The Asian Free Trade Area (AFTA) is the economic core of the ASEAN group of nations.

In order to join the ASEAN club, Cambodia is expected to liberalize customs duties

and make other reforms. What is required, and how will Cambodia achieve it? Hurley

Scroggins reports.

THE Finance Ministry has tentatively decided to take a slow approach to liberalizing

tariffs with Cambodia's neighbors as it prepares to join the Association of Southeast

Asian Nations (ASEAN). Fears of losing customs revenues outweighed hopes that comprehensive

liberalization would attract a surge in foreign investment.

With cigarettes accounting for 28 percent of total imports- which attract import

duties of up to 70 percent - and customs duties providing 72 percent of the government's

(non aid-related) budget revenue, it is hardly surprising that Finance Ministry officials

are reluctant to slash duties.

The boldest option considered by the government was to reduce tariffs on nearly all

items originating in ASEAN to a maximum of 20 percent. If the current decision to

take a conservative approach holds, consumers can expect no price reductions during

the first year of membership.

The debate highlights the need for tax reform to broaden the government's sources

of revenue and reduce dependence on customs. Extensive legislation would be required

to do this and, in light of uncertainty that the National Assembly will convene,

officials have decided to take a cautious approach to making commitments to its neighbors.

While the strategy may change, the initial list of products slated for tariff reduction

next year, sent to the second ASEAN Special Economic Official's Meeting in Ho Chi

Minh city in April, included only items which have low duties already or are not

heavily traded. There was a lot of pressure to submit something, so the Ministry

of Finance took a minimalist approach including items such as snow skis and heavy

outerwear.

Policy-makers operate on the assumption that 78 percent of customs revenues come

from cigarettes, beer, soft drinks, motorcycles, petroleum products, televisions,

VCRs and radio cassette players. These items will not be on the list, even though

many do not meet 40 percent ASEAN local-content requirements and much of the volume

is re-exported.

To join ASEAN, every member has to commit to lowering import duties on most products

originating in the group to between 0 to 5 percent within 10 years. It is up to each

country to decide how quickly it implements the Common Effective Preferential Tariff

(CEPT) scheme, the core instrument of the Asian Free Trade Area (AFTA).

AFTA is essentially the economic core of ASEAN. Its purpose is to ensure the competitiveness

of the region in the global marketplace by liberalizing trade between its members.

In doing so ASEAN leaders hope to increase trade and lure foreign investors into

the region, attracted to its market of 500 million consumers.

The pace of liberalization is up to the country, but the target date to reach the

0 to 5 percent goal has moved forward steadily since the inception of AFTA in 1992.

The original six members have decided to meet the target within two to three years.

Generally, 20 percent of items a country imports is put on the list initially and

an equal number is included annually for five years.

"At first, they agreed to phase reductions in over 15 years," says a Finance

Ministry official, who insisted that he not be identified. "Now it is officially

10, but I recently heard that Thailand proposed to reduce it to eight. That has not

been approved."

The CEPT acts as a mechanism to achieve reciprocal tariff reductions. The agreement

divides goods into four categories: inclusion, temporary exclusion, sensitive and

general exception lists. Governments have to produce an inclusion list when they

join. Members do not have to include products that may affect national security,

public health or morals. These items may be put on the general exclusion list.

Temporary exclusions may be granted for items deemed sensitive in terms of national

production, but have to be phased into the inclusion list within five years in 20

percent increments. Unprocessed agricultural products may be put on the sensitive

list and can be dealt with separately, although the trend in ASEAN is towards inclusion.

Cambodian Institute for Cooperation and Peace executive director Kao Kim Hourn concedes

that the country has a long way to go, particularly in terms of legal reform to comply

with the agreements.

"We need a functional court - a third party to arbitrate. Progress is slow in

that regard and it will take time. We do have good foreign investment laws, however,

and less red tape than others in the region," he says. "We have to find

out what Cambodia can gain. It can be a win-win situation, but we must understand

the process and its intricacies."

The main challenge is to speed up organizing institutional structures and law reform.

"The implementation of the AFTA/CEPT framework will compel Cambodia to re-examine

and re-adjust its existing institutional structures, laws and procedures, especially

for sectors relating to trade and customs," wrote Minister of Finance Keat Chhon

and Ministry policy planner Dr Aun Porn Moniroth in a recent discussion paper.

"The Commercial Code also needs to be finalized, including: intellectual property

laws, the establishment of rules of origin, the harmonization of standards and quality

with other ASEAN countries, the ratification of treaties on double taxation avoidance

with fellow bloc members and, most importantly the harmonization of tariff nomenclature,

customs valuation and procedures and the computerization of customs activities,"

they say.

Making up for the shortfall in national income with income taxes will be limited

by low official salaries and a 9 percent ceiling on corporate taxes, they surmise.

Officials are looking at taxes on goods and services, particularly introducing a

British-style Valued Added Tax (VAT). Property taxes may also be introduced.

"We have received recommendations from foreign economists to impose excise taxes

on those sensitive items," says the Finance official. "Now this issue is

being considered by our department."

The Ministry of Finance is concerned about losing revenues and is seeking to broaden

the country's tax base through income, property and excise taxes. He says that the

ministry had prepared a list of 1,067 "tariff lines" - categories of goods

which are, or could be, imported into Cambodia - which it was prepared to have low

tariffs for.

The total number of tariff lines is 5,200. The ministry is giving no promises that

the others will attract lower duties in the near future.

"Our strategy is to submit to ASEAN the tariff lines with the least trading

value," the official says. "The most heavily-traded items will be included

in the temporary exclusion list. We have to evaluate [the impact] and look for other

sources of revenue."

Ministry of Commerce officials were initially up-beat about rapid liberalization,

but have agreed to enter the agreement slowly at first. "We originally wanted

1500 items on the list, but after an inter-ministerial meeting with the Ministry

of Finance, the Ministry of Agriculture and the Ministry of Industry, we agreed to

lower the number," a Commerce official says. "Nothing will change the first

year. We plan for a 10-year reduction. It's no problem; we can go step-by-step."

"The most challenging issues are losing tax revenues," observes Kao Kim

Hourn. "But we have to realize that the government is taking steps to broaden

the tax base. A salary tax is coming in July and it is a very important part of tax

reform."

One positive note is Cambodia's relatively small production base, Hourn says, and

the small scale of industrialization may make it easier to cope with competition.

"To be honest, what do we have? We have few state enterprises. There is no infant

industry we need to protect. At what cost should we subsidize?"

Nobody has an absolutely clear idea what the effects of the agreement will be, but

many like Hourn say that they believe membership will bring about positive changes.

"For me, joining ASEAN and AFTA means three things," he explains. "First,

we can hope to increase trade. Second, we can be a part of the region and have a

positive profile, attracting balanced foreign-direct investment and creating more

jobs. Third, we can increase tourism. There is a lot of potential. We can tap into

Singapore and Thailand and bring in hard currency, but we need to ascertain to what

extent we can absorb it in terms of infrastructure."

Honoring AFTA will also affect trade flows and the country's balance of payments.

"Presently, the production base and the economic structure of Cambodia is still

very weak," the paper states. "These are key factors in determining Cambodia's

competitiveness. The integration and liberalization of the economy may affect Cambodia's

economy, particularly its balance of payments and the natural resources, if its production

base and economic structure remain weak."

The paper also says that as trade increases, there will be an ever-increasing demand

for foreign exchange to pay for imports. "Presently, external assistance is

a source of foreign exchange for Cambodia, but this source of assistance cannot be

used for international trade outside the context of donor-supported development projects."

The authors predict that in the absence of a sound production base, an increase in

exports of raw materials and natural resources will be needed to shore up the trade

deficit. "Such a situation is not sustainable over the long run." They

see an increase in foreign direct investment and export-led growth as mitigating

factors.

Policy-makers underline the need to find out in what sectors Cambodia already has

a comparative advantage in the region. The report points out the agricultural sector-

particularly rice, rubber and wood - is already competitive within limits of sustainable

exploitation. It also says that the agro-industrial field, labor-intensive manufacturing

and the tourism sectors show promise, but that the growth and productivity of the

above are still relatively low.

"Trying to pick winners is a risky business," says a foreign economic advisor.

"The gain is not to be made by pushing what is exported now, but looking at

the country as a production platform for new industries."

He points to manufacturers who located here after Cambodia was given preferential

trade status by the European Union and the US. Garment exports rose 5,400 percent

in 1995, were up 169 percent last year and are slated to maintain growth by at least

20 percent until 2001. The Commerce Ministry's mandate is to increase employment

and economic growth, which may be best served by rapid liberalization.

"A lot of goods are on the exclusion list," says the advisor. "Potential

investors have no idea what items will be included when. The uncertainty affects

investor sentiment. There are a lot of companies in the region looking for a labor-intensive

manufacturing base. The ultimate competition will be between Cambodia, Laos and Burma

and Vietnam and it is unlikely all will benefit."

Meanwhile, the Finance Ministry is under pressure from the rest of the government

and the international community to keep money flowing in. "Our concern is customs

revenues. The revenues will decrease and we will face a lot of difficulties,"

maintains a Finance Ministry official. "Our strategy is to study the issue deeply,

then split imports into four lists, so we can maintain customs revenues."

He maintains that no matter what others suggest, it is his ministry that has the

responsibility and authority to deal with the issue. "Tariff reduction is done

here. Customs is part of the Ministry of Finance," he says. "Everything

is drafted here.

"We are not sure if tax reform can compensate for the losses, so for the first

three years, we will include only the least traded lines The most traded lines will

be kept aside. If domestic reform can generate enough revenues, we can start to phase

in the items. It has to be phased in strategically and carefully.

No matter what pace government leaders choose, tariff liberalization is part of a

global trend that experts concede is inevitable. "AFTA is not everything. It

is a training ground. If Cambodia is to join the WTO [World Trade Organization] and

APEC [Asia Pacific Economic Community] it is good practice," says Hourn. "AFTA

is part of the WTO. It will give Cambodia on-the-job training. It is crucial. It

will test economic policy."

Officials are trying to find a way to join ASEAN if the National Assembly does not

convene, and MPs are unable to ratify 19 international agreements which are necessary

for Cambodia for join the regional grouping. The 19 agreements are supposed to be

approved by May 31, in order to clear the way for Cambodia's hoped-for admission

to ASEAN in July.

"The 19 documents are a precondition to join ASEAN. They are not so much laws,

but agreements, protocols and memoranda of understanding," says a Finance official.

"ASEAN requires all of them to be ratified by the National Assembly. The government

doesn't want to take responsibility alone. It wants them ratified by the National

Assembly."

"If the National Assembly can't ratify the 19 documents due to some reason [Foreign

Minister] Ung Huot can send a letter to the secretary general of ASEAN and confirm

that the government has approved them and is only waiting for ratification, it will

be OK," says Ministry of Foreign Affairs official Hor Suthorn. "ASEAN understands

well our political condition. If the 19 are not ratified by July, we can't join."

He says that while the ministry was confident that the National Assembly would convene,

it took precautions just in case it did not. "Ung Huot signed a letter [assuring

ASEAN of Cambodia's commitment to AFTA] and it was sent on May 9, but that is not

enough. We have to ratify some of the 19, but if the National Assembly does not convene

we can see which way we can deal with it. If it doesn't convene, for example, we

can see a way our Prime Ministers can sign on the government's behalf."

Suthon claims to be optimistic that the matter will be resolved. "Some of the

agreements must be ratified, but not all," he says. "We can look at other

ways to deal with it to assure ASEAN leadership. The other way is a letter from the

two Prime Ministers."

Notable numbers

DETAILED trade figures are beginning to surface in the drive to determine the effects

of AFTA. Among the findings of current imports and exports, and future projections,

are:

• Logs are slated to constitute 16-17% of total exports until 2001;

• Re-exports made up half of what was exported and one-third of what was imported

  in 1995;

• Log exports totaled 69% of both total exports and customs revenues in 1995, dropping

  to .05% in 1996. Sawn timber exports have risen from 20 to 67% in the same period;

• Cigarettes account for 28% of import tariff revenues, while cement accounted

  for .87%;

• Switzerland exported the lions share of goods to Cambodia, more than all of East

  Asia, in 1995 accounting for 25.5 of total value - 10% more than Singapore;

• Gold imports accounted for most imports in 1995 - 35% of the total, dropping

  to 5% in 1996;

• The value of tax exemptions was nearly twice that of duties paid in 1996;

• Declared alcohol imports grew by 1,740% in 1994 after UNTAC left the country;

• Malaysia remains the leader in foreign-direct investment: 52% of fixed assets

  and 42% of registered capital. Taiwan has 4.2% of fixed assets and 4.5% of registered

  capital, but can potentially employ 26,000 workers as opposed to 20,500 for Malaysia.

Source: Customs Dept and other government agencies.