House Of Representatives

Explanatory Memorandum

(Circulated by authority of the Minister for Immigration and Border Protection the Honourable Peter Dutton MP)

Regulation impact statement

INTRODUCTION

1. This Regulation Impact Statement (RIS) relates to the China-Australia Free Trade Agreement (ChAFTA). Negotiations on a free trade agreement (FTA) with China commenced in May 2005 after the conclusion in March that year of a joint government study on the feasibility of a bilateral FTA. Following 21 formal rounds of negotiations, Prime Minister Tony Abbott and President Xi Jinping announced the conclusion of negotiations on 17 November 2014.

PROBLEM IDENTIFICATION

2. Australia has an extensive, growing and highly complementary economic relationship with China. In 2013-14, two-way trade in goods and services reached $159.7 billion, making China Australia's largest trading partner. China is both Australia's largest export market ($107.6 billion or 32 per cent of total exports - goods exports worth $100.1 billion and services exports worth $7.5 billion) and largest source of imports ($52.1 billion or 15 per cent of total imports). The bilateral trade relationship is also among the fastest growing: exports grew 27 per cent from 2012-13 to 2013-14, while five-year trend growth to 2013-14 reached 19 per cent.

3. At the end of 2013, Chinese investment in Australia was valued at $31.9 billion and Australian investment in China was $29.6 billion. While bilateral investment figures are modest compared to other trade and investment relationships, investment in both directions is growing rapidly: at the end of 2013, Australian investment in China was 39 per cent higher and Chinese investment in Australia was 41 per cent higher than the previous year.

4. Despite the strength of the bilateral trade and investment relationship, and the continued expansion of Australia's economic ties with China, the absence of a bilateral trade agreement:

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limits trade opportunities due to persisting high import tariffs, particularly in agriculture;

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exposes Australian goods and services exporters to erosion of competitiveness due to China's existing and future preferential agreements with other countries;

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constrains Australian businesses' ability to fully capitalise on the increasing orientation of the Chinese economy towards consumption and services;

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denies Australian exporters the benefit of increased certainty as to treatment of their goods and services and investments in the Chinese market;

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risks Australia becoming less attractive to Chinese investment;

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deprives us of a framework for Australia and China to deepen liberalisation and expand market access over the longer term.

High import tariffs limit trade opportunities, particularly in agriculture

5. China is Australia's largest goods export market, worth $100.1 billion in 2013-14.

6. It is Australia's most important agricultural market, with exports already worth $9 billion. There is considerable potential for growth. The Australian Bureau of Resource Economics and Sciences predicts China will account for 43 per cent of all growth world-wide in agricultural demand to 2050. Opportunities for Australia, with our reputation for high-quality, safe and sustainable food production, will be significant.

7. China is also Australia's largest resources and energy market, with exports worth over $88 billion in 2013-14, and a major export market for Australian manufactured products, with exports worth $4.6 billion in 2013-14.

8. Australian exports currently face significant tariff barriers into China, including tariff peaks for key products. This has limited Australian businesses' ability to take full advantage of the growing Chinese market. China's imposition of high tariffs does not just constrain trade, it also reduces the efficiency and profitability of traded items by adding additional costs.

9. China's average applied tariff in 2013 was 9.9 per cent ^[1] . Tariffs are particularly high for agricultural products, with an average tariff of 15.6 per cent. Tariffs on resource products are generally low, but given the volume of trade the overall cost can be significant. China applies tariffs of up to 47 per cent on some of Australia's manufactured exports, including pharmaceuticals, mining machinery, medical equipment, paper products, automotive parts, clothing and film.

10. ChAFTA will eliminate the vast majority of tariffs faced by Australian exports into China.

Australian goods exporters are losing market share because of preferential access secured by competitors through existing FTAs with China

11. China already has in place trade agreements with the Association of Southeast Asian Nations (ASEAN); Pakistan; Chile; New Zealand; Singapore; Peru; Costa Rica; Iceland; and Switzerland. These agreements have put Australian exporters at a competitive disadvantage. As a result of the high tariffs and market access barriers faced by Australia and the preferential access given to our competitors, without a bilateral FTA, the market share of Australian exports in China (of these products facing tariffs) could be expected to decline as they lose competitiveness.

12. Dairy is a good example. Since New Zealand's FTA with China entered into force in 2008, with preferential access for dairy products, its dairy exports to China have grown by 864 per cent. During the same period Australia's dairy exports have grown, but only by 152 per cent (Chart 1 refers).

13. Australia also needs to hedge against potential preferential access granted to competitors in future trade deals. China has recently concluded negotiations with Korea and is participating in the Regional Comprehensive Economic Partnership (RCEP) negotiations, which include key trading partners in the Asia-Pacific, and trilateral negotiations with Korea and Japan. China is negotiating with the Gulf Cooperation Council (GCC), conducting a feasibility study with India and is also considering launching FTA negotiations with the European Union (EU) and Canada.

14. As well as giving Australian exporters an immediate competitive advantage over countries that do not have trade deals with China, ChAFTA also includes a built-in agenda to allow for further market access and liberalisation to be negotiated in future.

Lack of certainty for Australian businesses

15. On some products China applies a tariff lower than the maximum permitted under its World Trade Organization (WTO) commitments, which means China has scope to raise tariffs for such products at any time. For example, in October 2014 China increased its tariff applied on anthracite and coking coal from zero to three per cent, and on non-coking coal/bituminous coal to six per cent, which was consistent with WTO rules, but nevertheless caused difficulties for Australian coal exporters. With these tariffs in place, Australian coal no longer competes on a level playing field with major supplier Indonesia, which continues to export coal to China duty free under the ASEAN-China FTA.

16. ChAFTA will eliminate most of China's import tariffs and lock in these reductions, providing greater certainty for Australian businesses.

Exposure to loss of competitiveness in services and investment

17. There is significant scope to expand bilateral services trade and investment to the benefit of both countries. China is Australia's largest services market, with exports worth $7.5 billion in 2013-14 (13 per cent of Australia's services exports). China is Australia's eighth largest source of foreign investment and the twelfth largest destination for Australian investment.

18. China's existing WTO commitments to Australia relating to services are limited. China's commitments in FTAs with New Zealand, Switzerland, Chile and Iceland build on its WTO commitments, including in relation to investment in services activities located in China. In the absence of an FTA there is a risk that Australian suppliers may receive less favourable treatment in China than suppliers from these countries, at a time when services are playing a more important role in the Australian economy.

19. Through ChAFTA, China will bind its regulatory regime in a much wider range of service sectors, providing greater certainty of treatment for Australian service providers and investors. In some areas, ChAFTA will provide new access for Australian companies in China, potentially providing preferential market access if the treatment is not extended to other countries. ChAFTA provides commitments on and forums for discussing market access interests as they emerge, and mechanisms to encourage mutually beneficial collaboration and cooperation in service sectors.

20. A 1988 bilateral treaty on the encouragement and protection of investments commits China and Australia to provide minimum standards of treatment in relation to each other's investors and investments and includes an investor-state dispute settlement (ISDS) mechanism. It does not include market access obligations. ChAFTA will offer increased certainty for investors of both countries. It will encourage further growth of Chinese investment into Australia, in particular by raising the screening threshold at which investments in non-sensitive sectors by private sector entities from China are considered by the Foreign Investment Review Board (FIRB) from $252 million to $1,094 million.

21. ChAFTA will also commit China to providing Australian investors with the most favourable treatment it gives to any other investment partner in the future. As China implements its bilateral investment treaty with Canada and progresses investment treaty negotiations with the United States (US) and EU, this commitment will help secure Australia's interests - that is, being able to invest in China on terms as good as those provided to any other country.

OBJECTIVES OF GOVERNMENT ACTION

22. The Government's objectives for concluding a high-quality bilateral free trade agreement as soon as practicable were to secure and improve Australia's competitiveness in a key market, through:

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improved goods market access, including through the elimination of Chinese tariffs on a broad range of Australian agricultural, resources, energy and manufacturing goods over the shortest possible timeframe and a mechanism to address non-tariff measures;

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improved or restored competitiveness for Australia's agricultural and services exports;

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expanded access for Australian service suppliers in the large Chinese market;

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increased certainty for Australian investors in the Chinese market;

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a commitment to negotiate a reciprocal agreement on government procurement after the completion of China's negotiations to join the WTO Government Procurement Agreement;

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commitments to enhance the use of electronic commerce in goods and services, including by ensuring that customs duties will not be introduced on electronic transmissions;

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retention of full access to WTO trade remedies, including anti-dumping and countervailing measures;

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commitments to ensure that the benefits of ChAFTA are not undermined by anti-competitive practices; and

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a framework for settling disputes under ChAFTA.

OPTIONS THAT MAY ACHIEVE THESE OBJECTIVES

23. While China's high growth rates of recent decades have moderated, the economic outlook remains comparatively strong: the IMF is forecesting 6.8 per cent growth in 2015, easing to 6.3 per cent by 2019. China is rebalancing from an investment, manufacturing and export-intensive model of growth, towards a more consumption and services-oriented economy as it looks to sustain economic growth over coming years. China continues to urbanise rapidly, building cities, infrastructure and amenities. The middle class continues to expand, with increasing demand for a variety of foods and high-value manufactures, as well as services. As China's economy develops and the consumption habits of its rising middle class begin to change, opportunities are opening up for a more diversified bilateral trade relationship, with a growing focus on premium agricultural exports and services such as finance, and health and aged care, as well as professional services.

24. As outlined in the 'Problem identification' section of this RIS, China maintains trade barriers on goods and services of interest to Australia. Without an arrangement to reduce these restrictions, Australian exporters will remain constrained in their ability to capitalise fully on the opportunities presented by China's large, growing and transitioning economy. Furthermore, it is in Australia's interest to ensure the competitiveness of its agricultural and manufacturing industries in China, particularly at a time when many of Australia's trade competitors have gained preferential access, or are negotiating preferential access, through bilateral FTAs. A bilateral FTA would also give Australian services exporters improved access to China's significant and growing services sector, which in 2014 accounted for 48 per cent of GDP.

25. The only realistic option available to the Government to achieve these objectives was the negotiation of a bilateral FTA with China. This section considers other options available to the Government.

No action

26. The absence of an FTA risks Australia losing competitiveness in the large and growing Chinese market. With no action, Chinese tariffs on Australian goods would continue to constrain Australian exporters' ability to capitalise fully on continued growth in the Chinese economy. Without an FTA, it would be difficult to restore the competitiveness of Australian industries against rival producers from other countries that already have FTAs in place with China (e.g. dairy, meat, seafood and wine in relation to New Zealand's FTA with China). As Australia's trade competitors conclude FTAs with China into the future, Australia's export-focussed industries would be even further disadvantaged. The absence of an FTA would also deny Australian services providers a competitive advantage from gaining the best access China has ever provided any trading partner.

27. The opportunity costs would be significant: China's economy is transitioning from an export and investment-driven model toward greater consumption of goods and services while its middle class expands and its population steadily urbanises.

28. On the import side, under the status quo without an FTA, Australian demand for imports from China, which are dominated by textiles, clothing and footwear, electrical goods and home furnishings, could be expected to follow current trends (in 2013-14 China's exports to Australia grew by 12.7 per cent) subject to the growth of the Australian economy. The absence of an FTA would deny Australian consumers and businesses which rely on Chinese imports the more competitive prices on Chinese goods available through tariff elimination.

Regional trade negotiations

29. At present, the Regional Comprehensive Economic Partnership (RCEP) negotiations could be viewed as a possible alternative to a bilateral FTA with China.

30. RCEP negotiations provide an opportunity for Australia to pursue its trade and investment interests in China. However, RCEP may not deliver the objectives and specific outcomes sought in relation to China in a timely manner. RCEP negotiations include all 10 ASEAN Member States and ASEAN's six FTA partners - Australia, China, India, Japan, Korea and New Zealand. In 2012, Leaders agreed the Guiding Principles and Objectives for Negotiating the RCEP, which state that RCEP aims to achieve a modern, comprehensive, high-quality and mutually beneficial economic partnership agreement. However, the plurilateral negotiating dynamics in RCEP may not deliver the preferential commitments from China on our priorities that are obtainable from a bilateral negotiation.

31. Key issues on the scope and level of market access for goods, services and investment are still under intense consideration in the RCEP negotiations. As RCEP negotiations are not scheduled to conclude before the end of 2015, ChAFTA provides certainty that market access outcomes will be delivered sooner.

Multilateral trade negotiations

32. The WTO Doha Round of trade negotiations was launched in 2001 and is a trade policy priority for the Government. However, the WTO's capacity to deliver significant market access through negotiations has been disappointingly low since the Uruguay Round, which concluded in the early 1990s. While securing outcomes through the Doha Round would advance Australia's trade interests with China, there is no certainty that the Doha Round would deliver outcomes that address Australia's priority interests with China as extensively, or in as timely a way, as is possible under ChAFTA.

Bilateral trade negotiations

33. A high-quality, WTO-consistent bilateral FTA with China is, therefore, the only realistic option to achieve the Government's objectives in a timely and comprehensive manner.