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From Africa Recovery, Vol.13#1 (June 1999), page 1
Likely revenue losses worry some Southern African states
South Africa and European Union conclude sweeping trade agreement
By Jacqueline Irving
South Africa has signed a wide-ranging trade pact with the European Union (EU), which South African Minister of Trade and Industry Alec Erwin described as "the most comprehensive economic agreement" the country has ever concluded with "any other partner." But several of South Africa's smaller regional trading partners are likely to be hard hit by revenue losses and other repercussions of the new arrangement, concluded with the EU on 26 March.
Botswana, Namibia, Lesotho and Swaziland will stand to lose up to 15 per cent of fiscal revenue as tariffs are scrapped under the pact. Because of their strong economic ties to South Africa through the Southern African Customs Union (SACU), the deal means the four smaller economies will be obliged to accept a de facto free trade area with the EU. South Africa, however, must still win the unanimous support of its SACU partners before the deal can take effect.
And because of South Africa's membership in the 14-nation Southern African Development Community (SADC), the agreement has broader significance for other countries in Southern Africa, raising fears that many sectors across the region will become vulnerable to intense competition from European producers (see "Trade pact's wider Souther African impact").
The Trade, Development and Cooperation Agreement (TDCA) will open up South Africa's market to 86 per cent of EU goods over a 12-year period, while opening the 15 EU economies to 95 per cent of South African goods over a 10-year period. The EU -- already South Africa's largest market, source of foreign investment and development aid -- pledged to drop average duties on South African goods from 2.7 per cent to 1.5 per cent. For its part, South Africa agreed to cut average duties on EU goods from 10 per cent to 4.3 per cent. The deal is also notable for the EU because it constitutes the first time that the regional grouping has included agriculture in a bilateral free trade agreement. Following ratification by South Africa and the EU, the agreement is slated to be phased in beginning in January 2000.
Many exceptions and protocols
The result of nearly four years of hard-nosed bargaining during 22 rounds of talks, the final compromise includes many exceptions and protocols. Following two days of intense discussions in March, the final barriers to reaching agreement were swept away when Spain and Portugal agreed to drop their long-standing objections to the use of the terms "sherry" and "port" by South African fortified wine producers in their domestic market for a further 12 years. The two EU states argued throughout the trade talks that the terms should be reserved exclusively for fortified wines produced in the regions of Jerez, Spain, and Oporto, Portugal.
Under the eleventh-hour compromise, this contentious issue is to be revisited at the end of the trade pact's phase-in period, when "new denominations" for those products will be jointly agreed by South Africa and the EU. Clearly displeased that the final deal basically grants the EU a right to veto the use of "port" and "sherry" on South African wine labels, the South African Port Producers' Association quickly announced its intention to challenge the decision by taking the case to the World Trade Organization.
Lingering concerns of Spain, Portugal, France, Italy and Greece that the EU's terms in the agricultural sector were too generous had also delayed conclusion of the deal. Fearing damage to their fruit, fruit processing and cut flowers sectors, in February the five EU states vetoed a draft agreement brokered by Mr. Erwin and Mr. João de Deus Pinheiro, European Commissioner for Development. But as the talks entered their final stages, all five states agreed to compromise. The final agreement grants South Africa sizeable zero-tariff quotas, which allow the country to export a predetermined volume of goods in these sectors on a duty-free basis.
Negotiations continue separately on a fisheries deal, as well as a wider agreement on trade in wines and spirits. The EU insists on maintaining trade restrictions on South African fishery products until South Africa opens its waters to EU fishing boats.
Controversial agricultural deal
South African fortified wine producers are not alone in harbouring concerns about the deal's impact on South Africa's economy. Some South African agriculturalists complain that only 61.4 per cent of the country's farm products will gain unrestricted access to EU markets, while trade barriers on another 13 per cent (including table wine) will be partially liberalized. In contrast, South Africa is obliged to scrap tariffs on 95 per cent of agricultural imports from the EU over a 10-year period.
A comprehensive study on the region-wide impact of the deal, carried out in April 1999 by the Johannesburg-based South Africa Foundation (SAF), refers to the agricultural side of the agreement as "perhaps the most controversial," while noting that South Africa nevertheless did manage to improve access for key products in the final negotiations. The study, South Africa and the EU: the Free Trade Agreement and Related Developments, refers to the EU's practice of generously subsidizing its agricultural exports (through the much-criticized Common Agricultural Policy) as a factor that will continue to impede the ability of South African agricultural producers to compete in international markets. Already hard hit by competition from heavily subsidized EU goods, local manufacturers of processed fruits and vegetables are expected to suffer further losses because the trade agreement obliges South Africa to cut customs duties on these products.
The SAF study describes the trade deal's initial impact on South Africa's economy as "limited" because significant sections of EU-South Africa trade are already "substantially duty-free." However, the study does conclude that over time, access to the European market will increase for South African producers, imported capital and consumer goods will be available more cheaply to producers and consumers, and the South African economy's competitiveness will generally increase.
BLNS adjustment costs
But it is the economies of South Africa's SACU neighbors -- Botswana, Lesotho, Namibia and Swaziland (known as the BLNS countries) -- that will feel the harshest effects of the trade deal. Having achieved the deepest form of regional integration on the African continent, SACU links the trade regimes of its five members and also interlinks the value of the currencies of SACU members, with the exception of Botswana's currency, the pula. Since trade between SACU economies is tariff free, a South African free trade agreement with the EU would therefore in effect be extended to the smaller BLNS economies.
And because the five Southern African countries share common external tariffs, the erosion of these tariffs over the next 12 years under the terms of the South Africa-EU trade pact is expected to impose considerable adjustment costs. BLNS governments rely heavily on revenue from customs duties, which provide around half of total government revenue for Lesotho and Namibia, about one-third of Swaziland's fiscal revenue and 14 per cent of Botswana's fiscal revenue, according to an April 1998 working paper issued by the European Centre for Development Policy Management. With the EU as the source of 42 per cent of SACU imports in 1997, this means BLNS governments face a worrying loss in fiscal revenue. The BLNS countries could see revenue cutbacks of as much as 15 per cent (R1.9 bn to R3.5 bn per year), as tariffs on EU imports erode. Their customs revenue from non-EU imports may also fall as EU imports increase their SACU market share due to the lower tariffs, projects the SAF study.
Citing the results of studies commissioned by the BLNS states and financed by the EU, a January 1999 memorandum prepared jointly by the BLNS governments predicts that revenue losses associated with the South Africa-EU agreement will have "particularly severe" effects on the budget deficits of Lesotho and Namibia, which stand to lose some 13-21 per cent and 9-14 per cent of fiscal revenue, respectively. The revenue losses will also have "serious consequences" for Swaziland, says the memo, with only Botswana appearing to have any "real scope" for making the personal and corporate income tax increases that would be required to manage the fiscal adjustments.
Alternative revenue sources
"We certainly are looking at alternative [revenue sources] now, being aware of the fact that the revenue pool is not going to be there forever," Mr. Mpho Malie, Lesotho's Minister of Industry, Trade and Marketing, told Africa Recovery. He cited royalties from the country's massive Highlands Water Project and extra taxes on cigarettes and liquor as possible ways of compensating for some of the revenue shortfall. But if the reduction of fiscal revenue from the SACU external tariff barrier is "well planned and well phased, then we would be able to deal with it," Mr. Malie added.
Noting that the phased nature of the trade agreement means that it will mainly affect fiscal revenues in the second half of the next decade, Ms. Musa Fakudze, Principal Secretary to Swaziland's Minister of Finance, says that her government has already begun considering measures to address the expected fiscal impact. Proposed measures include a review of the tax system as part of a revenue diversification package and improvements to public sector management.
"It is conceivable that the tax base will be broadened by being able to import more goods from the EU at comparatively cheap prices -- including production inputs that have been barred from entering our markets because of the [SACU] tariff," Mr. Hidipo Hamutenya, Namibian Minister of Trade, recently told Africa Recovery. Taking an overall positive view of the trade agreement's medium- and long-term effects, Mr. Hamutenya sees the liberalization of the external SACU tariff as "an opportunity for us now to be able to develop our own capacity for revenue collection."
Similarly, Mr. Prega Ramsamy, Deputy Executive Secretary of SADC, explained to Africa Recovery how the scrapping of tariff walls could actually have beneficial effects on fiscal revenue and the overall economy in cases where producers buy inputs more cheaply from the EU and "plow back this money that they have not paid to the government in the form of customs duties into their own productive units, or to improve their businesses." And, of course, increased corporate profits could mean increased corporate tax revenues. But Mr. Ramsamy emphasized that creating a free trade area is a "win-win situation" so long as the economies involved take an "incremental approach."
EU support package
The EU must "fully recognize the seriousness of the adjustment effort" that the anticipated revenue cutbacks will impose on the BLNS countries, "if fiscal stability is to be promoted," urges the January BLNS memorandum. For its part, the European Commission stresses that the revenue cuts will occur only gradually and it has offered to provide a "support package" to ease possible difficulties in these countries as the external tariff is gradually dismantled.
In late May, the EU gave some $1.3 mn to Swaziland to help cushion the impact of the trade deal. "The idea is to help Swaziland cope with any fall-out or effects from the South Africa-EU free trade agreement," Mr. Pierre Bide, an EU economist in Swaziland, told the UN's Integrated Regional Information Network. "We want to help build economic capacity in that country." He said that similar compensatory packages were being considered for Botswana, Lesotho and Namibia, but that a meeting scheduled for June to take up the issue had been postponed for several months.
Other factors at play -- such as SACU members' negotiations on reform of their own customs union -- could lead to further erosion of revenues from customs duties, Mr. Sam Geiseb, acting Chief Executive of the Namibia Chamber of Commerce and Industry, told Africa Recovery. At present, income from the region's customs and excise duties is pooled and then distributed to BLNS countries according to a complicated formula, with South Africa receiving remaining income after the BLNS countries are allocated their fixed share. This has been one of the thornier issues on SACU's agenda for some time: negotiations to reform the overall pact governing the regional organization have been under way since 1994. Only a few days after reaching agreement with the EU on the trade pact, South Africa and its four SACU partners met in Pretoria to discuss South African proposals for revamping the revenue-sharing mechanism.
At the same time, South Africa used the meeting to try to convince its SACU partners that its free trade agreement with the EU also would benefit their economies. This was particularly necessary as any bilateral trade deal with non-SACU countries requires the approval of the other SACU members.
Limited consultation
Because the agreement was "designed with a strong regional component," an April 1999 report on the TDCA published by the EU Commission specifically states the EU's conviction that "in the long-term the EU-South Africa free trade agreement will have net positive effects for Botswana, Lesotho, Namibia and Swaziland." According to the report, the BLNS countries were consulted regularly by both the South African government and the EU Commission to ensure that the trade agreement would "be of benefit for the Southern African region as a whole."
But Mr. Malie, Lesotho's Minister of Industry, Trade and Marketing, recently expressed concerns that BLNS trade ministers were largely "kept out of the picture" during the lengthy negotiating period. Pointing out that information on the emerging trade deal was relayed to BLNS ambassadors in Brussels rather than directly to the countries' trade ministers, Mr. Malie described both the South African and the EU negotiating teams as being "fairly cagey about what was being discussed." While making clear that the BLNS countries acknowledge there are more advantages than disadvantages associated with free trade in the long run, he felt that the SACU agreement meant "South Africa ought not to have moved into that kind of negotiation without taking members' concerns on board."
"We were anxious to take part, but unfortunately the EU actually told us that we should not participate in the whole thing," Ms. Fakudze said. "We all understood that these were supposed to be negotiations between South Africa and the EU. But despite that, they undertook to brief us now and again and they were also looking at our own positions as BLNS countries," Ms. Fakudze added.
Flood of imports
Some sectors will be particularly vulnerable as SACU economies are opened to EU competitors. "The flood of imports of subsidized EU agricultural products will definitely impact negatively," said Mr. Hamutenya, noting that up to 70 per cent of the population in the SACU region is employed in agriculture. Many local observers argue that the export of cheaply priced agricultural goods by the EU to SACU countries constitutes a form of unfair trade known as "dumping" because of the generous subsidies under the EU's Common Agricultural Policy.
Agricultural products -- such as dairy products in Namibia, canned fruit and jam in Swaziland, asparagus in Lesotho and flour-based products in Botswana -- figured prominently on a list of sectors, cited in the BLNS memorandum, where "difficulties could emerge." Moreover, the document pointed out that the anticipated difficulties faced by SACU producers could range from a loss of domestic market share to EU producers in certain sectors, to a loss of region-wide (SACU) market share and, in some sectors, complete loss of the South African market. Furthermore, some SACU producers faced with large market-share losses likely would be forced to incur significant restructuring costs or close down. Some 12,000 full-time workers across the SACU region are potentially affected, according to the memorandum.
The April 1999 European Commission report concedes that some SACU sectors "might suffer adjustment costs" and admits that certain sectors may need continued protection. For example, throughout the trade pact negotiations, Namibia in particular was worried about its beef industry, with meat products accounting for some 70 per cent of the country's exports. Swaziland was worried about its sugar sector, which provides 17 per cent of its export revenue.
Speaking at a 1997 conference of the European Network for Information and Action on Southern Africa, Mr. Pinheiro specifically referred to the exclusion of sensitive sectors such as beef and sugar from any free trade agreement between the EU and South Africa as "the most effective defensive instrument." During the conference, Mr. Pinheiro also made clear his conviction that "sensible plumbing and engineering" could keep painful short-term effects for South Africa and its SACU neighbors to "an absolute minimum and will be far outweighed by [the agreement's] positive effects."
Consequently, beef and sugar were both excluded from the final trade agreement. Moreover, the pact includes a safeguard clause that can be invoked to protect infant industries in the SACU region.
But the exclusion of beef from the free trade agreement will not protect Namibia's beef sector from cheaply priced EU beef products, predicts the SAF study, which notes that highly subsidized beef from the EU is already used in 70-80 per cent of all canned meat in South Africa.
Swaziland's sugar producers also find it difficult to compete with EU sugar sold in the region at artificially cheap prices. And the expected increase in EU exports of products containing sugar (such as beverages and biscuits) to SACU countries under the TDCA will further lower demand for Swazi sugar, according to Mr. Mike Matsebula, Chief Executive Officer of the Swaziland Sugar Association. Faced with lower demand within SACU, Swaziland will be forced to sell more sugar on the world market where the price is much lower than the price in SACU markets, says Mr. Matsebula.
Monitoring problems
"Of course, the problem is that although there might be some [safeguard] mechanisms in place, the fact that [SACU] is a common market really makes it difficult to monitor where these products land and how they actually flow in the market," added Mr. Geiseb.
The trade ministers for Lesotho and Namibia recently expressed similar concerns, stating that they really do not yet know whether the agreed infant industry safeguard clause and protection accorded to sensitive sectors will provide effective protection. Mr. Malie mentioned that he and the other BLNS trade ministers planned to meet in the near future to "flesh out some of the concerns that we have in order to take them up with the EU."
But Mr. Hamutenya stresses that there will be gains as well as losses associated with the trade agreement, with SACU "consumers certainly better off" in terms of the range of cheaper products available. He also believes that it is important for local beef and other agricultural producers to adopt a more aggressive attitude to marketing and to begin to diversify their export markets.
"No doubt the EU-South Africa trade agreement will force the pace of tariff reduction," says Mr. Hamutenya. Noting that South Africa built a high wall of protective trade barriers during the apartheid years, Mr. Hamutenya adds that "it's critical that sooner or later we're going to have to face up to this reduction because of World Trade Organization pressure that tariffs must come down."
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