CAFTA-DR Overview: The Agreement in Summary

7/21/2006

This white paper-style article serves as both a CAFTA-DR primer and an update on the agreement, including background, key facts about the pact and sourcing advice.

For those who have been sourcing in the region for years and those just starting their exploration, it can be very challenging to navigate the maze of trade rules in Central America and the Caribbean.

But making the effort to take advantage of trade agreements and preference programs can really pay off, and understanding the latest deal, CAFTA-DR, can lead to major savings.

What is CAFTA?

CAFTA stands for Central American Free Trade Agreement. It has been on the negotiation table since 2002, when five Central American countries ( Guatemala, El Salvador, Honduras, Nicaragua and Costa Rica) and the United States decided to look for ways to increase trade and the related benefits for industries within the region.

Later on, the original signing countries were joined by the Dominican Republic, which was searching to remain competitive within the region, mainly in the textile and apparel industries. At this point, the agreement became known as CAFTA-DR.

CAFTA-DR makes it possible for the region to have access to U.S. markets with benefits that would otherwise expire in 2008 under the Caribbean Basin Trade Partnership Act (CBTPA), and to have a modified set of rules in the relationship. The CBTPA includes 23 countries of the Caribbean Basin region. The CBTPA was part of the Trade and Development Act of 2000 signed by President Clinton in May 2000. This act was created to support the damaged economy of the region after it was hit by hurricanes Mitch and Georges in 1998, to promote the export of U.S. cotton and other fibers and textile products, to promote economic growth and to decrease illegal immigration from the region into the United States, among other goals.

There are some differences between CAFTA-DR and CBTPA for textile and apparel products, mainly:

  • CAFTA-DR includes a smaller set of countries

  • CBTPA is unilateral, CAFTA-DR is reciprocal

  • Included textile and apparel products vary:

    • CBTPA includes the following HTS (Harmonized Tariff Schedule) codes -- apparel product codes 61 and 62, footwear code 64 and luggage code 64

    • CAFTA-DR includes almost all products, including agricultural products, industrial products and services. It is a comprehensive free trade agreement modeled after NAFTA. It includes textile and apparel product codes 50 through 63, some footwear parts of textile origin, luggage code 64 and pillows code 9409.90

  • CAFTA-DR includes a series of rules of origin. These rules include Trade Preference Levels (TPLs) for Nicaragua, a wool provision for Costa Rica and cumulation with NAFTA. Rules of origin within CAFTA-DR are further described later in this article.

  • CBTPA states that U.S. origin is required for most cases (yarn, fabric, components, etc.).

Agreement approval: the status

CAFTA-DR was signed into law by the United States through President Bush on Aug. 2, 2005. The signing followed months of intense lobbying for and against the agreement. The U.S. Senate was the first to approve CAFTA-DR. Then the U.S. House of Representatives approved it by only two votes on July 28, 2005.

However, the agreement was not effective until each of the other countries approved it, and implemented internal legislative changes to comply with the treaty requirements, particularly with regard to labor, environmental and intellectual property protection and modifications to agricultural safeguards and government procurement regulations.

To start implementation, the Central American countries and the Dominican Republic have to ratify the agreement, and then the United States has to determine if the partner country's laws are in compliance with the provisions stated in the agreement. As of press time, all countries except Costa Rica had ratified the agreement. Following is a summary of the status by country:

El Salvador

El Salvador was the first country to implement the agreement, starting March 1, 2006. Some negotiations related to sanitary inspections of U.S. meat were required, but the treaty is already a reality for the United States and El Salvador.

Honduras and Nicaragua

Honduras and Nicaragua made the necessary adjustments to their internal laws and implemented the agreement starting April 1, 2006.

Guatemala

Guatemala joined the agreement on July 1, 2006. After several weeks in negotiation with the United States on intellectual property rights, the acceptance of the U.S. meat inspection system as equivalent in Guatemala, and other legal discussions, both countries have reached consensus on implementing the treaty.

Costa Rica

Costa Rica still has to ratify the agreement. There are some concerns in the country on the potential impact of the treaty on the telephone industry. New President Oscar Arias has made it a very important part of his agenda to ratify and implement the treaty.

Dominican Republic

The Dominican Republic will likely enter the agreement on Aug. 1, 2006. Some issues regarding D.R. laws on intellectual property and a debate on a Dominican Republic tax on sweeteners, among other items, are holding up the agreement.

CAFTA-DR region: U.S. market share

According to trade data from the U.S. Office of Textiles & Apparel (OTEXA), overall U.S. apparel imports grew in 2005 by 10.3 percent, compared to 2004. As for the CAFTA-DR region, U.S. apparel imports grew by only 0.1 percent in the same period. The region's share of the U.S. market declined from 19 percent in 2004 to 17.2 percent in 2005, and U.S. fabric exports to the region fell 9.1 percent (in dollar terms) for the first time since the end of 2000, when the trade preference program was implemented.

The statistics show that delays in the implementation of the CAFTA-DR treaty have negatively affected the region's textile and apparel industries, and quota elimination since Jan. 1, 2005, has favored imports from other regions, mainly Asia.

Delays in CAFTA-DR implementation reside mainly on the required modifications to local laws regarding labor and environmental and intellectual property protection. But there is an additional modification to the treaty that must be agreed to as an amendment. This modification pertains to the U.S. request that pocketing and linings must originate in the United States or the CAFTA-DR region. One important implication regarding apparel is the fact that products containing inputs from non-ratifying countries are not eligible for duty-free status.

Most analysts agree that implementation of CAFTA-DR will bring growth to exports from Central American countries and the Dominican Republic to the United States. Early projections foresaw increments in exports of 15 percent in the textile, apparel and leather industries. It is very likely imports from the region will grow, and the growth amount will depend on how much investment is directed to the region from U.S. and international investors.

CAFTA-DR's special rules

Following is a summary of the main textile and apparel provisions of CAFTA-DR from the trade law firm Sandler, Travis & Rosenberg, P.A.:

  • All qualifying apparel will be duty-free immediately upon the effective date of the agreement, provided that all components (with exceptions as defined in the rules of origin) originate in countries which have implemented the treaty.

  • Qualifying goods may be eligible for duty-free treatment retroactive to Jan. 1, 2004, with some exceptions.

  • Retroactivity is based on a country-by-country determination.

  • The rule of origin applies in general only to the "component that determines the tariff classification of the good," i.e., the "essential character" of the item.

  • Most apparel is subject to a "yarn forward" rule of origin, i.e., the yarn must have been spun or extruded, the fabric woven or knit and the goods cut and assembled in the region to be considered eligible.

  • Certain knit fabric is subject to a "fiber forward" rule of origin, i.e., either the raw cotton must be regionally grown and/or the man-made fibers regionally produced, depending on the finished product.

  • Goods in HTSUS Chapters 61, 62 and 63 must be made using regionally produced sewing thread, and certain apparel in Chapters 61 and 62 (suit jackets and suit-type coats, skirts, etc.) with a visible lining must use regionally formed lining fabrics.

  • Wool apparel is subject to a "fabric forward" rule of origin, i.e., the yarns can be imported from anywhere, but the fabric must originate in the region.

  • Brassieres, woven cotton and man-made fiber boxers, textile luggage, pajamas, nightwear and certain girls' dresses are subject to a "cut and sew" requirement only. In other words, the fabric can be imported from anywhere, provided the apparel is both cut and sewn or otherwise assembled in the region.

  • For sets, each piece in a set must meet the origin requirements; alternatively, up to 10 percent of the total adjusted value of the set can be non-originating.

  • Certain fibers, yarns or fabric have been determined to be in short supply and therefore can be imported from anywhere, and certain woven fabrics produced in Canada and Mexico can be used.

  • Goods in Chapters 61 to 63 that are cut and sewn (using U.S.-formed sewing thread) from U.S.-formed fabric (or knit-to-shape components) made with non-originating yarns are subject to a reduced duty liability in which the MFN duty rate will be applied to the full value of the finished good, less the value of the U.S. fabric or knit-to-shape components.

There also are single-step transformation provisions for brassieres, woven cotton and man-made fiber boxers, pajamas, nightwear, certain girls' dresses and textile luggage. Also notable are the wool "fabric forward" rule of origin and rules applied to specific countries, such as a TPL for Nicaragua and a wool provision for Costa Rica.

What's next?

As the industry waits for the Dominican Republic and Costa Rica to implement the treaty, there are some products that will need to be treated within a "special regime" if they are partially manufactured in countries not yet fully participating in CAFTA-DR and then finished in a country that has completed its CAFTA-DR implementation. Legislators from the involved countries are working to handle this situation.

The main competitor the region faces in the race for maintaining and gaining U.S. market share is Asia. CAFTA-DR gives the apparel and textile industries in the involved countries an advantage over their Asian competitors. However, duty rates are only one factor in the formula to successfully navigate in such a market. Companies interested in continuing or expanding operations/transactions in the region must take into account the existing and planned capabilities at several phases in the supply chain, including:

  • product development;

  • availability of materials (yarn, fabric, thread, accessories, etc.);

  • lead-time execution;

  • fill rates;

  • compliance; and

  • cost factors (labor, energy, fuel, transportation, etc.).

Evaluating the opportunities

Many manufacturing and retail companies in the United States already use the CAFTA-DR region to source apparel and related accessories. There will be further opportunities for these and for other companies with this treaty. For companies evaluating the feasibility of this region, here are some factors to review:

  • Cost factors within the region. Determine which countries offer favorable conditions, as these vary from textile to apparel (and within apparel categories).

  • Product assortment. Determine which product lines lend themselves to CAFTA-DR sourcing advantages. Not all products are affected in the same manner by cost factors.

  • Product demands and seasonality. These factors will drive decisions on the amount to be sourced from each country/region.

  • Seasonality patterns and product development requirements. Define them in order to compare them to capabilities currently in place or to be demanded.

  • Sensitivity analysis. Conduct one to assess vulnerability to social, political or economical stimuli.

The previous list includes only some of the necessary steps to perform when analyzing feasibilities in the region, which can be a complex environment. It makes sense to analyze this environment with a partner, such as a consulting firm, that is already familiar with it.

Here are a few types of analysis that a consulting partner can help perform:

  • Geographic analyses to determine which areas within the CAFTA-DR region are ideal for manufacturing different types of product. Identification of opportunities for savings on landed cost in the United States.

  • Development of a sourcing strategy for balancing volume allocation and product mix across manufacturing sites in both the CAFTA-DR region and other global regions. By helping your firm relocate production within Mexico and the CAFTA-DR region, a consulting partner could help your business save significant sourcing costs for specific product lines, without hindering delivery times to your U.S. distribution network.

  • Evaluation of current manufacturing operations in the region, and determination of which product lines can be competitively produced in the region in the post-quota world.

  • Definition of current and potential competitiveness levels through the assessment of market trends, local costs, product diversity, efficiencies and currency fluctuations, among other factors.

  • Supplier selection and evaluation programs, including RFI/RFPs, prospect interviews and on-site visits.

Whether you are exploring the start-up of owned and operated facilities or entering into joint ventures or partnerships with local vendors, one of the key factors for success in a sourcing strategy is working with highly productive plants, and this is not less important in the CAFTA-DR region. It is important to spend the necessary time and resources on thorough site selection and efficient start-up of facilities in the region.

There is no doubt that CAFTA-DR will provide favorable conditions for sourcing an extended list of product/variety combinations. Success on grasping those opportunities will be a matter of conscious analysis, timely action and effective performance.

About the Author: Jesus Baltazar is a manager with the consulting firm Kurt Salmon Associates (KSA). Working within KSA's Supply Chain Group, he assists manufacturing and logistics operations in the United States , Mexico and Central America with process improvement, as well as offshore capacity development, human resources development, productivity improvement, responsive manufacturing programs and supply chain strategy and implementation. He helps clients to start up facilities and reach productivity improvements of 35 percent to 40 percent, and define and implement sourcing strategies that deliver significant cost savings. He can be reached at: jesus[email protected]. For more information about KSA, visit www.kurtsalmon.com.

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