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In 2020, the US and Kenya commenced negotiations to conclude a Free Trade Agreement (FTA).
These negotiations slowed down under President Biden’s presidency. Furthermore, the term for the US Trade Promotion Authority which gives the President authority to conclude bilateral trade agreements expired on 1 July 2021. For the better part of this year, the new US administration has been reviewing ongoing trade talks to ensure compatibility with their agenda.
However, with a new US Trade Representative in office, there have been indications that talks between the two countries are resuming in earnest. Further, a motion to renew the term of the Trade Promotion Authority was tabled before the US Congress on 27 July 2021. It, therefore, appears that the two countries may make headway in concluding the anticipated bilateral trade arrangement.
In this article, we discuss the operation of a potential US-Kenya FTA in the context of the East African Community (EAC) Customs Union. Drawing on the negotiating objectives set out by the parties, we highlight potential implementation challenges for consideration during negotiations, with a focus on tariff treatment and rules of origin.
Key highlights of the proposed FTA
As we set out in the previous article in this series, the key difference between an FTA and a customs union is the erection of a common external tariff applicable to third countries. If Kenya and the US were to conclude an FTA, they would likely eliminate tariffs on goods originating from each other’s countries, but they would not apply a common tariff on goods originating from third countries.
When embarking in the negotiations, the US and Kenya each made public their negotiating objectives. The US, for example, intends to achieve duty free market access for industrial goods, textiles, and apparel products. Further, it intends to reduce or eliminate tariffs on agricultural products. Kenya’s negotiating objectives, while less elaborate, are similar but contain some deviations. For example, its objectives relating to the establishment of rules of origin and the scheduling of tariff commitments are subject to its domestic laws and other existing bilateral, multilateral and regional commitments. In other words, it intends to factor in its regional integration goals within the proposed FTA.
Elimination of Tariffs
In their negotiating objectives, the US has stated that it intends to pursue the elimination of all tariffs on industrial goods, textiles and apparel products. The same objective would be sought for agricultural products. This duty-free access to the Kenyan market may be incompatible with the EAC’s common external tariff.
Kenya attempts to address this issue by including in its negotiating objectives a requirement that the “scheduling of tariff commitments should seek to maximise the benefits of regional economic integration.” It is not immediately clear how this would be achieved, however, since the US may choose to negotiate preferential access directly with the other members of the regional blocs as opposed to indirectly through its arrangement with Kenya.
Further, Kenya aims to have a priority list for the elimination of tariffs to ensure it is compatible with its interest. With this objective, it seems Kenya intends to prioritise the elimination of tariffs on products that Kenya predominantly exports to the US such as woven apparel (which in 2019, amounted to $286 million). There may be some challenges aligning this with the US’s objectives.
Rules of Origin
Rules of Origin are a key feature of the negotiating objectives of both parties in the proposed US-Kenya FTA. On one hand, the US seeks to negotiate Rules of Origin that ensure the benefits of the proposed FTA go to products genuinely made in the territories of the state parties. On the other hand, Kenya seeks to negotiate Rules of Origin that encourage regional value chains by allowing cumulation across the existing regional blocs and providing for wider cumulation provisions that include extended cumulation. Bridging this divergence in objectives will determine the scope of preferential tariff treatment on products under the proposed FTA.
Rules of Origin are specific conditions setting out the origin conferring criteria for products within Regional Trade Agreements. This originating status is required for a product to qualify for the preferential tariff treatment within an FTA. Without Rules of Origin, the preferential tariff treatment would be exploited by states not party to the FTA through the practice of trade diversion, which we mentioned in the first installation of this series. Generally, Rules of Origin confer originating status if the product was wholly produced in an FTA member state or, in cases where the production involved imported inputs, if the imported inputs were substantially processed locally so as to confer originating status. Under Rules of Origin, different tests are used to determine whether goods would qualify for a preferential tariff, particularly where imported components are used to further process the said goods.[i]
The concept of cumulation regulates the treatment of foreign inputs as if they were sourced locally. Put simply, cumulation confers originating status on a product even when the product does not originate from the exporting country. The primary form of cumulation within an FTA is bilateral cumulation, where a product imported from a partner state is considered to be produced locally for purposes of Rules of Origin. Diagonal cumulation is the same as bilateral cumulation but involves more than two partner states. Full cumulation differs from the first two types because it allows inputs sourced from non-member countries to gain originating status if they are sufficiently worked on or processed as per the Rules of Origin.
Extended cumulation is the most flexible form of cumulation.[ii] This form of cumulation enables both bilateral and diagonal cumulation even where the parties involved are not linked by an FTA. Furthermore, if more than one FTA exists, the Rules of Origin need not be identical for the cumulation to operate. As illustrated here.
2. General Rules of Origin under the African Growth and Opportunity Act
The African Growth and Opportunity Act (AGOA) is the current mechanism that secures Kenya’s tariff-free access to the US market. It is a United States Trade Act, enacted on 18 May 2000 as Public Law 106 of the 200th Congress. The legislation significantly enhances market access to the US for qualifying Sub-Saharan African (SSA) countries. We have previously discussed the AGOA in relation to the proposed US-Kenya FTA. Kenya and the US hope to replace it with an FTA on its expiry in 2025.
AGOA’s General Rules of Origin cover imports of all products, other than textiles and apparel, from AGOA-beneficiary countries. Textiles and apparel are covered by the AGOA Apparel Rules of Origin. The AGOA Rules of Origin regime is pertinent to this discussion because Kenya seeks to build on it in negotiating the Rules of Origin under the proposed FTA. Therefore, the AGOA Rules of Origin may give an indication as to what the Kenyan side may consider as a positive outcome in the negotiation of Rules of Origin under the proposed FTA.
The General Rules of Origin provide that products will only enjoy preferential treatment under the AGOA framework if they are imported from an AGOA-beneficiary country into the US. Additionally, the products must be grown, produced or manufactured in the territory of one or more AGOA-beneficiary countries. In this way, the AGOA Rules of Origin regime provides for diagonal cumulation. A product not wholly produced in an AGOA-beneficiary country may still access the preferential treatment if the value of the materials sourced from an AGOA-beneficiary country plus the direct cost of processing conducted in the AGOA-beneficiary country equates to a minimum of 35% of the product’s appraised value at the US port of entry. AGOA provides for bilateral cumulation between the US and the AGOA-beneficiary countries; therefore, 15% of the 35% may comprise of materials sourced from the US.
3. The potential interplay between the EAC Rules of Origin and those of the proposed US-Kenya FTA
The EAC Rules of Origin are provided for in Annex III of the EAC Customs Union Protocol. These Rules of Origin determine which goods are considered to originate in the territory of the Partner States. Eligibility for preferential tariff treatment under the EAC Customs Union is dependent on this originating status from an EAC partner state. For goods to be considered to originate from an EAC Partner State, they must either be wholly produced in the territory of a Partner State or produced in the Partner State incorporating materials which have not been wholly obtained there, provided that such materials have undergone sufficient working or processing in the Partner State. Under this scheme, materials imported from the US into Kenya under the proposed FTA shall be considered as non-originated products at the point of importation. However, these materials may acquire originating status if they are sufficiently worked on or processed as per the threshold set out in Rule 6 read together with Part 1 of the First Schedule of The East African Community Customs Union (Rules of Origin) Rules, which indicate what action confers originating status.
The EAC Rules of Origin provide for cumulation under Rule 8. Rule 8 (3) provides for cumulation of materials originating into the territory of an EAC Partner State on a quota-free and duty-free basis. Such goods will acquire the originating status of the EAC Partner State. Therefore, the US imports into Kenya can also acquire originating status as products originating from Kenya if they are incorporated into goods produced in Kenya, where the working or processing carried out in Kenya is sufficient to confer originating status.
In other words, if the US exports fertilisers to Kenya, the fertilisers can be considered to originate from Kenya for the purpose of EAC Customs Union when subjected to the working or further processing considered adequate to confer originating status in Part 1 of the First Schedule of the EAC Rules of Origin. In this case, the value of all foreign material used in the final fertiliser product should not exceed 70% of the ex-works price of the product.[iii] Consequently, US products imported into Kenya under the proposed US-Kenya FTA may benefit from the preferential treatment conferred to products originating from the EAC Partner States.
Goods imported into Kenya from the EAC Partner States may be subjected to different treatment under the proposed FTA depending on the Rules of Origin settled on. This difference in treatment is based on whether the US will apply extended cumulation to this category of products and, consequently, categorise them as products originating in Kenya for the purpose of customs. If not, the products from the other EAC Partner States will be excluded from the preferential tariff treatment within the proposed FTA while US exports into Kenya will have an avenue to access the preferential tariffs under the EAC Customs Union.
As Kenya and the US continue to explore bilateral trade relations and move towards concluding an FTA, Kenya will need to consider how such an agreement could impact its regional commitments.
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[i] The tests include tariff heading jump (whereby the final product is classified under the HS coding nomenclature under a different heading to its non-originating imported materials, a percentage test whereby a certain percentage or weight threshold must be met, usually expressed as a minimum threshold of local content, or a technical requirement whereby specific technical or processing conditions must be met, as set out in the Rules of Origin.
[ii] Extended cumulation is also called third party or cross cumulation.
[iii] Ex-works price is defined in the EAC Rules of Origin under Rule 3 as the price determined in accordance with the provisions of the First Schedule paid for the product ex-works to the manufacturer in the Partner State in whose undertaking the last working or processing is carried out. It broadly refers to the cumulative price of a product before exportation.