Cambodia's LDC transition: Navigating new challenges in textile trade

This achievement is a significant milestone for Cambodia, reflecting its successful use of preferential trade agreements and increased export capabilities. However, while the transition to a higher economic status brings numerous advantages, it also poses challenges. Cambodia may lose some of the tariff preferences it currently enjoys, particularly with key markets such as the European Union and the UK. Industries like footwear and garments, which have benefitted from these tariff privileges, could face new competitive pressures as Cambodia moves away from its LDC status.

Cambodia’s current trade scenario

Exhibit 1: Cambodia’s garments exports to the world in January-July 2024 (in $ mn)

Source: ITC Trademap, F2F Analysis

Cambodia's apparel exports in 2024 show a mixed performance, with an initial dip followed by a strong recovery. From January to February, there was a slight decline of 5.5 per cent, likely due to post-holiday season impacts. A more significant drop occurred in April, with exports falling by 19.6 per cent, which could be attributed to seasonal factors or production delays. However, from May onwards, exports saw a remarkable recovery, surging by 52.3 per cent in May compared to April. June continued the positive trend with an 8.5 per cent increase, followed by a further 9.3 per cent growth in July, reaching a peak of $985.61 million. This sharp rise in exports during the mid-year months suggests that Cambodia’s apparel sector is benefitting from strong demand, particularly driven by seasonal factors and global retail cycles. The steady growth from May to July indicates a robust upward trend, positioning Cambodia’s apparel exports for a favourable second half of 2024.

The focus of this analysis is on the textile industry of Cambodia, given its substantial contribution of 70 per cent to total exports. The garment industry in Cambodia has attracted significant interest, especially from the US and the European Union (EU). Among its various industries, Cambodia’s garment sector has effectively utilised the Generalized System of Preferences (GSP) in the EU and has been a key exporter to countries such as Spain, Germany, and the Netherlands.

Exhibit 2: Cambodia’s top 5 markets for garments (in $ mn)

Source: ITC Trademap

Exhibit 3: Cambodia’s garment exports to EU 27 countries (in $ bn)

Source: ITCTrademap

GSP is typically granted to countries classified as Least Developed Countries by the United Nations. Cambodia's transition could lead to:

1. the loss of preferential tariffs with respect to 15 countries that provide special tariffs (subject to discretion)
2. changes in the rules of origin
3. certain disadvantages under World Trade Organization (WTO) rules

Table 1: MFN tariff rates and preferential tariff rates for Cambodia’s top exporting countries

Source: World Integrated Trade Solution (WITS) database, F2F Analysis

The table above depicts the tariff rates that top exporting countries apply to Cambodia. From these rates, it is reasonable to assume that Cambodia has made significant use of its LDC status, particularly with respect to the EU 27, Japan, and Canada. The table compares the Most-Favoured-Nation (MFN) tariff rates with the preferential tariffs Cambodia receives for HS 61 and HS 62 products (mainly apparel) in different markets.

Cambodia enjoys significant advantages in the EU and Japan, where preferential tariffs are much lower than the MFN rates, particularly for HS 61 and HS 62 products, with reductions of around 9-10 per cent in the EU and zero tariffs in Japan. This gives Cambodian exporters a competitive edge in these markets. Similarly, Canada has granted significant leeway to Cambodia with respect to garment exports. The US has removed GSP status for Cambodia, and as a result, Cambodia faces near MFN tariffs for most of the apparel products except a few items. The removal of these preferential tariffs would surely hurt the Cambodian economy.

Rules of Origin

There are certain Rules of Origin issues that might arise with Japan, Canada and EU 27, which are of particular focus due to the fewer number of tariffs along with lesser product requirements with respect to Rules of Origin.

US-Cambodia

Cambodia would not be significantly affected by the removal of the GSP rules with respect to textiles. However, it is susceptible to the blanket 10 per cent tariff rates that will be applied by the Trump Administration. Cambodia’s focus on increasing its input capabilities might keep Cambodian textiles in the US market albeit with lower profits for exporters.

Japan-Cambodia

Japan has a trade agreement with Cambodia, considering its membership in the ASEAN region along with the RCEP agreement to which it continues to be a part of. With respect to the ASEAN agreement, a majority of raw materials are allowed to be imported from a non-member country (non-ASEAN country); however, the raw material which would be converted into a woven fabric only within the originating country (ASEAN countries or Japan). Under the GSP rule, less than 10 per cent of any form of material from non-originating sources can be used in final production.

The ASEAN-Japan agreement along with the RCEP will rule supreme when the GSP is removed for Cambodia. Cambodia lacks in backward linkages with respect to the garment industry with a lot of its raw materials coming from non-originating countries such as China, Taiwan and in some cases Korea. Vietnam might see a boost in its exports to Cambodia in this scenario.

UK-Cambodia

With the UK, Cambodia benefits from the Developing Countries Trading Scheme (DCTS) agreement which is expected to stay in place despite the removal of GSP rules. Cambodia is not expected to lose out from the DCTS scheme, however, some changes in rules might be expected due to its renewed status.

Canada-Cambodia

Canada's GSP Rules of Origin (ROO) for LDCs allow products to qualify for preferential treatment if they meet specific criteria regarding their origin. For textile and apparel goods, the rules focus on ensuring that the materials used in production come from LDCs, Canada, or other approved countries, with certain value-added thresholds. For example, if the value of non-originating materials does not exceed a set percentage (such as 60 per cent or 75 per cent) of the ex-factory price of the good, it can still qualify for preferential treatment.

Additionally, certain assembly and production processes, like cutting, sewing, or knitting in LDCs from eligible materials, are also considered in determining the origin. Given Canada does not have any other agreement with Cambodia in any shape or form, Cambodia is set to lose with respect to not only tariffs but also raw materials which was more than 50 per cent of the final good.

EU27-Cambodia

Since LDCs primarily export textiles, footwear, and agricultural products, EU 27 applies fewer restrictions with respect to rules of origin on these countries for these products. The EU has updated the previous rules for GSP nations by allowing only single transformation, which means that the imported goods from a non-originating country should undergo significant processing only once. This is a relief for LDC countries as the previous requirement was for double transformation. However, following the removal of GSP rules for Cambodia, the country would be subjected to higher tariff rates along with increased product requirements.

Road Ahead for Cambodia

Cambodia's first initiative should focus on developing its backward linkages. The country heavily relies on China and Vietnam for its raw materials, particularly synthetic and man-made fibres. With the new US trade rules, there would be not only an increase in tariffs but also changes in ROO, especially concerning Chinese inputs. Cambodia will most likely turn to neighbouring ASEAN countries for raw materials. However, increased investment, spurred by the removal of its LDC status, is sure to enhance the country's yarn and fabric capabilities. Domestic private investment, driven by stricter trade and product compliances in advanced technology, would not only boost economic growth but also promote greener trade practices. As highlighted by a United Nations Development Programme (UNDP) report, such investments could enable Cambodia to meet the high-quality standards demanded by markets like Japan and the EU's 27 member states, fostering stronger trade relationships and supporting sustainable development.

Cambodia should also consider gradually opening its economy after moving out of the LDC status. Given its reliance on the garment sector, it should continue to receive reduced benefits and be given ample time to develop backward linkages and input capabilities within the country.

Fibre2Fashion News Desk (NS)