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How the new RCEP will be transformative

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EY Singapore

Multidisciplinary professional services organization

8 minute read 26 Feb 2021
Related topics
Tax
Global trade
Public policy
Supply-chain
Tax leaders’ agenda

Companies need to understand the requirements and utilize the benefits of FTAs to remain competitive in international markets.

In brief

  • The RCEP will be the largest FTA covering 15 member countries that account for about a third of the world’s GDP and population.
  • Companies that utilize FTAs face the key challenge of understanding requirements that determine whether their products qualify for preferential duty rates.
  • The RCEP’s unified rules of origin will particularly benefit SMEs as they greatly reduce the complexity and therefore cost of compliance with FTA rules.

The Singapore government has always maintained a focus on establishing and helping companies make the most from Free Trade Agreements (FTAs). Recently, the Regional Comprehensive Economic Partnership (RCEP) agreement, an FTA covering 15 countries in the Asia-Pacific region, was signed. For companies that engage in cross-border trade, it is important to understand why Singapore places such emphasis on the creation of an FTA network and how they can benefit from it in today’s disrupted world of trade.

FTAs have been important drivers of change. The ASEAN Free Trade Area (AFTA) Agreement, which was signed in Singapore in January 1992 and put into effect on 1 January 1993, has transformed manufacturing, supply chains and trade across Southeast Asia. While many factors have influenced the growth of trade over the intervening years and the impact of AFTA was not an overnight phenomenon, its impact cannot be underestimated. Manufacturing and distribution silos at national levels have been transformed into connected and integrated supply chains across Southeast Asia.

Currently, the Intra-ASEAN tariffs for ASEAN origin products are at 0% for approximately 98% of tariff lines across the ASEAN-10 countries and at 0% for more than 99% of tariff lines across the ASEAN-6 countries (Brunei, Indonesia, Malaysia, Philippines, Singapore and Thailand). Representing approximately 23% of the total trade in goods, ASEAN collectively is the largest market for ASEAN goods.

China, supported by regional proximity and economic growth, is Southeast Asia’s largest external trading partner, accounting for approximately 17% of the region’s total imports and exports. It is no coincidence that average tariffs under the ASEAN-China FTA are less than 1% for ASEAN-origin products exported to China, and vice versa. Effectively, for qualifying products under FTAs, tariffs within ASEAN have been eliminated and almost so for tariffs to and from China.

The future of FTAs

However, outside of FTAs, most-favored-nation (MFN) tariffs remain for many products moving between Southeast Asian countries and also between the region and its trading partners. Despite its name, MFN tariffs are typically just the standard non-preferential tariffs that are applied to imports from all World Trade Organization (WTO) countries. In 1993, the Uruguay round of multilateral trade negotiations covering 123 countries was concluded and led to reduced MFN tariffs and formation of the WTO. The failure of subsequent multilateral negotiations like the Doha Development Round to agree to reductions in MFN tariffs has cemented FTAs as the way for companies to reduce tariffs on their products.

Even before the Doha Development Round was formally launched in 2001, Singapore was already focused on and had invested considerable time and resources in the development of a comprehensive FTA network to support Singapore companies. Currently, this comprises 14 bilateral FTAs between Singapore and a single trading partner, and 11 regional FTAs between Singapore and a group of trading partners. There is also an economic agreement with Taiwan that has many characteristics of an FTA. More FTAs are under active negotiation and Singapore’s existing FTAs are continually being enhanced.

Some would argue that the proliferation of FTAs over the last 20 years has had the effect of undercutting multilateral negotiations. More likely, the challenges of further negotiating an agreement with more than 100 countries were seen as too huge to produce meaningful tariff reductions. Singapore and numerous other countries saw that investing in an FTA network would yield greater tangible and more focused opportunities for companies in their markets.

In a world of trade disruption, FTAs, in helping to support international trade, create greater certainty for business.  While an FTA can potentially be challenged and renegotiated, the impact of withdrawing from an FTA that is implemented can be considerable, which is probably why withdrawals from FTAs are uncommon. In short, FTAs are here to stay and increasingly the primary vehicle by which companies are able to gain competitive access to overseas markets. Singapore’s long-term focus on developing a network of FTAs is thus an astute investment.

How EY can Help

The basics of RCEP

It is against the backdrop of trade disruption and the WTO’s inability to push forward on a new round of multilateral tariff reductions that the RCEP negotiations were conducted and an agreement was signed on 15 November 2020. The signing of the agreement came after more than 30 rounds of negotiations and several ministerial meetings. During negotiations, India opted out due to concerns over tariff elimination, particularly in relation to trade from China and how this would impact its domestic industry. As an open accession agreement, India can still opt to join the RCEP, although there are no signs of that happening imminently.
 

The RCEP covers 15 countries, including the ASEAN member countries (Brunei, Cambodia, Indonesia, Lao PDR, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam) and Australia, China, Japan, South Korea and New Zealand. Upon entering into force, the RCEP will be the largest FTA in the world. The 15 member countries represent approximately 30% of the world’s GDP and 30% of the world’s population. Member countries cover a wide range of GDP per capita, from low-income to high-income and over the last 30 years, have also been some of the fastest-growing economies in the world. The RCEP is being promoted as an FTA that will support high growth levels continuously, stimulating economies in a post-COVID-19 business environment.
 

The RCEP is expected to eliminate duties on 85%–90% of tariff lines over a period of 20 years after coming into force. This is not considered an aggressive target in comparison to other FTAs. However, the RCEP is the first significant FTA that connects China, Japan and South Korea, which is a key development in trade relations. Even without an FTA between them, China and South Korea are Japan’s largest and third-largest trading partners respectively. It is expected that trade among these countries will gain particular stimuli from the RCEP.
 

More importantly, there will be a harmonized set of rules for determining countries of origin, greatly simplifying the various rules under existing FTAs in the Asia-Pacific region.
 

The RCEP will enter into force 60 days after the date on which at least 6 ASEAN signatory countries and 3 non-ASEAN signatory countries have completed ratification. It is anticipated that several countries will ratify the RCEP in 2021, with it likely to come into force in 2022. Any countries that have yet to ratify the RCEP will join thereafter once they have completed the due domestic process.
 

“Conditional” not “free” trade

For many companies, the key challenge of utilizing FTAs is in understanding the requirements that determine whether their products qualify for preferential duty rates. In this respect, FTAs are not “free” but “conditional” agreements that come at the cost of companies having to invest in understanding the rules and developing processes and systems to comply with the rules. The cost of compliance can be considerable and there is a perception that the major beneficiaries of FTAs have been large multinational corporations with the resources to invest in exploiting the benefits of FTAs.
 

It is also a fact that the cost of compliance with FTA rules falls heavily on the exporter, with benefits accruing to the importer. If the exporter is somehow non-compliant, there can be significant commercial implications as the importer may be subject to the recovery of underpaid duties and to penalties — which it will likely try to recover from the exporter. Many exporters, especially small- and medium-sized enterprises (SMEs) selling to third parties overseas, would often rather forego the FTA benefits than be exposed to the commercial risk of non-compliance. This may mean that they rule themselves out of selling to some potential customers as there is an increasing requirement for buyers to insist upon Certificates of Origin to support reduced tariffs under FTA arrangements.
 

The aforementioned harmonized set of origin rules under the RCEP is one of the most practical benefits provided to companies as this is expected to considerably reduce the complexity and challenges of compliance, thus increasing uptake by companies that will be able to benefit from it. All companies will benefit from the RCEP’s unified rules of origin, but the SMEs are likely to benefit the most. The significance of the RCEP’s benefit should not be underestimated.
 

FTAs have helped transform Southeast Asian supply chains over the last 25 years. In today’s trade-disrupted world, FTAs are even more important and will continue to influence supply chains and international trade over the coming decades. The RCEP has cemented the future significance of FTAs to companies as a way of accessing international markets.
 

Singapore’s creation of a network of FTAs has provided plenty of opportunities but much of that is unrealized potential. The transformative potential of FTAs is, more than ever, considerable with companies that need to utilize the benefits of FTAs to be competitive in international markets.

The transformative potential of FTAs is, more than ever, considerable with companies that need to utilize the benefits of FTAs to be competitive in international markets.

Adrian Ball

Former EY Partner

This article was written by former EY Partner Adrian Ball.

Summary

FTAs have supported the transformation of Southeast Asian supply chains and will continue to influence international trade in the future. The signing of the Regional Comprehensive Economic Partnership (RCEP) agreement highlights the significance of FTAs as a way for companies to access international markets.

The harmonized set of origin rules under the RCEP can help companies to overcome the potentially high compliance cost of FTAs by greatly reducing the complexity of compliance.

About this article

Black logo ey
EY Singapore
Multidisciplinary professional services organization
Related topics
Tax
Global trade
Public policy
Supply-chain
Tax leaders’ agenda

EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients.