade structure is complementary to COMESA s, the region could still under truly free trade, offer some interesting opportunities to Malagasy exporters who may not be ready for the more competitive OECD export markets. In fact, as Table 1 below shows, some of Madagascar main exports were in 2001 among the top products traded between COMESA FTA countries, such as: tea, tobacco, sugar, live animals, cotton and textile products, rice and so on. Overall, the COMESA region as a whole could offer a relatively large market completely untapped as a source of some raw materials and a destination of some Malagasy products currently traded in the region. In particular, the COMESA region will become an attractive source of cotton fabrics once the AGOA special regulations for LDCs expire. The current AGOA regime allows LDCs to export garments to the US under preferential conditions until 2005 using fabrics from any third countries. After 2005, Malagasy garments will have to be made out of inputs from other AGOA countries or the US. Thirteen countries in COMESA are also eligible under AGOA and could provide an alternative source of fabrics to substitute for those currently imported from Asia. A larger, targeted effort involving both the public and the private sector should be carried out to explore the market and seek opportunities emerging in the region. According to officials from the Ministry of Trade, the COMESA Secretariat administers a fund for capacity building, market studies and missions for member states. The Malagasy Government, which has recently stepped up its dialogue with the COMESA Secretariat should make use of some of these funds. 7

8 TABLE 1 TOP EXPORT PRODUCTS INTRA COMESA FTA TRADE, 2001, PRELIMINARY DATA) SITC Description US$ Other black tea 88,614, Tobacco, partly or wholly stemmed/stripped 61,816, Cane sugar, raw, in solid form 24,648, Live animals, nes 24,177, Denim, with >=85% cotton, >=200g/m2 15,686, Motor spirit (gasoline) including aviation spirit 13,661, Looped pile fabrics of textile materials 13,538, Iron/steel bars and rods, hot-rolled 11,303, Cotton, not carded or combed 10,793, Rice, semi-milled or wholly milled glazed, 10,549, U,I,H,L or T sections of iron/steel, hot-rolled 8,965, Tobacco, not stemmed/stripped 7,322, Cotton yarn (excl. sewing thread), 7,319, Other products not elsewhere specified 6,475, Woven fabrics of cotton, 5,746, Yarn of combed wool, 5,358, Refined copper 5,129, Edible Vegetable products 5,068, Medicaments, 4,950, Flour of wheat or of meslin 4,895, Other beet or cane sugar 4,375, Weft knits or crocheted fabrics 4,373, Shrimps and prawns, frozen 3,599, Books 3,258, Portland cement 3,171, Wire of refined copper 3,050, Waters (incl. mineral and aerated) 2,990, Sanitary towels and tampons, napkins 2,798, Rubber New pneumatic tyres 2,731, Printed woven cotton fabrics 2,564, Paper Cartons, boxes and cases 2,329, Fertilizers, nes, containing the elements: N, P, and K 2,165, Railway or tramway sleepers (cross-ties) of wood 1,859,848 Source: COMESA Secretariat In addition, in the medium term the authorities should assess the suitability of joining the African Trade Insurance Agency (ATI) as a way to demonstrate their commitment to increasing trade with the region. ATI was established with World Bank support and launched by the COMESA Summit in May Its main goal is to promote and 8

9 facilitate intra-regional trade by providing political risk insurance for trade transactions, and thus help mitigate the problem of a perception of high risk in the region -which constraints financing of productive activities and raises the cost of intra- and extraregional trade. At present, ATI comprisesten member countries. In spite of its potential demand has been minimal and the World Bank is currently discussing with COMESA and ATI the extension of its financial facilities to align them to market needs. COMESA s Customs Union And Its Implications For Madagascar In 1994 COMESA members agreed to move to a Customs Union by A Customs Union involves a much higher degree of trade integration among members and requires the following measures: (ii) agreement on a Common External Tariff (CET) implemented by all country members; (ii) internal trade liberalization in order to ensure the free movement of goods within the new customs territory; (iii) the harmonization of regulations and technical measures for the effective and uniform application of the customs union and its smooth operation; (iv) an institutional framework that can enforce and monitor the implementation of the common Customs Union regulations; (v) a system for managing the collection and distribution of customs and tax revenue and; (vi) a common external trade policy that will ensure consistency in the application of the CET across countries. The central policy instrument of the customs union is the Common External Tariff. Its structure and rates have important implications for the economic, fiscal, trade and industrial policies of its members and should be carefully considered. According to WTO regulations (art. 24), the final level of any new tariff should, on average, be lower than the existing level. Any new CET should be simple and transparent (not more than three or four tariff bands) to foster uniform and effective implementation, not only by customs administrations but by companies and intermediaries. The CET should also contribute to an open customs union with low average and maximum tariff rates, thus reducing the risks of trade diversion and enabling the progressive and gradual integration of COMESA into the world economy. Although the COMESA Secretariat has worked intensively to complete the Road Map to the Customs Union, much of the technical work remains to be done (COMESA 2003), and some critical decisions have not yet been taken. It is therefore prudent to expect that the date of entry into force will be postponed. The Government of Madagascar is in principle favourable to the idea of joining the COMESA Customs Union. The effect of this decision will hinge critically on the structure and level of the Common External Tariff, which has not yet been agreed on. A 1997 COMESA-commissioned study recommended a 4-band (3 non-zero) tariff structure for the COMESA Common External Tariff. The rates recommended were 0 percent for capital goods, 5 percent for raw materials, 10 percent for intermediate goods and 30 percent for final goods. A formal decision from the Council of Ministers approving these rates has not yet been taken. However, most preparatory work and analysis has been carried out using them as the reference tariff rates. 9

10 Whatever the final rates and categories of a Common External Tariff (once adopted), they will affect both public sector revenue (as government revenues may be affected) and trade policy (specifically with regard to the final level of protection and tariff bindings notified to the WTO). A recent COMESA study 4 on the revenue implications of the proposed CET rates based on 2001 statistics reveal that 10 of the 13 member States would experience a rise in revenue collection, while three would suffer declines 5. No country for which data was available would remain unaffected. According to the COMESA study, if the structure of the CET is maintained as proposed, revenue considerations should not pose a major impediment for Madagascar to the establishment of the COMESA Customs Union. This static analysis consisted mainly in simulating what would be the revenue effects under the current trade flows using the proposed CET. In this scenario, Madagascar would experience an increase of customs revenues of around 100 million dollars per year? However, the implementation of the proposed CET would imply raising 3,100 tariff rates, thus increasing protection which would likely reduce imports and hence revenues. Therefore, due to its simplicity this static analysis must be viewed cautiously. In order to get a more accurate estimate of likely effects on government revenue a more sophisticated model is required, estimated at the commodity level of disaggregation, which should include some estimations of demand elasticities. TABLE 2: EFFECTS OF PROPOSED COMESA CET RATES ON CUSTOMS DUTY, 2001 Change in No. of No. of Change in Customs duty attributed to unaffected Tariff lines Tariff lines Customs duty lines US$M going down attributed to lines US$M (8.1) No. of Tariff lines going up Source: COMESA Secretariat (2003) Net Increase/ (Decrease) in Customs duty in US$M 4 COMESA Secretariat : Towards a COMESA Customs Union. Discussion Paper. Lusaka, March, Mauritius, Seychelles and Sudan. 10

11 One of the problems of the proposed CET is that it increases the trade weighted average tariff for most countries (exceptions being Mauritius, Seychelles and Sudan) and thus it raises their effective rate of protection. This implies that its implementation would be in contravention to the provisions of GATT 1994 (Article XXIV). Therefore, given that the general direction of trade policy in COMESA member States, in line with WTO, is to gradually reduce trade taxes, it may be difficult to justify. In the case of Madagascar, the proposed rate would raise the trade weighted average rate from 3.4 per cent to 14.8 per cent. In view of this situation, COMESA may be forced to recommend a CET with lower maximum taxes or a different structure that reduces the weighted average tariff of all members. Further simulations following the same methodology were carried by the COMESA Secretariat to obtain an estimate of the likely impact on revenue and average rates of other different possible CET (Table 3 and 4). TABLE 3 EFFECTS OF VARIOUS CET RATES ON MADAGASCAR GOVERNMENT REVENUE, 2001 DATA (US$) Total Imports value (US$) Computed customs duty (2001 tariff rates) Estimated customs duty under CET of Estimated customs duty under CET of Estimated customs duty under CET of ,100,480 29,895, ,559, ,461, ,364,488 TABLE 4 TRADE WEIGHTED AVERAGE APPLIED TARIFF RATES USING A CET OF 0%-10%- 25% AND 0%-10%-20% (2001 DATA) Tradeweighted average tariff rate (2001) Trade-weighted average tariff rate under CET Trade-weighted average tariff rate under CET Trade-weighted average tariff rate under CET Trade-weighted average tariff rate under CET Source: COMESA Secretariat 11

12 Given Madagascar s low weighted average tariff rate of 3.4 percent 6, COMESA estimations show no scenario under which there would be a loss of tariff revenues. However, under the proposed CET and the alternative scenarios Madagascar would be forced to raise the current levels of protection on (?) 3,100 tariff lines in the base CET which would likely lead to welfare losses for consumers and increase incentives for sentseeking to avoid the higher tariffs. Another serious potential problem with this proposal is that it promotes tariff escalation tariffs on finished goods are much higher than those on raw or intermediate goods. This may bode well for those countries that produce mostly finished goods, but it is likely to have particularly adverse consequences for the lesser-developed members of COMESA, like Madagascar. A Customs Union built around a relatively high CET tends to benefit the relatively more developed countries. Following the establishment of the CET and the fall of preferential tariff rates the least developed members are likely to increase their imports of manufactured products from the more developed partners, whose firms may not be internationally competitive but are well protected behind high external tariffs. This trade diversion will harm the poorer countries since they would lose tariff revenue and substitute more efficient products from the rest of the world for less competitive ones from partner countries 7. In summary, relatively under-developed countries would end up subsidizing production from the relatively more industrialized states. Hence, it is probably not in the interest of Madagascar to agree on a COMESA CET that increases the average level of protection. Another essential element in the formation of the COMESA Customs Union will be how customs revenues and other taxes will be collected and distributed between member countries. Options range from a centralized system with a regional body responsible for collecting and distributing customs revenues (such as in the case of the EU), to a system in which individual countries collect and retain revenues at the final port of entry. The latter is the mechanism suggested by the COMESA Secretariat and it should be the option favoured by Madagascar. In view of the current modest trade with COMESA countries (with the exception of Mauritius), the importance that trade taxes play in the budget, and its special island location, it is probably not in the interest of Madagascar to agree at this stage on any yet-to-be-determined customs sharing mechanism. Yet, although the proposed system - in which each country collects its own duties as is the case now - may present a pragmatic solution, it eradicates many of the benefits of the customs union and does not address the costs. Rules of origin will have to be retained and hence COMESA will not reap the administrative efficiencies usually associated with customs unions. 6 COMESA Secretariat. 7 For a more comprehensive discussion on trade diversion effects, see SADC section below and Annex 1. 12

13 Conclusion The different simulations conducted by the COMESA Secretariat using the proposed bands indicate that there would be no revenue loss for Madagascar from the implementation of the Common External Tariff. Although these exercises should be assessed cautiously due to their limitations, the results are not surprising given the relatively low level of current tariffs. The advantages of a simple four-tier CET are significant, but may be overshadowed in this case, by the costs of increased protection and tariff escalation. Under the proposed CET Madagascar will be required to raise tariffs on a range of critical imports, including some foodstuffs that may not be available within the region at a reasonable quality or price; this would lower consumers welfare and induce rent-seeking to avoid higher tariffs. Moreover, there is a risk that the CU will induce trade diversion, benefiting the more developed member countries, but harming others like Madagascar, which would lose tariff revenues and have to source their imports from less efficient countries. In addition to failing to comply with WTO regulations, the proposed CET would entail a set back in Madagascar s long-term strategic policy to liberalize trade and integrate into the world economy. Ultimately, the decision on the structure of the CET raises the question as to whether such a customs union is the most appropriate or desired form of integration in COMESA at this time, and whether it would be in the interest of Madagascar to join in given the current low levels of trade flows with COMESA countries. In spite of the risks, if the Government of Madagascar is committed to the COMESA agenda and wishes to join the future customs union, it should do so but under conditions that maximize its welfare. Therefore, the government should clearly indicate that its priority is to agree to a lower and uniform Common External Tariff, compatible with WTO regulations, which reduces the levels of protection and minimizes tariff escalation and trade diversion. 1.2 The Indian Ocean Commission (IOC) Created in Victoria Seychelles, in 1984 by the General Agreement of Cooperation, the Indian Ocean Commission (IOC) comprises five member States: Comoros, Madagascar, Mauritius, Reunion (France), and the Seychelles. Its main objective is to promote regional trade and cooperation in all possible sectors, in particular, in diplomatic, economic, social, cultural, and technical fields (environment, tourism, health and so on). The work of the IOC is carried out with the financial support of the European Union (EU), its main sponsor. EU support of the IOC comes primarily through the European Development Fund. The five-year Regional Integrated Program for the Development of Exchanges or PRIDE program has been implemented since Its aim is to strengthen the IOC regional integration process through the liberalization of trade exchanges and the coherence of investment and commercial policies. A plan to eliminate customs duties on intra-regional trade (on a reciprocal basis) has been fully implemented by Madagascar and Mauritius since 1 January The other member States are in the process of implementation. 13

14 In the past, Madagascar has been a relatively passive participant in this organisation, which is mostly driven by Mauritius. Recently, the Government has taken a more proactive stance and defined IOC as the first circle to enhance Madagascar s role in regional integration. It is not clear whether this means deepening sectoral cooperation or also dealing with specific IOC trade agreements. During the last few years, aligning IOC trade regulations with those of COMESA has been problematic, especially in the exchanges between Madagascar and Mauritius. However, it seems that IOC countries are adopting the COMESA framework for their bilateral trade operations (except Reunion which is part of France and not a member of COMESA). Thus, complaints from Malagasy producers regarding the transhipment of some goods such as soap and others, into the country through Mauritius using dubious or too easily granted certificates of origin, are being resolved following COMESA procedures. In conclusion, it is probably in Madagascar s interest to deepen its participation in IOC in areas of regional cooperation, but resolve the trade issues within the COMESA framework. 1.3 The Southern Africa Development Community (SADC) The Government of Madagascar favours accession to SADC as a way to gain access to the South African market, which is the most important regional economic partner. Although a formal application has not yet been put forward, the Malagasy Government has approached the South Africa to discuss this possibility. Despite the significant interest among government officials in joining SADC, there less knowledge and understanding within the country of SADC and the potential implications of becoming a member. The Southern African Development Community (SADC) was established by the SADC Treaty in July 1992 when it replaced the Southern African Development Coordination Conference (SADCC), which was an informal sector and project-led regional arrangement between 10 member States. SADC's objectives, as stated in its Treaty Article 5, aim to achieve development and economic growth by reducing economic dependence, forging links for regional integration and promoting international cooperation. SADC consists of 14 member states namely Angola, Botswana, the Democratic Republic of Congo, Lesotho, Malawi, Mauritius, Mozambique, Namibia, Seychelles, South Africa, Swaziland, Tanzania, Zambia and Zimbabwe. In 1999, SADC authorities decided to undertake a thorough review of SADC institutions and operations, which led to a plan strengthening the Secretariat in Gaborone with the incorporation of all the 14 Sector Coordination Units that were until then scattered in different countries. This plan has almost been accomplished. They also foresaw the preparation, by the end of 2001, of a 5-yr Regional Indicative Strategic Development Plan (RISDP), with a rolling budget, to provide strategic direction to all Sectors. The preparation of the RISDP is now almost complete and was discussed (?) at the Council of Ministers in June SADC was originally created to serve regional security and solidarity objectives. Since the end of apartheid in South Africa, SADC has expanded its scope to address other 14

15 political issues, coordinate regional policies, as well as to facilitate regional trade and investment. SADC members have signed some 19 protocols, which they are expected to comply with (although this is often not the case). Topics include trade, health, energy, water resources, standards, national security, corruption, transportation, telecommunications, drugs, etc. SADC Trade Protocol The current framework governing trade relations among SADC members is the SADC Trade Protocol, which was signed in It entered into force January 25, 2000 and was officially launched in September 1, Trade liberalization in the protocol focuses on the elimination of customs duties and various non-tariff barriers to trade among SADC members. The protocol also envisions regional regulatory cooperation, promotion of trade in services, cross-border investment, and trade facilitation (including customs cooperation and facilitation of transit trade). However, progress with implementing the protocols varies widely from country to country. The SADC Trade Protocol provides for the implementation of a SADC Free Trade Area by After lengthy and complex negotiations, the member countries agreed to a complicated tariff phase down schedule, most rules of origin and dispute settlements. The SADC FTA will be implemented through an 8-year transition period with approximately 85 per cent of all SADC trade scheduled to be free of duties by Some special sensitive products, accounting for not more than 15 per cent of total trade will be liberalized in 2012, while some others are excluding from any liberalization, which is probably not in conformity with art. 24 of GATT. The Trade Protocol incorporated the principle of asymmetry, whereby SACU will phase down tariffs in 8 years while the rest of SADC will do so in 12 years (by 2012). One of the problems revealed after the entry into force of the Protocol is that the phase down of most sensitive tariffs are backloaded towards the end of the transition period and most of the products already liberalized are those with already very low tariffs or insignificant in terms of intra-regional trade. By 2004, half way through the full implementation of the Protocol, only a small proportion of intra-sadc trade will have been liberalized. Furthermore, by 2008, except for SACU, most countries will not have achieved an 80 per cent liberalization. For all the above reasons, progress in liberalizing trade flows within the region has, so far, been very limited. A key and contentious aspect of the Trade Protocol, which could have important implications for Madagascar, refers to the rules of origin for products to be traded among SADC member states. Although the general rules are similar to those of COMESA, specific rules of origin apply to many products consisting of specific transformation or requirements that they need to undergo in order to obtain the originating status (e.g., motor vehicles and sugar). Moreover, final agreement has yet to be reached on rules of origin for textiles, wheat flour and food products using wheat flour, spices, plastics, machinery and equipment, motor vehicles and components and certain products in chapter

16 SADC rules of origin have become a particularly key hurdle preventing the expansion of regional exports to South Africa,. especially in industries where successful competition in international markets requires participating in global supply chains. Their protectionism reduces the scope for creating backward and forward linkages across countries within the SADC region. Unlike a protective tariff, for example, overly restrictive rules of origin do not generate revenues for Governments, but force producers to incur additional costs of complying with local content requirements, and therefore can become an impediment to regional trade. Opportunities And Risks Of The SADC Trade Protocol Since tariff-free access to most of the other SADC members is provided to through the COMESA FTA, the main motivation for Madagascar in joining SADC lies in the potential benefits stemming from a better access to the South African market. In theory, the South African market, with its relative large economic size and close distance could represent an attractive option for Madagascar prospects of expanding markets and increasing exports. South Africa s GDP alone represents over 70 per cent of SADC s GDP and its total trade is several times bigger than all the other SADC countries combined. Up to now however, Madagascar exports to South African have been very small, amounting to barely US$2.1 million in These exports are very concentrated, with the three main categories of products (sisal and other textile fibres, cloves and spices, and fruits and nuts) accounting for around 57 percent of the total exports. A first analysis of South African imports of Madagascar traditional agriculture exports would confirm the great potential of its market, which amounts to more than US$166 million per year. Moreover, as Table 5 indicates, around twenty percent of those imports is supplied regionally by SADC countries, an indication that there could be opportunities for Malagasy exporters if they were to be more competitive. In fact, in the long-run if Madagascar were to stay outside of the SADC preferential area as the Trade Protocol is implemented, it would probably lose the little market access it already has. For instance, Madagascar s exports to South Africa, such as shrimps, fish, vanilla, ginger and coffee will be competing on unfavorable terms with exports from preferred SADC partners like Mozambique (for shrimps and vanilla) and Tanzania (for cloves and spices). 16

17 TABLE 5 SOUTH AFRICAN IMPORTS FROM THE WORLD AND FROM SADC OF MADAGASCAR MAIN AGRICULTURE EXPORTS IN 2001 (THOUSANDS OF US$) SITC-4 Product name Total SADC SADC/World 342 Fish,frozen exc.fillets 6, % 36 Crustaceans molluscs etc 20,118 5, % 371 Fish, prepared/preserved 19, % 542 Dried legumes 10, % 566 Vegetables, presvd/frozn % 567 Vegetables prep/pres nes 9, % 579 Fruit fresh/dried nes 2, % 611 Raw sugars % 612 Cane/beet sugar nes % 711 Coffee, not roasted 13, % 721 Cocoa beans,raw/roasted 3, % 751 Peppers dried/crush/grnd 3, % 752 Spices ex pepper/pimento 10, % 7521 Vanilla % 7524 Clove 1, % 2483 Softwood shaped/grooved 1,452 1, % 2631 Raw cotton,excl linters 46,847 38, % 2654 Sisal etc unspun/tow/wst % 2923 Veg plaiting materials % 2929 Vegetable materials nes 14, % TOTAL 166,940 48, % Source: COMTRADE Notwithstanding the above, recent developments within SADC seem to indicate that preferential access to South Africa granted through the SADC Trade Protocol or other bilateral arrangements may not necessarily translate into greater and more balanced level of trade with this country. In fact, although intra-regional trade flows within SADC have more than doubled during the 90s, participation in the regional trade flows has grown utterly unbalanced in favor of South Africa. Its exports to the region have soared accounting nowadays for more than 70 percent of the intra-sadc imports, displacing the EU as the main origin of imports. There seems to be a case to suggest that the renewed engagement of South Africa in the region since the democratic non-racial elections in 1994 has led to an important degree of import shifting from European goods in favor of South African ones South Africa large trade surpluses and economic dominance in the region have been and continue to be a source of conflict. 17

18 Reviewing the experience and problems faced during the last few years by SADC countries in accessing the South Africa market can be extremely illustrative for Madagascar. A recent World Bank study (World Bank 2003) shows that SADC countries have faced significant difficulties in increasing their agriculture exports to this market. Although many of them are produced in the region, South Africa generally imports these goods from other parts of the world. This is explained to a large extent by the slow pace of liberalization agreed to in the Trade Protocol. In addition, transport costs, protectionist rules of origin, communications problems, insufficient volume, lack of knowledge of market characteristics, quality and standards issues, and bureaucracy and corruption are the main hurdles cited by SADC operators willing to increase their exports to South Africa. In the apparel and clothing sector, South Africa imports account for more than US$200 million annually, but only around 10 per cent is imported from SADC countries. As currently agreed, movement towards liberalization of SADC trade in textiles and garments is extremely slow and subject to relatively complex transitional arrangements, including tariffs and quotas. Moreover, rules of origin for textiles and garments require that imported raw materials undergo a minimum of two stages of production ( double transformation ) from yarn into fabric and into garment before they can be considered to have originated in a SADC country. Although they are officially established to promote the development of backward linkages, in practice they are very difficult to satisfy for most regional partners, 8 and thus represent a particularly expensive method of protecting domestic producer interests at the expense of consumers. These are precisely the sort of linkages that Madagascar s garment industry must create by 2004, after which time AGOA rules will require garment producers to use inputs sourced either from within Sub-Saharan Africa AGOA eligible countries or from the U.S. The case of Mauritius is very illustrative of this problem, since, despite its competitive garment industry in world markets, it barely exports US$1 million of clothing to South Africa per year. A case can be made that by joining SADC Madagascar will attract increasing levels of South African investments to supply the South African market. Here again, some caution is necessary and the recent experience of SADC countries can be useful for the analysis. For example, encouraged by South Africa s balance of payment regulations 9 several SADC countries have witnessed the arrival of important South African investment. One notorious case is the supermarket revolution referring to the investments and operational spread of major South African supermarket chains. While they have provided numerous jobs, benefits have not always been as expected. Many food manufacturers and farmer groups in Zambia or Malawi have had difficulty 8 The double transformation rules for garments and fabric are waived for Malawi, Mozambique, Tanzania and Zambia, but only until 2005, and subject to very small quotas. 9 Under current controls on balance of payment South African companies are allowed to invest only up to 50 million Rands abroad. The cap raises up to 250 million Rand for investments in SADC countries. 18

19 complying with the product and service standards, and quantity and time deliveries of the supermarket chains and hence the backward linkages of the supermarket system have not always been successful 10. As a result, these supermarkets now source up to 40 percent of their goods from South Africa, 11 and local food producers and retailers have been badly affected. This is not to say that there are not ample opportunities to achieve import substitution, both in fresh and processed food products but yet much more direct support is needed to re-level the playing field and improve the capacities and products of local suppliers. In summary, if Madagascar is to join SADC a more detailed analysis should be carried out on the current obstacles, whether flaws in the Trade protocol or other hidden NTBs, that prevent the formation of a regional supply chain; how would those affect Madagascar access to the South African market? In addition, what negotiation strategy should it adopt to overcome these constraints?. In part, the emergence of a regional supply chain is constrained by the kinds of regional problems - non-transparent business and investment climate, inadequate infrastructure, poor training facilities that also plague Madagascar. However, additional impediments can be found in the restrictive trade practices in South Africa, including its tariff, non-tariff and antidumping policies. Madagascar should be aware of them and negotiate in favor of their reform. South-South Agreements, Trade Diversion And Revenue Effects A key lesson of South-South trade arrangements, like SADC, among developing countries is that they generally tend to result in unequal benefits, favoring the largest and more advanced members. The issue has been explicitly recognized in SADC and an effort has been made to deal with it through asymmetric liberalization. While it is too early to judge the success of this approach, the government of Madagascar needs to be alert of the potential problems stemming therein, especially as there is little evidence that asymmetric liberalization has succeeded in avoiding polarization of benefits in other regional groupings of developing countries that have tried it, for example in Central America. Connected with the problem of asymmetric distribution of benefits in South-South Agreements is the issue of trade diversion (see Annex 1). Trade diversion occurs when imports from low-cost, efficient trading partners are displaced by tariff-free imports from less efficient but preferred trading partners. This is particularly likely when one of the agreement s partners is large and its production is relatively inefficient compared with world prices. Under such conditions, regionalism leads to a loss in overall economic efficiency and may raise serious budgetary implications for member countries. In general the larger the share of your preferential partner s products in your total imports the smaller the risk of trade diversion. 12. Trade diversion could constitute a 10 For a detailed analysis of the Zambia case, see World Bank World Bank See Schiff and Winters (2003) for a more detailed explanation of trade diversion effects. 19

20 particularly important problem for Madagascar where customs duties represent around 30 per cent of total government revenue 13. Currently, Madagascar imports from South Africa are relatively small amounting to less than US$30 million or around 4 percent of total imports. They are made up mostly of sugar, iron and steel, minerals, chemical products and machinery. Although detailed data on the customs revenue collected from South Africa products is not available, this figure is likely to be small. If Madagascar were to join SADC the risk of trade diversion would be high due to South Africa s relatively large production capacity and current low share in Madagascar total imports. In light of this, to avoid abrupt increases of imports from South Africa, long transition tariff phase-out periods should be negotiated. Yet, in the long run trade diversion is unlikely to be so critical since Madagascar might have to lower its tariffs with the rest of the world in the context of the WTO negotiations, and will also phase out its bilateral tariffs for EU products under the EPAs. 1.4 Overlapping Membership One of the main challenges that Madagascar will face if it joins SADC is common to a number of countries in Eastern and Southern Africa -- how to implement effectively more than one regional trade agreement, each of which contains a number of complex and varied obligations, different rules of origin, tariff structures, non-tariff barriers (NTBs), speed of adjustment, custom procedures, and so on. This would have implications in several areas: Limited capacity: From the start, SADC obligations expand much beyond trade issues into other areas as reflected into its numerous protocols. Were Madagascar to join SADC in the short term, its capacity to study, discuss, approve and implement the SADC Protocols in addition to the follow up of the COMESA agenda would be significantly strained. 14 Yet, the main challenge to deal with both agreements will no doubt lie in the customs authorities, which will have to scrutinize imports from a variety of sources each with a different tariff rate and each subject to different rules of origin and customs procedures. The opportunities for both confusion and corruption will multiply creating an uncertain business environment that will obstruct investment and marketing decisions, which could undermine the whole purpose of participating in the trade agreements. The management and administration of both agreements will inflict a heavy burden on the limited capacity of the customs authorities. Rules of origin: RoO can pose special problems. First, they have the potential to not only become a great obstacle for trade as was discussed above, but also due to their 13 Excluding value added and excise tariffs levied on imports. 14 At present, there are only 6 civil servants devoted to follow up international trade issues at the Trade Ministry: three of them cover the WTO negotiations, and three deal with regional and bilateral agreements 20