Cambodia’s Free Trade Agreement (FTA) with China kicks off a series of FTAs in future but for now, critics wonder what else the parties could bring to the table apart from what it already has to date

By the end of this year, Cambodia would have concluded its first Free Trade Agreement (FTA), and with no other than China.

In the background, the partial withdrawal of the EU’s Everything but Arms (EBA) preferential scheme would have taken its course on several lines of garment and footwear products – a process that might cost Cambodia approximately €1 billion or one-fifth of its annual exports to the bloc.

Added to the impact from the Covid-19 pandemic, Cambodia’s gross domestic product is projected to regress to -1.9 per cent this year, official data showed.

Talks on the FTA between both parties started late last year, rapidly culminating in a signing within eight months, perhaps the fastest on record for bilateral agreements, observed Dr Lili Yan Ing, lead adviser for Southeast Asia at the Economic Research Institute for ASEAN and East Asia (ERIA).

At the time of writing, little is known about the contents of this FTA, on the basis that the text was never shared publicly.

Fundamentally, it aims to enhance economic cooperation between the nations, unloading its benefits on the people through trade liberalisation in goods and services, and increased investments.

But the speed in which talks were completed, possibly due to the economic urgency, and in secrecy at that, elicits a level of suspicion over the outcome of the agreement, which could result in a lopsided deal benefitting the stronger assertive party, including its influence over dispute settlements.

Dr Yan Ing, a former senior adviser on trade and investment at the Indonesian President’s Office, agreed that should be the case because smaller countries tend to depend a lot on the larger countries in terms of the share of trade investments.

“It is also [the strength] of the negotiation team. We have to be honest with ourselves that, like most developing countries, we probably do not have enough lawyers, trained analysts, and economists to stand up for what our nations need,” she said.

This could leave Cambodia vulnerable to demands by powerful parties to amend domestic policies which undermine national interests and security. At times, changing government policies can result in investors suing them for loss of profit and alleged unfair trade practices.

To give an idea, as of December 31, 2019, out of 1023 known investor-state dispute settlement cases, only 674 have concluded, 343 are pending and six are unknown. The disputes are usually onerous, highly technical and often conducted in secret.

At the same time, the idea of signing the FTA amid a pandemic is somewhat disconcerting as it could restrict the regulatory and policy space which is presently requiring unprecedented measures to deal with the impact.

Analysts have cautioned that there could be future pandemics given that the world has experienced virus outbreaks such as SARS, MERS, Zika, swine flu and bird flu, which could force governments to enforce lockdowns in future.

On this pretext, Cambodia might need to add in a health exception at the very least, to make sure it covers all chapters in their FTA before it is signed and ratified so the Kingdom does not get caught out by the clauses in the agreement.

For instance, rules and commitments in the FTA might need to be reviewed to implement government measures in times of crises such as capital controls, sovereign debt restructuring or even manufacturing health products to meet local needs.

Cambodian think-tank Asian Vision Institute’s Centre for Governance Innovation and Democracy director Dr Chheng Kimlong does not think such commitments were included.

“It’s hard to focus on two different areas in one go. A separate discussion or negotiations can be conducted later if both governments wish to emphasise joint economic recovery strategies amid Covid-19 and other structural challenges and strategic cooperation,” he said.

Understandably, the effects of the FTA will likely take several months, if not years, to materialise.

“The agreement is a long way off from coming into effect. Only negotiations have been concluded and it still needs to be signed and ratified by both parties,” said Dr Jayant Menon, visiting senior fellow at the Institute of Southeast Asian Studies-Yusof Ishak Institute in Singapore.

But what makes the FTA interesting is that it falls outside the jurisdiction of the China-ASEAN FTA that was signed in 2010, and the impending Regional Comprehensive Economic Partnership (RCEP) involving all 10 ASEAN members plus six countries, including China.

Also, Cambodia has in its pipeline, FTAs with South Korea, India, the UK and Eurasia Economic Union, comprising East European nations and Russia.

Separately, Cambodia has in force 16 bilateral investment treaties (BITs) and 14 treaties with investment provisions (TIPs), mostly via ASEAN.

So, why sign an FTA with China?

Jayant says bilateral FTAs are supposed to be able to go further and deeper than plurilateral ones and therefore potentially have real effects on trade and investment flows.

“This could happen here, although a lot of the cross-border trade is informal or unrecorded, and occurs outside official channels,” he said.

The relationship between China and Cambodia dates back 2,000 years with a documentation of the life and culture of Khmer people by Chinese envoy Zhou Danguan, and regular visits by Admiral Zheng He, a Ming Dynasty navigator, during his world voyages in the 15th century.

In the mid-1950s, Chinese Prime Minister Zhou Enlai, impressed by Cambodian Prime Minister Prince Norodom Sihanouk’s leadership in gaining independence from the French, struck up a friendship with him when they met in Bandung, Indonesia.

This paved the way for diplomatic ties that have lasted until now.

Today, China is the largest foreign direct investor in Cambodia, accounting for 43 per cent of a total investment of $3.5 billion in 2019, mostly in real estate and construction.

Source: General Department of Customs and Exercise, and National Bank of Cambodia staff calculation

Bilateral trade grew 27.3 per cent to $9.4 billion in 2019, said the Chinese embassy in Phnom Penh, with total two-way trade expected to hit $10 billion by 2023.

But while trade expanded between the nations, so did Cambodia’s negative trade balance, otherwise known as a trade deficit.

In 2018, bilateral trade amounted to $7.4 billion but the trade deficit stood at $6.02 billion, up from $4.5 billion in 2018.

Unlike China which exports raw materials for manufacturing and construction to Cambodia, the latter only exports around $800 million worth of agricultural products to China.

In the past, China has liberalised 94.1 per cent of tariffs under its FTA with ASEAN, whereas Cambodia has removed 89.9 per cent of tariffs based on the six-digit HS (harmonised system) code.

Under the Sino-Cambodian FTA, China will remove another four per cent, bringing its total tariff waiver for Cambodia’s exports to 98 per cent tariffs, while Cambodia waives a meagre 0.1 per cent of tariffs on Chinese imports.

The tax waivers will be gradually reduced in the next 10 years.

Cambodia expects an additional 340 items to some 10,000 items to be exempted from tax, Ministry of Commerce secretary of state Sok Sopheak, who led the FTA negotiations, said late last month.

For now, exempted items include pepper, dried chilli, cashew nut, garlic and honey, he said, adding that there are sufficient means to produce goods for export to China such as vegetables, fruits, fish and meat.

Cambodia hopes to add milled rice, natural rubber and sugar into the tax-exempted list leading up to the ratification of the agreement.

On the other hand, China will have more than 9,500 tax-free items for export in the coming years.

This can pose a challenge to Cambodia because cheaper Chinese products than locally- produced goods can worsen Cambodia’s trade balance. But this is most likely not a major concern in the FTA.

“The focus of the deal is to promote some exports of agricultural products and agro-industrial goods,” Kimlong said.

No benefit vs costs study

However, this is mere speculation as the government has yet to share the textual content of the FTA which will be made public after the signing, tentatively on August 12.

“That would be too late because the deal is done,” said an analyst, who spoke on condition of anonymity due to his close working relationship with global south governments.

Similarly, it is uncertain if Cambodia commissioned economic modelling on the likely impact on its exports and goods trade balance with China, given that the tariffs will be removed.

The economic modelling is commonly done by some governments before signing or ratifying FTAs to ensure the benefits outweigh the costs.

When asked, Sopheak said answers to a series of questions submitted to him would be handled by Kemvichet Long, deputy director-general for International Trade at the Ministry of Commerce.

However, on the question of whether the study was conducted, Kimlong said, “I don’t think so.”

Then how can Cambodia sign and ratify an FTA if it does not know whether the benefits outweigh the costs?

“The government has made some assessment of the potential gains from the deal. The Ministry of Commerce must have done so and consulted with various government bodies,” he replied.

Source: Investment Dispute Settlement Navigator , UN Conference on Trade & Development (Dec 31, 2019)

China’s dominant role

However, ERIA’s Yan Ing is confident that the FTA deal will be in favour of China which continues to face trade tensions with the US.

“The tension among businesses and the US society has been escalating. It’s the same in China. I don’t think the tensions will ease in reality, even if it does at the political level or if [US presidential candidate] Joe Biden takes over the administration,” said the senior economist.

Based on this premise, Yan Ing opined that China must have first initiated the bilateral FTA in a desperate bid to relocate some of its vast investments.

And using its dominance as the second-largest economy, coupled with the likelihood of it becoming the largest investor, particularly in most Asian countries, means that it might have taken the lead in the Cambodia-China FTA.

“I see very little value-adding for Cambodia in terms of tariff reductions, but on the positive side – and I am trying to understand Cambodia and putting myself in its shoes – I think Cambodia is trying to increase investments from China because investments in China have been leaving.

“[This] are either Chinese-origin investors or foreign investment in China [who] are trying to relocate their investments. Of course, the relocations are either to Vietnam, Thailand, Malaysia, Indonesia and perhaps to some extent Cambodia and other ASEAN countries,” Yan Ing said.

Accordingly, this would be China’s third bilateral FTA in Southeast Asia, more than a decade after it signed with Singapore and Thailand.

But things have changed. In the past years since its regional FTAs, the global narrative on China has shifted, heavily laced with criticism over its overarching investments and quid pro quo demands.

However, this did not shake Cambodia’s relationship with China, whom it has largely benefitted from via aid and nearly $5 billion worth of loans.

On a general level, since Cambodia is already a relatively open economy with low tariffs, an FTA with an important trade and investment partner like China can be beneficial in economic terms, Jayant said.

If it can address the many non-tariff barriers that currently impede trade, then the benefits will be even larger.

“This FTA with Cambodia might help China strengthen and cement existing diplomatic and political ties.

“It is probably driven more by political rather than economic imperatives. China may be looking to shore up its allies in a region growing increasingly suspicious of its motives as it pursues a more aggressive stance concerning the South China Sea, in particular,” he said.

But Jayant warned that Cambodia’s growing dependence on China increases its vulnerability to external shocks emanating from just one source.

“To reduce this risk, Cambodia should look to further diversify its trade and investment flows, so that it is not overly dependent on one or a few trading partners.

“This FTA should be considered carefully in the context of how it affects the diversification objective, or how it increases dependency,” he said.

Can it make up for EBA losses?

Ministry of Economy and Finance spokesman Meas Soksensan flatly said no.

“The FTA is not compensation for the EBA. It is a win-win agreement,” he stressed.

Kimlong concurred, adding that the FTA is not likely to cover the losses due to the different product line and categories to China.

“However, there is an urgency and vital significance in diversifying export markets and trade partnerships with the rest of the world to reduce risks,” he said.

Associate professor Samreth Sovannroeun, an economics lecturer at a Japanese university, said: “To me, this should be considered in different dimensions.

“In terms of the substitution of the market, the Cambodia-China FTA will not help to make up the possible loss from the partial withdrawal of the EBA scheme, given that China is also an exporter of garment products.

“It is hard to consider that Cambodia can increase its export of these products to China, after this FTA comes into effect, at least in the short-term.

“However, in terms of export value, this FTA may help to make up the loss from the partial withdrawal, although the extent to which it can help is the subject for detailed investigation.”