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Tobacco Tests the Limit of Balkan Free Trade

23 11 2006  Governments seeking to protect cigarette producers and farmers risk scuppering a critically important plan to enhance free trade across the region.

By Saida Mustajbegović in Sarajevo and Anna McTaggart in Zagreb (Balkan Insight, 23 Nov 06)

Alas, November 9 might have been an important date for the Balkan economies.

A short time before, senior trade officials in the region had signalled that on this day they would initial a new agreement bringing six countries into CEFTA, the Central European Free Trade Agreement.

Established in 1992 as a stepping-stone to broader free trade within the European Union by previous candidate states such as Poland and the Czech Republic, CEFTA is seen by policymakers as a key transit point for countries proceeding toward eventual EU membership.

The eastern trading bloc currently includes Romania, Bulgaria, Croatia and Macedonia. The prospect of CEFTA membership for Serbia, Bosnia and Herzegovina, Montenegro, Albania, Kosovo, and Moldova was therefore hailed, in advance of the deal, as a major step forward - the moment when myriad bilateral trade deals on the books in the region would be streamlined and clarified within a single agreement. [see BI 56: EU Hails Balkan Free Trade Deal as Milestone ]

But negotiations broke down at the last minute. After a series of rounds, Serbia and Bosnia and Herzegovina stepped away, refusing to accept the terms.

Their endorsement of the treaty, sponsored by the EU and the Stability Pact for Southeast Europe, was foreseen as a mere formality. But Serbian and Bosnian delegations backed out after their late appeals regarding trade with Croatia, an existing CEFTA member, were rejected. The appeals called for revision of existing trade rules, an idea Zagreb refused to entertain.

Experts now warn that the source of the problem, a dispute over the tobacco industries of Serbia and Croatia, could keep both Serbia and Bosnia and Herzegovina out of the organisation.

“Failure to admit Serbia and Bosnia to CEFTA would essentially halve the organisation’s significance,” said Nikola Grabovac, a Sarajevo economist. It would leave a gaping territorial hole in the trading area, preventing more than 12 million Serb and Bosnian consumers from benefiting from CEFTA trading rules.

Serbia wants to protect domestic cigarette production, a promise made upon the 600 million euro combined purchase of Serbian cigarette-rolling plants by foreign tobacco giants Philip Morris and British-American Tobacco, BAT. To date, Belgrade has been able to protect domestic production by applying discriminatory taxes on imported cigarettes, many of which come from Croatia. This practice, which contradicts World Trade Organisation rules, is barred likewise by CEFTA.

Serbia’s government has therefore tried another tack. It agreed to scrap the barred tax, but on the condition that it would add a compensatory hike in import duties, already some of the lowest in Europe. But Croatia, with its own strong domestic cigarette lobby dominated by Rovinj Tobacco Factory, rejected the move.

Zagreb cites the basic principle of the CEFTA negotiations, that the treaty should not change existing trade arrangements. Serbia’s retort is that, in addition to higher import tariffs, the Croatian tobacco market is regulated in a way that closes it to competition, echoing complaints from BAT.

Analysts predict Belgrade will eventually back down, absorb the consequent loss in revenue and compensate investors. While the BAT and Philip Morris investments are important to Serbia, a loss related to tobacco is likely to be offset by gains to Serbia, as a major player in regional trade, made available through CEFTA.

But the same cannot be said for Bosnian agriculture. Sarajevo has sought to revise its arrangements with Croatia and Serbia on agricultural trade, undoing agreements signed in 1996 and 2001 but later viewed as detrimental. Bosnian officials aim to increase tariffs on the import of meat and dairy products, lest its frail farming industry wilt in the face of competition from stronger neighbours.

Again, Croatian assent is critically important. Nenad Pandurovic, a member of Bosnia and Herzegovina’s trade negotiating team, said Croatian negotiators had assured them through months of talks that they sympathised with their request for a renegotiation of meat and dairy rules. “But when it came time to seal the agreement, Croatia declined to accept any changes,” he said.

Zagreb ultimately took the position that exceptions should not be made for Bosnia and Herzegovina or Serbia. “The basic premise of the negotiations was made clear in April, that we would maintain and extend the degree of trade liberalisation existing in bilateral agreements,” explained Vladimir Vrankovic, Croatia’s state secretary for economy.

Members of the Bosnian negotiating team said they believe their position is suffering collateral damage from Zagreb’s broad effort to avoid renegotiation of tobacco trading rules with Serbia. Rather than focusing on tobacco alone, Zagreb has come out with a categorical refusal to renegotiate bilateral conditions for the sake of CEFTA’s enlargement.

“Croatia’s interest in accessing Serbia’s market goes beyond just trade and transcends into investment, because from there it can export to Russia tax-free,” said Pandurovic.

Sarajevo remains adamant that Croatia must reconsider. Antun Rill, Bosnia and Herzegovina’s chief CEFTA negotiator, explained that Sarajevo seeks “a brief delay in opening the market completely to some products, with the same terms applying for Serbia and Croatia in order to catch up with them by 2010, the deadline for the complete liberalisation of the regional market”.

The root of the problem, said Rill, is that Bosnia and Herzegovina failed to assess properly the potential impact of bilateral free trade agreements before signing them with Serbia and Croatia.

Arguably, Sarajevo’s trading woes date back to 1995, when the Dayton Peace Accords were signed. Its market devastated by war, the country could not meet domestic consumer demand for food. Authorities therefore liberalised trade with neighbouring countries on an emergency basis, signing agreements allowing tax-free food shipments from Serbia and Croatia.

Seadeta Ceric, Bosnia and Herzegovina’s former chief trade negotiator, said such post-war agreements should have been scrapped a few years later. Instead, they were followed by an enhanced 2001 version signed by all countries in the region, further opening the Bosnian market.

“We gained a beneficial agreement with Croatia and Serbia on a gradual reduction of taxes on their exports, bringing them down to zero over three years,” said Ceric.

But after three years of tax-free exports to Serbia and Croatia, when the relationship was due to be equalised, Bosnian producers turned against them. Concerned that they were unable to compete, they threatened to stage roadblocks. In response, the Bosnian authorities cancelled compliance with agricultural components of the free trade deals. That decision created rifts that remain unresolved.

“When we sat down to negotiate the CEFTA agreement, we realised it was a completely new treaty allowing us to rectify the errors made,” said Pandurevic. He argues that Croatia and Serbia have chosen to ignore Article 13 of their bilateral agreements with Bosnia and Herzegovina, which allows alterations if a signatory’s trading position is being damaged under the existing conditions of the agreements.

Rill now asserts the agreements were flawed, because they failed to take into account the level of domestic subsidies to farmers. “Bosnia and Herzegovina had … no mechanisms for subsidising domestic products”, giving Croatia and Serbia non-tariff advantages, he said.

“We have the Stability Pact’s and the European Union’s principal support and understanding although they were initially sceptical regarding amendments to the effective agreements,” continued Rill.

But the race is now on to win support in Zagreb. A final signing ceremony for the CEFTA agreement has been set for December 19 in Bucharest.

“If Bosnia and Herzegovina fails to reach agreement with Croatia and Serbia regarding open issues by that date, there is a realistic possibility that our country will stay out of CEFTA,” said Grabovac, the Sarajevo economist.

Yet compromise looks unlikely. “The parties are not talking directly to one another, but through us,” said an international official involved in the CEFTA negotiations.

Statements from Vrankovic, Croatia’s state secretary for economy, suggests as much. Despite his description of the negotiation process as “good and friendly, in line with international standards”, his insistence that Croatia has nothing further to negotiate indicates a zero-sum stance.

Yet a failure on CEFTA would risk further damaging the region’s trading potential and its reputation in Europe. Erhard Busek, head of the Stability Pact, has made clear that CEFTA negotiations are a test for regional cooperation, and as such, “a precondition for EU integration”.

Saida Mustajbegovic is a Balkan Insight contributor. Anna McTaggart is BIRN’s Croatia Project Manager. Balkan Insight is BIRN’s online publication.