By  on September 27, 2005

SAN PEDRO SULA, Honduras — In the heart of Central America, the implementation of a freshly minted free-trade agreement with the U.S. has enormous political and economic implications, but the ebullient outlook is punctured by a plethora of issues.

It has been 59 days since the U.S. Congress narrowly passed the Central American Free Trade Agreement, and the global retail, apparel and textile manufacturing industries are sorting out its potential benefits and drawbacks. For a large contingency of U.S. and regional apparel and textile sourcing executives who convened in San Pedro Sula last week, the post-CAFTA future is oblique at best.

Uncertainty surrounding the implementation of the pact, unresolved side apparel and textile deals reached in the 11th hour to secure votes in the House, rising oil prices and the impact of the quota-free environment cast a veil of anxiety over the 270 or so companies attending a conference dubbed "El Foro" and sponsored by the Sewn Products Equipment Suppliers Association, TC2 and the Honduran Apparel Manufacturers Association.

In the realm of apparel and textile production, CAFTA is a colossal agreement that could boost trade in many of the fledgling democracies so desperate to climb their way out of poverty and generate economic and social growth.

The six CAFTA countries combined exported about $9.5 billion worth of apparel and textiles to the U.S. during the 12 months ended July 31, according to Commerce Department figures. Together, the trade bloc accounts for 18 percent of the U.S. apparel import market — second only to China, which controls 22.6 percent of the U.S. apparel import market. Three of the six countries, including Honduras, El Salvador and the Dominican Republic, are among the top 10 apparel suppliers to the U.S.

Conversely, the region is the second largest export market for U.S. fabrics and yarns, which totaled $4.2 billion in 2004, although it is unclear whether U.S. producers will be able to maintain their existing business under CAFTA, which loosened the rule of origin for importers and retailers, allowing them to use more regional and third-country fabric and yarns.

The CAFTA countries are ramping up to take advantage of its implementation, targeted for Jan. 1 by investing in apparel training and development centers, schools, roads and more vertical operations — all in an effort to attract new foreign business.Many are eyeing a trade mission U.S. Secretary of Commerce Carlos Gutierrez will take with U.S. businesses in October in three CAFTA cities: Guatemala City, San Pedro Sula and San Salvador.

Honduran President Ricardo Maduro, who addressed attendees at the sourcing conference in San Pedro Sula, said he is pinning his hopes on CAFTA to help generate more jobs and provide economic growth in one of the poorest countries in the Western Hemisphere.

"We need jobs in Honduras," said Maduro. "We have high unemployment and the [apparel] maquilas is one of the sectors that has been growing the highest and the fastest in job creation."

In San Pedro Sula — the industrial center of Honduras — the prevalence of machine-gun-toting armed guards and fortified compounds ringed with barbed wire fences and security systems has not deterred businessmen from investing heavily in the city's industrial export zones and government officials are banking on CAFTA to bring in more investment.

Per capita income in the region ranges from $1,000 to $3,000, according to Maduro. By comparison, per capita income in the U.S. is $40,100, according to the U.S. government.

"I would like to emphasize that CAFTA is not only a commercial and economic instrument, it's a transformation instrument," Maduro said. "The [vertical] integration will obviously be strengthened now with CAFTA, where we can use locally sourced cotton and yarn."

He noted that the number of apparel companies in Honduras has increased to 270 since 2001, a growth of 30 percent, while employment in the sector has grown 24 percent to 136,000 and value-added business has increased 38 percent to $990 million. Investment in apparel factories and related industries is up to $1.74 billion, of which just over 50 percent is U.S. or international investment, he added.

Honduras represents just one of the six countries anxiously awaiting the implementation of CAFTA. Nicaragua and Costa Rica have not yet ratified the treaty, but U.S. officials maintain the free-trade agreement will go into effect with the countries that have approved the deal.

Executives attending "El Foro" said the region needs to take more steps toward vertical integration — producing the yarn through the finished product and packaging it for export — to compete with other countries around the globe and attract new investment. Many company officials and trade association representatives in the U.S. and the region said the opportunities CAFTA affords lie in such product categories as bras, wovens, denim and yarn manufacturing.However, there are also several challenges, including China's dominance in the sector and unfinished CAFTA apparel and textile side deals that could impede progress. In addition, the elimination of global quotas at the beginning of the year has had an adverse impact on apparel maquilas in the region.

Henry Fransen Jr., executive director of the Honduran Manufacturers Association, said "quite a few companies have closed" as a result of the elimination of quotas. He said one apparel factory, employing 800 workers, will shut its doors this week, while another employing 1,500 workers plans to shutter in December.

"They said it is cheaper to source in China," Fransen said.

Despite such closures, he said the losses are offset by new investments and the net result is job growth every year.

Jesus Canahuati, general manager of The Lovable Group, one of the largest apparel companies with several factories in Honduras, implored executives to invest in training and development centers to prepare for the onslaught of potential business and competition once CAFTA is implemented.

"We don't have a formula to defeat China, but I would like to get across that we have a formula to compete with China and that is attitude," said Canahuati. "We have to learn from the Chinese because the Chinese are investing billions of dollars and they are getting a return on what they are doing."

To that end, the Honduran private sector has joined forces with the government to invest $6 million in a technical school in an effort to train 600 people a year.

"We also have commitments from companies of $300 million in the next 12 months in areas of yarn, woven fabrics and knit fabrics," said Canahuati. "We hope this is only the beginning."

The Dominican Republic is building a 40,000-square-foot training center with the help of $300,000 in U.S. funding to gear up for the anticipated business, according to Arturo Peguero, executive president of the Dominican Association of Free Zones. His association represents 250 apparel companies employing some 120,000 people, and exporting primarily trousers, knit shirts and underwear.

Peguero said two companies are setting up a huge textile knitting mill, including Gildan Mills, which recently opened its doors, and Sara Lee Branded Apparel, which has a big mill under construction. He noted that there has been a shift in business in the Dominican Republic. The country is losing trouser production, but gaining knits and underwear, he said.El Salvador, Guatemala, Costa Rica and Nicaragua all shared similar investment strategies and stories at the forum. Several U.S. sourcing executives said they plan to at least maintain and potentially increase their business in the region.

Jockey International operates a wholly owned factory in San Pedro Sula, another in Costa Rica and two in Jamaica, according to James Kupfer, vice president of global operations.

"Right now, we have the capacity we need at our plants," said Kupfer. "However, if we decided to expand, we would try to expand capacity in our own plants or try to find partners."

He said the implementation of CAFTA will "make it easier to ship products back to the U.S. and be less expensive due to duty preferences.

"All companies for the last six to eight months were sitting and waiting with two or three different plans," said Kupfer. "We have all had these plans and now that CAFTA has passed, we are slowly pulling triggers on different steps."

Despite the potential for investment in the poverty-stricken region, Central American and Dominican Republic companies face a multitude of challenges and hurdles before the advantages of CAFTA materialize.

One of the biggest concerns raised at "El Foro" is how the U.S. and six countries will resolve several side deals crafted outside of the original agreement, many of which would change the rules of the game and require some legislative action. The Bush administration made several commitments to textile House members to secure enough votes to push CAFTA over the finish line at the end of July. The side deals seek to help protect existing U.S. textile business in the region.

Among the final side deals the administration made with certain House members in exchange for their votes was getting a commitment from Nicaragua to buy one unit of U.S. fabric each time it buys a unit of fabric outside of the region for man-made trouser fabric. There is also a similar, but not exact, arrangement for cotton trouser fabric, according to sources. Nicaragua has an allowance to use 100 million square meters equivalent of fabrics from outside the U.S and the region.

As a concession to its one-for-one agreement, the U.S. agreed to let the 100 million SME allowance stay in place for a full 10 years instead of being phased out beginning in the sixth year. The lawmakers also were looking for, and said they received, further commitments from the CAFTA trade ministers that will agree to change a provision for pocketing and lining fabrics to require that it be made by one of the signatory countries.A third commitment involved a provision that allows a limited amount of woven, denim and wool apparel made in the CAFTA countries from Mexican and Canadian fabric to qualify for duty-free treatment in the U.S. As part of the so-called deal, the U.S. said it would forgo the implementation of cumulation with Mexico and Canada until customs procedures were improved and all of the CAFTA countries completed trade deals with Mexico and Canada.

Finally, Rep. Robert Aderholt (R., Ala.), said he received a commitment from the administration to seek to negotiate a 10-year phaseout of tariffs on socks with the six CAFTA countries, instead of eliminating that tariff immediately upon implementation, as is currently written in CAFTA.

There is a lot of confusion surrounding these side deals, such as whether or not every country has to agree to them and which deals, if agreed to, would then require congressional approval by all of the countries. U.S. officials have maintained they will hold consultations with the countries, although it is unclear whether they will consult with individual countries or as a bloc.

The other layer of complication is trade-offs and many of the Central American trade organizations at the summit claimed they will be or have already demanded concessions for some of the changes the U.S. is seeking. The U.S. appears to be willing to make concessions in the area of single transformation and allow more products to qualify under the rule, according to industry sources. Currently, there are single transformation rules for bras, boxers, pajamas and woven dresses that make them eligible for duty-free treatment in the U.S. if they are cut and sewn in the region using U.S. or regional thread. Fabric may be sourced from anywhere in the world under these rules.

U.S. officials are expected to hold a meeting with CAFTA trade ministers this week to discuss implementation issues and some sources believe the side deals will be on the agenda.

Canahuati said the Honduran industry is pressing U.S. officials for a trade-off on the pocketing and lining fabric change.

"If we give up pocketing, [the U.S.] has to give up something else because, if not, the shirting industry is going to suffer," he said.Fransen of the Honduran apparel association said the potential sock change is the biggest issue for companies in the region.

"The problem here right now is the way the free-trade agreement was written, socks have [duty-free] preferences here and a lot of companies invested already, and if the rug is pulled out from under them, it would affect them enormously," he said. "It's a high volume, very low profit margin, so it is very price sensitive."

Similarly, Peguero of the Dominican Republic claimed U.S. trade officials have indicated they will make trade-offs in exchange for some of the changes.

"There will be a negotiation and trade-offs will be on the table," he said.

However, Jim Leonard, Deputy Assistant Secretary of Textiles & Apparel at Commerce, who gave a presentation at the conference, was circumspect in the face of a barrage of questions from attendees.

Leonard contradicted Aderholt's interpretation of the administration's commitment on socks.

"There was no commitment made on things like changing the rule of origin [on socks] or changing the time frame for tariffs going away," said Leonard. "To my knowledge, a commitment was made that we will look into rather than commit to do them. The only commitment that was made [on socks] by the administration is if we deem that [market disruption] to occur, we will be prepared to take a safeguard action."

He noted that the safeguard action is different from the China safeguard quotas in that it allows the U.S. to raise tariffs if a product is deemed to cause market disruption.

Asked whether he would characterize the consultation on the side deals as a negotiation and whether the U.S. was prepared to make concessions, Leonard said: "It is my understanding there will be discussions between [the U.S. Trade Representative's office] and the countries. I can't go any further than that."

Leonard did reveal, however, that the U.S. has concluded an investigation, which was requested by Honduras, into whether U.S. textile mills could provide sufficient commercial supply of more than 50 shirting fabrics in a timely manner. Honduran officials made the request for an investigation into the "commercial availability" of the fabrics in the U.S. in the hope of having the fabrics placed on a permanent short-supply list."We did determine that there is commercial availability in the U.S. for some of those fabrics and that report will be issued fairly shortly," Leonard said.

Textile and Apparel Firms and Suppliers in CAFTA
Total by Country
El Salvador
Costa Rica
Total by Sector

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