US embassy cable - 05NAIROBI4023

UNCLAS SECTION 01 OF 04 NAIROBI 004023 
 
SIPDIS 
 
SENSITIVE 
 
DEPT FOR AF/E, AF/EPS 
DEPT PASS USTR 
USAID FOR AFR/EA JULIA ESCALONA 
TREASURY FOR ANN ALIKONIS 
LONDON AND PARIS FOR AFRICA WATCHERS 
 
E.O. 12958:  N/A 
TAGS: ETRD, ECIN, ECON, KE, TZ 
SUBJECT: East African Community Customs Union: Just Teething 
Problems or Falling Apart? 
 
REF: 04 Dar Es Salaam 2625 
 
Sensitive-but-unclassified.  Not for release outside USG 
channels. 
 
1.  (SBU) Summary: The East African Community Customs Union, 
established at the start of 2005, is experiencing teething 
problems - and in the minority view, may be unraveling.  A 
slew of problems, ranging from tariff rates for 
pharmaceuticals to rules of origin for vehicles assembled 
locally by General Motors, confronted EAC ministers at a 
recent meeting in Arusha, Tanzania.  Kenyan government 
officials downplay the seriousness of these disputes, and 
see them as a natural result of closer trade ties within the 
EAC region, which combines Kenya, Tanzania, and Uganda. 
Kenyan observers, however, nonetheless see Tanzania as the 
potential wildcard, claiming the latter has a fear of Kenyan 
competition and a lingering ideological distaste for 
capitalism and free trade.  It's probably too early to tell 
whether the EAC Customs Union succeeds in expanding trade 
and prosperity in the region, collapses, or just muddles 
along without actually achieving much in the way of tangible 
integration and growth.  End summary. 
 
--------------------------------- 
The ABCs of the EAC Customs Union 
--------------------------------- 
 
2.  (U) The original East African Community collapsed in 
1974 due to differences between the countries' leaders and 
levels of economic and industrial development.  Beginning in 
the mid-1990s, Kenya, Tanzania, and Uganda renewed the 
process of regional economic integration by forming a 
grouping called East Africa Cooperation, which they 
transformed into the East African Community (EAC) in 2001. 
In the future, the leaders of the three EAC states have 
ambitious plans for a monetary union, free movement of 
labor, and eventually some form of political union.  But as 
a first step towards this kind of deeper political and 
economic integration in a grouping that comprises a combined 
GDP of $27 billion and 90 million consumers, the EAC treaty 
provided for the formation of a customs union by 2004. 
Ready or not, the EAC Customs Union thus came into existence 
on January 1, 2005. 
 
3.  (U) As negotiated by the three members states, the EAC 
Customs Union is not by definition a pure customs union - at 
least not yet.  The Customs Union indeed creates a common 
external tariff (CET) for all goods imported from outside 
the union.  The CET consists of three bands - 0% for raw 
materials, 10% for intermediate goods, and 25% for finished 
products.  But within the union, the accepted principle of 
asymmetry recognizes that Kenya's relatively larger and more 
competitive economy requires that both Uganda and Tanzania 
be permitted to continue to assess a "suspended duty" on a 
select group of "imports" from Kenya.  For Uganda, this list 
comprises 443 products whose tariffs will be reduced from 
10% to 0% over five years.  Tanzania will apply a shifting 
set of tariff rates and reductions to a total of 880 
products lines, but all rates will go to zero after five 
years. 
 
----------------------------- 
Teething Problems - or Worse? 
----------------------------- 
 
4.  (SBU) Media reports in Kenya in late August and early 
September following the EAC's 10th Council of Ministers 
meeting in Arusha, Tanzania indicated that the well- 
intentioned Customs Union is at best experiencing teething 
problems.  Some business contacts, frustrated by the slow 
pace of implementation of the union, go further and believe 
it could be unraveling.  Contentious disputes between the 
member states in Arusha in August reportedly centered on the 
following: 
 
-- Kenya and Pharmaceuticals: In April, EAC ministers 
decided to make an exception and lower the CET on 
pharmaceutical products from the 10% intermediate rate to 
zero, largely in response to a chorus of protests from the 
healthcare community in the context of the region's HIV/AIDS 
pandemic and other health challenges.  Kenya, which had 
always zero-rated pharmaceuticals, was seen as leading the 
charge to make this exception.  (Note: The U.S. Mission to 
Kenya, home to the largest single PEPFAR program worldwide, 
specifically pressed the Kenyan government to zero-rate all 
drugs used to treat HIV/AIDS.  End note).  Tanzania, 
according to Kenyan media reports, fought back during the 
August Council of Ministers meeting, with the country's 
small pharmaceutical industry reportedly threatening to sue 
Kenya over the issue. 
 
-- Tanzania and NTBs: The press also made hay of the alleged 
pique expressed in Arusha by Kenya's Minister of Industry 
and Trade, Mukhisa Kituyi, over a series of non-tariff 
barriers (NTBs) being imposed on Kenyan products to prevent 
them from crossing into Tanzania, including a $50 fee 
imposed on Kenyan traders and businesspeople at border 
crossing points.  This followed earlier and intense press 
coverage in Kenya of the expulsion from Tanzania of three 
Kenyan journalists perceived to have written politically- 
incorrect news reports. 
 
-- Uganda and Infant Industries:  A week after the ruckus 
over duties on pharmaceuticals, Kenya and Tanzania protested 
a Ugandan request to exempt from duty a list of products, 
tied to a list of specific companies, in order to allow 
these "infant industry" firms to survive and prosper. 
Kenyan Trade Minister Kituyi was quoted in the local press 
as saying, "National interests also have to be involved on 
how we negotiate, how much more concession should be given 
to Uganda." 
 
-------------------------------------------- 
GM: Not Reaping Rewards of the Customs Union 
-------------------------------------------- 
 
5.  (SBU) The experience of General Motors East Africa, a 
Nairobi-based vehicle assembler owned by GM, illustrates the 
problems the Customs Union faces in achieving its ultimate 
objective of expanding intra-regional trade.  Bill Lay, GM 
East Africa's Managing Director, believes the union will 
implode eventually - though perhaps his opinion should be 
taken with a grain of salt given his personal experience. 
He began laying the groundwork for taking advantage of the 
Customs Union early on, establishing contacts and dealers in 
Tanzania and lobbying early and often for favorable rules of 
origin for his assembled vehicles.  After selling a small 
number of trucks and vans into Tanzania in the spring, 
hassles began at the border according to Lay, and by June, 
Tanzania's Finance and Foreign Ministers were loudly 
protesting against the Union's agreed-upon "substantial 
transformation" rule of origin.  Under this provision, a 
product like GM's vehicles assembled from imported kits is 
considered to be locally produced if the conversion from 
inputs to finished product results in a change in 
classification of the final product's tariff heading. 
 
6.  (SBU) Lay says Kenya and Uganda went along with Tanzania 
and the substantial transformation provision was suspended 
until the end of the year, which means he has to fall back 
on a far less favorable methodology requiring a more 
expensive process of demonstrating at least 35% value-added 
local content.  Lay says it's difficult for him to meet this 
rule because fewer and fewer local parts makers can produce 
the increasingly high-tech parts that go into his assembled 
vehicles.  Caught in this catch-22 and now unable to sell 
vehicles into Tanzania after so much planning, Lay says 
despairingly that auto assembly and manufacturing has little 
future in East Africa.  He is looking at an import-based 
strategy over the next few years and is already importing 
and selling South Korean-made Chevys in Kenya.   Lay blames 
Tanzania's resistance to GM's locally-assembled vehicles on 
politically well-connected importers of used vehicles in 
Tanzania. 
 
--------------------------------------------- ---- 
Kenyan Officials: All's Well in the Customs Union 
--------------------------------------------- ---- 
 
7.  (SBU) Senior Government of Kenya (GOK) officials deny 
the Customs Union is in any danger of falling apart.   Trade 
Minister Kituyi told the press in early September that 
"teething problems and even beyond teething" are a normal 
result of closer trade relations between neighbors, just as 
EU member states battle over agricultural subsidies.   In a 
September 6 meeting, Kituyi's Permanent Secretary, David 
Nalo, told Econoffs that the problems reported in the press 
were blown out of proportion.  He ticked off the final 
results of the August Ministerial meeting with regard to 
each trouble spot: 
 
-- Pharmaceutical Duties: While the Tanzanian private sector 
remains vociferously opposed to the 0% duty, the Government 
of Tanzanian told EAC ministers that it is fully committed 
to zero-rating, and will remain so.  This issue, said Nalo, 
is resolved. 
 
-- Tanzania's NTBs: Barrack Ndwega, Director of the EAC 
Directorate at the Ministry of East African and Regional 
Cooperation, told Econoff on September 20 that non-tariff 
barriers remain a problem, and that Kenya has "a long list 
of NTBs blocking our goods."  But he said that the EAC 
Secretariat is establishing a mechanism, to be up and 
 
SIPDIS 
running hopefully by November, to identify and deal with 
NTBs as they arise.  The $50 fee on Kenyan businesspeople 
entering Tanzania has been dropped, he said. 
 
-- Uganda's Infant Industries: Nalo said EAC ministers had 
agreed in principle with Uganda's argument to provide 
preferential treatment to certain key infant industries, 
given the country's relatively lower level of development. 
But the issue became contentious, he said, when Uganda 
submitted a list of duty-exempt products to be imported by a 
list of infant industry firms.  Both lists, he said were 
inflated, to the consternation of Kenya and Tanzania.  The 
list of 134 products was investigated and pared back to 51, 
and the list of 112 infant enterprises cut back to 34.  In 
the end, ministers resolved to establish a mechanism at the 
EAC Secretariat to track infant enterprises in Uganda, which 
will only be allowed preferential treatment if they sell 
their finished goods locally in Uganda.  Once they are ready 
to "export" products to other union members, they will have 
to pay normal tariffs on their imported inputs and/or pay a 
duty of some kind so as not to undermine competitors within 
the EAC area. 
 
-- Cars and Rules of Origin: In contrast to GM's far bleaker 
assessment, Nalo said the issue of rules of origin has been 
resolved and that only GM's most stripped-down truck models 
are unable to meet the 35% local content criteria.  Ndwega 
of the Ministry of East African and Regional Cooperation 
conceded that Kenyan products are often blocked by disputes 
over rules of origin, but claimed these issues are being 
ironed out. 
 
------------------------- 
Comment I: Time Will Tell 
------------------------- 
 
8.  (SBU) We are rooting for its success, but only time will 
tell whether the EAC Customs Union succeeds in significantly 
boosting trade and prosperity in East Africa or falls apart 
thanks to political and/or economic differences between its 
members.  A third path might be to simply muddle along, 
alive in name, but failing to expand prosperity 
significantly as members cave in to narrow, short-term 
interests and find ways to constantly stymie truly free 
trade - as appears to be the case thus far. 
 
------------------------------- 
Comment II: Kenya vs. Tanzania? 
------------------------------- 
 
9.  (SBU) From the Kenyan perspective, the potential spoiler 
in the mix is clearly Tanzania, for two reasons.  First, 
Kenyans believe that Tanzania is fearful of being swamped 
economically by a more competitive Kenya and more aggressive 
Kenyans.  Second, they suspect that Tanzania, having 
abandoned socialism more recently, still has lingering 
ideological misgivings about the benefits of free trade and 
market-based economics, and that it therefore has less 
enthusiasm for the Customs Union generally.  On this note, 
Trade Permanent Secretary Nalo reported that Kenya initiated 
a very frank closed-door session at the end of the recent 
ministerial meetings at which Tanzania's alleged xenophobic 
tendencies, as manifested in the expulsion of the three 
Kenyan reporters in July, were put on the table and 
discussed as an obstacle to progress in the Customs Union. 
Kenya, in turn, is perceived as arrogant and overbearing 
within the region, at least according to some observers, 
precisely because of these views. 
 
10.  (SBU) Finally, there may be a structural challenge, as 
well.  Tanzania, it is noted, is a member of the EAC, but 
unlike Kenya and Uganda, is not a member of the Common 
Market for Eastern and Southern Africa (COMESA), a 21-member 
regional trade bloc that plans to form an even larger 
customs union by 2008.  Tanzania withdrew from COMESA in 
2000 and is instead a member of the Southern African 
Development Community (SADC), while Kenya and Uganda are 
not.   We frankly aren't sure what this means for the future 
of the EAC Customs Union, but would warmly welcome 
perspectives on these issues from colleagues at Embassies 
Dar, Kampala, and elsewhere in the region. 
Bellamy