Rules of origin need proper perspective under trade pacts

Financial Express, Delhi, 10 May 2004

OP-ED: Rules of origin need proper perspective under trade pacts

RAM UPENDRA DAS

Rules of origin (RoI) are emerging as one of the most important issues in the context of preferential trading relations of a country. They are a set of instruments, a lack of consensus on which can, and have, delayed several agreements on trade. For instance, they have delayed the implementation of the Draft Framework Agreement on the India-Thailand free trade agreement (FTA). The recently signed South Asia Free Trade Agreement (SAFTA) treaty has also kept this issue open for further negotiations, while it was with great difficulty that India and Sri Lanka agreed upon RoIs during the negotiations for their bilateral FTA a few years back. The absence of provisions relating to origin-rules under the India-Nepal FTA too raised concerns about imports from Nepal into India, thereby having adverse implications for some Indian domestic sectors. The problem was finally tackled by setting these rules in place during subsequent negotiations. Even within the ambit of negotiations on non-preferential rules of origin under the WTO framework, consensus on this issue has proved to be elusive.

The obvious question that follows is why RoIs are so important as to have such a strong bearing on the outcome of international trade negotiations. The answer perhaps lies in the conceptual ambiguity which envelopes this policy instrument in developing countries. Whether or not a product has originated in a particular country is decided if the product has undergone substantial transformation. There are three major ways of determining this:

- First, the change in tariff-heading test, implying that the tariff-heading of the final product is different from the tariff-headings of its inputs.

- Second, a percentage test is applied, according to which a minimum percentage of total value addition should be achieved with the help of domestic inputs.

- Finally, specified process tests require a product to undergo certain stipulated processes.

However, agreement on implementing these tests is often difficult. For instance, the extent of ’substantial transformation’ for different products would depend on the level of disaggregation (ie, HS 4- or 6-digit level) on which tariff-shift is envisaged. Similarly, fixing of percentages of minimum value addition varies between products, depending on the prevailing labour costs and the product-specific import dependence of the country in terms of intermediates.

In this context, it is worth recalling the nature of of policy concerns that were raised during the SAPTA negotiations. A few members viewed the system of RoIs as an obstacle to intra-regional trade flows. It was felt that diluted origin-rules facilitate intra-regional trade, as lack of adequate natural resources as well as intermediate and capital goods make these economies import-dependent, which in turn prevent them from meeting the local-content requirement of the RoI system. These policy conflicts can be resolved if the role of origin-rules are clearly understood.

One of the prime functions of RoIs is to prevent trade deflection in trading arrangements. In any FTA, members set their own external tariffs but give preferential treatment to each other. The divergence between external tariffs of the members and the preferential tariffs becomes a potential source of trade deflection. In the absence of any RoIs within the FTA, the country with the lowest external tariffs is likely to serve as an entry point into the partner’s market for the goods of the non-member countries. In this sense, RoIs are important tools for checking trade deflection of third country goods from one member country to another.

The three modalities of determining the origin of a product aim at substantial trasformation in inputs. Together, they facilitate value-addition in the manufacturing country and play a developmental role. Such requirements have the potential for generating backward and forward linkages in a country adhering to the rules.

Thus, a member country is prevented from becoming a mere trading country as these requirements act as a deterrent to assembly production kind of activities. However, RoIs should be designed in a manner that is not trade restrictive. They should not become trade barriers due to their complex methods of implementation.

Developed countries use RoIs for developmental purposes, although in some cases they do act as non-tariff barriers (NTBs). NAFTA or the North American Free Trade Agreement is a case in point, wherein for the automotive sector different percentages of the regonal value content are laid down for various phases. For instance, 56% between 1998 and 2002 and 62.5% thereafter for some categories of motor vehicles.

In the case of textiles and apparel, there is a "triple-transformation test" that requires fabrics or clothing items to be spun from yarns or fibres produced in North America as well as to be cut and sewn within the free trade area. Cutting does not determine the country of origin as the new rules are based on processing or assembly operations.

It is clear from the above that RoIs, if designed adequately can not only prevent trade deflection possibilities, but also act as a catalyst to value-addition efforts in members of an FTA. Their implementation should, however, not swing to the other side of spectrum wherein its effects are akin to NTBs. This remains a policy challenge, especially in FTA negotiations in the developing world.

The author is fellow, RIS, New Delhi. The views presented here are personal.