AFTA (“ASEAN FREE TRADE AREA”)

Background of AFTA
AFTA was established in 1992. AFTA is a collective effort by ASEAN member countries to reduce/eliminate tariffs
on intra-ASEAN trade.

The primary goals of AFTA seek to:

• Increase ASEAN's competitive edge as a production base in the world market through the elimination,
within ASEAN, of tariffs and non-tariff barriers; and
• Attract more foreign direct investment to ASEAN.

With a combined population of 513 million people, the establishment of the Free Trade Area among ASEAN, offers
vast potential for greater economic collaboration.

Mechanism to realise AFTA

AFTA has been realised through the Common Effective Preferential Tariff (CEPT) Scheme. Under the CEPT:
• import duties among member countries will be reduced to between 0-5% by the full implementation of
AFTA in 2010
• elimination of quantitative restrictions (import permit, quota) & other non-tariff barriers (NTBs) among
ASEAN Member countries
• progressive transfer of products into the CEPT Scheme based on each ASEAN member's capacity and
capability.

The Common Effective Preferential Tariff (CEPT) scheme

CEPT is cooperative arrangement among ASEAN Member States to reduce intra-regional tariffs and remove non-
tariff barriers over a 10 year period commencing 1 January 1993. Objective of the Scheme is to reduce tariffs on all
manufactured goods to 0-5% by the year 2003 for the original six member states, Malaysia, Singapore, Brunei,
Thailand, Philippines and Indonesia.

The new members of ASEAN, namely Vietnam, Lao PDR, Myanmar and Cambodia have been given the same 10
year flexibility to reduce tariffs from the time of their membership of ASEAN;
• Vietnam will reduce tariffs to 0-5% by 2006
• Laos PDR and Myanmar by 2008
• Cambodia by 2010

In 2003 for the original six member states, a total of 98.8% of tariff lines are already in the inclusion list for tariff
reduction, out of which 99.55% now have duties between 0-5%.

Products excluded from the CEPT scheme

Products that are excluded presently from the CEPT are listed in the Temporary Exclusion List, Sensitive and Highly
Sensitive List and General Exclusion List.

Implementation of AFTA in Vietnam

Initial conditions
AFTA was officially agreed in 1992 under a favourable regional and global environment. When joining AFTA,
Vietnam clearly identified and balanced possible advantages and difficulties it might have to cope with during the
realisation of AFTA. According to many researchers, the phasing in of Vietnam into AFTA enjoyed a quite
advantageous context. Some reasons for this assessment are as follows:
First, as a result of the "Doi moi" policy, Vietnam is in transition to a market-based economy with a socialist
orientation under State control. As a result, Vietnam has actively advocated diversification and intensification of
external economic relations.

Furthermore, macroeconomic development has shown a positive trend. The achieved growth rate of GDP in the 1990-
1995 period was relatively high, compared to other countries in the region (a growth rate of 9% in 1995 compared to
an average growth rate of ASEAN of 5.2-8.9%). During the period of 1985-1995, the rate of exports of Vietnam was
also higher than that of other ASEAN members (32% per year compared to 29%).

Vietnam also has a supportive administrative environment for the commitment to AFTA. Among the more than 3000
items in the inclusion list, 52% of these have tariffs at 0-5%, meeting the standards of the CEPT Agreement. This
percentage is high compared to this of other ASEAN members at the start of AFTA: 9% for Indonesia, 27% for
Thailand and 32% for the Philippines. In addition, Vietnam has considerably eliminated quota restrictions to exports
and imports. Therefore, Vietnam’s market is seen as a relatively highly open market in the region.

Impact of AFTA on Vietnam's economy

1. Impact on trade activities

Under the CEPT Agreement, ASEAN member states give each other preferential tariff rates of 0-5%. This helps
Vietnamese products to access a regional market that incorporates many substantial advantages: a population of more
than 500 million, convenient transportation systems and relatively moderate requirements on product quality.
Moreover, the reduction in import tariffs or duties lowers investment costs, thereby enhancing the competitiveness of
Vietnamese products in the regional market.

Nevertheless, influences of free trade often are two-sided. On the one hand, free trade helps to create large markets
and encourage production and exports. On the other hand, if the domestic economy as a whole is not strong and
competitive enough, many economic sectors may forfeit even in the home market. Put simply, the home market will
shrink and lots of enterprises that are rather weak and uncompetitive will be in danger of bankruptcy.

Besides, throughout the realisation of CEPT, changes in trade structure will also arise and originate trade losses. The
reason is that the regional trade liberalisation allows intra-regional trade at lower prices due to lower tariff rates.
Meanwhile, the same products produced by a non-ASEAN country at lower or equal production costs may become
more expensive. This blocks inflows of goods from non-ASEAN countries into Vietnam, thereby inducing a loss in
taxation revenue (import duties) and raising import prices instead of lowering these.

According to many economic researchers, compliance to CEPT will enhance Vietnam’s ASEAN import and export
value with lower increases in exports than in imports. As to Vietnam’s extra-ASEAN trade, exports will expand at the
same time that imports will contract due to the changing trade structure. Generally speaking, overall increases in
export value stem mainly from increases in the quantity of exports.

The Vietnam-ASEAN trading relations have considerably improved. ASEAN member countries have become
increasingly important business partners of Vietnam. The average growth rate of Vietnam-ASEAN trade is at 20-25%
per year. In total Vietnam's export turnover to ASEAN, exports to Singapore contributes some 60-70%. Singapore is
a typical market for re-exports. It is therefore too soon to conclude that ASEAN is the dominant market for the
Vietnamese products. Shares of major products exported to ASEAN are 16%, 18% and 6.6% for crude oil, rice and
sea food respectively; garments are exported to Singapore for re-exportation.

According to some forecasts, the ASEAN market represents about 13% of Vietnam exports in 2000. This figure is
expected to be 11% and 10% in 2001 and 2002, respectively. Major products are rice, peanut core, cashew, seafood,
manufactured goods and household goods. In the last few years, Vietnam's trade deficits with ASEAN have remained
at a quite high level. In 1998 this deficit amounted to US$ 1.34 billion, representing 60% of Vietnam’s total trade
deficit and more than 50% of total exports to ASEAN. Therefore, accelerating exports to ASEAN and establishing a
trade balance are considered as a one of most critical issues of Vietnam for years to come.

In spite of many challenges ahead, Vietnam has been undertaking two key policies, in attempting to achieve a trade
balance with ASEAN. On the one hand, it endeavours to deepen its export volume, especially of manufactured and
semi-manufactured goods, and to concentrate on directly commercialised goods instead of goods for re-export, in
order to strengthen export efficiency. On the other hand, Vietnam effectively sets out requirements on exports to
ASEAN in exchange for imports from ASEAN. Most of the imported goods from ASEAN are now motorbike parts
and fertilisers. For example, Vietnam would ask exporting countries to import Vietnamese goods, such as rice, peanut
core, and cashew, etc. Importantly, these two policies should be accompanied by a further continuing enhancement
in product quality so that Vietnamese products can be firmly traded in the entire ASEAN market and the severe
competition of imported goods from ASEAN does not impede domestic sectors.

General speaking, AFTA does not have direct impact on import-export relations of Vietnam. Equivalently, AFTA
will not create any extremely quick momentum or fundamental changes for Vietnam's trade unless there are
improvements in the structure of domestic production. However, together with movements in economy and society,
domestic demand for consumer goods will change. Over the past few years of “Doi moi”, these changes have been
seen considerably large both in terms of structure and quantity. At present, products from China, though low in
quality, are still holding a strong position in the domestic market due to very low prices, and thus possibly affordable
for most consumers. As the overall purchasing power increases, consumers’ choice will become wider. Therefore,
benefiting from AFTA' s preferences, ASEAN goods will probably occupy a large part of Vietnam's market and
thus put a strong pressure on goods from China, especially smuggled goods.

2. Impact on attracting foreign investment

Up to December 1999, Vietnam has accomplished considerable achievements in attracting foreign direct investment
(FDI). According to statistics from the Ministry of Planning and Investment, Vietnam has witnessed more than 2500
FDI projects with a total initially registered capital and added capital of approximately US$ 40 billion. The amount of
investment capital realised is US$ 16 billion, representing almost 40% of total registered capital. More than 1000
projects have been started with total revenues achieved of over US$ 11 billion.

According to many researchers, the structure of FDI in Vietnam is more and more in harmony with the new
requirements of the transformation of the economic structure. By 1990, investment capital in tourism was higher than
in industry and forestry-agriculture. However, during the past decade, foreign investors have been more engaged in
industry sectors, thereby raising the share of foreign capital invested in industry in 1999 up to 51.03% (compared to
37.04% in tourism and 11.93% in forestryagriculture and fishery). Several industrial sectors are performing with
100% foreign invested capital.

Examples are crude oil extraction and production, and vehicle manufacture. In other sectors like steel industry,
television manufacturing and detergent production, the share of FDI in total investment is showing an increasing
trend.

Asian FDI inflows increased over the years (table 2). Particularly, ASEAN members obtained about US$ 13,998
million of FDI in 1998. In 1999, this figure went down by 34.3% to approximately US$ 9.2 billion. FDI in most
countries in the region was seen to be lower than that in 1998: Malaysia down by 27%, Singapore 25% and Vietnam
18.4%. In the case of Indonesia, about US$ 356 million of FDI came out of the country. Thailand has been relatively
quick in economy recovery; consequently FDI registered in Thailand in 1998 was of US$ 7,449 million, double of
that in 1997. This overall reduction in FDI in ASEAN is mainly caused by the Asian crisis, instability of politics in
Indonesia, the low reform of financial systems and the devaluation of currencies of countries in the region, the
appreciation of the Japanese yen and the increases in interest rates by the American Federal Reserve since the
beginning of 1999. In addition, FDI to Vietnam from ASEAN has strongly improved, of which Singapore and
Malaysia were two of the ten biggest investors in Vietnam at the end of 1999.

In general, investment projects in ASEAN are small in scale and basically do not differ from those in developed
countries in terms of investment structure. Most of the projects relate to amounts of US$ 1million to US$ 5 million,
with low technology and high intensity in labour and resources. Among ASEAN, Singapore has a few high-tech
projects. Apart from limitations, FDI of ASEAN in Vietnam has in an important way contributed to social-economic
developments in Vietnam over the past few years. FDI of ASEAN has helped Vietnam to generate US$ 369 million
of export revenue and provide jobs to more than 34,400 people.

Nevertheless, as far as attracting FDI from non-ASEAN countries is concerned, other member states are in a better
position than Vietnam, for reasons related to Vietnam's investment environment which is less attractive compared to
that of other ASEAN members. Research on more than 1000 large corporations by American International
Investment Consultancy Inc. A.T. Kearney shows that among 25 countries and territories that have the most
favourable investment environment in the world, there are four ASEAN states. Thailand ranks 15th, Singapore 21st,
Malaysia 24th and the Philippines 25th in this list. Clearly, a strong competition in attracting foreign investment
between ASEAN members is considered as a large obstacle for the development of Vietnam's economy in the coming
years.
3. Impact on the production structure
The implementation of the AFTA commitments will lead to market expansion and trade liberalisation which will
substantially contribute to a boost of intra-ASEAN flows of capital, labour and technology. This will help Vietnam as
well as other member states to speed up the transformation of the structure of production. Vietnam is now actively
seeking and determining its comparative economic advantages. Tropical agriculture and an abundant source of labour
with various skills are eminent examples of Vietnam's advantages. Under AFTA the more developed ASEAN
countries will benefit when sectors that require a large amount of labour and low technology are reduced and the
activities transferred to developing ASEAN members. The more developed member states will be able to faster
develop hightech sectors, thereby strengthening their industrialisation levels. In the meantime, the less developed
and developing members will also enjoy opportunities to make use of their cheap labour resources, apply appropriate
technologies and learn from experiences of the developed members how to accelerate the industrialisation process,
shorten social-economic disparities and keep up economic development in line with the others.

Studies by Seiji Naya, Pearl Imada and Manuel Montes indicate that ASEAN members will experience changes in the
production structure. Yet these changes are small:
• In Indonesia, production will achieve the highest growth in sectors using a lot of labour and natural
resources, such as textiles, garments, wooden products, paper and paper-related products.
• In Malaysia, production will expand in sectors using a lot of labour like the garments and wood
industry. The manufacturing industry with high capital content will also strongly expand. Sectors
that will shrink most are these producing food, paper and paper-related products, ceramic and
glass-related products, and non-metallic products.
• In the Philippines, production will increase in sectors with a high capital content, including nonmetallic
manufactured products and electrical engines. Industrial chemicals and wooden products
will be slightly down. Among ASEAN, the Philippines is less affected by AFTA since its trade cooperation
with other countries in the region is fairly moderate.
• In Thailand, the food sector will strongly go up. Electrical engines, leather products, metallic and
non-metallic products will also increase but at a lower rate. Wood processing, non-electrical
engines and industrial chemicals will contract.
• In Singapore, production will be boosted in sectors with a high capital and technology content. In
the mean time decreases will be experienced in sectors using large amounts of labour.
• In Vietnam, production will expand in sectors with a heavy labour and natural resources content,
such as textiles, garments, handicrafts, agroproducts processing, and increase slightly in high
capital and technology intensive sectors such as metallic and non-metallic products, food and
beverages, electronic products and chemicals.

Generally speaking, although overall changes in production are not notable, the structure of production
will adjust. The higher the level of industrialisation, the higher the capability of integration.

Additional Information:
AVERAGE CEPT TARIFF RATES BY SELECTED COUNTRY

Country 2000 2001 2002 2003

Malaysia 2.57 2.40 2.27 1.97
Vietnam 3.38 2.97 2.72 1.78
ASEAN 3.74 3.54 3.17 2.63
Source: ASEAN Secretariat

Above table indicates that the profile of CEPT tariff rates for Vietnam is closely related to that of Malaysia. Hence,
the impact of AFTA regulations is expected to closely mimic that of Malaysia.