ERITREAN FREE TRADE ZONES - GSE'S PLANS AND POST

C O N F I D E N T I A L SECTION 01 OF 05 ASMARA 000683

SIPDIS

SIPDIS

LONDON, PARIS FOR AFRICA WATCHERS

E.O. 12958: DECL: 08/13/2017
TAGS: ECON PINR ER
SUBJECT: ERITREAN FREE TRADE ZONES - GSE'S PLANS AND POST
ANALYSIS

REF: ASMARA 615

Classified By: CDA Holly C. Holzer, for reasons 1.4 (b)
and (d).


1. (C) Summary: On July 26, the Public Affairs Section
featured Dr. Araia Tseggai, Chief Executive Officer of the
Eritrea Free Zone Authority (the Authority),as speaker for
the monthly American Center lecture. Part I of this cable
reports on Dr. Araia's presentation of the Government of the
State of Eritrea's (GSE) plans for establishing Free Zones
(FZ) in Eritrea. Part II provides Post's analysis of the
GSE's probable approaches in implementing these plans, within
the context of the GSE's strict control over all aspects of
the Eritrean economy and points out the loopholes the GSE has
established to ensure that only the government and the sole
political party reap the benefits of the FZ. GSE envisions
the FZs as means to secure a dependable supply of hard
currency entirely under their control and most importantly -
without having to make any economic reforms - the GSE will be
better able to maintain the political status quo. End
Summary.

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PART I: DR. ARAIA PRESENTS THE GSE'S PLANS FOR FREE ZONES
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ERITREAN CONCEPTS FOR A FREE ZONE


2. (U) Dr. Araia began his July 26 presentation with a
background on GSE's thinking on establishing Free Zones.
Following Eritrea's independence in 1993, the GSE sent
economists to Dubai and Singapore to explore how free trade
zones would work for their new country. (Note: Although the
rest of the world refers to these areas as Free Trade Zones,
the GSE prefers to refer to them Free Zones. End Note.) The
GSE studied the matter for eight years before deciding in
2001 to make the port city of Massawa Eritrea,s first FZ.
Assab, Eritrea,s other port city, is scheduled to become the
second FZ in late 2007. Araia said that the GSE plans to
eventually establish multiple FZs in Eritrea, and that a FZ
could be designated for something as small as a single
building or factory. Each entity within the FZ will be
treated "as an Embassy", and local rules and regulations will
be set aside in order to attract investors.


3. (U) Araia claimed that the primary purpose of an FZ is not
to make money, although a successful FZ will increase
revenues to the GSE by developing the economy through
attracting trade and investment. He added that the GSE will
not view these entities as "cash cows", but rather as
mechanisms to transform the Eritrean economy by creating jobs
and bringing in international business expertise. Araia
noted that 40,000 ships pass through the Red Sea annually but
very few dock at Eritrean ports. Developing Massawa and
Assab as FZs will attract more of these ships to Eritrea
along with associated industries. Araia assesses that
attracting even 1 percent of this shipping traffic will have
a significant impact on the Eritrean economy. (Note: Post
has heard from various sources that neither harbor is
naturally configured to handle large amounts of shipping
traffic nor large vessels. End Note.)

HARD CURRENCY BENEFITS


4. (U) According to Araia, all business transactions,
internal and external, with the FZs will be conducted only in
dollars. If a transaction takes place between an entity in
the FZ and one inside Eritrea, the transaction will be
calculated in dollars however the payments within Eritrea
must be paid in the local currency (nakfa). All currency
exchanges between dollars and nakfa must be conducted through
the Eritrean Central Bank. Araia noted that these
transactions will result in a 97 percent profit to the
central bank, commenting this is an exchange of "paper for
dollars, nothing for something" and that the GSE anticipates
these transactions would become their primary source of hard
currency revenue.

WORK STANDARDS

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5. (U) Araia stated that the GSE will maintain high labor and
environmental standards within the FZs. Work days will be
restricted to eight hours and overtime pay will be required
for extra hours worked, although there will be no mandated
minimum wage. (Note: The suspension of the minimum wage
requirements provides a typical example of the GSE ignoring
its own laws. End note.) Health and safety regulations will
be enforced and there will be "published procedures for
hiring and firing workers". International environmental
conventions, especially in regard to the coastal waters, will
also be strictly enforced.


6. (U) Other published rules for the FZs include:


A. The GSE will establish FZs throughout the country in order
to transform the economy.

B. The FZs will be directly governed by a board of
stakeholders, not the GSE.

C. No officials of the GSE or the sole political party, the
People's Front for Democracy and Justice (PFDJ),will be
permitted to have direct business interests in the FZs. Both
the GSE and PFDJ will only be able to conduct activities
within the FZs at the request of the board, and to provide
crucial services such as infrastructure construction.

D. Eritrean companies must represent 50 percent of the
businesses operating in the FZs. Only companies with a
proven business track record will be allowed to operate in
the FZs.

BENEFITS TO THE PEOPLE


7. (U) Araia stated that the FZs will significantly increase
employment and develop higher skill sets for Eritrean
workers. He added that modern production methods will be
transferred from within the zone to domestic enterprises and
that Eritrean companies will learn to successfully provide
products that the rest of the world will want to buy. He
noted a case where a PFDJ-owned company attempted to export
locally produced gin and cognac to Japan, but the Eritrean
produced bottles could not be opened by the Japanese nor did
they meet international standards. Araia cited this as an
example in which a Free Zone could have assisted Eritrean
businesses in learning to market to customer needs through
interaction with international companies. Araia also stated
that the FZs will increase both the quantity and diversity of
goods within Eritrea.

BENEFITS TO INVESTORS


8. (U) Araia commented that the GSE "does not want the entire
world to come," but felt that Eritrea possesses advantages
that will attract a number of investors. (Note: The GSE has
been selectively courting potential investors for the FZs,
approaching only those countries deemed politically strategic
and unlikely to be critical of its regional policies or
treatment of Eritrea's citizens. End note.) Araia stressed
Eritrea's valuable location on the Red Sea and referred to
Assab as the port with the lowest overhead in the region,
adding that it was "second only to Singapore in the calmness
of its waters". He commented that Eritrea is the gateway to
Africa due to the international affiliations in East Africa
and through Central Africa into West Africa, and that Eritrea
"has some valuable natural resources and tourism potential".
Araia emphasized that Eritrea's best asset was low cost of
operations, in particular, claiming that Eritrean labor was
more "productive than in surrounding countries" and very
cheap. The GSE aims to become the cheapest FZ in the region,
he added, and Eritrea will compete on price with any other
country, even going so far as "to offer free land" to attract
development.


9. (U) Other stated benefits to investors included:


A. No taxes on income, profits, or dividends;

B. No customs duties on imports or products;

C. No convertibility restrictions on currencies;

D. No minimum level of investment;

E. 100 percent foreign ownership allowed for investing
companies;

ASMARA 00000683 003 OF 005



F. 100 percent repatriation on profits and capital;

G. Cheap land leases, renewable every 15 years; and

H. A one-stop shop for all governmental interaction.

WHAT HAS THE GSE DONE SO FAR?


10. (U) No progress was made on implementing FZs in Eritrea
from 2001 to 2003. The Authority took over the old Eritrean
Naval base in Massawa in 2003 and now uses it as its
headquarters. Araia stated that, as of today, two companies
from Dubai are licensed to set up operations in Massawa and a
total of twelve companies are registered and waiting for
licenses. Twelve more companies - mostly from China but also
from Italy, Germany, and Dubai - are considering investing in
Massawa and Assab. Investors are interested mostly in salt,
flowers, refining oil in Assab, and seaport/airport
management. Araia added that "many companies" have
demonstrated interest but are waiting until operations
actually begin before inquiring more seriously. These
companies include Cargil from the U.S., Horizon from Bahrain,
the Qatar Investment Agency, and LaFarge from Geneva. Local
news reports in July stated that Chinese government
representatives signed several trade deals with the GSE and
visited Massawa to examine potential investments.

EXPANDING THE PORT OF MASSAWA


11. (U) Recent news reports in Eritrea mentioned that three
massive new cranes have been installed in the port of Massawa
among other recent improvements totaling between $30 and $35
million. The Authority is also building shell facilities
that can be quickly re-purposed to meet the needs of
investors. These buildings are very large, open structures
with easily changeable internal layouts. In Massawa, the
Authority converted three old Navy mess halls, built seven
new warehouse-sized facilities and are constructing at least
six more. Araia said that the first investors from UAE
(business unspecified) will begin production within two or
three months and will soon advertise for workers.

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PART II: POST ANALYSIS
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CONCEPTS FOR FZS VERSUS CURRENT REALITIES


12. (C) Araia painted a very bright picture of the projected
operations of Eritrean FZs but did not address the other
underlying motivations of the GSE nor the loopholes
established to ensure the GSE maintains complete control over
the FZ and the Eritrean partners. The GSE's economic
policies for the last six years seem little more than
pillaging existing assets, luring unsuspecting investors into
the country prior to changing business rules to the point
that they can no longer operate, and shaking down individual
business owners for hard currency. While these policies
initially met the GSE's immediate currency needs, investors
have grown wiser and the sources of these funds are not as
readily available. In addition, most small businesses access
to hard currency is extremely limited and most businesses are
not permitted to exchange nakfa for hard currency within
Eritrea, thus completely restricting their ability to
operate. The GSE's primary economic goals continue to focus
on ensuring dependable flows of hard currency and controlling
all hard currency transactions made inside Eritrea. Thus, in
the FZ, payments made by investors for salaries, utilities,
and for other services in Eritrea proper will instantly
become a nearly 100 percent profit to the GSE through
currency conversion.

ENRICHING THE GOVERNMENT AND THE PARTY


13. (C) The GSE and the PFDJ will maintain complete control
over the FS and will reap all of the benefits. Half of all
companies in the FZ are to be Eritrean-owned, but only
established companies are allowed to operate. In Eritrea,
nearly all functioning companies are owned by either the GSE
or by PFDJ's Hidri Trust. Araia's presentation revealed a
means through which the GSE will be able to circumvent their
own requirement that governmental and party entities are not

ASMARA 00000683 004 OF 005


to be represented in the zone by "allowing the creation of
joint ventures with foreign companies" with the GSE for
government-owned assets, such as seaports, airports, and the
refinery in Assab and allowing for the FZ board to grant
exceptions. (Comment: Post anticipates that like most of
these purportedly independent non-government entities such as
the FZ and the Eritrean Mining Corporation the board will be
comprised of key party members and government officials. End
Comment.) By requiring a proven track record and access to
hard currency for operations, the GSE's policies essentially
exclude any private Eritrean company (new or old) from
operating in the zone other than as an outside supplier.
Moreover, these contracts will likely accrue to
government-owned entities as well. Because all transactions
in the zone require payment in dollars, the GSE's
restrictions on hard currency also will preclude any Eritrean
small businesses from operating within the FZs.

WHO WILL GET THE JOBS?


14. (C) Another major question is who will get the jobs?
Post envisions several different possible scenarios. One
possibility, with known precedents, is that the GSE will
establish a mechanism to assign individuals pressed into
national service to provide labor in the zone. This would
allow the GSE to receive dollar payments at the market rate
for employees, but then make substantially reduced payments
to the workers in nakfa. (Note: National service in Eritrea
pays only the equivalent of $30 per month, which is not
enough to support an individual, let alone a family. Those
in national service must be financially subsidized by friends
or family in order to survive. End note.) Using national
service labor would provide a huge, additional bonanza to the
GSE. Most companies engaged in business in the zone
(predominantly from Persian Gulf countries and China) would
likely acquiesce to using this labor pool, as long as the
personnel payments remain below market prices and the GSE
prevents any labor unrest in the zone. Araia emphasized that
Eritrean FZs will always undercut their competitors and will
not be outbid in terms of price; one way to accomplish this
objective is through an assured cheap labor source.


15. (C) Araia said that an "advisory, not mandatory referral
system for employment" will be created to assist matching
employers and employees. Eritrea's high unemployment makes
this system unnecessary, since employers receive multiple
applicants for every job they advertise. This system could
also be abused by the GSE for providing jobs to GSE and PFDJ
supporters, such as ex-fighters. (Note: The GSE, as a matter
of course, gives preferential hiring treatment to individuals
who have served in combat, without regard for education or
qualifications. For example, well-connected ex-fighters with
little or no education often serve as judges in civil courts
or in mid-level Ministerial positions. End note.) Post
could easily envision the GSE imposing their hiring
preferences through this referral process. Araia said that
the GSE will control internal migration of labor to FZs to
prevent overpopulation, which gives them effective control of
the labor supply. Companies in the FZ who do not want to run
afoul of Eritrean authorities will view it as less risky to
hire employees in line with the referral system rather than
hiring possible illegal workers. Controlling the hiring for
these jobs would provide the GSE a good tool for rewarding
their supporters such as ex-fighters and their families.

HOUSING


16. (C) The chronic shortage and high expense of remaining
housing near the FZs presents another challenge to the GSE.
Hundreds of individuals were displaced in Massawa when their
neighborhoods were demolished to create space for the FZ.
Araia claimed that all owners had been fairly compensated.
Embassy officers have noted from several visits to Massawa
over the last year that the displaced persons continue to
struggle without evidence of governmental support and most
been forced to move to existing, shoddy shanties made of
discarded lumber, corrugated tin, and stones and compensation
was non-existent. Araia indicated that the government will
build rental housing for the FZ workers, with the rent
deducted directly from employee paychecks.

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ASSAB ) A VIABLE FZ?


17. (C) Assab these days seems little more than a military
camp. (See reftel.) Electricity is not available between
10:00 pm and 6:00 am, which effectively closes down the city
during those hours. Before the 1998-2000 border war, Assab
served as Eritrea's main port for trade with Ethiopia.
Without the trade links to Ethiopia, Assab serves little
purpose in purely economic terms, due to its remote location
from the rest of the country. Araia noted that several
companies from the U.A.E. were interested in operating the
old, unused Russian-built refinery. He believes that some
entity will eventually invest in the plant and begin
operations if they are convinced that the worldwide shortage
of refining capacity will continue and that refining margins
will remain high. Other contacts have told Emboffs that the
refinery is too antiquated to rehabilitate and would need
rebuilding to be operational.

CONCLUSION


18. (C) The GSE is in desperate need of hard currency, and
the FZ is an option that could be a useful mechanism for them
to meet their revenue goals, is dependable and entirely under
their control. Due to Eritrea's small size, even a small
amount of activity within the FZ could have a significant
impact on the GSE-controlled economy. By offering much
needed hard currency without requiring the GSE to make any
reforms in the command economy, the GSE will gain greater
economic security and thus maintain the political status quo.
HOLZER