Tag: Free Trade Agreement

How to Liberalise EU-Ukraine Trade under DCFTA: Tariff Rate Quotas

Posted on June 4, 2020 | Policy Brief

Image with a building and European Union flags in front of the building representing EU Ukraine DCFTA trade deal

This policy brief focuses on trade relations between Ukraine and the EU amid preparations for the review of the Deep and Comprehensive Free Trade Agreement (DCFTA) due in 2021. In particular, it analyses Ukraine’s utilization of the DCFTA tariff rate quotas (TRQs) over 2016-2019. According to the results, Ukraine has been steadily increasing the level of TRQs usage – in terms of the number of utilized TRQs and export volumes within and beyond TRQs. For some DCFTA TRQs, total exports to the EU far outweigh quota volumes, while for other TRQs supply is limited by quota volume. The brief provides arguments and recommendations for the DCFTA TRQs update to increase Ukraine’s duty-free access to the EU market.

Why Update DCFTA TRQs for Ukraine?

EU-Ukraine trade under the Deep and Comprehensive Free Trade Agreement (DCFTA, in effect since January 1, 2016) progressed considerably. Ukraine’s exports of goods to the EU reached $20.8 billion in 2019 – a 54% increase compared to 2016 and a 24% increase compared to pre-crisis 2013.

According to the EU-Ukraine Association Agreement/DCFTA, the parties may initiate a review of its provisions in five years from its implementation – in 2021. So far, both governments confirmed their readiness to start such negotiations next year.

Ukraine advocates for further trade liberalisation with the EU through reducing the existing tariff and, most importantly, non-tariff barriers. This is an imperative for maintaining positive trade dynamics and providing new impetus to deepening bilateral economic integration.

Updating duty-free tariff rate quotas (TRQs) under the DCFTA is at the top of the EU-Ukraine 2021 negotiations agenda. Current quota volumes are based on outdated statistics, as it has been 10 years since the DCFTA negotiations (2008-2011).

Many TRQs are too low in terms of Ukraine’s current export and production capacities. For example, Ukraine’s total exports of grains (annual averages) increased from 19 million tons in 2008-2010 to 42.3 million tons in 2016-2018. Honey exports increased from 5.9 thousand tons in 2008-2010 to 58 thousand tons in 2016-2018. As a result, some TRQs are fully exhausted in the first days or months of the year.

High competition for access to duty-free quota volumes is a barrier first of all for SMEs that cannot compete effectively for it with large companies, while out-off-quota tariffs may be too restrictive for them.

Ukraine’s TRQs Utilisation During 2016-2019

DCFTA TRQs grant partial liberalisation of market access to the EU. Zero tariff rates are only applied to a specified quantity of imported goods inside a TRQ, while beyond TRQ imports to the EU are dutiable on a regular basis (subject to third-country tariff rates).

The EU applies TRQs for 36 groups of agro-food products originated in Ukraine plus 4 additional TRQs for certain product groups (in total 40 TRQs under DCFTA) – see Table 1. Ukraine applies TRQs for 3 groups of products plus 2 additional TRQs.

By the level of utilisation, TRQs fall into three groups: 1) fully utilised. They, in turn, can be divided into TRQs with and without over-quota supply; 2) partially utilised; and 3) not utilised.

The data indicate a general upward trend in Ukraine’s utilisation of TRQs under the DCFTA. In general, Ukrainian exporters utilised 32 TRQs in 2019 (80%) comparing to 26 TRQs in 2016 (65%).

Figure 1. Number of DCFTA TRQs utilized by Ukraine during 2016-2019.

Table 1 shows Ukraine’s utilization of 40 DCFTA TRQs over 2016-2019 – in tons and %. The main findings include:

The number of fully exhausted TRQs has been increasing. In 2019, Ukraine filled up 12 TRQs including honey; processed tomatoes; wheat; maize; poultry meat; barley groats and flour, other cereal grains; sugars; grape and apple juice; butter and dairy spreads starches; starch processed; as well as malt-starch processed products. For 9 of them, Ukraine’s supplies exceeded TRQs volumes.

The number of partially utilized TRQs increased from 16 in 2016 to 20 in 2019. In 2018-2019, Ukraine began using new TRQs such as fermented-milk processed products; malt-starch processed products; sugar syrups. High TRQs utilization rates (over 80%) in 2019 were observed for malt and wheat gluten; cereal processed products; eggs (main); barley, barley flour and pellets.

Moreover, Ukraine increased utilisation of TRQs for processed products. For example, utilisation of a TRQ for cereal processed products increased from 2.7% in 2016 to 99.5% in 2019. This signifies the growing ability of Ukrainian producers to comply with the EU food safety requirements and standards for processed products. Exports of processed starch increased significantly in 2019 and exceeded TRQ volume by a lot.

Ukraine’s utilisation of some TRQs has decreased. For example, a TRQ for oats gradually decreased from 100% in 2016 to 31% in 2019 due to a decrease in total exports and domestic production of oats in Ukraine during this period. Low utilisation of other TRQs may also be attributed to high price competition and quality requirements in the EU, complex quota allocation procedure, etc.

The number of not utilized TRQs decreased from 14 in 2016 to 8 in 2019. For instance, no exports within TRQs were observed for beef, pork, sheep meat, as Ukraine has not yet been authorized to export these meat products to the EU.

Moreover, since October 2017, Ukraine has been able to use provisional TRQs that were granted by the EU as autonomous trade measures (ATM) for 3 years. They increased duty-free access for 8 groups of Ukrainian products – in addition to the relevant DCFTA TRQs. So far, Ukraine fully utilises 5 ATM TRQs including honey; processed tomatoes; barley groats and meal, cereal grains otherwise worked; wheat, flour and pellets; maize, flour and pellets.

Total Exports to the EU vs Duty-Free Exports Within TRQs

For most fully utilized DCFTA TRQs, Ukraine’s total exports of the covered products exceeded TRQ volumes during 2016-2019. Considerable over-quota supply occurred for: honey; processed tomatoes; barley groats and meal, cereal grains; apple and grape juice; maize, flour and pellets; poultry meat; wheat, flour and pellets; sugars; butter and dairy spreads; starch processed.

For instance, over-quota exports of processed tomatoes from Ukraine to the EU in 2019 (31.2 thousand t) more than doubled the quota volumes (10,000 t of the DCFTA TRQ and 3,000 t of the provisional ATM TRQ). See Figure 2 for more examples.

Figure 2. Ukraine’s exports to the EU within and beyond certain TRQs, 2016-2019.

Increasing exports beyond TRQs indicate significant demand for these Ukrainian products in the EU, and their competitiveness in terms of price and quality on the EU market.

It also signifies that volumes of these fully utilised DCFTA TRQs with increasing over quota exports are rather low in terms of Ukraine’s export and production potential. Therefore, these TRQs are the primary candidates for updating.

At the same time, for certain DCFTA TRQs (malt-starch processed products; starch, malt and wheat gluten), exports to the EU were about 100% of TRQ volume but did not go far beyond. This may indicate a significant restrictive impact of those TRQs and out-of-quota tariffs for Ukrainian exports. These TRQs also need to be further analysed and revised.

Тable 1. Utilisation of DCFTA tariff rate quotas by Ukraine, 2016-2019.

2016 2019
Quota name Quota volume Utilised Quota volume Utilised
  t t % t t %
“First-come, first-served” method for TRQ allocation
Sheep meat  1500 0 0,0% 1950 0 0,0%
Honey 5000 5000 100% 5600 5600 100%
Garlic 500 49 9,8% 500 393 78,6%
Oats 4000 4000 100% 4000 1239 31,0%
Sugars 20070 20070 100% 20070 20070 100%
Other sugars 10000 5929 59,3% 16000 1006 6,3%
Sugar syrups 2000 0 0,0% 2000 7 0,4%
Barley groats and meal, cereal grains otherwise worked 6300 6300 100% 7200 7200 100%
Malt and wheat gluten 7000 7000 100% 7000 6319 90,3%
Starches 10000 1898 19,0% 10000 10000 100%
Starch processed 1000 0 0,0% 1600 1600 100%
Bran, wastes and residues 17000 7286 42,9% 20000 14467 72,3%
Mushrooms main 500 0 0,1% 500 0 0,0%
Mushrooms additional 500 0 0,0% 500 0 0,0%
Processed tomatoes 10000 10000 100% 10000 10000 100%
Grape and apple juice 10000 10000 100% 16000 16000 100%
Fermented-milk processed products 2000 0 0,0% 2000 866 43,3%
Processed butter products 250 0 0,0% 250 0 0,0%
Sweetcorn 1500 13 0,9% 1500 23 1,5%
Sugar processed products 2000 340 17,0% 2600 417 16,0%
Cereal processed products 2000 55 2,7% 2000 1989 99,5%
Milk-cream processed products 300 73 24,4% 420 9 2,2%
Food preparations 2000 5 0,3% 2000 65 3,2%
Ethanol 27000 1889 7,0% 70800 6083 8,6%
Cigars and cigarettes 2500 0 0,0% 2500 0 0,002%
Mannitol-sorbitol 100 0 0,0% 100 0 0,0%
Malt-starch processed products 2000 0 0,0% 2000 1998 99,9%*
Import licensing method for TRQ allocation
Beef meat 12000 0 0,0% 12000 0 0,0%
Pork meat main 20000 0 0,0% 20000 0 0,0%
Pork meat additional 20000 0 0,0% 20000 0 0,0%
Poultry meat and preparations main  16000 16000 100% 18400 18400 100%
Poultry meat and preparations additional 20000 8552 42,8% 20000 9174 45,9%
Eggs and albumins main 1500 232 15,5% 2400 2027 84,5%
Eggs and albumins additional 3000 0 0,0% 3000 1891 63,0%
Wheat, flours, and pellets 950000 950000 100% 980000 980000 100%
Barley, flour and pellets 250000 249460 99,8% 310000 249250 80,4%
Maize, flour and pellets 400000 400000 100% 550000 550000 100%
Milk, cream, condensed milk and yogurts 8000 0 0,0% 9200 250 2,7%
Milk powder 1500 450 30,0% 3600 560 15,6%
Butter and dairy spreads 1500 690 46,0% 2400 2400 100%

Source: European Commission, own calculations   * Note: We consider 99.9% usage rate as fully utilized TRQ.

Conclusion

The EU and Ukraine confirmed their readiness to initiate the update of the DCFTA due in 2021. Ukraine is interested in increasing duty-free trade under DCFTA with the EU in line with the current state of Ukraine’s production and export capacities, as well as EU-Ukraine bilateral trade developments.

Although many DCFTA TRQs did not limit over-quota exports, Ukraine wants to revise DCFTA TRQs to secure permanent broader duty-free access to the EU market and reduce access barriers for SMEs (as SMEs are more affected by TRQs and other non-tariff barriers). So far, the EU temporarily increased certain TRQs in 2017 for three years as autonomous trade preferences for Ukraine. The primary candidates for the update should include DCFTA TRQs demonstrating high utilization rates, with or without over-quota supply (honey; processed tomatoes; barley groats and meal, cereal grains; apple juice; sugars; butter and dairy spreads; starch processed, etc.).

Amid future DCFTA update negotiations, Ukraine should conduct a detailed analysis for each DCFTA TRQ (taking into account temporary ATM quotas) to prepare its suggestions how and to what extent to liberalise them. It is worth considering different options of such liberalisation – by either increasing TRQs’ volumes or setting up preferential tariff rates for Ukraine instead, etc.

In the framework of the future negotiations with the EU, a special emphasis should be placed on increasing duty-free access for Ukrainian processed goods to promote their exports to the EU – as stipulated in the Export Strategy of Ukraine. For this purpose, Ukraine may explore possibilities for modifying the structure of certain TRQs (such as wheat, flour and pellets; maize, flour and pellets; barley, flour and pellets) to separate primary and processed products and to ensure more duty-free volumes for processed products.

References

Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.

Trade Policy Uncertainty and External Trade: Potential Gains of Ukraine Joining the CU vs. the Signing Free Trade Agreement with the EU

Posted on June 12, 2013 | Policy Brief

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This policy brief summarizes the results of recent research which predicts gains in Ukrainian exports from signing a deep and comprehensive free trade agreement with EU, and compares these gains with predicted gains from joining the Customs Union of Belarus, Kazakhstan, and Russia. We argue that the gains would be mostly due to elimination of uncertainty in trade policy of Ukraine with the CU and the EU countries. We find that European integration brings higher potential for export growth, and that it also shifts the structure of Ukrainian exports towards capital goods, reducing the share of raw materials in total export.

Trade Policy Uncertainty and Export

Trade policy uncertainty (TPU) is a powerful negative factor that prevents economy from the realization of its export potential. In a recent paper, Handley and Limao (2012) argue that since the exporting decision involves substantial fixed costs, TPU significantly affects investment and entry decisions in international trade. In particular, they show that preferential trade agreements (PTAs) are important even when the pre-PTA tariff barriers are low. Comparing pre- and post-EU accession patterns of Portuguese exports, they find that Portuguese trade increased dramatically after 1985. The increase was the largest towards the EU partners, suggesting that it was caused by the accession. Export expanded through considerable entry of Portuguese firms into EU markets, even in industries where applied tariffs did not change. Handley and Limao estimated that the tariff reduction, which averaged 0.66 percentage points, has been responsible for only 20 percent of the increase in exports to EU10 after the EU accession, while 80 percent of the increase was due to resolving TPU.

Handley and Limao further argue that the Portuguese example should be highly relevant for any small open economy, facing important trade policy choices. In this regard, Ukraine is facing a very hard choice of selecting its regional integration strategy – towards the EU or the Customs Union (CU) with Belarus, Kazakhstan and Russia, resulting in severe TPU. The options are mutually exclusive since the CU trade policy is not compatible with neither the WTO commitments of Ukraine, or with the parameters of the deep and comprehensive free trade agreement (FTA) between Ukraine and the EU, finalized in 2012. Average tariff protection within the CU in 2012 was 10 percent (Shepotylo and Tarr, 2012), while the average WTO binding tariff rates in Ukraine were only 5 percent; the parameters of the FTA with the EU are even less protective, which would cause even stronger disagreements regarding the tariff schedules. Moreover, technical and phyto-sanitary standards in the EU and the CU are different; therefore, it would be extremely hard to harmonize the Ukrainian standards with both of them.

Despite low tariff protection, uncertainty on the parameters of the long run trade policy of Ukraine with the CU and EU countries is extremely high. It is crucial for both foreign and domestic investors to understand in what direction the regional integration will proceed before making decisions on investing or exporting, since these decisions can incur substantial sunk costs. Suppose that a large European multinational firm were interested in including Ukrainian companies in its production chains only if Ukraine signs the FTA with the EU (integrate vertically). If Ukraine instead joined the CU, this presumed European company would rather be interested in horizontal integration and invest by building a plant for final assembly of products to serve the Ukrainian and CIS markets. For Russian companies the situation would be the reversed. They would be interested to integrate vertically if Ukraine is a member of the CU and integrate horizontally if Ukraine signed FTA with EU. However, since vertical and horizontal integration are quite different strategies, neither European nor Russian companies invest in Ukraine before the uncertainty is resolved. The same holds true for domestic companies which would like to extend their export activities to new markets. Since entrance to new markets is costly and requires some irreversible investment, it is optimal to wait until the policy uncertainty is resolved.

Modeling Trade Policy Options of Ukraine

In Shepotylo (2013), we investigate which integration scenario is more preferable for Ukraine under the assumption that TPU is fully resolved and Ukraine trades up to its potential. Based on export data in 2001-2011, we estimate the gravity model by Helpman, Melitz, and Rubinstein (2008) method, adjusted for panel data case and endogeneity of a decision to sign a PTA. Using this model, we predict bilateral exports of Ukraine under three counterfactual scenarios: a) Ukraine joined the Customs Union in 2009 (CU); b) Ukraine signed the FTA with the EU in 2009 (EU FTA); c) Ukraine joined the EU in 2009 (EU). The model predictions take into account the level of economic development, geographical location, industrial structure, and quality of government and regulatory agencies. It also accounts for macro trends, including the global trade collapse of 2008-2009.

The results are not intended for a short-term forecast, but should be rather used as indicators of the long-run effects. Their interpretation is as follows. Suppose that Ukraine has signed the FTA with the EU in 2009. Taking into account all observable characteristics of Ukraine, what would be the level of Ukrainian export of product k to country j, if Ukraine, in all other respects, would behave as a typical country-member of the FTA EU? That would involve removal of the trade policy uncertainty, stronger integration of domestic companies into the global supply chains, and increase in foreign direct investments from the EU countries.

Unlike the studies based on the Computable General Equilibrium (CGE) method, which assumes that the policy choice affects the economy only marginally through reduced tariff barriers, and that the underlying economic structure and expectations of the economic agents remain intact, the gravity model captures all changes that occur in the economy over the investigated period and extract the differences in export flows between any two counterfactual scenarios, given all background economic changes.

Results

Our main results are as follows. First, the actual exports of Ukraine are far below their potential, compared with performance of both the CU countries and the FTA EU countries. The expected long run gains in Ukrainian exports to all countries under the CU scenario are equal to 17.9 percent above the export level in 2009-2011. The corresponding number for the FTA EU scenario is 36 percent, and for the full EU scenario, 46.1 percent. Based on 2011, the export of Ukraine would have been 98 billion US dollars under the EU scenario, 91 billion US dollars under the FTA EU scenario, and 72 billion US dollars under the CU scenario. All these numbers should be compared with the actual 68 billion US dollars of Ukrainian export in 2011.

Figure 1. Ukrainian Export under the Different Scenarios
shepotylo_fig1

Second, any scenario predicts that Ukraine severely underperforms in its trade with both CIS and EU countries, while its export to the rest of the world is in line with the predictions of the model. These results are consistent with the theory that unresolved TPU in relationships with the CIS and EU countries severely hurts the Ukrainian export potential to these countries.

Table 1. Ukrainian Export under the Different Scenarios
shepotylo_tab1
Note: CIS – Commonwealth of Independent States; EU12 – countries that joined EU after 2003; EU15 – countries that joined EU before 2004; RoW – rest of the World

Third, CU integration would be more beneficial for the Ukrainian agriculture and food industry, while FTA EU or full EU integration would be more beneficial for textiles, metals, machinery and electrical goods, and transportation. Conditional on not worsening its market access to Russia, Ukraine would expand its trade in these sectors to all countries, including Russia and other members of CU.

Figure 2. Expected Increase of Ukrainian Export under the Different Scenarios

 shepotylo_fig2

Finally, the CU integration would lead to a small increase in the share of capital goods from 17 percent to 20 percent of total exports. FTA EU would increase the share of capital goods to 28 percent, while full EU integration would increase it to 29 percent. In all scenarios, the share of raw materials would decline from 16 percent to 10-12 percent. The share of intermediate goods would decline from 48 percent to around 40 percent under the two EU scenarios and would only marginally decrease under the CU scenario. The share of consumer goods would remain stable around 20 percent.

Conclusions

Ukraine would be better off by signing a deep and comprehensive trade agreement with the EU and integrate into its production chains than joining the CU. Right now, Ukraine severely underperforms by exporting far below its potential. Evidence shows that high trade policy uncertainty plays a large role in Ukraine’s poor performance, since the gap between actual and potential exports are mainly due to low levels of export to the EU and CIS countries. Moreover, Ukraine should be interested in moving the integration process even further, because EU accession would bring even better results.

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References

  • Handley, K., & Limão, N. (2012). Trade and investment under policy uncertainty: theory and firm evidence (No. w17790). National Bureau of Economic Research.
  • Helpman, E., Melitz, M., & Rubinstein, Y. (2008). Estimating trade flows: Trading partners and trading volumes. The Quarterly Journal of Economics,123(2), 441-487.
  • Shepotylo, O., & Tarr, D. (2012). Impact of WTO accession and the customs union on the bound and applied tariff rates of the Russian federation. World Bank Policy Research Working Paper, (6161).