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Cafta: Trade deal has hidden qualities

The Financial Times Limited 2008

Adam Thomson

In May 2004, when government officials from the US, Costa Rica, Honduras, Nicaragua, El Salvador and Guatemala gathered in Washington to sign a 2,400-page trade agreement, there was a sense of achievement in the air.

The Central American Free Trade Agreement, Cafta, would bring the region closer to the US, its main trading partner. Commerce would flow like it had never done before, investment opportunities would flourish and prosperity and development would gradually spread.

Four years later, that early enthusiasm and optimism has come down several notches. Implementation of the accord has been slow and inconsistent. El Salvador completed ratification of the treaty, including all associated legislative changes, in March 2006; Costa Rica has still not implemented the treaty, and progress has been painfully slow since the country voted in favour of Cafta in last year’s referendum.

Moreover, there have been diverging signals in terms of the benefits. While exports to the US have risen – Nicaragua’s exports to the US grew 24 per cent in 2006 compared with the previous year – so have imports from the US.

To take just one example, Guatemalan exports grew 6 per cent in 2006, about 7.5 per cent in 2007 and are expected to climb nearly 9 per cent in 2009. Yet imports, which grew 11 per cent in 2006, are predicted to grow almost 15 per cent in 2009.

In large part, the faster growth of imports has come about because almost all of the region’s exports to the US already entered free of tariffs as part of the Caribbean Basin Initiative, which was introduced by Washington in 1983 and implemented the following year. Meanwhile, Cafta’s implementation meant that 80 per cent of US industrial goods and more than half of its agricultural products could enter Central America duty free with immediate effect.

A report on Central America by the Inter-American Development Bank (IDB) last year left no doubt about the likely result. “The increase in purchases from the US will probably translate into new imports [to Central America] rather than a substitution of existing ones from other regions ... This could imply an increase in the region’s trade gap.”

All this has led Jaime Granados, a specialist in Central American trade at the IDB, to conclude: “The expectations surrounding Cafta so far have been greater than the results.”

Even so, Mr Granados and other analysts recognise that Cafta has brought overall benefits for Central America. One is foreign direct investment, which has deepened thanks to investor perceptions of much clearer and more binding rules and guarantees. As Marco Vinicio, Costa Rica’s foreign trade minister, told the FT recently: “Cafta has given foreign businesses enormous legal security.”

There have already been a string of notable examples. In April, International Textile Group, a US-based fabric manufacturer, opened a denim factory just outside Managua, Nicaragua’s capital. The plant, which was first announced in 2006 and employs 850 people, plans to produce 28m yards of denim a year. The $100m investment is equivalent to about 2 per cent of the country’s gross domestic product (GDP).

One of the benefits for ITG of settling in Nicaragua was the country’s negotiation with the US to establish a nine-year Tariff Preference Level, which allows the textile sector to import large volumes of fabric from third countries for manufacture without endangering Cafta’s rules-of-origin clauses.

According to ProNicaragua, the government agency responsible for encouraging foreign investment, the measure has attracted an additional $265m investment in the textile sector since ITG made its announcement.

A second high-profile example came in July 2006 when HSBC announced that it would buy Banistmo, Central America’s largest bank.

The UK-based financial group agreed to pay $1.7bn for Banistmo, which owns almost all of Panama’s leading bank and had a presence in Honduras, Costa Rica and Nicaragua.

Cafta has brought improvements to the region in at least two other areas. First, the agreement has forced Central American nations to streamline procedures and strengthen trade institutions. Much of the paperwork that exporters had to endure previous to the agreement has been turned into online application processes, saving companies time and money employing people to stand in long queues in government offices.

Government procurement procedures are gradually becoming more transparent and in line with those of their neighbours. Over time, the hope is that government purchases will require less paperwork, and end up costing much less.

Second, there are some signs that Cafta is persuading many businesses in the region to move from the informal to the formal sectors as they attempt to take advantage of its perceived benefits. In Guatemala, the number of businesses joining the country’s official business registry grew 15 per cent in 2006 compared with the previous year.

That sort of growth is particularly encouraging in a region that has long suffered from low levels of government income that result from large and unmonitored economic sectors. In Guatemala, the government’s tax take is still only equivalent to about 12 per cent of GDP, one of the lowest in Latin America.

Beyond these positive signs, however, all the potential that governments and investors identified in Cafta has remained just that.

Mr Granados argues that, to take full advantage of the agreement, countries need to “improve institutions, the rule of law, physical infrastructure, promote education and technological innovation, [and have] sound finances, macroeconomic stability and adequate social-safety nets”.

As anyone who has even a passing acquaintance with Central America knows, that is considerably easier said than done.

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