THE FUTURE OF THE ASEAN FREE TRADE AREA AND THE

FREE TRADE AREAS BETWEEN ASEAN AND ITS DIALOGUE

PARTNERS

BY

RAUL L. CORDENILLO*

SYNOPSIS:

This paper highlights ASEANs commitment to keeping its current standing as a

vibrant and viable business centre in Asia though the ASEAN FTA strategy. This
two-pronged strategy entails: (a) the acceleration of ASEANs economic integration
and (b) the forging of free trade areas with dialogue partners. Whilst the objective of
the former is to maintain an open, outward-oriented and integrated economy, the
latter intends to complement ASEANs internal integration process and secure
ASEANs linkages with its economic partners. The overall goal is to realise the
ASEAN Economic Community, which is a business environment that is predictable
and in tune with the needs of the private sector.

Keywords: ASEAN; China; Free Trade Areas; Foreign Direct Investments;

Industrial Cooperation; Rules of Origin; Trade in Goods; Trade in
Services

*Senior Officer at the Investment and Enterprise Unit of the Bureau for Economic
Integration of the ASEAN Secretariat in Jakarta, Indonesia

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I. Introduction

In October 2003, the Leaders of the Association of Southeast Asian Nations

(ASEAN) signed Bali Concord II, which stipulates ASEANs commitment to creating
a stable, prosperous and highly competitive ASEAN economic region. In line with
that commitment and in the interest of maintaining its current standing as a vibrant
and viable business centre in Asia, ASEAN is currently accelerating economic
integration and, at the same time, forging free trade areas (FTAs) with its closest
economic partners. This two-pronged strategy is ASEANs response to the ever
growing challenges that continue to confront the region.

The objective of this paper is to present the future of the ASEAN Free Trade Area
(AFTA) and the status of ASEANs FTAs with China, India, Japan, Australia and New
Zealand and South Korea. In order to understand this better, however, one must first
have a clear perspective of AFTA, its features and current status, as well as its
threats and challenges.

It is in this regard, that this paper is organised as follows. Part II will discuss AFTA
and its implementation. Part III will identify threats and challenges to AFTA. Part IV
will discuss ASEANs two-pronged response. Finally, Part V will conclude with
prospects for AFTA and the role of the private sector.

II. The ASEAN Free Trade Area

The ultimate objective of AFTA is to increase ASEANs competitive edge as a

production base geared for the world market through trade and investment
liberalisation and closer economic co-operation. Currently, four main ASEAN
agreements seek to achieve this objective. These are the:

Agreement on the Common Effective Preferential Tariff Scheme for the

ASEAN Free Trade Area (CEPT-AFTA), which was signed in 1992;
ASEAN Framework Agreement on Services (AFAS), which was signed in
1995;
Basic Agreement on the ASEAN Industrial Cooperation Scheme (AICO),
which was signed in 1996; and
Framework Agreement on the ASEAN Investment Area (AIA), which was
signed in 1998.

A close look at the main features of these agreements and their implementation
would yield an overview of AFTA today.

CEPT-AFTA

The CEPT-AFTA is a cooperative arrangement amongst ASEAN Member Countries

that would reduce intra-regional tariffs and remove non-tariff barriers, beginning 1

2
January 1993. In particular, it seeks tariff elimination by 2010 for ASEAN 61 and
2015 for the CLMV2.

Figure 1 below illustrates the current level of tariffs under the CEPT-AFTA.

Figure 1. Percentage of Tariff Lines at 0-5% in the

Tentative 2005 CEPT Package
0.07 0.04
100% 0 11.12
0.94 28.95
80%

60%
98.99
88.84
40% 71.05

20%

0%
ASEAN 6 CLMV Total ASEAN
0-5% >5% Others

Tariffs on 98.99% (or 65,080 out of the total 65,743 tariff lines) of the products of the
ASEAN-6 have been reduced to the 0-5 percent tariff range. For CLMV, on the other
hand, 71.05% of tariff lines are in the 0-5 percent tariff range (or 26,676 out of the
37,545). Overall, 88.84% of ASEAN tariffs are now in the 0-5% and notably, 46,600
of these tariffs are at 0%.

This tariff reduction in CEPT-AFTA is supported by a dynamic CEPT Rules of Origin

(ROO). Aside from the general rule of 40% ASEAN value-added, its features include:

a set of general principles and guidelines to standardize the calculation of

local/ASEAN content;
provisions on locally-procured materials;
substantial transformation as an alternative rule for wheat flour, wood-based
products and aluminium products;
improvements in the ASEAN Cumulative Rules of Origin; and
strengthened origin verification rules through verification visits.

Notably, substantial transformation rules for iron and steel will be implemented soon,
pending internal procedures.

The progress in CEPT-AFTA is reflected in the latest trade figures in Table 1 below.

1
This includes Brunei Darussalam, Indonesia, Malaysia, Philippines, Singapore and Thailand.
2
This includes Cambodia, Lao PDR, Myanmar and Viet Nam.

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 Table 1. ASEAN Total Trade (in US$ million)
Economy 2003 2004 Growth
Intra-ASEAN 181,203.5 221,589.2 22%
Japan 113,384.7 135,910.1 20%
USA 117,884.3 129,721.2 10%
EU (15) 98,315.6 119,102.0 21%
China 59,588.9 81,871.7 37%
TOTAL 799,956.6 984,643.9 22%
Source: ASEAN Trade Database (Data excludes Lao PDR and Viet Nam)

In 2004, ASEAN total trade grew by 22%. Notably, intra-ASEAN trade dominates
ASEAN trade, followed by trade with Japan, the USA, the EU (15) and then China. It
must be pointed out that there has been a shift in the trend of ASEAN trade in 1993
and 2004 as reflected in Figure 1 and 2 below.

Figure 2. Share of Total Trade (1993)

Share of ASEAN's Total Trade - 1993

Intra-ASEAN
26.29% 19.18%
China
2.06%
Japan
EU-15
20.15% USA
17.61%
14.70% ROW

Figure 3. Share of Total Trade (2004)

Share of ASEAN's Total Trade - 2004

Intra-ASEAN
22.50%
30.11% China
Japan
8.31% EU-15

13.17% USA
13.80%
12.10% ROW

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In particular, reductions in the share of trade of Japan, the US and the EU (15) have
been absorbed by intra-ASEAN trade, China and other markets. This shows that
over the years, not only has intra-ASEAN trade grown, ASEAN has also diversified
its markets.

Table 2 below shows the fastest growing trading partners of ASEAN. This is led by
Russia at 43%, then India at 41%, China at 37% and Australia and New Zealand,
both at 31%

Table 2. ASEAN Total Trade (in US$ million)

Economy 2003 2004 Growth
Russia 2,272.6 3,432.1 43%
India 12,511.5 17,615.7 41%
China 59,588.9 81,871.7 37%
Australia 19,166.3 25,160.0 31%
New Zealand 2,621.0 3,420.6 31%
Source: ASEAN Trade Database (Data excludes Lao PDR and Viet Nam)

AFAS

In the economies of the ASEAN Member Countries, the service sector is now playing
an increasingly important role as reflected in the rising share of the service sector to
GDP. The AFAS recognizes this development and intends to harness this for the
mutual development of the region. Thus, it aims to substantially eliminate restrictions
to trade in services amongst ASEAN Member Countries; improve the efficiency and
competitiveness of ASEAN service suppliers by progressively liberalising services
sectors; and promote cooperation amongst service suppliers across the region.

To date, 4 packages of commitments, which build on WTO GATS commitments,

have been agreed by ASEAN Member Countries. The sectors covered in these
packages include:

business services,
communications,
construction,
finance,
health-related services,
recreational services,
transport and
tourism.

Currently, negotiations for the 5th package of commitments are underway.

Furthermore, underscoring the importance of trade in services liberalization, it was
agreed that 2015 shall be the end-date for the liberalization of all services sector
across the region.

In order to support the liberalization of trade in services, a Mutual Recognition

Agreement (MRA) in Engineering was signed and currently, an MRA for Nursing is
being considered. MRAs in architecture, accountancy, land surveying and tourism
are currently also being discussed.

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 AICO

The AICO Scheme encourages resource sharing/pooling and industrial

complementation in the ASEAN region. It eases the burden of material procurement
by firms by providing preferential tariffs for manufacturing inputs. Currently, all
ASEAN Member Countries, except for Myanmar, accord an AICO preferential tariff
rate of 0%

As of March 2006, the ASEAN Secretariat has issued a total of 129 AICO
Certificates of Eligibility to participating companies. Of these 129 AICO
Arrangements, 16 are on auto components, 100 are on automotive CKD packs, 6
are on electronics, 1 is on agricultural machinery, 5 is on food and 1 is on safety
glass. To date, the estimated value per year of these AICO Arrangements is
US$1.72 billion. Table 3 below illustrates the current state of AICO utilisation.

Table 3. Current Status of AICO Utilisation (as of March 2003)

NO. OF
COMPANY PRODUCT CATEGORY PARTICIPATING COUNTRIES
ARRANGEMENT
Sanden 1 Automotive components Singapore, Thailand
Denso 8 Automotive components Indonesia, Malaysia, Philippines, Thailand
Toyota 33 Automotive CKD pack Indonesia, Malaysia, Philippines, Thailand
Honda 44 Automotive CKD pack Indonesia, Malaysia, Philippines, Thailand
Volvo 7 Automotive CKD pack Malaysia, Thailand
Sony 2 Electronics Singapore, Thailand, Vietnam
Thai Steel Cable/Armstrong 1 Automotive components Malaysia, Thailand
Clipsal/Bowden 1 Electrical Indonesia, Malaysia
Isuzu 2 Automotive CKD pack Indonesia, Philippines, Thailand
Yanmar 1 Agriculture machinery Indonesia, Thailand
Matsushita 2 Electronics Indonesia, Malaysia, Thailand, Philippines
Nissan 6 Automotive CKD pack Indonesia, Malaysia, Thailand, Philippines
Nestle/Goya 5 Food processing Indonesia, Malaysia, Thailand, Philippines
Ford 2 Automotive CKD pack & CBU Philippines, Thailand
Mistubishi Electric/Lippo Melco 3 Automotive components Indonesia, Philippines, Thailand
Showa 1 Automotive components Indonesia, Thailand
Mitsubishi 2 Automotive CKD pack Indonesia, Philippines, Thailand
Asahi Glass 1 Safety glass Philippines, Thailand
Daihatsu 1 Automotive CKD pack Indonesia, Malaysia
Mistuba 1 Automotive components Philippines, Thailand
Yamaha 1 Automotive CKD pack Indonesia, Malaysia
Samsung 1 Electronics Malaysia, Vietnam
Autrans/Harada 1 Automotive components Thailand, Vietnam
Hino 2 Automotive CKD pack Indonesia, Malaysia, Thailand
Source: AICO Monitor, ASEAN Secretariat

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It must be pointed out that in the interest of promoting wider participation in the AICO
Scheme, as well as expanding its coverage, steps to enhance the Scheme are now
underway.

AIA

The objective of the AIA Agreement is to substantially increase the flow of

investments into ASEAN from both ASEAN and non-ASEAN investors through a
liberal and transparent environment amongst ASEAN Member Countries. Whilst the
AIA Agreement promotes all kinds of direct investments into ASEAN, in particular, it
seeks to liberalise the following sectors and services incidental to such sectors:

Manufacturing,
Agriculture,
Fishery,
Forestry and
Mining and Quarrying.

Today, ASEAN continues to be an attractive region for foreign direct investments

(FDI). Table 4 below illustrates recent ASEAN FDI statistics:

Table 4. ASEAN FDI Inflows (in US$ million)

Economy 2003 2004
EU (15) 6,674.73 6,357.72
USA 1,395.30 5,051.87
Japan 2,317.71 2,538.20
ASEAN 2,301.81 2,432.74
Total 18,446.98 25,654.17
Source: ASEAN FDI Database

FDI inflows to ASEAN grew by 39% to 25.6 billion in 2004. It must be noted that
whilst ASEANs top FDI sources are the EU, USA and Japan, intra-ASEAN is the
fourth largest FDI source. Meanwhile, in terms of sectors, manufacturing, financial
services and mining and quarrying are the top three FDI recipients.

In addition to the significant FDI inflows to the region, ASEAN Member Countries like
Singapore and Malaysia are also now large investors by international standards.
This suggests that a number of ASEAN firms have already established a track record
as among the worlds top investors and have diversified their portfolio of assets to
remain globally competitive.

III. Threats and Challenges

Indeed, much has been achieved in AFTA. As the latest trade and investment
statistics suggest, ASEAN continues to be an important trading partner and
investment location in Asia.

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As it is, however, ASEAN operates in a highly competitive environment. For with
stellar economic growth ASEANs closest neighbours, particularly China and India,
have gained in importance as trading partners and investment location. In fact, these
countries are now competing with ASEAN.

China, probably ASEANs biggest competitor, received US$53 billion in FDI or 8.2
percent of the worlds total more than any other country in 2003. Chinas export
prowess can be gleaned by how deep it has penetrated the consumer markets of the
US and the EU, which are also top trading partners of ASEAN.

Moreover, China formed the Mainland-Hong Kong Closer Economic Partnership

Agreement (CEPA) in the beginning of 2004, which is a free trade arrangement. In
tandem with CEPA is the South China common market known as the Pan River
Delta Regional Co-operation and Development Forum (or Pan-PRD or 9+2), which is
a first attempt to create a regional bloc in the Chinese mainland. The Pan-PRD is
envisioned to pave the way for China to become an integrated and efficient regional
economy.

India, on the other hand, through world-class businesses in knowledge-based

industries such as software, IT services and pharmaceuticals has emerged as a key
player in the world economy. This growth in its service sector has greatly contributed
to Indias domestic output and has made it a top recipient of FDI (US$4.7 billion in
2003, up from $3 billion in 2002).

Notably, Japan which has always been a traditional trading partner and a top
investment source of ASEAN is also now becoming an FDI competitor. Due to over a
decade of deflationary pressures, coupled with high productivity, Japan is now a
lower business costs FDI host with cost structures comparable to emerging
economies including some ASEAN Member Countries.

Aside from developments amongst ASEANs closest neighbours, ASEAN also

recognises that it is still remains a small market. Figure 4 below illustrates ASEANs
population and GDP relative to other regional trading areas (RTAs).

Figure 4. Population and GDP Comparison of Regional Trading Areas

concluded on or before 2004

Population, billions

1.6

1.4 SA FTA
BIMSTEC FTA
1.2

1
EU-Mercosur FTA
0.8

0.6 Cent ral American-US FTA

0.4 ASEAN
EU
0.2 Andean Communit y-Merc osur FTA
0

Source: ASEAN Investment Surveillance Report 2004

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The three largest RTAs in terms of GDP to date are that of Central American-US
FTA and the EU-Mercosur FTA, which are FTAs between developing countries and
the US and the EU, respectively. These two are ASEANs important trade and
investment partners.

Whilst intra-ASEAN trade and investment have gained in significance over the years,
ASEAN is aware that bulk of its trade and investment are with its external trading
partners. As such, necessary steps must be taken in order to secure ASEANs
linkages with them.

IV. The ASEAN FTA Strategy

In order to meet the challenges of intense competition from its closest neighbours
and expand its market, particularly with its important economic partners, ASEAN has
embarked on a two-pronged strategy: (a) the acceleration of its internal economic
integration and (b) the forging of free trade areas with dialogue partners.

Accelerating Economic Integration

ASEANs accelerated internal integration is currently focused on an initial eleven

priority integration sectors, which are deemed as the models for other sectors to
follow. These sectors, which were selected on the basis of ASEANs and each
Member Countrys absolute and comparative advantages include:

agro-based products,
air-travel,
automotives,
electronics,
e-ASEAN,
fisheries,
healthcare,
rubber-based products,
textiles and apparels,
tourism, and
wood-based products.

Measures with clear timelines that cover liberalisation, trade and investment
facilitation, and promotion and monitoring, were drawn up in order to realise the
integration of these sectors. Moreover, sector-specific measures, which particularly
recognise the need for ASEAN firms to move up higher along the value added chain
in order to ensure ASEANs competitive standing, were crafted in consultation with
the private sector.

Amongst these measures are:

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 the elimination of all tariffs in relation to products covered by the priority
sectors by 2007 for ASEAN 6 and 2012 for the CLMV, which is effectively an
acceleration of the tariff elimination by three years under CEPT-AFTA;
the establishment of a definitive work programme for the elimination of non-
tariff measures and the standardisation of ROO;
the harmonisation of customs declaration forms and the development of the
Single Window approach for customs;
the harmonisation of standards;
acceleration of trade in services liberalisation and the development of MRAs;
and
progressive elimination of restrictive investment measures by 2010 for
ASEAN 6, 2013 for Viet Nam and 2015 for Cambodia, Lao PDR and
Myanmar.

Importantly, these measures are meant to address the remaining barriers in the
AFTA and thus, intend to develop a cohesive and seamless business environment
for the region. This, in turn, would lower transaction costs across borders and enable
firms to achieve economies of scale and scope across the region.

FTAs with Dialogue Partners

This accelerated integration will be complemented by the benefits of an enlarged

market that would open more opportunities to ASEAN entrepreneurs. Seeing itself as
a launch pad for shared prosperity in the region, ASEAN has embarked on free trade
agreements with China, India, Japan, Korea and Australia and New Zealand. These
trading partners, whilst generally seen as competitors, recognise that there are
synergies of mutual interest that could be realised with ASEAN.

In the case of China, the Early Harvest Programme and the Trade in Goods
Agreement of the ASEAN-China Free Trade Area (ACFTA), which was implemented
in July 2005, has bolstered further the already rapidly growing trade relations
between China and ASEAN. This free movement of goods, and soon, movement of
services and investment, with the completion of the agreements on trade in services
and investment, which are currently in negotiation, should help create alliances
between the two regions and contribute to the emergence of efficient industries.
Meanwhile, FTA negotiations for Korea have also progressed significantly with the
conclusion of the ASEAN-Korea Framework Agreement on Comprehensive
Economic Cooperation and finalisation of the ASEAN-Korea Trade in Goods
Agreement of the ASEAN-Korea Free Trade Area (AKFTA), which is set for signing
soon.

It must be noted that the Trade in Goods Agreements of the ACFTA and the AKFTA
include iron and steel products, with some exceptions, under the normal track. As
such, tariffs of these products would be eliminated in 2010 and 2009, respectively.

In the case FTA negotiations with India for a Regional Trade and Investment Area,
which includes a free trade are in goods, services and investment. Negotiations with
Australia and New Zealand have also commenced and are set to finish within two
years. For Japan, whilst bilateral negotiations have already begun, negotiations for

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the regional Economic Partnership Agreement (EPA) are now underway and are
also expected to finish in two years time.

These FTAs once completed should secure ASEANs linkages with economies
outside of Southeast Asia. In order to ensure this, ASEAN has taken great care to
avoid creating a spaghetti bowl of rules, particularly on ROO, that would confuse
the private sector. To the extent possible, it has advocated for the extension of rules
that are currently in effect in AFTA so that the private sector could enjoy the same
benefits under the FTA.

ASEAN is also careful in ensuring that the FTAs do not undermine ASEANs internal
integration efforts. As such, ASEAN Member Countries are always accorded more
benefits than dialogue partners.

What is important is that these FTAs would translate to more trade, more FDI, and
more substantial infrastructure, as well as other long term projects. In particular, it
would lead to many opportunities and possibilities for entrepreneurs and investors
within and outside ASEAN.

V. Prospects

Under ASEANs two-pronged approach, one therefore should expect a more

integrated AFTA and a network of FTAs with important dialogue partners. It must be
noted that already FTAs with the EU and even the US are being considered.

In this economic scenario, the stage is set for the ASEAN Economic Community
(AEC), which is the realisation of the end-goal of economic integration as outlined in
the ASEAN Vision 2020. The AEC is envisioned as a stable, prosperous and highly
competitive ASEAN economic region in which there is a free flow of goods, services,
investment and a freer flow of capital, equitable economic development and reduced
poverty and socio-economic disparities in year 2020.

Clearly, a lot more work has to be done in order to reach that vision. It is in this
regard that ASEAN continues to be on top of things by instituting policies that
contribute to this goal and, at the same time, by ensuring a business environment
that is predictable and in touch with the needs of the private sector.

Ultimately, the private sector is a major stakeholder of the AEC. As such, ASEAN
promotes close coordination between government and the private sector.
Communication with national governments should be kept open so that government
is aware of private sectors concerns and is able to understand them. In this way,
these concerns are clearly and aptly conveyed in the various ASEAN integration fora
so that a balance of benefits in ASEAN economic integration and in the FTAs is
achieved.

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