Changes in the Rules of Origin of EU-GSP Scheme and Bangladesh’s RMG Industry

Bangladesh Garments Worker StencilBangladesh has graduated rapidly from being a predominantly aid-dependent country to an external-trade driven one, and the ready-made garments manufacturing industry has played a pivotal role in this process. During the past decades, various national and international institutions and their policies have been instrumental behind the rapid growth of this premier foreign exchange earner. The relatively favored market access terms the European Union’s Generalised System of Preferences (GSP) scheme offers for least-developed countries has   provided the apparel sector with its biggest destination of export. Any amendment in the provisions of this international trade arrangement, such as the changes made on 18th November 2010 by the European Commission (EC) in the rules of origin (RoO) system that came into force on 1st January 2011, would, understandably, generate ramifications for the whole industry. The RMG-sector in Bangladesh employs almost 3 million people, and its multiplier impact on the GDP is substantial. According to CPD calculations, exports had crossed US$ 20 billion (appx.) in FY 2010-11. RMG accounts for more than 80 percent of total export earnings of Bangladesh with 60 percent of overseas sales made in the EU market.

The EU’s GSP Scheme and Rules of Origin The European Community was the first to extend the privileges of a GSP scheme in 1971 and now 176 developing countries enjoy this scheme with 7200 tariff lines covered for the LDCs. In 1947, when the first talks for GATT had begun, it was recognized that developing and least-developed countries needed preferential market access facilities for them to survive in the world market and close the gap with the developed capitalist countries (DCCs). The EU took this philosophical underpinning into its bilateral relations with LDCs, and the result is the various GSP schemes on offer. Since its independence, Bangladesh has been enjoying special and targeted GSP from many entities including the EU. These preferential market access schemes are subject to various degrees of RoO, which are specific to individual GSPs. These GSP schemes offer two major benefits for particular products: (a) preferential market access in the form of reduced (or zero) tariff, and (b) greater market access in the form of enhanced quota or quota/ceiling-free entry into domestic markets of DCCs. Currently, Bangladesh is the beneficiary of the duty-free, quota-free market access for all-products-except-arms to the EU under the Everything but Arms Initiative, popularly known as EU-EBA. The uniqueness of this initiative is that this include a large number of new products, which were outside the scope of the previously in placed GSP . Currently, 49 countries are regarded as LDCs and enjoy the scheme, which has been granted for an unlimited period and is not subject to any intermittent renewal or revision.The EU-GSP gives the widest range of product coverage among DCCs. Bangladesh is one of the biggest beneficiaries of this scheme. The EBA has removed the uncertainties, which prevailed under the earlier GSP, and has added an element of security in terms of market access to the EU. The previously in place schemes had provided Bangladesh zero-tariff, quota-free access to the EC market for most of her manufactured exports, subject to conformity with RoO. However, after the introduction of the EU-EBA scheme, 919 more tariff lines came under the arrangement.Notwithstanding all its positives, EBA does have some limitations as well. As an institutional arrangement, it is non-contractual, meaning the EU can withdraw it anytime as it is a unilateral and non-reciprocal concession rather than an international agreement bound by law. Moreover, one important aspect of the erstwhile GSP had been left unchanged in the EU-EBA: the RoO. This is an important aspect, which played a critical role in terms of accessing the benefits of the initiative by Bangladesh as, at times, it had been difficult to comply with the RoO. It resulted in GSP utilization rate of just 40% by the Bangladeshi RMG sector in the year 2000. Research showed in 2004 that if the RoO restrictions for Bangladesh’s apparel sector had been removed then she would have gained significantly with the incremental gain being US$ 102.3 million. RoO lies at the very pivot of the EU-GSP, which set the rules for determining how and when a product would be recognized as having originated in a country eligible as a beneficiary of the scheme. As stipulated by Article 67 of the EC Custom Code (ECCC), a product shall be considered as originating in a beneficiary country if it has been either wholly obtained or undergone sufficient working or processing in that country.  Most articles of apparel and clothing accessories previously required manufacturing from yarn up. This meant that the use of imported fabric did not confer origin. This was the so-called 2-stage production rule. For certain products, the rule was that the value of the imported goods must not exceed a certain percentage of the value of the manufactured output .

The two-stage conversion RoO of the GSP had severely affected Bangladesh’s ability to access the facility resulting in just 55% RMG export to the EU being able to comply. Bangladesh’s GSP utilization fell from 41.18% in 1996 to 19.93% in 1997 due to stringent RoO when the conversion process was 3-stage for knitwear and 2-stage for woven-wear. But once the EU changed its RoO to allow imported yarn for knitwear—the 2-stage system—and was more liberal towards woven-wear, the utilization rate registered considerable increase and the overall export to the EU reached 31.20% in 1998 and has been growing steadily ever since. This actually shows a direct correlation between RoO and GSP utilization rate.

Key Terminologies in International Trade—Tariff, Quota and Origin: 

Here the concepts of tariff, quota and origin should be discussed. Tariff is the most common example of a trade policy instrument by governments. It is a tax levied on imported goods leading to “a wedge between the prices at which goods are traded internationally and the prices at which they are sold domestically” . The import quota also works like tariff in increasing the domestic price of the imported goods and protecting the domestic industry. “An import quota is imposed to restrict the import quantity up to a certain limit. The restriction is usually enforced by issuing licenses.”  On the other hand, origin, which is an important tool in deciding on tariffs and quotas, is the “economic” nationality of goods in international trade. These are two kinds, non-preferential and preferential. Non-preferential origin is used for determining the origin of products subject to all kinds of trade policies. Preferential origin confers certain benefits on goods traded between particular countries, namely entry at a reduced or zero rate of duty.The concept of ‘quota’ as practiced by the EU needs to be clarified to understand the actual worth of quota-free access. Tariff rate quotas (TRQ) regulate imports in the EU. As distinct from quota, which puts a ceiling on imports, a TRQ is a system where a particular tariff rate is imposed on import, up to a certain quantitative limit. Beyond this, imports are allowed, up to unlimited levels, but at higher tariff rates. Thus, quota-free access to the EU provided significant advantages as it eliminated the higher tariffs beyond the quotas. Therefore, Bangladesh has to pay no tariffs and can export without any limit whereas its rival developing countries like India and China have to pay higher rate of tariffs once they go beyond a certain level. Under the regular GSP, India gets a 15-20% tariff drawback on 12.5% tariff rate whereas Bangladesh gets a 100% drawback under EBA making its products cheaper and more competitive.Recent Changes in the RoO and its Effects on the RMG Industry Under the previous 2-stage system, for some woven products, 1-stage conversion was allowed given the value of the imported input does not exceed a certain limit—generally, 40-49%—of the ex-work price of the product. So, the RoO actually required 51% domestic input, which was still very difficult to achieve. The knit industry however used to fulfill this criterion as the value addition of this sector is almost 60%.

The revised regulation has relaxed and simplified the rules and procedures for developing countries. It has been projected that the new RoO would not only increase Bangladesh’s export volume of RMG to EU markets but also will help it to become more competitive and diversified. Now, the EU is allowing duty free access of Bangladeshi apparels produced from imported fabrics. This has created a sudden import spree of fabrics into Bangladesh by garments factory owners. It was reported that between January and June, 2011, apparel exporters imported fabrics worth over US$ 10 million from China alone which was almost US$ 8 million more from the same period of the previous year. The previous RoO of the EU was in place for last 12 years and had worked as a protective shield for local textile mills as it compelled garments exporters to buy most of their fabrics from domestic sources to enjoy the benefits.

The EC has adopted this new rule so that it became easier for developing countries to understand and to comply with in the new globalized world. The old RoO became outdated, too complex, and stringent resulting in many LDCs finding it difficult to comply with in order to access the preferences on offer. But the most important thing is that special provisions have now been included for LDCs like Bangladesh which will allow them to claim origin for many more products which have been processed in their territories, even if the primary inputs were imported. This rule is so liberal that even if up to 70% materials do not originate domestically, it will still be considered as a product from that country. This has been done to help the industries in the world’s poorest countries.
For a product to be considered originating in the beneficiary country concerned, it must be wholly obtained e.g. grown, mined or harvested, or have undergone sufficient processing therein. The EC defines ‘sufficient processing’ through a list of origin criteria which varies between products and may be based on change of tariff heading, value added, a specific processing requirement, the use of wholly obtained inputs, or a combination of these . In the textile and clothing sector, single-stage processing (manufacturing from fabric) is now allowed in place of the previous two-stage one (manufacturing from yarn). These new adjustments have been done so that those who are in real need get to reap the benefits. It also reduces the number of countries under the EBA scheme hence reducing the competitive pressure and making it more meaningful for LDCs.

It has been projected that the new rules will also favor the diversification of apparel products in Bangladesh, especially those made of artificial fabrics. Previously, products made of polyester, nylon, and wool did not get any GSP facility, as Bangladesh does not produce any such synthetic yarn or fabric. However, under the new rules, it can import the raw materials for such products and export the processed end-outputs. There are scopes of diversification in the woven production as well, in the past, due to the lack of domestic yarn production, the full potential in this sub-section was not realized.

Response of Bangladesh’s RMG Sector

A minuscule study was conducted at the University of Sheffield Management School from July to September, 2011 to assess the impacts of the revised RoO on Bangladesh’s RMG sector. It must be mentioned that for a full appraisal of the affects, data of 6 months were not substantially enough. But it was generally observed that the entrepreneurs were taking the new rules positively; export volume and value, by and large, had increased since 1st January, 2011; orders for more diversified and, at times, better quality products had been received from buyers; and factory owners were taking measures to avail the opportunities offered by the changes. BGMEA disclosed that for first 6 months of that year, apparel export to the EU had increased by 43%. Therefore, this was clearly visible that GSP-RoO relaxation had influenced the local industry.
We should remember that, in today’s market, low-cost and capacity of the labor force is not all, but skill and experience is. In our country, most of the factories are making cotton-based products and the labor force is accustomed with it. They are not comfortable in non-cotton and synthetic items. Consequently, even if with the softening of the RoO, opportunities of making new products come, the Bangladeshi garments industries are not in a position to capitalize, as they do not have the necessary machines or skill. Thus, much needed diversification in the product basket will not come suddenly but gradually.
Bangladeshi entrepreneurs need to be more proactive with the buyers in the marketing side. The BGMEA and government also should engage in more economic diplomacy to disseminate the information, both at home and abroad, to make businesspeople aware of opportunities present in Bangladesh. It also has to establish a strong backward linkage with primary industries. For this, Bangladeshi manufacturers must expand their buyer portfolio from mass and bulk buyers to up-stream and fashion buyers. The local textile mills must cut their costs and reduce their margin of profit in order to be more competitive. Liberalizing the import of yarn from India over land can also help in cost efficiency and in reducing lead-time for manufacturers. Training and well-being of the workers, and compliance with buyers’ specifications have also emerged as of prime importance.
It must be mentioned that as the EU buyers are getting a 12% tax relief by taking products from Bangladesh, so its companies deserve a better price than what they are getting now. Actually this is the main spirit of GSP, to make the developing and least developed countries more self-sufficient, to help create more businesses and jobs, and to help them to come out of the poverty trap.
To wrap up the discussion, in order to benefit from lower barriers to trade, like duty-free or quota-free access, some companies invest in or outsource manufacturing and supplying orders to a given country. This is exactly the case when EU retail companies place orders to Bangladeshi apparel factories so that they can reap the benefits of special schemes when they import from an LDC. On the other hand, one of the key challenges for indigenous businesses in utilizing such opportunities is to act in accordance with regulations that may apply to them.
The EU-GSP scheme is essential for Bangladesh as it provides vital market entrance opportunities for an increasingly export-oriented economy. Whether Bangladesh is able to capitalize on the recent changes would depend much on the initiatives taken by the entrepreneurs and on government policies. For this, a successful blending of the supply side and operational capabilities is needed. BGMEA needs to take the right coordinating role as well. One of the main problems our apparel industry faces is that it grew very rapidly without proper and substantial backward linkage industries. Too much product and market concentration and heavy dependency on imported goods meant that it had struggled to take advantage of the world market and the preferential arrangements due to strict RoO. To take full advantage of the more liberalized RoO of the EU, Bangladesh must be more dynamic and proactive in entrepreneurship, financing, diplomacy, infrastructure building and compliance. However, it should be taken into consideration that, as Dr. K. G. Moazzem—Senior Research Fellow of CPD—puts it, there are “many other natural, structural, socio-economic and competitive forces at play in the world economy.”

Kazi Niaz Ahmed is a Research Faculty at the Institute of Governance Studies (IGS), Brac University, and one of the founding members of Foreign Affairs Insights and Reviews (FAIR).
This write-up was published in FAIR, April-June 2012, volume 1, Number 1.

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