US embassy cable - 03TEGUCIGALPA752

UNCLAS SECTION 01 OF 04 TEGUCIGALPA 000752 
 
SIPDIS 
 
SENSITIVE 
 
STATE FOR WHA/CEN, WHA/EPSC, EB/TPP/BTA/ANA 
STATE PASS AID FOR LAC/CEN 
PASS TO USTR FOR ANDREA GASH DURKIN 
PASS TO USTR FOR SARAH SIPKINS 
COMMERCE FOR ITA/JEFFREY DUTTON 
TREASURY FOR BONNIE RESNICK 
 
E.O. 12958: N/A 
 
TAGS: ETRD, KTEX, HO 
SUBJECT: U.S.-CAFTA: Honduran Textile Goals in the U.S.- 
CAFTA Negotiations 
 
REF: A) TEGUC 00546 
     B) TEGUC 01391 
     C) TEGUC 02647 
 
1. (SBU) Summary: Honduras can be expected to fight hard in 
the U.S.-CAFTA textile negotiations for rules of origin that 
allow use of fabrics produced in NAFTA, Central American, 
CBI and Andean countries, including allowing the manufacture 
of woven products, short supply provisions and flexible 
rules of origin mechanisms such as accumulation.  The GOH 
will continue to insist on maintaining special import 
regimes after tariffs in the U.S.-CAFTA region are 
eliminated because of their interest in short supply 
provisions and Honduras' belief that the free trade zones 
are a key reason for Honduras' success in the sector to 
date.  In addition, many Honduran firms (even those which do 
not export) have come to consider the tax exemptions an 
entitlement.  Unless the government's fiscal woes worsen 
significantly, we expect the GOH to insist on maintaining 
its "WTO right" to provide these tax incentives to 
investors. End Summary. 
 
-------------------- 
The Maquila Industry 
-------------------- 
 
2. (SBU) The attraction of the apparel assembly and related 
maquila operations has been one of Honduras' few success 
stories in diversifying from traditional agricultural 
exports such as bananas and coffee.  The sector was expected 
to expand at double-digit rates after the adoption of 
expanded Caribbean Basin Trade Partnership Act (CBTPA) 
benefits in the U.S. but instead contracted for two years 
due to the downturn in the U.S. economy.  The importance of 
the sector to job creation and export earnings and the need 
to remain competitive after the planned elimination of 
worldwide textile and apparel quotas in 2005 make expanded 
market access for Honduran textiles and apparel its most 
important goal in U.S.-CAFTA negotiations. 
 
3. (U) Accumulated investment in the sector in 2002 totaled 
USD 1.422 billion, with USD 981.12 million in foreign 
investment.  Accumulated U.S. investment in the sector is 
estimated at 568.8 million, or 40 percent of the total 
maquila investment.  Currently, there are approximately 66 
U.S. textile companies in Honduras with the most prominent 
being Fruit of Loom, Sara Lee, Russell, Hugger, Dickies and 
Jockey.  Honduran companies account for some USD 440.8 
million, or 31 percent of total industry investment.  The 
rest of the investment is principally split between Korean, 
Canadian, Taiwanese and Chinese companies. 
 
Origin of Accumulated Investment in 2002 (USD Millions) 
 
U.S.      568.80 
Honduras  440.80 
Korea     213.30 
China     56.88 
Canada    49.20 
Taiwan    28.44 
Singapore 18.80 
Other     45.78 
 
Source: Honduran Maquila Association 
 
4. (U) The downturn in the U.S. economy since 2001 has led 
to maquila closings, net job losses in the sector and lower 
than expected earnings for 2002.  Total employment in the 
sector by December 2002 totaled 107,000 (approximately 26 
percent of the country's private sector workforce).  The 
industry had grown to over 125,000 in 2000 and officials 
predicted that maquila employment would double by 2005 to 
250,000 jobs.  However, that estimate has been substantially 
lowered to around 150,000 by 2005. 
 
Industry Employment 
 
1995       65,000 
1996       76,000 
1997       87,000 
1998      110,000 
1999      120,000 
2000      125,000 
2001      110,000 
2002      107,000 
Source: Honduran Maquila Association 
 
5. (U) Maquila sector exports have more than doubled since 
1995 when the industry registered USD 921 million in sales. 
In 2002, exports decreased to USD 2,287.6 billion compared 
to USD 2.344 billion in 2001.  However, Honduras is still 
the third ranked exporter of textiles worldwide, following 
Mexico and China. 
 
Exports (USD millions) 
 
1995        921.1 
1996      1,219.5 
1997      1,659.0 
1998      1,855.1 
1999      2,158.3 
2000      2,361.8 
2001      2,344.2 
2002      2,287.6 
 
Source: Honduran Maquila Association 
 
6. (U) The unilateral preferences provided by the USG to 
Honduran apparel industry through the Caribbean Basin 
Initiative (CBI) and related programs helped launch the 
growth in the industry in Honduras.  According to the GOH, 
Honduras' exports to the U.S. of textiles and apparel grew 
from 27 percent of total exports to the U.S. in 1990 to 70 
percent of total exports to the U.S. in 2001. 
 
7. (U) GOH officials also emphasize in their discussions on 
the sector that the U.S. and Central American textile 
markets have become more and more interrelated.  They cite 
the figure that U.S. cotton yarn exports to Honduras doubled 
in the period from 2001 to 2002, after passage of the Trade 
Development Act. 
 
----------------------- 
U.S-CAFTA Negotiating Goals 
----------------------- 
 
8. (SBU) In February 4, 2003 written testimony by the 
Embassy of Honduras before the U.S. International Trade 
Commission on investigation 332-338, the Honduran Embassy 
spelled out the GOH's negotiating goals on textiles bluntly: 
 
-- Allow for the development of a seamless hemispheric 
textile and apparel industry; 
-- Establish rules of origin that are flexible enough to 
allow the use of fabrics produced in NAFTA, Central America, 
CBI and Andean countries and which will allow the 
manufacture of woven products; 
-- Rules of origin that include provisions such as TPL's, 
required percentages of regional and U.S. fabric, or inputs 
(accumulation), or similar mechanisms that will allow the 
integrated U.S.-Central American textile industry to use 
cost competitive fabrics; 
-- Integrate and simplify the custom compliance and security 
programs for Central America so the region's industry can be 
competitive; 
-- Establish technical provisions for qualifying textiles 
and apparel that will allow, among other procedures, dyeing, 
finishing and printing of all fabrics in the region; access 
for woven fabrics and commercially reasonable use of short 
supply provisions. 
 
----------------------------- 
Drawback and Free Trade Zones 
----------------------------- 
 
9. (SBU) Hondurans firmly believe that, in addition to the 
U.S.'s CBI and CBTPA programs, the country's success as the 
number three exporter of textiles to the U.S. is rooted in 
its three free trade zone regimes.  During the negotiations 
leading up to the launch of the Doha Agenda, one of the 
GOH's main goals was to secure agreement on its "right," 
under Article 7 of the Subsidies Agreement, to continue to 
operate free trade zones and provide related investment 
incentives, for 10 years.  Note: Honduras still has a per 
capita income under the Article 7 cap of USD 1000 but this 
level should be exceeded in the next couple of years; in 
addition, it should be noted that international financial 
institutions believe the Honduran GDP is generally 
understated. End Note.  The Honduran Finance Ministry and to 
a lesser extent the rest of the GOH is aware that the web of 
tax waivers provided through these programs and many other 
special laws is costing the government dearly in foregone 
tax receipts.  These revenue losses in turn have contributed 
to budget deficits, failure to meet IMF targets and the 
postponement of its HIPC debt relief).  Nonetheless, they 
continue to argue fiercely that the free trade zones are 
indispensable to Central America's continued 
competitiveness.  It should also be recognized that in the 
current domestic political environment, a U.S.-CAFTA 
agreement which forced the removal of these tax exemptions 
from so many of the country's prominent Honduran investors 
(30-40 percent of the investment is Honduran) would not be 
considered viable, no matter how attractive other benefits 
might be. 
 
10. (SBU) The three principal free trade zone regimes are: 
 
-- Temporary Importation regime (Regimen de importacion 
temporal or RIT).  Benefits are provided to Honduran-owned 
producers of any kind of product or service.  The regime was 
set up in the 1980s in order to provide Honduran national 
non-traditional exporters with tax incentives given in 
previous years to foreign investors (however, over the years 
implementation has been lax and many producers for the local 
market have also been given these RIT exemptions).  Customs 
benefits include: tax-free importation of all raw materials, 
intermediate goods, and capital goods exclusively related to 
production.  These companies were also exempt from income 
tax until 1994.  The beneficiaries are allowed to sell 
inputs, intermediate goods and final goods to other 
companies, free of sales tax.  The beneficiaries can buy 
locally made goods used directly in production process and 
receive either an exemption from sales tax or an income tax 
credit.  Approximately 530 Honduran establishments are 
incorporated under the RIT regime, of which close to 100 
produce raw material, 150 produce food products and 120 
produce textiles and apparel. 
 
-- Free Processing Industrial Zones (Zonas Industriales de 
Libre Procesamiento or ZIP) and Free Zones (Zona Libre or 
ZOLI).  The ZIP industrial parks house only manufacturing 
companies producing for export, which engage in 
transformation of imported imports into final exported 
products.  There are currently eight operating ZIP companies 
which house 48 assembly plants.  Enterprises established 
under the ZOLI regime receive similar benefits, but do not 
have to be located in a special zone or industrial park. 
Companies in ZIPs and ZOLIs are exempt from paying import 
duties on raw materials, intermediate products, and capital 
goods, and these do not need to be linked directly to the 
productive process.  ZIP companies are exempt from the 
national income tax for 20 years, and from municipal taxes 
for 10 years.  ZOLI firms have permanent exemptions from 
income tax and municipal taxes.  The companies are also 
provided unrestricted currency conversion and customs 
clearance is performed on-site (by contracted customs 
officials whose salaries are paid by the company). 
 
11. (SBU) A recent IDB sponsored study of Honduran tax 
policy found that in the year 2000, the special free trade 
zone regimes resulted in 47 million lempiras (USD 3.25 
million) in waived export duties and 553 million (USD 37.9 
million) in waived sales taxes.  Of these amounts, the 
majority of tax exemptions (39 million lempiras in customs 
duties and 467 million lempiras in waived sales taxes) went 
to Honduran companies under the RIT system.  There is no 
estimate of waived duties for companies operating in the ZIP 
and ZOLI regimes.  The study identified a negligible amount 
(around USD 150) in drawback refunded to companies in 2000. 
 
12. (SBU) The study also identified several flaws with the 
current system of investment incentives for exporting firms. 
Of particular note is the fact that foreign firms with 
assembly plants tend to treat their Honduran plants as a 
cost center.  Their profits are therefore not attributable 
to their Honduran activities and they would generally be 
reflected in the company's consolidated income statements in 
their home country.  For these foreign firms, the income tax 
exemptions are considered redundant and unnecessary to 
encourage foreign investment.  In other cases, it is 
possible that the signing of a Double Taxation agreement 
with the U.S. and other investor countries could help spur 
additional foreign investment without forfeiting tax 
revenues.  The GOH has recently asked the Embassy for more 
information on requesting that the Department of Treasury 
negotiate a Double Taxation treaty.  Finally, many other 
Honduran laws have been enacted over the years giving a 
variety of sectors and individual companies special import 
duty and other tax exemptions. 
 
13. (SBU) Another reason for the Honduran insistence on the 
maintenance of special import regimes, even after 
negotiating U.S.-CAFTA, lies in their negotiating goal of 
obtaining U.S. market access for woven fabrics and goods and 
use of short supply provisions (that allow duty free 
treatment of Central American products made from non-U.S. or 
regional fabric if that product is not available from 
regional sources).  Honduran trade officials note that the 
NAFTA has such provisions.  If U.S.-CAFTA includes short 
supply provisions, Honduran companies would want to continue 
to import the fabric through special import regimes. 
 
14. (SBU) GOH trade officials reject the argument that 
continued use of duty waivers for non-U.S. or regional 
fabric will provide a platform for circumvention of the 
rules of origin requirements.  Honduras has done fairly well 
over the years in U.S. Customs Service inspections of 
compliance with CBI and CBTPA rules. 
 
------------------------------- 
Customs Compliance and Security 
------------------------------- 
 
15. (SBU) The U.S. Customs Service's new rules on 24 hour 
advance manifests and expectations of additional port 
security requirements are of great concern to the Honduran 
textile and apparel industry, which specializes in quick 
deliveries because of its proximity to the U.S. market. 
Puerto Cortes and the Honduran  textile and apparel sector 
would benefit tremendously from cooperation on port 
security, and if possible, initiation of a Container 
Security Initiative program in Puerto Cortes. 
Palmer