The possible impact of the EurasEC customs union on Kyrgyzstan

Jill Washington

13 December 2010

Kyrgyzstan’s economic situation would worsen considerably if the country loses access to its current duty-free supply of oil products and other raw materials from Russia and Kazakhstan. © OSCE/Roel Janssens

Kyrgyzstan’s economic situation would worsen considerably if the country loses access to its current duty-free supply of oil products and other raw materials from Russia and Kazakhstan. © OSCE/Roel Janssens

The potential impact of the Eurasia Economic Community’s (EurasEC) customs union, the customs code for which formally came into effect for Belarus, Kazakhstan, and the Russian Federation on 5 July 2010, has been widely discussed in Kyrgyzstan. Before drawing conclusions about the advantages and disadvantages of Kyrgyzstan’s possible accession, two issues should be emphasized. First, this topic should be addressed from a purely pragmatic point of view, to draw analytical conclusions on the basis of specific economic indicators. Second, one should thoroughly examine the actual operation of the customs union. At this point, I agree with Muktar Djumaliev (deputy head of Kyrgyzstan’s presidential administration) that at present the government of Kyrgyzstan cannot even negotiate with the customs union, because we do not know enough about it.

Kyrgyzstan’s foreign trade policy is quite liberal in terms of customs duties; in 2009, the average import tariff was slightly over 5 percent. Practically no export duties are applied whatsoever. According to official statistics, Kyrgyzstan’s foreign trade volume in 2009 was $4.4 billion, of which imports constituted around $3 billion (68 percent) and exports $1.4 billion (32 percent). Customs union countries were responsible for 41 percent of Kyrgyzstan’s trade volume (50 percent of imports and 23 percent of exports). Whereas the share of imports from these countries has been relatively stable, the share of exports purchased by customs union countries shows a noticeable downward trend. It should be emphasized, however, that official statistics do not give a full view of Kyrgyzstan’s foreign trade situation, because significant volumes of goods are imported under a simplified customs clearance scheme, which distorts reported import prices.

Customs union: Implications for members and non-members

What does the creation of the customs union mean for member countries? The supranational Customs Union Commission was created in order to coordinate the activity of member countries. Decisions are made according to a simple majority of votes. These are distributed as follows: Russia—57 percent, Kazakhstan—21.5 percent, and Belarus—21.5 percent. Customs union revenues are to be divided as follows: Russia—87.7 percent, Kazakhstan—7 percent, and Belarus—5.3 percent. The single value added tax rate (which has not yet come into force) is set at 17 percent. This suggests that Russia has a preemptive position within the customs union. This may be because the size of these three economies are quite different: Kazakhstan’s GDP in 2008 was only 8 percent of Russia’s, while Belarus’s was only 4 percent. This suggests that Russia’s interests may prevail in the customs union’s trade policies: some 92 percent of the common external tariff rates are based on Russia’s tariff rates. In addition to protecting Russian producers from imports, this regime will give consumers in other customs union countries incentives to switch to Russian products.\

Analyses conducted by the Asian Development Bank, the European Bank for Reconstruction and Development, and USAID indicate that, because of significant differences in economic structures, tariff rates in Kyrgyzstan and the customs union countries vary greatly. As the below table shows, Kyrgyzstan’s tariff rates are concentrated in groups at which lower duties are applied. Moreover, in addition to these ad valorem rates, the customs union’s common external tariff applies specific rates for 5.3 percent and combined rates for 2 percent of total imports. By contrast, Kyrgyzstan applies specific tariff rates for only 1 percent of total imports, and combined rates for 1.3 percent of imports.

Table 1: The share of  imports falling under different tariff rates in the Kyrgyz Republic and the EurasEC customs union

* Under the customs union’s common external tariff

These differences reflect inter alia Kyrgyzstan’s membership in the World Trade Organization: upon its WTO accession Kyrgyzstan committed itself to maintain its average tariff rate at a reference level of about 7.7 percent. Moreover, were Kyrgyzstan to consider joining the customs union and adopting its (higher) common external tariff, it would have to coordinate this decision with other WTO members. [Editors note: none of the customs union member countries have acceded to the WTO.] However, the value added tax rate on imports under the custom union’s customs code will be 17 percent—which will also apply to imports from Kyrgyzstan (where the VAT rate is 12 percent).

Kyrgyzstan’s accession to the customs union would imply the adoption of its common external tariff—the average value of which is 10.6 percent, compared to Kyrgyzstan’s average customs tariff rate of 5.1 percent in 2009. Such a hike would significantly reduce Kyrgyzstan’s trade with other countries, while increasing trade with Russia and other customs union members. In addition, Kyrgyzstan’s average tariff rate does not reflect the considerable volume of imports from China carried out based on simplified customs clearance procedures with a very low rate.

Kyrgyzstan’s Ministry of Economic Regulation has calculated that 34 percent of total imports face duties that coincide with those under the common external tariff. Some 21 percent of imports face duties that are roughly comparable to the common external tariff rates, while 43 percent do not coincide at all. Changes in these duties would need to be negotiated with the WTO, which could entail significant technical difficulties. Accession to the customs union could also reduce Kyrgyzstan’s budget revenues and increase inflation. More generally, Kyrgyzstan would have to revise the basic directions of its trade policy to reflect the interests of bigger countries, primarily Russia. Favourable conditions for imports, including from China, would likewise be revised, significantly reducing the reexport of Chinese goods.

On the other hand, Kyrgyzstan’s accession to the customs union could have a number of positive implications. These reflect the fact that Kyrgyzstani producers would obtain preferential access to the large regional market of the custom union countries, providing scale advantages for local companies. It would also make Kyrgyzstan more attractive for foreign investments, from Russia and Kazakhstan and from non-customs union countries.

What happens if Kyrgyzstan does not join the customs union? This would depend in part on whether pre-existing bilateral and multilateral free trade agreements with these countries, which provide for most favoured nation (MFN) treatment for Kyrgyzstan’s exports, will continue to be honoured. The possible revision of bilateral MFN agreements and of the 15 April 1994 agreement among member countries of the Commonwealth of Independent States (as amended as of 2 April 1999) could be quite serious in this regard. Moreover, Kyrgyzstan’s economic situation would worsen considerably if the country loses access to its current duty-free supply of oil products and other raw materials from Russia and Kazakhstan. Non-accession could also slow Kyrgyzstan’s integration into post-Soviet regional entities, such as EurasEC and the CIS. Much therefore depends on the government’s negotiations with its main trade partners, Russia and Kazakhstan.

Possible recommendations

WTO membership does not automatically preclude membership in various customs unions, because the WTO’s main goal is to reduce barriers to international trade. As such the issues discussed here would become the subject of negotiations and consultations for the government of Kyrgyzstan. The country’s most favourable option could therefore be in pursuit of a gradual, step-by-step accession in the customs union, as certain conditions would be met. One of these would be the eventual accession of Russia, Kazakhstan and Belarus to the WTO—which, most probably, is a matter of time. These countries’ WTO accession would facilitate the joint resolution of a number of issues associated with Kyrgyzstan’s prospective customs union membership, such as compensation for increases in customs tariffs. Prior to the possible WTO accession of Russia, Kazakhstan, and Belarus, Kyrgyzstan could reasonably request observer status in the customs union. This would demonstrate good faith on the part of the Kyrgyz Republic, and minimize the risks (for Kyrgyzstan) associated with the customs union’s creation. During this time, Kyrgyzstan should seek to boost investment from WTO countries, including from China in order to make good use of its comparative trade advantages.

Talaibek Koichumanov is Head of the Secretariat of the Business Development and Investments Council under the Government of the Kyrgyz Republic.