Apparel & Clothing Industry News

Summary

• In January 2010, China and ASEAN completed the formation of CAFTA to establish the world’s largest free trade area (FTA) by population and third largest FTA by combined GDP. After entirely phasing in the 5-year tariff reduction schedule for goods on the normal track, around 7,000 items traded between China and ASEAN are now zero-rated.
• ASEAN accounts for about 10% of Hong Kong’s total trade, surpassing that with NAFTA and trailing behind that with the EU. Due to the global economic downturn touched off by the financial tsunami, Hong Kong’s exports and re-exports of China-origin to ASEAN fell 17% in 2009.
• Analysis of trade before the plummet in 2009 shows that Hong Kong’s re-exports of China-origin to ASEAN grew at a double-digit rate from 2006-2008 after ASEAN’s tariff cuts were applied to China-origin goods, holding up well compared with 2002-2005 without showing very strong signs of trade diversion in favour of direct China-ASEAN trade.
• With electrical machinery and machinery accounting for a predominant part of Hong Kong’s trade with ASEAN or China, and many traded items already zero-rated due to WTO-ITA coverage, CAFTA tariff cuts have not adversely affected Hong Kong’s exports of electrical machinery and machinery, and in this connection, the broader re-export trade.
• Although Hong Kong is not a CAFTA member, Hong Kong manufacturers on the mainland can benefit from CAFTA’s zero-tariff treatment as they export their compliant China-origin goods to ASEAN, and their cost of importing ASEAN products like rubber and plastics is also lowered.
• CAFTA is expected to further promote China-ASEAN and intra-Asia trade alongside expanding intra-industry trade. With Asia becoming a more integrated production base for the global supply chain, this will help attract extra-Asia investment and Hong Kong, as a popular choice for regional headquarters and service platform, may benefit as a result.

Proliferation of free trade agreements in East Asia

Over the past decade, many Asian economies have shown a keen interest to forge free trade agreements (FTAs) with their trading partners inside and out of the region, in particular amid the slow progress of multilateral trade liberalisation under the WTO’s auspices. On the other hand, the importance of FTAs in promoting intra-regional trade, as well as shaping economic integration in Asia, is being increasingly recognised.

The 10-nation ASEAN, for example, has taken on a very active role in negotiating and entering into FTAs. For instance, FTAs have been signed to establish free trade zones with, respectively, China, Korea, Japan, New Zealand-Australia, and India. These six economies along with ASEAN have also formed the East Asia Summit (EAS) to explore ways to deepen regional economic cooperation and integration.

China has also become active in its pursuit of FTAs in the past decade. After joining the WTO in late 2001, the Chinese mainland signed an agreement with Hong Kong in 2003, the Closer Economic Partnership Arrangement (CEPA), which has since been strengthened in scope as well as extent of liberalisation by the annual Supplement additions.

Following the CEPAs signed with Hong Kong and Macau, both of which are Special Administrative Regions (SARs) of China, the Chinese government has entered into many other FTAs with its trading partners. Most of the FTAs are in Asia, with some in Latin America and Africa. Among these FTAs, the one with ASEAN pertaining to the establishment of CAFTA is the first “external” FTA signed by China, and perhaps the most notable one implemented thus far with a bearing on Hong Kong.

Completion of CAFTA in 2010

Both China and ASEAN started to implement the CAFTA’s Trade in Goods Agreement with import tariff reductions from July 2005, with the five-year tariff reduction schedule entirely phased in from January 2010. This signified the completion of CAFTA while creating the world’s largest free trade area by population (i.e. 1.9 billion). With a combined GDP estimated to be about US$6 trillion, CAFTA trails only the European Union (EU) and North American Free Trade Agreement (NAFTA) in terms of GDP.

Tariff Rate Cut Schedule for China & ASEAN-6 on Normal Track

Source: Association of Southeast Asian Nations

CAFTA is being seen as a major step to expanding pluralistic trade in the region, as it involves 11 countries in Asia that account for a significant share of intra-regional trade. The IMF estimates that more than half of the trade conducted by Asian economies is intra-regional, with an even higher ratio for the trade in parts and components. With CAFTA, import tariffs on traded items on “Normal Track” have been reduced in four phases (2005, 2007, 2009 and 2010) for ASEAN-6 (i.e. the six original ASEAN members of Brunei, Indonesia, Malaysia, the Philippines, Singapore and Thailand). Tariff reductions on selected “Sensitive Track” items will be eliminated by 2018.

The average tariff on ASEAN-origin exports to China is lowered to 0.1% in 2010, while the average tariff on China-origin exports to ASEAN-6 is slashed to 0.6%. Currently, around 7,000 items traded between China and ASEAN are zero-rated. By 2015, the policy of zero-tariff rate for 90% of traded goods is expected to apply between China and the four new ASEAN members of Cambodia, Laos, Myanmar and Vietnam.

Owing to the global economic downturn, China-ASEAN trade shrank by 8% year-on-year (YoY) to hit US$212 billion in 2009; trade with ASEAN represented close to one-tenth of China’s total trade for the same period. Hence, ASEAN is China’s fourth largest trade partner, whereas China is ASEAN’s third largest trade partner.

Prior to 2009, China-ASEAN trade had already been fast expanding, with bilateral trade growing by about 24% annually from 2003 to 2008 to reach US$231 billion in 2008, almost tripling the 2003 level of US$78 billion. Since China has yet to secure any FTA with its top three trading partners, namely the EU, US and Japan, which have a combined share of more than 40% of China’s total trade, China’s FTA with ASEAN would therefore be the most significant FTA achieved among its trading partners.

The table above shows that China-ASEAN trade from 1997 to 2005 had grown at an average annual rate or CAGR of 23%, slightly faster than the CAGR of 20% for overall trade, and higher than the CAGR for either China-EU trade (22%) or China-US trade (20%). From 2006 to 2008, when CAFTA’s first two phases of import tariff cuts were implemented, China-ASEAN trade rose at a CAGR of 20%, similar to the CAGR of 21% for overall trade.

Comparing CAGRs between 1997-2005 and 2006-2008, most of China’s trading partners did not see CAGR deviate much from one period to another, with the CAGR for China-ASEAN trade down slightly from 23% to 20%. Yet, there are a few exceptions. Growth of China-US trade slowed down sharply from a CAGR of 20% during 1997-2005 to 13% during 2006-2008. Similarly, the CAGR of Taiwan-mainland trade went down by almost 12%. Australia is the only exception with a much quickened CAGR in its trade with China, with the CAGR for 2006-2008 rising to 34% from 23% during 1997-2005.

It is worth noting the expanding role of China-ASEAN trade in China’s overall trade in recent years. It ranked among the fastest growing with China’s trading partners during 2006-2008 despite a lower CAGR compared with 1997-2005. Besides, China-ASEAN trade dropped only 8% in 2009, bested only by China-Australia trade.

Regarding the mix of China-ASEAN trade, it has witnessed drastic changes over the past two decades. Chinese exports to ASEAN are relatively more diversified, including such items as electrical machinery, machinery, ships and boats, minerals and fuels, optical and medical instruments, metal articles, vehicles, iron and steel, textiles and apparel, vegetables and footwear.

Evidently, the importance of electrical machinery and machinery in Chinese exports has grown significantly, with the corresponding share surging from 28% in 1997 to 45% in 2008. Hurt by weaker global demand for electronic goods and related products, Chinese exports of electrical machinery alone declined by 17% YoY in 2009. Consequently, the combined share of electrical machinery and machinery nudged down to 42% of Chinese exports to ASEAN in 2009.

In comparison, China’s imports from ASEAN are relatively less diversified, with the bulk consisting of electrical machinery and machinery, minerals and fuels, plastics, fats and oils, rubber and organic chemicals. In the years preceding the Asian financial crisis of 1997-98, top ASEAN exports to China remained oil and fuel, wood, oils and fats, electrical machinery and machinery. The importance of electrical machinery and machinery, however, was becoming increasingly visible towards 2000, with their weight continually growing through the last decade. Notably, more than 60% of China’s imports in 2008 were electrical machinery and machinery, more than double the corresponding share of 26% found in 1997.

This expanded share of electrical machinery and machinery in China-ASEAN trade clearly reflects the dramatic rise in intra-regional and intra-industry trade, with Asia increasingly turning into an integrated production base for the global supply chain.

Hong Kong-ASEAN trade

In the past two decades, Hong Kong has greatly benefited from the flourishing trade between the Chinese mainland and ASEAN, thanks to its strategic location between the mainland and ASEAN, as well as its excellent transportation and business infrastructure and network. ASEAN as a bloc accounted for about 10% of Hong Kong’s total trade in 2009, surpassing Hong Kong-NAFTA trade (i.e. the US, Canada and Mexico) and trailing fractionally behind Hong Kong-EU trade.

Although Hong Kong’s trade with ASEAN shrank by 12% YoY in 2009, with exports and imports declining by 17% and 10% respectively over the same period, double-digit growth in exports had been evident in the immediately preceding years. Notably, Hong Kong’s trade with ASEAN is among the fastest-growing trade with major trading partners, whether for the period of 2006-2008 when CAFTA was in force, or prior to CAFTA taking effect through the longer period of 1997-2005.

In 2009, the top 10 exports to ASEAN accounted for more than 70% of Hong Kong’s total exports to the 10-nation trade bloc, with the next 15 categories taking up another 21%. Exports of electrical machinery alone represented more than 40% of Hong Kong’s total exports to ASEAN, with double-digit growth reported in either the period of 2002-2005 or 2006-2008. Besides, the overall CAGR accelerated from 11% during 2002-2005 to 15% during 2006-2008. Regarding respective product categories, 13 out of the top 20 export items recorded trend increases between the two periods.

Impact of CAFTA tariff cuts on Hong Kong’s export performance

For China and ASEAN, the establishment of CAFTA and the removal of trade barriers among participating members are akin to market enlargement, as exporters are presented with the opportunities to sell into a larger and more integrated market (i.e. expanding intra-bloc trade), leading to better economies of scale, lower production costs, as well as higher efficiency and economic growth. While CAFTA members are naturally expected to benefit from trade creation, trade with non-members might decline as preferential treatment induces trade diversion (i.e. shrinking extra-bloc trade).

The Chinese mainland and ASEAN are respectively the largest and third largest trading partners of Hong Kong, a non-signatory member to CAFTA that may conceptually be suffering from trade diversion in its trade with CAFTA members. Yet, CAFTA’s impact on individual non-member economies could likely vary drastically, with the impact much depending on how well a non-member is linked individually to signatory members in terms of trade, production, supply chains and other business arrangements. In the case of Hong Kong, about half of its exports go to the Chinese mainland and it is the mainland’s largest source of inward foreign direct investment (FDI), including a fair share of manufacturing investment in the Pearl River Delta (PRD).

The bulk of Hong Kong manufacturing is now undertaken on the mainland, in particular the PRD, and CAFTA’s import tariff cuts will be extended to Hong Kong manufacturers on the mainland so long as they comply with the required country-of-origin rules (see section below).

Country-of-origin requirements for CAFTA’s preferential tariff treatment

From January 2010, around 7,000 items traded between China and ASEAN are zero-rated. Generally, the origin rules require that no less than 40% of a product’s value must originate in China or ASEAN, or the culminated CAFTA content of the final product is not less than 40%. Besides, products having received sufficient transformation can also be treated as originating goods.

The origin rules require additionally that the consigned products should primarily be transported through CAFTA. Where these products are transported through non-CAFTA territories, such as Hong Kong, neither should they be entered into trade or consumption, nor should they undergo any operations other than unloading or reloading.

Import tariff treatment – CAFTA and most-favoured Nation (MFN)

Imported items subject to higher CAFTA tariff rates relative to MFN rates would conceptually be affected by a larger extent than items which attract lower rates. In other words, the wider the CAFTA-MFN differential, the higher would be the likelihood of re-exports being shifted as direct trade. Since it is hard to list out the CAFTA-MFN differential for each individual tariff line, the MFN rates below indicate only the ranges of applicable import tariffs.

Broadly speaking, for items attracting higher MFN import tariffs, as in the case of textiles and garments, the MFN-CAFTA differentials would be wider, in particular after the last tranche of CAFTA tariff cuts took effect from 1 January 2010. On the other hand, for imports that are currently subject to nil or very low MFN tariff rates, such as products within the electrical machinery category, the MFN-CAFTA differentials could be zero or negligible.

Framework for analysing the impact of CAFTA’s tariff arrangements

Whether CAFTA creates net trade creation or diversion for its signatory members is not the main focus of this analysis, which instead places its attention on the extent to which Hong Kong as a non-CAFTA member would be affected. The issue at stake is whether there is any strong evidence of trade diversion of Hong Kong’s major exports to CAFTA.

As explained earlier, Hong Kong companies manufacturing on the mainland may have little difficulty in meeting the origin rules to enjoy CAFTA’s preferential tariff treatment as their indigenous counterparts, when their products are sold to ASEAN as China-origin products, either shipped direct from mainland ports or transhipped through Hong Kong.

With CAFTA tariff cuts, the bulk of trade volume growth should predictably be found in the direct trade between China and ASEAN. Over time, this will be reflected by a shrinking share of re-export trade via Hong Kong. Therefore, instead of looking at the share of China-ASEAN trade handled by Hong Kong, the current analysis on trade diversion is made on the basis of working out the CAGR differential between the period of 2006-2008 (when CAFTA tariff cuts were implemented) and the preceding period of 2002-2005.

The analysis purposely excludes the anaemic performance of 2009, because international trade was severely disrupted by the global economic downturn. If the trade performance of 2009 were to be included, the resultant CAGR would be a lot lower for 2006-2009, thus obscuring a meaningful comparison between the two periods. A CAGR for 2006-2008 that is considerably lower than that for 2002-05 suggests that Hong Kong’s re-export trade would be adversely affected.

Performance of Re-exports of China-Origin to ASEAN

The average annual growth of China-ASEAN trade was 20% during 2006-2008, edging down slightly from the CAGR of 23% during 2002-05. This sets the scene by highlighting that China-ASEAN trade shows no signs of significant pickup in the first three years after CAFTA tariff cuts were implemented. Nonetheless, Chinese exports to ASEAN surged during 2006-2008, with CAGR surging to 27% from 20% during 2002-2005.

In the case of Hong Kong, double-digit growth was witnessed in its trade with ASEAN or re-exports of China-origin to the 10-nation trade bloc through 2002-2008. The CAGR of China-origin re-exports to ASEAN for 2002-05 was 10%, two percentage points higher than that for 2006-08. Broadly stated, CAFTA tariff cuts introduced from July 2005 did not lead to any substantially adverse trade diversion for the period considered.

Re-exports of China-origin to ASEAN not adversely affected by CAFTA cuts

Treating electrical machinery alone, the CAGR differential between 2006-2008 and 2002-2005 was at best marginal. If the longer period of 1997-2005 was considered, Hong Kong’s re-exports of electrical machinery originating from the mainland actually accelerated by more than five percentage points to 13% during 2006-2008, from less than 8% during 1997-2005.

In 2009, Hong Kong’s re-exports to ASEAN of these China-origin items accounted for 65% of Hong Kong’s ASEAN-bound re-exports of China-origin. Reflecting the broader trade, these re-exports grew at a double-digit rate through 2002-2008. In essence, three of the top 10 re-exports of China-origin recorded double-digit growth during 2006-2008, while four out of 10 saw trend increases between the two compared periods.

It is also worth noting that CAGR for Hong Kong’s electrical machinery exports (of all origins) to ASEAN stood at 15% and 11% for the respective periods of 2006-2008 and 2002-2005, contrasting with CAGRs of 13% for the corresponding re-exports of China-origin items to ASEAN. It appears that Hong Kong’s concerned exports to ASEAN registered double-digit growth irrespective of country-of-origin.
 

Re-exports of ASEAN-origin to the mainland not badly affected by CAFTA

Many Hong Kong companies are engaged in outward processing trade on the mainland, and the raw materials, parts and components required for product manufacturing are excluded from application of import tariffs. The share of processing trade in China's total exports stood at 49% in 2009, edging down from 53% in 2006. Where import tariffs are applied to manufactured items like parts and components, they remain at relatively low levels.

From the table below, half of the top 10 re-exports of ASEAN-origin to the Chinese mainland recorded double-digit growth during 2006-2008, with one showing triple-digit growth. Besides, three of the top 10 items posted trend increases between the two periods. Electrical machinery and machinery represented a combined share of 81% of the concerned re-exports in 2009, and their CAGR reached 15% during 2006-2008.
 

Upswing of the global electronics cycle

The strong performance of Hong Kong’s exports of electrical machinery to ASEAN through the period of 2002-2008, including China-origin items, was closely tied to the upswing of the global semiconductor and electronics cycle since 2002, in tandem with a post-Internet bubble recovery.

The surge in sales of electronics, semiconductors and information technology products in the past decade or so owes much to the conclusion of the WTO’s Information Technology Agreement (ITA), which took effect in 1997 with participating members committed to eliminating import tariffs on covered products in four stages by 2000. The commitments undertaken under the WTO-ITA are on an "MFN" basis, meaning that benefits must be extended to all WTO members.

The WTO-ITA covers such products as telecommunications equipment, computer software, hardware and peripherals, semiconductors and electronic components, office machines, semiconductor testing and manufacturing equipment, and analytical instruments.  As such, many electrical machinery and machinery items under HS Chapters 84 and 85, as well as some under HS Chapter 90 (i.e. optical and related equipment), are now zero-rated in the trade among WTO members.

After becoming a WTO member in 2001, China was committed to eliminating import tariffs on covered ITA products by 2005, and so were some ASEAN participants that had kept import tariffs on certain ITA products beyond January 2000, like Thailand and Indonesia. Meanwhile, the number of ITA participants has grown to 70 (including China and most ASEAN members), representing about 97% of world trade in information technology products and accounting for more than US$1.5 trillion of exports worldwide.

For China, the combined electrical machinery and machinery exports to ASEAN as a share of corresponding exports grew from 28% in 1997 to 45% in 2008 to reach US$47.8 billion, whereas the import share surged from 26% to 60% to hit US$65.4 billion over the same period.

With electrical machinery and machinery also forming a big chunk of Hong Kong’s trade with either ASEAN or China, and many traded items already zero-rated thanks to the WTO-ITA coverage, CAFTA rate cuts would thereby not have much negative bearing on Hong Kong’s exports of electrical machinery and machinery, even though Hong Kong is not a CAFTA member.

Although re-exports of China-origin through Hong Kong, especially those with larger MFN-CAFTA differentials, may conceptually be affected more as per the origin rules on consignments through non-CAFTA territories, the impact on Hong Kong as a third-party trading partner is far from adverse. Take textiles for example, there is no strong sign of diversion of mainland fabrics re-exported through Hong Kong to ASEAN (6% share), with CAGR edging up to 8% during 2006-2008 from 7% during 2002-2005. On the other hand, re-exports of China-origin cotton (3% share) to ASEAN went down by about 3% between the two periods. In sum, current trade statistics do not support a notion that there has been a sizeable migration of Hong Kong re-exports in favour of direct shipment in China-ASEAN trade.

Varied growth of China-origin re-exports to ASEAN countries

Through 2002-2008, double-digit growth was recorded for Hong Kong’s total re-exports of China-origin to ASEAN, as for the top two re-export items of electrical machinery and machinery. While CAGR edged down somewhat between the two periods of 2002-2005 and 2006-2008, there are considerable variations in CAGR differential as far as individual ASEAN members are concerned.

Quickened CAGRs were noted in Thailand (up 4%) and Indonesia (up 10%), with lower CAGRs in Singapore (down 10%), Malaysia (down 11%) and the Philippines (down 4%). By and large, this reflects the ebb and flow of corresponding re-exports of electrical machinery and machinery to the concerned ASEAN countries, as they are the top two re-exports of China-origin to these countries, representing some 62-77% of Hong Kong’s China-origin re-exports to respective ASEAN countries. As previously mentioned, many of the items under these two categories are subject to zero-tariff due to the WTO-ITA coverage.

For Hong Kong’s third-ranked exports to the five ASEAN countries as listed in the table below, mixed performances are evident. Comparing CAGR changes between 2006-2008 and 2002-2005 shows re-exports of toys and games to Singapore decelerate, and re-exports of pearls and precious stones to Thailand gather pace. Of note is that Singapore is essentially a free port, while Thailand applies import tariffs on pearls and precious stones.

Yet, the combined value of these third-ranked items reached US$716 million or less than 6% of Hong Kong’s total re-exports of China-origin to ASEAN in 2009. Should re-exports to Singapore be excluded due to the country’s free-port treatment to imports, the concerned items totalled around 4% of Hong Kong’s re-exports of China-origin to ASEAN, not to mention that re-exports of pearls and precious stones to Thailand recorded a YoY increase in 2009 and a positive trend change. This also supports the earlier finding that Hong Kong was not adversely affected in re-export trade despite ASEAN implementing CAFTA’s tariff cuts.

Seacargo transhipments not adversely affected by CAFTA tariff cuts

CAFTA’s origin rules grant that consigned products transhipped rather than re-exported through a non-CAFTA territory like Hong Kong remain entitled to the preferential tariff treatment. Since airfreight is related to relatively time-sensitive items, many of which are electronics and telecom products and related parts that are subject to zero import tariffs, there is no compelling need for converting re-exports of these products to transhipments.

Predictably, airborne cargo, which features prominently in intra-Asia and Hong Kong-ASEAN trade, should largely follow the trend of re-exports through 2002-2008 as described in the preceding sections. From airfreight figures from Hactl, which handles about 80% of cargo moving through the Hong Kong Airport, about 30% of the cargo concerning the Southeast Asia is transhipment, with the rest being import and export cargo. In 2009, transhipment (consisting of both inward and outward cargo) concerning the Southeast Asia plunged by 15%, while the combined tonnage of exports and imports fell 5.7%.

As far as transhipment of seacargo is concerned, it has been a key driver of Hong Kong’s seacargo growth over the past few years, accounting for roughly two-thirds of the seacargo processed in Hong Kong. Transhipment of seacargo originating from the Chinese mainland accounts for about one-tenth of Hong Kong’s seacargo throughput, of which about 16% was attributed to ASEAN-5 in the first 11 months of 2009, when transhipment of China-origin seacargo dropped by 31%. Prior to that, ASEAN-bound transhipment of China-origin seacargo had grown eight percentage points from 11% during 2002-2005 to 19% during 2006-2008.

It is worth noting that CAGR for seacargo transhipment of China-origin actually went up between the two periods, meaning that CAFTA cuts have not induced a migration from Hong Kong’s port in favour of mainland shipment from mainland ports.

While it is likely that some less time-sensitive items that are subject to higher MFN tariff rates would shift from re-exports to transhipments as CAFTA tariff cuts are in force, the concerned transhipments of ASEAN-5 amount to no more than 2% of the seacargo that Hong Kong handles, and would at best have a very marginal effect on Hong Kong’s port activities.

Asia as an integrated production base, helped by lower input costs

Completing the establishment of CAFTA in January 2010 with elimination of tariff barriers is conducive for further driving down overall production costs and promoting the development of intra-Asia and intra-industry trade. Product differentiation and economies of scale are expected to grow over time and the role of Asia as an integrated production base for the global supply chain will also be strengthened. This should keep attracting extra-Asia investment to further strengthen production linkages in the region, and Hong Kong as a popular choice for regional headquarters and service platform may benefit as a result.

Besides, Hong Kong manufacturers on the mainland benefit from CAFTA’s zero-tariff treatment as they sell China-origin goods to ASEAN, and their costs of importing raw materials like rubber and plastics from ASEAN to their mainland-based factories are also lowered. This should also help them target the ASEAN market, in particular many middle-class ASEAN consumers who are sufficiently affluent to demand for products of better grades.

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