What Is a Free Trade Agreement?

THROUGH the Minister of Finance Regulation No. 79/PMK.010/2020 promulgated on 3 July 2020, the government stipulates import duty rates in the context of the Asean-Hong Kong Free Trade Agreement (AHKFTA).

The regulation has been released as a follow-up to the ratification of the Asean-Hong Kong free trade agreement stated in Presidential Regulation Number 34/2020. This agreement also adds to the list of free trade agreements of the Government of Indonesia.

As such, what exactly is a free trade agreement?

Definition

Quoting the official website of the Ministry of Trade of the Republic of Indonesia, a free trade agreement (FTA) refers to an agreement between two or more countries to establish a free trade zone.

A free trade zone is a block/group of economic cooperation between countries located in a particular region. A free trade zone is a form of economic cooperation that renders every line of life more developed, including trade.

FTAs result in cross-border trade in goods or services without tariff or non-tariff barriers. Tariff barriers relate to levies imposed on goods from a country, such as import duties or taxes on imports (PDRI).

On the other hand, non-tariff barriers generally relate to non-taxation measures used by governments to restrict imports from other countries. For example, restrictions or prohibitions as well as certain requirements make it more difficult for imported goods to enter a country.

The establishment of FTAs is aimed at enabling more rapid developments of cross-border business. This implies that FTAs are expected to benefit all parties involved in the agreement.

Benefits of FTAs

Benefits from FTAs include trade creation and trade diversion. Trade creation refers to the creation of unprecedented trade transactions between FTA members due to incentives derived from the establishment of FTAs.

Trade diversion, on the other hand, refers to the transition of imports from one country to another. Trade diversion generally occurs because the diversion is considered more efficient or profitable from an economic point of view.

For example, the reduction in tariffs resulted in Indonesia, which had always imported sugar from China, now importing sugar from Thailand. The diversion occurs because the costs of importing sugar from Thailand are considered more efficient and thus, Indonesia has stopped importing sugar from China.

In addition, FTAs enable preferential tariffs for exporters in a country. These preferential tariffs allow exporters and entrepreneurs to suppress production costs to increase industrial competitiveness.

Referring to the International Bureau of Fiscal Documentation (IBFD) International Tax Glossary (2015), a preferential tariff refers to a tariff that imposes a special, low rate on imports from certain countries or on imports of certain goods. Check out the dictionary ‘What Are Preferential Tariffs’.

Preferential tariffs are imposed under the FTA scheme whose tariffs have been stipulated in a minister of finance regulation. As an incentive, the amount of the preferential tariff may differ from the most favoured nation (MFN). Check out the Dictionary ‘What is Most Favoured Nation’.

Examples of FTAs involving Indonesia, both bilaterally and regionally, can be seen in Article 2 paragraph (2) of MoF Reg. 109/2019, including the Asean-China Free Trade Area (AC ETA), Asean-Korea Free Trade Area (AKFTA) and Asean-Australia-New Zealand Free Trade Area (AANZFTA). (Bsi)