U.S.-CAFTA: Honduran Textile Goals in the U.S.-

UNCLAS SECTION 01 OF 04 TEGUCIGALPA 000752

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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.

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The Maquila Industry
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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.

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U.S-CAFTA Negotiating Goals
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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.

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Drawback and Free Trade Zones
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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.

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Customs Compliance and Security
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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