Trade issues continue to be very important to the U.S. cotton industry. Since the NCC annual meeting, the Senate and the House have passed different versions of Trade Promotion Authority, and legislation creating trade preferences for the Andean region and modifying preferences for the Caribbean and Africa have advanced. China has moved forward on its version of tariff rate quota implementation and the enactment of the U.S. farm bill has caused howls of protest worldwide.

This report summarizes some of these issues, focusing on China’s implementation of the tariff rate quota. Other reports provided by Council staff during the Board meeting will provide additional detail on Trade Promotion Authority and textile trade preferences.

Both the House and the Senate have passed versions of ouH "Trade Promotion Authority." The legislation is currently in conference.

Both bills provide fast-track negotiating authority until June 2005, with the possibility of an extension through June 2007. Under fast-track, trade agreements can receive expedited consideration in Congress and must be subjected to a no-amendment, up or down vote in both houses. Agreements entered into under the WTO, with Chile, Singapore or with Latin America in an FTA arrangement are also covered by the fast-track procedures, even though those negotiations have already begun. When the President submits an agreement for approval, he must also submit an implementation and enforcement plan.

The bills provide overall negotiating objectives and lists "principal negotiating objectives" within several specific categories or sectors. For example, there are specific subsections on trade barriers, electronic commerce and agriculture, to name a few.

The overall negotiating objectives are broad and appropriate. For example, the legislation calls on U.S. negotiators to obtain more open, equitable and reciprocal market access; obtain reduction or elimination of barriers; strengthen the system of international trading disciplines; and to foster economic growth. The objectives include provisions to ensure that trade and environmental policies are mutually supportive, and that promote respect for worker rights and rights of children consistent with the International Labor Organization.

Within the Principal Negotiating Objectives relating to trade barriers and distortions, the bill directs US negotiators to expand competitive market opportunities for US exports and obtain more open conditions of trade – reducing or eliminating tariff and non-tariff barriers. It also instructs US negotiators to obtain reciprocal tariff and non-tariff barrier elimination agreements.

The subsection on agriculture is extensive. US negotiators are to obtain competitive opportunities for US exports in foreign markets substantially equivalent to the competitive opportunities afforded foreign exports in US markets.

It lists several areas where this can be achieved, including—

• reducing or eliminating tariffs, giving priority to products that are subject to significantly higher tariffs or subsidy regimes of major producing countries;
• reducing tariffs to levels that are the same as or lower than those in the US;
• reducing or eliminating subsidies;
• allowing preservation of programs that support family farms but do not distort trade;
• developing disciplines for domestic support programs so that production that is in excess of domestic food security needs is sold at world prices;
• eliminating government policies that create price-depressing surpluses;
• eliminating state trading enterprises, whenever possible;
• strengthen rules, etc., to eliminate practices that restrict market access, such as labeling restrictions that affect new technologies, unjustified phytosanitary restrictions, administration of TRQ, and others; and
• maintaining bona fide food assistance programs and preserving US market development and export credit programs.

With respect to the impact the negotiation might have on domestic commodity programs, the House bill tells USTR to establish a common base year for calculating the aggregate measure of support as the end of each country’s Uruguay Round implementation period.

Significantly, both versions of the legislation contain textile negotiating language, with the Senate language being particularly helpful. Senator Edwards from North Carolina successfully amended the Senate bill to include the objective of obtaining competitive opportunities for U.S. textile exports that are substantially equivalent to the competitive opportunities provided imported textiles in the United States. The Edwards amendment emphasizes the importance of reciprocity in international textile trade and calls upon U.S. negotiators to take into account the degree to which textile exporting countries are complying with existing trade agreements and obligations.

During floor debate, the Senate legislation was amended to limit the applicability of the fast-track procedures. Essentially, the Senate version does not grant fast-track procedures to any provision in trade agreement implementing legislation that would modify or amend U.S. laws providing safeguards from unfair foreign trade practices. This amendment is viewed unfavorably by the Administration and is a major hurdle from their perspective. Because of its wording, it is difficult to predict how broad this amendment could be interpreted.

In order to obtain passage of Trade Promotion Authority in the House, the Administration made a series of concessions during the House debate. The language of the bill was modified to raise the profile of textiles significantly – although the change did not go as far as recommended by the Council and ATMI, nor as far as the Edwards amendment. In addition, side agreements were made with textile state lawmakers designed to ensure them that implementation of the CBTPA legislation would be corrected. These agreements, while short of Council positions urging full trade reciprocity for textiles, were a positive step.

The recently passed Senate trade bill also contains language that would expand Andean preferences to textiles and apparel, similarly to that contained in the Caribbean Basin Trade Preferences Act. These provisions will be conferenced with a bill providing Andean Trade Preferences that was previously passed by the House.

The House Andean bill would extend duty-free and quota-free treatment to: (1) apparel articles assembled or knit-to-shape and assembled in one or more beneficiary countries from yarns, fabrics, or components, including knit-to-shape components, wholly produced in the United States or in one or more beneficiary countries (imports of apparel made from regional fabric and regional yarn would be capped at 3 percent of U.S. imports growing to 6 percent of U.S. imports in 2006), and (2) apparel articles that are both cut (or knit-to-shape) and sewn or otherwise assembled in one or more beneficiary countries, from fabrics or yarn not produced in the United States, to the extent that apparel articles of such fabrics or yarn would be eligible for preferential treatment, without regard to the source of the fabrics or yarn, under Annex 401 of the NAFTA (short supply provisions).

The House Andean bill, therefore, contains preferences similar to the African Growth and Opportunity Act in that it contains a broader preference for apparel made from fabric or yarn produced in the region. There is a limit on imports of this type of apparel. Nevertheless, ATMI strongly opposes an Andean bill with this broad regional apparel provision.

The Senate version of Andean, S. 525, is narrower than the House bill and is based on a bill introduced by Senator Graham of Florida. Instead of a broad regional apparel provision, it contains a regional knit provision (with limits) that is closer to the Caribbean legislation. The textile industry tends to oppose the House legislation while having less problems with the Senate version.

Controversy continues concerning dyeing and finishing of fabrics in the Caribbean, African and Andean regions. U.S. textile interests continue to work toward a compromise on this issue.

Meanwhile, the House of Representatives included a provision in the recently passed supplemental appropriations bill that was designed to limit Caribbean trade preferences to fabrics dyed and finished in the United States, and to extend a similar limitation to any Andean textile trade preferences. Caribbean provisions on regional knit fabrics are not affected by the dyeing and finishing restrictions. The House leadership included this provision in order to fulfill its earlier promise to Representative DeMint during the Trade Promotion Authority debate.

In February through April of 2002, China issued information confirming its allocation of an 818,500 ton cotton tariff rate quota as follows:

• 500,000 tons to the Processing Trade
• 270,000 tons to State Owned Mills
• 48,500 tons to Private Mills for the general trade

The 48,500 metric tons announced for private mills is to be allocated by the SDPC from applications received during a set application period – October 15-30 of each year. ¹ To qualify, mills must:

• be registered with the State Industry and Commerce Management Authorities;
• have a good financial status and tax payment record;
• have no violation record with Customs, Industry and Commerce, or Quarantine authorities;
• have a 2001 annual inspection qualification certificate; and
• have capacity to operate more than 50,000 spindles.

There are estimates that the number of spinning mills in China may exceed 6,000. Some individuals familiar with the process estimate that over 500 mills applied for the general trade quota. Sources indicate that around 140 to 150 end users received allocations, with some allocations as small as 200 metric tons (roughly 800 bales with a value of around $200,000). Some officials speculated that SDPC would move quota allocation from 270,000 to the general trade category – but this was not confirmed by SDPC.

Once a mill receives quota, they must apply for an Agricultural Product Tariff Quota Certificate (A) at the "authorizing agency," using their Notice and signed import contracts. The certificate is to be issued by the authorizing agency within 5 working days.

If the quota cannot be used by the end of the year, the entity must return the remainder to the authorizing agency by September 15. If the end user has not utilized all the quota and did not return the unused portion by September 15, its next year allocation will be reduced by a proportional amount.

Once imported, the cotton can be used by the mills to produce products that can enter the general trade of China.

The "processing trade" was allocated 500,000 metric tons of the quota³ and has a more flexible application procedure. About 50% of total mill use in China is exported.

Eligible entities will meet the same criteria as for the General Trade and must have a Processing Trade License commonly issued by MOFTEC.

Using Processing Trade Certificates issued by MOFTEC, applicants will apply for Agricultural Product Tariff Quota Certificates (B) at agencies authorized by SDPC in their jurisdiction⁴. The regulations state they shall receive such allocation. However, the local "authorized agency" will determine eligibility before forwarding the application to the central SDPC offices. ⁵

Applicants can apply for a processing trade quota throughout the year, with the same September 15 deadline as imposed for the general trade.

However, even if the quota is allocated, it appears firms must show evidence of a contract and must agree to export the resulting textile product⁶. Products imported in category B are not allowed for sale on domestic markets. If they are unable to be exported within the prescribed period of time, there are apparently stipulated contract cancellation procedures and Customs shall assess the waived levy using outside TRQ tariff rates⁷. The rules state that if the product is not exported and is sold within China, the entity will be considered to have engaged in smuggling⁸. If the product is sold within China, the importer will be subject to stiff penalties.⁹

State Owned Enterprises were allocated 270,000 metric tons which will basically be available to these entities as they request it. However, because these entities are controlled by the State, market forces will not be the determinate factor governing whether these enterprises seek to import cotton.

China has implemented its TRQ commitments for cotton in a manner that effectively insulates internal competition from 94% of the tariff rate quota. By requiring the export of a processed product as a condition of entry of raw cotton, these rules do not comply with the U.S. – China bilateral agreement on China’s WTO accession and are contrary to WTO rules governing national treatment. Under the WTO, imported goods are to be given treatment "no less favorable" than domestic goods. Under China’s rules, imported cotton cannot enter the domestic market without paying over quota duties.

Chinese officials have been made aware of the concerns of the U.S. cotton industry. Those responsible for implementing the TRQ state that there has always been a processing / general trade distinction within China and believe it should continue.

Sources indicated there is a great deal of official concern that the cotton area in the Xinjiang province¹⁰ could not effectively compete against foreign cotton imports and would be sacrificed if the TRQ was implemented without a processing trade distinction.

Much of the implementation procedures introduce risk into normal commercial practice. It is contrary to general commercial practice to require importers to first obtain a signed contract to purchase imports and then obtain the import license. This "reverse order" process could put contracts at risk.

The rules governing re-export under the processing trade are unclear. When a spinning mill imports cotton to spin, must that mill export yarn, or may the product proceed further up the processing chain to be included in an apparel item. If so, how can the government determine that imported cotton was used in the exported apparel item and how does the original importer of the raw fiber prove this to government officials?

Although there are reports that quotas have been allocated among end users, the Chinese government has not published any list of quota recipients. Discussions with Chinese government officials indicated that the SDPC does not currently intend to publish such a list.

The inability to verify the allocation of quotas among mills is problematic and possibly inconsistent with the U.S. – China bilateral agreement on China’s WTO accession.

The U.S. cotton industry is trying to export cotton to China amid reports of between 140 and 500 mills receiving general trade quota allocations. In addition, there are unconfirmed reports of quota being allocated to certain, unspecified processing mills and quota being allocated to one or more of the state-owned enterprises¹¹. The U.S. industry cannot appropriately conduct business in China if the specifics of actual quota allocation remain a secret.

The application of the Value Added Tax on cotton (domestic and imported) is not clear and may create disincentives to imports.

According to a recent report developed by the U.S. Department of Agriculture¹², China offers VAT exemptions for producers of agricultural goods. This exemption is passed on to the next level of sale through an offset of 10% of the 13% VAT. Imported commodities are charged the full 13% VAT upon import and do not get the benefit of this 10% offset.

When discussing the application of the VAT with different sources in China, there was disagreement on how the VAT is applied to imports of cotton. The VAT appears to be applied at the port on all imports destined for the general trade, but it is unclear whether the VAT is likewise imposed on imports for the processing trade.

China provides a VAT rebate to exporters of textile products.

The U.S. merchandizing industry is interested in discussing revisions to standard contracts used in China and in developing workable, standardized dispute settlement mechanisms.

Standard Chinese contract terms, as reflected in Chinatex contracts, are generally regarded as being out of date and in need of revision. In addition, while there is an official arbitration system in China, it is not set up for cotton and is not working effectively in the opinion of U.S. cotton merchants.

In November, trade ministers from around the world agreed to start a full round of multilateral trade negotiations under the World Trade Organization. A negotiating agenda covering a variety of areas affecting international business and commerce, such as agriculture, services, industrial tariffs, investment, and environmentally harmful fishing subsidies, was agreed upon, with a goal of completion of negotiations in 2005.

US officials have a stated goal of eliminating agricultural export subsidies, increasing market access for agricultural products, and reducing trade distorting domestic agricultural support. The US also seeks improvement in implementation of existing WTO rules calling for application of sound science with respect to trade restrictions on genetically enhanced commodities. The US believes existing WTO rules require trade restrictions to be based on sound science but question whether all countries, particularly the European Communities, are living up to their obligations.

Additional issues include efforts by other countries to restrict US use of the export credit guarantee program, make animal welfare issues a subject of the agricultural negotiations, establish rules and disciplines concerning state trading enterprises and include the new concept of "multi-functionality" as justification for exempting some countries from agricultural trade commitments. While the US has made some progress in securing allies in its fight to combat export subsidies and reduce domestic agricultural support, it has been on the defensive concerning the export credit guarantee program and has recently been on the defense due to the new U.S. farm bill.

The Cotton Council has recently been working with a coalition of interested commodity groups and other associations to focus the Administration on the export credit guarantee program. Our basic position has been that the GSM program is not equivalent to export subsidy programs disciplined by the WTO and that the failed attempt to discipline export credit programs within the Organization for Economic Cooperation and Development should not be the starting point for WTO negotiations. We are receiving indications that this approach is having a positive impact on the Administration.

Textile exporting countries have also made several attempts to reopen the Uruguay Round textile agreement in order to force the US to open its market to imported textiles before the 2005 deadline for the phase out of import quotas. These countries also want significant reductions in US tariffs on imported textiles.

The international community has reacted rather strongly to the enactment of the U.S. farm bill. Australia, the European Community, Brazil and China are among the countries that have condemned the U.S. legislation.

The reaction by the EU and Australia is to be expected. Their concern with the U.S. action will continue to be reiterated on the international stage, but will be most significant within the ongoing WTO negotiations.

Brazil has announced its intention to challenge U.S. soybean and cotton programs within the World Trade Organization. Brazil believes that these U.S. programs prejudice its rights under the WTO. If Brazil does move forward, it is likely it will challenge the U.S. soybean program first before raising a specific challenge to cotton.

Likewise, the U.S. decision on steel imports has caused many countries to be highly critical of U.S. trade policy. Many affected countries have either threatened or taken retaliatory action against the U.S. import restrictions. The WTO decision against the U.S. Foreign Sales Corporations has also caused other countries to begin to retaliate against U.S. exports. Unfortunately, agricultural exports are often the target of this retaliatory action.

In general, recent events, from the steel decision to the passage of the farm bill, exacerbated by low commodity prices worldwide, may result in increased tensions in trade policy. The U.S. farm programs are likely to be challenged in several venues. The steel decision, and worldwide reaction to it, may make it more difficult for the U.S. to address other, similar issues.

The cotton industry has several challenges facing it in international trade policy.

• It is important that it work for an appropriate implementation by China of its trade obligations;
• It should work to ensure the US works in our industry’s interests in the WTO; and
• It is likely to face an increasing number of international challenges to U.S. farm programs – challenges that the industry will need to be prepared to answer.

1. In 2002, this allocation took place between February and April, 2002.
2. Article 14, Interim Rules and Regulations for Tariff Rate Quota, 2002 (Unofficial translation, GAIN Report #CH2007), hereinafter cited as "Gain, #CH2007,"
3. The regulations classify processing trade quota as "category B" quota.
4. There are about 37 local planning commissions that are authorized to review applications.
5. Several local sources in Hong Kong and China confirm that local and provincial governments could prevent the quota from being issued.
6. Sources indicate the processing trade firms are to be given 6 months to export the processed product.
7. Article 21, Gain Report #CH2007.
8. Article 31, Gain Report #CH2007.
9. "Smuggled imports of products subject to tariff quotas shall be levied at the rate for outside tariff quotas. In addition, smugglers will be penalized in accordance with appropriate laws." Article 37, Gain Report #CH2007.
10. Total crop in China for 01/02 was 5.3 mmt with Xinjiang province producing 1.6 million metric tons.
11. The specific amounts may be considered by the source to be confidential.
12. China’s VAT on Domestic and Imported Agricultural Products Unequal, 2002, GAIN Report #CH2013, May 22, 2002.