The WTO’s panel report has found the EU’s special tariff preferences for 12 developing countries under its “Drug Arrangements” — as prescribed in the EU’s GSP regulation — to be in violation of trade rules because these discriminate against other developing countries.

The panel was formed on the request of India (later joined by Paraguay) who had claimed the EU’s drug arrangement to be inconsistent with the principal of non-discrimination under Article 1.1 of Gatt 1994. Pakistan is one of the beneficiaries of this scheme since January 2002. The incentive includes suspension of customs tariff (effectively making it zero per cent duty) on imports from these countries for all products except those which “graduated” out of the GSP scheme. For Pakistan, it virtually includes all major export products except yarn, fabrics, carpets, leather and on technical grounds some seafood and rice.

In addition to Pakistan, the facility is also provided to Bolivia, Colombia, Costa Rica, Ecuador, El Salvador, Guatemala, Honduras, Nicaragua, Panama, Peru and Venezuela.

The panel report in itself does not amount to immediate withdrawal of the facility by the EU. The panel’s recommendation is that the Dispute Settlement Body (DSB) may request the European Community (EC) to bring its measure into conformity with its obligations under Gatt 1994. Now it is up to the DSB to either accept the panel report or reject it and the EU to file an appeal.

Its outcome is of critical importance to Pakistan, as this not only combated drug production and trafficking but also increased the exports. Pakistan’s export to the EU accounts for 25 per cent of its total export and the zero duty played a key role in the increment of clothing and textile made-up exports in particular. Pakistan’s export of textile under quota restraint has increased by approximately $300 million, creating 60,000 job opportunities. Consequently, a vast majority of those possibly tempted by drug trafficking have been provided with alternative sources of income. Pakistani exporters have invested around $2 billion in the last 2 years to successfully meet the challenges and exploit the opportunities of post-2005, when trading in textiles will be integrated into Gatt w.e.f. 1/1/2005 and have based their projection on the availability and continuation of this facility. The same may be equally true for exporters in the 11 countries. The withdrawal of this facility will prove highly damaging to such exporters.

Why the Panel gave such a ruling and what is the probability that this facility will be withdrawn by the EU in the immediate future and what are the implications of the panel ruling for Pakistan’s export to the EU? It is the purpose of this article to dwell on these questions.

While the EU had granted these facilities to 11 other countries, India challenged it in the WTO after it was extended to Pakistan. India may not be favourably remembered, but would be known to have given priority to few dollars worth of exports over the drug issue which poses a serious health problem in the EU, the US and all the drug producing and transit countries.

On 5 March 2002, India requested consultations with the EC over conditions under which the EC accords tariff preferences to developing countries under the scheme of generalized tariff preferences. Consultations on March 25 could not resolve the matter. On December 6, India requested the Dispute Settlement Body (DSB) to establish a panel which the DSB did.

India’s concerns against Pakistan, in addition to its timing of lodging the complaint, became all the more visible when it decided to confine its challenge only to the drug-related incentives (only this facility is provided to Pakistan) and not the environment and labour-based incentives of the EU’s GSP scheme on the flimsy ground that it reserves the right to do so later as only one country benefited from the labour and none from the environment-based incentives. The issue is not the number of countries; in drug it is also confined to a mere 12; if India was serious about the issue, it should have challenged on the basis of principal and not beneficiary country(ies).

India’s main argument was that the Drug Arrangements are inconsistent with Article I:1 of Gatt 1994 and are not justified by the Enabling Clause. Translated in simple words, it means that India asserts that this EU’s facility violates the Most Favoured Nation (MFN) concept, whereby, all the WTO members should be extended the same benefits unconditionally, thus other developing countries have been discriminated against by the EU.

The WTO allows several exemptions to the MFN concept including in the very GSP scheme for the LDC countries and under the RTA/FTAs and in fact under the Enabling clauses it overrides the MFN clause. The EU’s main argument was that its action is consistent with the Enabling Clause as it allows developed country members to accord preferential tariff treatment to products originating in developing countries in accordance with the GSP without according such treatment to other members notwithstanding the provision of the MFN clause. All the concerned parties, i.e., the EU, India and the third parties offered convincing arguments.In the end the panel accepted India’s version.This is an unfortunate finding of the panel as it misunderstood the overriding principle of the Enabling Clause which allows developed countries to provide incentives under the GSP as a matter of autonomous right and not an obligation to some developing countries by excluding others so long as it is administered generally and in a non-discriminatory manner. Thus, EU can give these incentives to the 12 countries but cannot deny this right to another developing country which also meets the same criteria but can deny it to those developing countries which do not meet the criteria. The US also denies certain GSP facilities to developing countries if it feels that such countries violate certain labour standards.

The panel also did not agree with Pakistan which contends that the Enabling Clause does not require that the same preferential treatment be granted to all developing countries since the entire GSP scheme is based on the granting of preferential treatment to different developing countries, taking into account their development needs. Accordingly, the Enabling Clause enables special and differential treatment of developing countries. Therefore, if preferential treatment is covered by any subparagraph of paragraph 2, then Article I:1 of Gatt 1994 does not apply. At the heart of the argument is that enabling clauses are autonomous rights of developed countries and not exceptions to Article 1.1.

Pakistan disagreed with the following three points raised by India: (1) the Enabling Clause does not permit developed countries to discriminate between developing countries; (2) the Drug Arrangements required a waiver; and (3) Pakistan’s inclusion in the Drug Arrangements is designed to respond to the policy objectives of the European Community rather than the needs of the developing countries .The last issue was pointed out as India specifically alleged this against Pakistan. Indeed, there is a popular misconception that this facility was extended to Pakistan as a reward for being a partner in fight against terrorism; this of course is not entirely true. Pakistan made tremendous efforts and success in combating the menace of drug production and trafficking, as well. Again in 2002 , there was a popular perception among the business community that the EU was “angry” with Pakistan for having purchased Boeing aircraft rather than Airbus and it retaliated by not providing extra quota to Pakistan which it traditionally did for a decade in what is technically called exceptional flexibility through intra-category transfer to the extent of 4,000 MT. Similarly, the EU’s misapprehension about Pakistan’s political landscape is being constructed or mis-constructed on account of non-finalization of the third generation agreement with Pakistan. Despite all these “anger”, the EU did not threaten to undertake such investigations that may allow it to withdraw the greatest facility it offered to Pakistan, i.e.,, duty-free market access.

The WTO panel recommended that the DSB request the EC to bring its measure into conformity with its obligations under Gatt 1994 but refrained from advising the EU on what to do. It is noteworthy that out of a 3-member panel, only one dissented, thus the DSB must consider the report very carefully.

The panel reporting does not bind the EU to withdraw the facility. The EU can go for appeal. The EU has also sought waiver in the WTO for these actions. Even the panel sympathized that this incentive may provide opportunity of benefits of sustainable development for these countries derived from the operation of the Drug Arrangements.

Pakistan and the other 11 countries must fully cooperate with the EU in the appeal process and impress upon the EU to file an appeal in case the DSB accepts the panel report. In case the EU also looses in the appeal, it may be requested to understand to use the maximum implementation time so that exporters can readjust their marketing strategy which has been based on assumption of availability of this facility till end 2005 at the least. The EU can withdraw the facility sometime in mid-2005 even if it looses in the appeal. If the EU wins, it may even extend the facility till 2008 after a midterm review in end 2005.

Regardless of the outcome, Pakistani exporters must prepare to compete on normal duty basis with the LDC being granted zero duty. The government on the other hand may cooperate with and accelerate the US’s proposal to move towards zero customs tariff, otherwise, Pakistan will suffer as countries under the FTA/RTA and the LDCs will enjoy zero duty, whereas, Pakistan cannot join any meaningful RTA/FTA. Customs duty now accounts for less than 15 per cent of Pakistan revenue and will continue to have a lower share. It is thus better to consolidate sales and other taxes and bring duty to zero per cent. For protection of local industries, safeguard mechanisms can be used and negotiated in the WTO by the developing countries as a whole.

For Pakistan, the stakes are high. The worse hit industry may be the bedwear, which in addition to the withdrawal of zero per cent may be faced with the normal MFN duty of around 11 per cent and further anti-dumping duty in the EU or a tariff quota which is presently under final stages of investigations in the EU.

In conclusion, while the panel report will not adversely affect Pakistan’s export to the EU in the short term, it must prepare itself for the inevitable when it will have tariff imposed on its products and many countries may enjoy zero duty either because of the LDC status and/or the RTA/FTA status.