MOLDOVA’S FOREIGN POLICY STATEWATCH

SHEDDING LIGHT ON THE ONGOING EU-MOLDOVA TRADE LIBERALISATION

Institute for Development and Social Initiatives “Viitorul”

Issue 13, November 2010

Evghenia Sleptsova

Moldova’s Foreign Policy Statewatch represents a series of brief analyses, written by local and foreign experts, dedicated to the most topical subjects related to the foreign policy of Moldova, major developments in the Black Sea Region, cooperation with international organizations and peace building activities in the region. It aims to create a common platform for discussion and to bring together experts, commentators, officials and diplomats who are concerned with the perspectives of European Integration of Moldova. It is also pertaining to offer to Moldova’s diplomats and analysts a valuable tribune for debating the most interesting and controversial points of view that could help Moldova to find its path to EU.

NEXT TOPICS TO BE COVERED:Opportunities in Moldovan-German relations

The Treaty regarding the border regime between Moldova and Romania

What are all these abbreviations about? ENP, EaP, AA and DCFTA

In the run up to the 2004 enlargement, the European Union launched a European Neighbourhood Policy (ENP), in order to create ‘a zone of prosperity, stability and security’ along its borders. While several new neighbours, such as Moldova and Ukraine, were strongly insisting on a membership perspective, the ENP, with its prospect of political association and deeper economic integration, was a ‘carrot’ that the EU was ready to offer to these countries while it was not in a position to offer a membership.

In 2009, under the Swedish presidency, the EU decided to strengthen the Eastern dimension of the ENP by launching the Eastern Partnership initiative (EaP), which would cover six CIS economies – Arme-nia, Azerbaijan, Belarus, Georgia, Moldova and Ukraine. Incentives offered to these countries in return for their progress in democratisation and reforms included trade liberalisation, increased mobility through visa facilitation agreements and joining the common EU aviation market, as well as participation in various EU programmes. Since 2008 with Ukraine and since January 2010 with Moldova the EU has been negotiating the Association Agreements (AA), which will replace the existing Partnership and Cooperation Agreements. The deep and comprehensive free trade agreement (DCFTA) – which is already being negotiated with Ukraine and soon to be negotiated with Moldova and Georgia – will constitute a key component of the AAs.1

1 Both the AAs and the DCFTAs are not automatic, and will be offered to countries that are willing to enter into a deeper engagement.

2 Moldova’s Foreign Policy Statewatch

Str. Iacob Hîncu 10/1, Chişinău MD-2005 Republic of Moldova 373 / 22 221844 phone 373 / 22 245714 fax office@viitorul.org www.viitorul.org

Moldova is not aloneThe situation, interests and readiness for a DCFTA are very different across Eastern Partnership

countries. Some countries, like Belarus and Azerbaijan, are not yet interested in full integration with the EU. Belarus’ and Armenia’s motivation is mainly political de-isolation. On the other hand, while Georgia is also actively seeking trade and visa liberalisation with the EU, its most important rationale for associa-tion with the EU is also internal security.2 Although the negotiations of a new Association Agreement with Georgia and Armenia have already been launched (in July 2010), these countries are still at an earlier stage of the required reform process compared to Ukraine and Moldova.3

Both Moldova and Ukraine have been criticising the ENP and the EaP for putting them together with countries that are clearly looking for a lower degree of EU integration. Moldova has, however, es-pecially more recently, taken a pragmatic approach to the EU integration and recognised that domestic reforms should precede a more generous offer from the EU. On a purely economic level, Moldova is also enjoying the highest degree of trade integration with the EU among the EaP countries, with over 50 per-cent of its exports going to the EU in 2009, while in Ukraine this share is only 24 percent.4

In Ukraine, the Orange Revolution increased expectations to the democratisation process, and the EU was willing to offer incentives to sustain this progress. This made Ukraine a frontrunner in the then ENP process. The negotiations of a new Association Agreement were launched in March 2007, and the DCFTA negotiations were opened shortly afterwards – in February 2008, as soon as Ukraine joined the WTO. However, the negotiations and the implementation of respective reforms have been moving rather slowly. Thus, the Ukrainian civil society notes that Ukraine only met 4 of the 60 reform priorities as of November 2010.5 As far as market access is concerned, while little information is publicly available, an example of disagreements is the EU’s reluctance to fully liberalise trade in cheese and confectioner-ies, where Ukraine feels it is already competitive enough, and to increase the tariff-free quota for meat imports from Ukraine.6

Partially due to this slow progress with Ukraine, in negotiations with Moldova, Georgia and Arme-nia the EU opted for its traditional conditionality-based approach – asking the countries to meet certain requirements before either the negotiations can be started or before a DCFTA can enter into force (de-pending on the requirements).

Moldova, although having started the negotiations on the Association Agreement later, seems to be moving faster. The ENP Progress Report on Moldova7 emphasises the strengths of the government programme on European integration, which is aligned with the objectives of the EU-Moldova Action Plan. The report highlights particular progress in civil society dialogue, in improving transparency of the public decision-making process, in fighting corruption and money laundering, as well in the area of judiciary reform and implementation of the rulings of the European Court of Human Rights. In trade related areas, notable improvements have been made in customs administration, sanitary and phytosanitary standards and financial services. Besides, Moldova joined the Energy Community and progressed significantly in negotiations with the EU on visa and air space liberalisation.

What is DCFTA?So what is a deep and comprehensive free trade agreement? And what does it entail for Moldo-

va? The difference between a DCFTA and a simple FTA is in the scope of integration. While simple FTA mainly involves liberalisation of trade in goods and services (i.e. abolition of tariffs and restrictions), a deep and comprehensive FTA covers integration along all trade-related areas, including services, intel-lectual property rights, customs, public procurement, energy-related issues, competition, etc, and also

2 Centru Roman pentru Politici Europene (2010) Making Sense of EU’s Eastern Partnership. Moldova as an Opportunity. 3 Progress Reports on the Implementation of the European Neighbourhood Policy in 2009 for Armenia and Georgia. http://ec.europa.eu/world/enp/documents_en.htm#3 4 UN Comtrade Online Database, retrieved on 8th of November 2010. 5 http://es-ukraina.blogspot.com/2010/11/experts-highlight-very-slow-progress-in.html 6 Interview with the Deputy Minister of Economy Valery Pyatnitskyi, 13/08/2010, available at http://www.radiosvoboda.org/content/ar-ticle/2127368.html7 Available at http://ec.europa.eu/world/enp/pdf/progress2010/sec10_523_en.pdf

3Moldova’s Foreign Policy Statewatch

Str. Iacob Hîncu 10/1, Chişinău MD-2005 Republic of Moldova 373 / 22 221844 phone 373 / 22 245714 fax office@viitorul.org www.viitorul.org

tackles the so-called “beyond the border” obstacles to trade through deep regulatory approximation with the trade-related EU acquis. A simple FTA would no longer be in Moldova’s interest as it already enjoys an asymmetric free trade regime with the EU through the Autonomous Trade Preferences (ATP), granted in 2008. In terms of real economic benefits, at the risk of simplification it can be said that the core benefit of a DCFTA for Moldova is greater attractiveness to foreign investment, with all the ensuing benefits it carries with it – technological upgrading, new jobs and potential positive spillover effects to domestic suppliers and distributors. Looking outwards, adopting the international ‘rules of the game’ will make Moldovan producers much more competitive internationally. In terms of market access, due to the fact that Moldova already enjoys the asymmetrical free trade regime, the DCFTA mainly entails liberalisation on the Moldovan side, although most likely with a transition period of five to ten years.8

Costs and benefits of the DCFTA for Moldova

The Feasibility Study ordered by the European Commission analysed four different scenarios to assess the aggregate-level gains for Moldova. Thus, the effect of a simple FTA is estimated as neutral; the effect of an FTA with limited liberalisation of sensitive agricultural products can even be negative; FTA with trade facilitation measures9 would yield a 6.5 percent increase in real GDP; while DCFTA is expected to result in about a 12.5 percent increase in real GDP.

The reason for limited positive gains from a simple FTA is the fact that Moldova already enjoys an asymmetrical free trade regime with the EU, therefore additional tariff liberalisation on the part of the EU would be negligible. At the same time, simple FTA entails losses of tariff revenue for the budget – even though Moldova has a very liberal trade regime – which would imply a limited negative effect on the economy. The scenario with restricted agricultural liberalisation would reduce the adjustment costs for rural areas, but is expected to have efficiency losses if protected sectors do not adjust to international pressures, and thus may have an overall negative effect.10 The largest gains, however, indisputably stem from the removal of non-tariff barriers to trade and making Moldova part of international production chains. Proximity to the EU, flexible and relatively skilled labours are the factors that would serve as im-portant initial incentives for foreign investors.

In order to reap these benefits, however, an economy needs to be prepared for a ‘structural shock’ of liberalisation. The insistence of the EU on Moldova’s progress in a number of market reforms is indeed partially meant to prepare a more beneficial environment for potential European investors, but most of these reforms are needed to Moldovan producers themselves, to have a level-playing field with the competitors both domestically and in the EU. Therefore, the following challenges and costs for Moldova need to be addressed in the earliest future.

ChallengesStill prevalent state interference in Moldova (either through a still large public sector, state aid

or insufficiently competitive public procurement) may hamper the economy’s adjustment capacity in the face of a structural shock of trade liberalisation. Although a satisfactory legal framework to fight corrup-tion has been adopted, its implementation still remains insufficient. Slow adoption of standards, technical regulations and conformity assessment procedures, and difficulty to cope with sanitary and phytosanitary standards are the key obstacles to exporters, in particular to agro-food producers. More effort (and per-haps financial assistance) is needed in order to implement a rather consistent legislation in the area of food safety. Poor transport infrastructure is also a major impediment to exporters and investors alike. Last

8 Less for industrial goods and longer for agriculture. 9 Bringing the administrative and time costs of exporting from Moldova to the level of Romania10 It has to be mentioned, that this is a mainstream approach to economic liberalisation, and the one adopted in the study. There is a growing literature and international practice showing that protection of small producers might be beneficial, as otherwise they may not adjust at all and go out of business to give way to multinational or simply larger foreign firms.

4 Moldova’s Foreign Policy Statewatch

Str. Iacob Hîncu 10/1, Chişinău MD-2005 Republic of Moldova 373 / 22 221844 phone 373 / 22 245714 fax office@viitorul.org www.viitorul.org

This publication was produced by IDIS “Viitorul” with the financial support of Soros Foundation Moldova and the National Endowment for Democracy. The opinions expressed in this publicati-on reflect the author’s/authors’ position and don’t necessary represent the views of the donors.

Str. Iacob Hîncu 10/1, Chişinău MD-2005 Republic of Moldova 373 / 22 221844 phone 373 / 22 245714 faxoffice@viitorul.org www.viitorul.org

but not least, although the DCFTA is expected to have long-term positive gains, in the short run there can be significant social costs, especially to small producers and farmers. Therefore there is an urgent need to strengthen the social safety net. 11

Clearly, most of these reforms require an enormous financial investment. The government needs to assess the financial costs involved into each of these areas, and then work out a programme of funding (or, more likely, co-funding) for each of the segments.

What the EU could do?12 Provide not only technical, but also financial assistance for the adoption of technical regulations

and SPS and for upgrading the road infrastructure. Inclusion of Moldova into the Pan-Euro-Med cumulation of origin would significantly help to in-

crease the rates of utilisation of tariff preferences, especially in textile and clothing sectors. Exclude a number of sensitive agricultural products from liberalisation on the Moldovan side, with

a transitional phase-out period.In view of the importance of migrant labour for the Moldovan economy, inclusion of migration-

related clauses into the DCFTA might be an important part of the agreement. Reduce the remaining protection of Moldovan exports of wine, barley, sugar and possibly wheat. Some estimates of the costs of institutional harmonisation put the costs for Moldova at as much

as US$1.1bn, or about 20 percent of its 2009 GDP. Even if half or quarter of this figure, Moldova will not bear these costs without some external assistance. Indeed, funding has been widely quoted as one of the weaknesses of the EaP. In May-June a Commission delegation carried out an evaluation of Moldova’s institutional and legislative capacity to negotiate and implement the DCFTA. The findings of this report are something to watch out for.

ConclusionsOne of the key conclusions with regard to the EU-Moldova DCFTA relates to the fact that since

Moldova already enjoys an asymmetrical free trade regime with the EU, the main benefits of the DCFTA will stem from the institutional and legislative harmonisation, or, in other words, from making Moldova a better place to run business and invest in. Therefore the approach taken by the EU in its negotiations with Moldova – not to start negotiations and not to sign the DCFTA until a number of reforms are implemented – although somewhat delaying the launch of negotiations, in fact creates the right mechanism for helping the Moldovan economy to reap full benefits from this agreement.

The second key point relates to the challenges that Moldova is facing in this process. While im-plementation capacity is often quoted as a main challenge, in fact the financial costs of implementation are equally important, and the sooner this issue is addressed, the lower will be the economic and social costs of liberalisation to the Moldovan economy.

11 Drawn from ITAQA (2009) Feasibility, Impact and Implications of a Free Trade Area between the European Union and Moldova. 12 Ibid.