Cablegate: East African Community Customs Union: Just Teething

This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 04 NAIROBI 004023

SIPDIS

SENSITIVE

DEPT FOR AF/E, AF/EPS
DEPT PASS USTR
USAID FOR AFR/EA JULIA ESCALONA
TREASURY FOR ANN ALIKONIS
LONDON AND PARIS FOR AFRICA WATCHERS

E.O. 12958: N/A
TAGS: ETRD ECIN ECON KE TZ
SUBJECT: East African Community Customs Union: Just Teething
Problems or Falling Apart?

REF: 04 Dar Es Salaam 2625

Sensitive-but-unclassified. Not for release outside USG
channels.

1. (SBU) Summary: The East African Community Customs Union,
established at the start of 2005, is experiencing teething
problems - and in the minority view, may be unraveling. A
slew of problems, ranging from tariff rates for
pharmaceuticals to rules of origin for vehicles assembled
locally by General Motors, confronted EAC ministers at a
recent meeting in Arusha, Tanzania. Kenyan government
officials downplay the seriousness of these disputes, and
see them as a natural result of closer trade ties within the
EAC region, which combines Kenya, Tanzania, and Uganda.
Kenyan observers, however, nonetheless see Tanzania as the
potential wildcard, claiming the latter has a fear of Kenyan
competition and a lingering ideological distaste for
capitalism and free trade. It's probably too early to tell
whether the EAC Customs Union succeeds in expanding trade
and prosperity in the region, collapses, or just muddles
along without actually achieving much in the way of tangible
integration and growth. End summary.

---------------------------------
The ABCs of the EAC Customs Union
---------------------------------

2. (U) The original East African Community collapsed in
1974 due to differences between the countries' leaders and
levels of economic and industrial development. Beginning in
the mid-1990s, Kenya, Tanzania, and Uganda renewed the
process of regional economic integration by forming a
grouping called East Africa Cooperation, which they
transformed into the East African Community (EAC) in 2001.
In the future, the leaders of the three EAC states have
ambitious plans for a monetary union, free movement of
labor, and eventually some form of political union. But as
a first step towards this kind of deeper political and
economic integration in a grouping that comprises a combined
GDP of $27 billion and 90 million consumers, the EAC treaty
provided for the formation of a customs union by 2004.
Ready or not, the EAC Customs Union thus came into existence
on January 1, 2005.

3. (U) As negotiated by the three members states, the EAC
Customs Union is not by definition a pure customs union - at
least not yet. The Customs Union indeed creates a common
external tariff (CET) for all goods imported from outside
the union. The CET consists of three bands - 0% for raw
materials, 10% for intermediate goods, and 25% for finished
products. But within the union, the accepted principle of
asymmetry recognizes that Kenya's relatively larger and more
competitive economy requires that both Uganda and Tanzania
be permitted to continue to assess a "suspended duty" on a
select group of "imports" from Kenya. For Uganda, this list
comprises 443 products whose tariffs will be reduced from
10% to 0% over five years. Tanzania will apply a shifting
set of tariff rates and reductions to a total of 880
products lines, but all rates will go to zero after five
years.

-----------------------------
Teething Problems - or Worse?
-----------------------------

4. (SBU) Media reports in Kenya in late August and early
September following the EAC's 10th Council of Ministers
meeting in Arusha, Tanzania indicated that the well-
intentioned Customs Union is at best experiencing teething
problems. Some business contacts, frustrated by the slow
pace of implementation of the union, go further and believe
it could be unraveling. Contentious disputes between the
member states in Arusha in August reportedly centered on the
following:

-- Kenya and Pharmaceuticals: In April, EAC ministers
decided to make an exception and lower the CET on
pharmaceutical products from the 10% intermediate rate to
zero, largely in response to a chorus of protests from the
healthcare community in the context of the region's HIV/AIDS
pandemic and other health challenges. Kenya, which had
always zero-rated pharmaceuticals, was seen as leading the
charge to make this exception. (Note: The U.S. Mission to
Kenya, home to the largest single PEPFAR program worldwide,
specifically pressed the Kenyan government to zero-rate all
drugs used to treat HIV/AIDS. End note). Tanzania,
according to Kenyan media reports, fought back during the
August Council of Ministers meeting, with the country's
small pharmaceutical industry reportedly threatening to sue
Kenya over the issue.

-- Tanzania and NTBs: The press also made hay of the alleged
pique expressed in Arusha by Kenya's Minister of Industry
and Trade, Mukhisa Kituyi, over a series of non-tariff
barriers (NTBs) being imposed on Kenyan products to prevent
them from crossing into Tanzania, including a $50 fee
imposed on Kenyan traders and businesspeople at border
crossing points. This followed earlier and intense press
coverage in Kenya of the expulsion from Tanzania of three
Kenyan journalists perceived to have written politically-
incorrect news reports.

-- Uganda and Infant Industries: A week after the ruckus
over duties on pharmaceuticals, Kenya and Tanzania protested
a Ugandan request to exempt from duty a list of products,
tied to a list of specific companies, in order to allow
these "infant industry" firms to survive and prosper.
Kenyan Trade Minister Kituyi was quoted in the local press
as saying, "National interests also have to be involved on
how we negotiate, how much more concession should be given
to Uganda."

--------------------------------------------
GM: Not Reaping Rewards of the Customs Union
--------------------------------------------

5. (SBU) The experience of General Motors East Africa, a
Nairobi-based vehicle assembler owned by GM, illustrates the
problems the Customs Union faces in achieving its ultimate
objective of expanding intra-regional trade. Bill Lay, GM
East Africa's Managing Director, believes the union will
implode eventually - though perhaps his opinion should be
taken with a grain of salt given his personal experience.
He began laying the groundwork for taking advantage of the
Customs Union early on, establishing contacts and dealers in
Tanzania and lobbying early and often for favorable rules of
origin for his assembled vehicles. After selling a small
number of trucks and vans into Tanzania in the spring,
hassles began at the border according to Lay, and by June,
Tanzania's Finance and Foreign Ministers were loudly
protesting against the Union's agreed-upon "substantial
transformation" rule of origin. Under this provision, a
product like GM's vehicles assembled from imported kits is
considered to be locally produced if the conversion from
inputs to finished product results in a change in
classification of the final product's tariff heading.

6. (SBU) Lay says Kenya and Uganda went along with Tanzania
and the substantial transformation provision was suspended
until the end of the year, which means he has to fall back
on a far less favorable methodology requiring a more
expensive process of demonstrating at least 35% value-added
local content. Lay says it's difficult for him to meet this
rule because fewer and fewer local parts makers can produce
the increasingly high-tech parts that go into his assembled
vehicles. Caught in this catch-22 and now unable to sell
vehicles into Tanzania after so much planning, Lay says
despairingly that auto assembly and manufacturing has little
future in East Africa. He is looking at an import-based
strategy over the next few years and is already importing
and selling South Korean-made Chevys in Kenya. Lay blames
Tanzania's resistance to GM's locally-assembled vehicles on
politically well-connected importers of used vehicles in
Tanzania.

--------------------------------------------- ----
Kenyan Officials: All's Well in the Customs Union
--------------------------------------------- ----

7. (SBU) Senior Government of Kenya (GOK) officials deny
the Customs Union is in any danger of falling apart. Trade
Minister Kituyi told the press in early September that
"teething problems and even beyond teething" are a normal
result of closer trade relations between neighbors, just as
EU member states battle over agricultural subsidies. In a
September 6 meeting, Kituyi's Permanent Secretary, David
Nalo, told Econoffs that the problems reported in the press
were blown out of proportion. He ticked off the final
results of the August Ministerial meeting with regard to
each trouble spot:

-- Pharmaceutical Duties: While the Tanzanian private sector
remains vociferously opposed to the 0% duty, the Government
of Tanzanian told EAC ministers that it is fully committed
to zero-rating, and will remain so. This issue, said Nalo,
is resolved.

-- Tanzania's NTBs: Barrack Ndwega, Director of the EAC
Directorate at the Ministry of East African and Regional
Cooperation, told Econoff on September 20 that non-tariff
barriers remain a problem, and that Kenya has "a long list
of NTBs blocking our goods." But he said that the EAC
Secretariat is establishing a mechanism, to be up and

SIPDIS
running hopefully by November, to identify and deal with
NTBs as they arise. The $50 fee on Kenyan businesspeople
entering Tanzania has been dropped, he said.

-- Uganda's Infant Industries: Nalo said EAC ministers had
agreed in principle with Uganda's argument to provide
preferential treatment to certain key infant industries,
given the country's relatively lower level of development.
But the issue became contentious, he said, when Uganda
submitted a list of duty-exempt products to be imported by a
list of infant industry firms. Both lists, he said were
inflated, to the consternation of Kenya and Tanzania. The
list of 134 products was investigated and pared back to 51,
and the list of 112 infant enterprises cut back to 34. In
the end, ministers resolved to establish a mechanism at the
EAC Secretariat to track infant enterprises in Uganda, which
will only be allowed preferential treatment if they sell
their finished goods locally in Uganda. Once they are ready
to "export" products to other union members, they will have
to pay normal tariffs on their imported inputs and/or pay a
duty of some kind so as not to undermine competitors within
the EAC area.

-- Cars and Rules of Origin: In contrast to GM's far bleaker
assessment, Nalo said the issue of rules of origin has been
resolved and that only GM's most stripped-down truck models
are unable to meet the 35% local content criteria. Ndwega
of the Ministry of East African and Regional Cooperation
conceded that Kenyan products are often blocked by disputes
over rules of origin, but claimed these issues are being
ironed out.

-------------------------
Comment I: Time Will Tell
-------------------------

8. (SBU) We are rooting for its success, but only time will
tell whether the EAC Customs Union succeeds in significantly
boosting trade and prosperity in East Africa or falls apart
thanks to political and/or economic differences between its
members. A third path might be to simply muddle along,
alive in name, but failing to expand prosperity
significantly as members cave in to narrow, short-term
interests and find ways to constantly stymie truly free
trade - as appears to be the case thus far.

-------------------------------
Comment II: Kenya vs. Tanzania?
-------------------------------

9. (SBU) From the Kenyan perspective, the potential spoiler
in the mix is clearly Tanzania, for two reasons. First,
Kenyans believe that Tanzania is fearful of being swamped
economically by a more competitive Kenya and more aggressive
Kenyans. Second, they suspect that Tanzania, having
abandoned socialism more recently, still has lingering
ideological misgivings about the benefits of free trade and
market-based economics, and that it therefore has less
enthusiasm for the Customs Union generally. On this note,
Trade Permanent Secretary Nalo reported that Kenya initiated
a very frank closed-door session at the end of the recent
ministerial meetings at which Tanzania's alleged xenophobic
tendencies, as manifested in the expulsion of the three
Kenyan reporters in July, were put on the table and
discussed as an obstacle to progress in the Customs Union.
Kenya, in turn, is perceived as arrogant and overbearing
within the region, at least according to some observers,
precisely because of these views.

10. (SBU) Finally, there may be a structural challenge, as
well. Tanzania, it is noted, is a member of the EAC, but
unlike Kenya and Uganda, is not a member of the Common
Market for Eastern and Southern Africa (COMESA), a 21-member
regional trade bloc that plans to form an even larger
customs union by 2008. Tanzania withdrew from COMESA in
2000 and is instead a member of the Southern African
Development Community (SADC), while Kenya and Uganda are
not. We frankly aren't sure what this means for the future
of the EAC Customs Union, but would warmly welcome
perspectives on these issues from colleagues at Embassies
Dar, Kampala, and elsewhere in the region.
Bellamy

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