Georgia and Bilateral Free Trade Agreements; What’s Next?

 

The Deep and Comprehensive Free Trade Agreement between Georgia and the EU, brought into effect in 2014, was hailed at the time by many as being of great importance to Georgian manufacturers and food/beverage producers. Skeptics commented that 7000 articles under the pre-existing GSP+ agreement with the EU were already duty-free and quota-free for many years, yet very few exporters had ever taken advantage of the concessions. Nonetheless, exporters of alcoholic beverages were keen for the deal to go ahead; while the EU makes up a small proportion of wine and spirits exports, free access to the world’s largest consumer goods market would facilitate steadily rising market share. This very basic treatise will look at alcoholic beverages as representative of Georgia’s primary industry; to a certain extent conclusions drawn here can be applied to other food commodities also.

Note that for all analyses that follow, wines sold are not confined to bottled wines. Cask wines and bulk wine in flexitanks are included in the totals.

Georgia traditionally has been a very Russia-focussed wine production country, as the following charts indicate.

Georgian Wine Exports by Value

Georgian Wine Exports by Volume

Source: UN Comtrade

A quick visual assessment of these charts indicates that Russia is a higher volume/lower price market for Georgian wine than the EU.

Coincidentally, 2014 was a boom year for Georgian alcohol producers; the Russian market that reopened in 2013 was robust and pent-up demand for Georgian wine meant that sales volumes were robust, while prices were acceptable.

Georgian Wine Exports to Russia, Value

Georgian Wine Exports to Russia.jpeg

Source: UN Comtrade

In the face of this, the urgency for diversifying into challenging new EU markets was probably dulled by the lure of familiar markets in Russia, despite the higher price capable of being captured in Europe if quality attributes were addressed. A few shrewd operators maintained a counter-cyclical approach, leveraging their Russian sales revenues into aggressive European and Asian marketing campaigns. Those producers are doing rather better now than their solely Russia-centric competitors.

Sales volumes of Georgian wine into the EU have shown satisfactory growth since the DCFTA was implemented, but the the average price per hectalitre has increased by almost 40% in dollar terms. Granted it is only two year’s worth of data points. It is also possible that the mix of products reaching the EU market has changed and that higher-end wines are a larger proportion of imports from Georgia. It will be interesting to observe whether exporters will restrain prices to aggressively capture market share, or continue with relatively high margins but with slower sales growth. It appears that the devaluation of the Euro in 2015 has had some impact upon dollar-denominated trade statistics. Why average price per HL goes up and volume sold goes up, but total $ revenue goes down, is something of a mystery.

Georgian Wine Exports to EU, Value

Georgian Wine Exports to EU, Litres.jpeg

Source: UN Comtrade

There are challenges in the European market; European consumers, especially in the West and South of the continent, have quite well-defined preferences and in many cases have been drinking the same wines from the same appellations for hundreds of years. Changing those preferences will not be easy. The proverbial “wine lake” of Europe means that table wine in Europe is cheaper than mineral water in many cases; Georgia does not effectively compete in this market segment, lacking the subsidies or economies of scale to do so. Data suggests that much of the Georgian wine entering the EU is premium or super-premium.

The next major Free Trade Agreement being pursued is with the People’s Republic of China. Until recently one of the fastest growing centres of wine consumption in the world, China is poised to exceed Russia as a wine consuming country before the end of this decade. However, the two-year Anti Corruption Campaign launched by the Chinese Central Government has constrained sales growth somewhat. In China, a substantial proportion of wine sold is used for gifts, for people from whom one desires a favour, so the anti-graft campaign has dulled the growth of this sector. That said, Georgian wine exporters have been capturing market share in China, from a very low base, at an encouraging rate despite economic slowdown and the anti-graft campaign. Import tariffs on wine imports into China are 14%; exporters from countries with a Free Trade Agreement with China do not have to pay this tariff.

Georgian Wine Exports Asia-Pacific by value

Georgian Wine Exports to Asia-Pacific.jpeg

Source: UN Comtrade

As one can see from the charts, China and Japan account for the majority of volume, and other markets are very much in “test-phase”. Wine sold in quantities of less than a full 20-foot container load have a very high freight price and slow transit time, which limits market uptake.

Until early this century, what little wine that was consumed in China was mostly domestic and of very poor quality. I can vividly remember buying a bottle of “Great Wall” Cabernet in 2000 in Shanghai, which had a can of Coca Cola taped to the neck of the bottle as a free gift. The serving suggestion was to blend the two, which would make the wine almost drinkable; otherwise, it tasted like furniture polish. In only 15 years, wine drinking has become a prestigious activity in China indicating sophistication, and China is poised to have one of the largest areas under vine in the world soon. Vineyard management and winemaking quality is dramatically improved. Wine imports have also boomed, with over a third accounted for by French wine, and New World exporters taking advantage of the fact that many Chinese consumers entering the wine market for the first time have yet to establish fixed habits regarding country of origin of their wines.

It is interesting to observe the average price per hectalitre commanded by exporters to the East Asian markets. France commands the highest premium, and Georgian and Australian wines fit a niche in the next tier, commanding significantly higher prices than Chilean or South African wines.

Wine Export Prices by Market

Source: UN Comtrade

Note that these prices per hectalitre are calculated on an FOB basis, not CIF. When freight and insurance are included, the picture is different and between-country discrepancies in pricing are reduced somewhat.

 

East Asia Wine Imports, Prices by Exporter

Source: UN Comtrade

This may change with time now that rail transport from Georgia across the Caspian to China has become faster and, hopefully, cheaper than sea freight. This could put Georgian wine exports at a competitive advantage to those from South America, Africa, Australasia and western Europe.

Interestingly, on average wines imported into Mainland China from France, Australia and Georgia are priced roughly the same on average on a CIF basis. This does not take into the account the price distribution of different products in the product mix, but it is still an interesting finding.

If we consider that Australia and Georgia have some similarities in this market (similar average price point), then it is worthwhile looking at Australia’s experiences in capturing emerging market share.  The following infographic from Wine Industry Insight Magazine’s Lewis Perdue should be interesting.

WineIntelligence-china-infographics-2-855x1024

Australia is a zero-subsidy jurisdiction. Georgia maintains floor prices for grape produced by smallholders, but there is no substantial subsidy for commercial-scale vignerons. Australian exporters have been able to capture significantly better prices on average than most of their competitors, through rigourous quality management, national and regional branding, and aggressive export marketing.

Concurrently, the Free Trade Agreement with China has significantly reduced the cost of Australian wine to Chinese distributors (the tariff of 14% of the Cost-Insurance-Freight value is now abolished for Australian wine) which allows flexibility for discounting to capture market share, or capturing better margins, or a mix of these strategies. It is still too early to see the effect on the Free Trade Agreement with China, effective December 2015.

Australian Wine Exports to China

Australian Wine Exports to China volume.jpeg

Source: UN Comtrade

A weakening Australian dollar over the past two years has substantially improved Australia’s trade competitiveness, so even though the drop in price per HL appears steep, in AUD terms it is much less pronounced and counteracted by a greater volume of sales.

Australia also implemented Free Trade Agreements with Japan (January 2015) and South Korea (December 2014) , and the effects on sales and average price can be seen here.

Australian Wine Exports to South Korea.jpeg

Australian Wine Exports to South Korea by volume .jpeg

Source: UN Comtrade

A 25% increase in sales turnover in one year after an FTA comes into force in USD terms is quite a good result.

In Japan’s case, the response to a FTA is a more mixed result

Australia Wine Exports to Japan by value

Australia Wine Exports to Japan by volume

 

 

 

 

 

 

 

Source: UN Comtrade

An substantial increase in wine sales in litres to Japan was noted in the first year of the FTA, with a tripling in bulk wine sales. Average price per hectalitre in USD terms has dropped in that period as a result of the change in product mix, compensated by the concurrent weakening of the AUD and improved terms of trade. Japan’s economy is still rather shaky so dramatic growth in wine prices is unlikely in the near future.

Granted these datasets only involve a few years and prices are averaged over many product classes. The next 2-3 years will yield very interesting data on the cost-benefit of FTA’s for wine exporting countries.

Hiro Tejima, Wine Australia’s Head of Market for Asia Pacific, comments on the short-term effects of these two FTA’s and how they see the future.

 

Non-traditional markets for Georgia have been core markets for Australia for some decades. The $6 billion a year wine import trade in the Asia Pacific region still has plenty of growth potential, and for wine producers in countries other than France, the opportunity exists to capture market share amongst first-time wine drinkers who are not yet firmly wedded to European wines.

Asia-Pacific Wine Imports

Source: UN Comtrade

Steady growth within the ASEAN (Association of South-East Asian Nations) FTA in wine imports is encouraging. Singapore is a Free Port, with no import duty on wines, but other neighbouring countries with high tariffs are showing good growth potential. Australia’s establishment of an FTA with New Zealand and ASEAN in October 2015 should provide impetus for further growth in wine exports. Currently ASEAN countries import between 15% (Singapore) to 50% (Malaysia) of their wine from Australia.

Asean ex-Singapore Wine Imports

Source: UN Comtrade 

Only 20 years ago, Australian wine was unknown in Asia. Now it is ubiquitous. Export market promotion has evolved over time, with levies imposed upon wineries and grapegrowers to fund export market development, vineyard R&D, and biosecurity programmes with government co-operation.

Brand Australia” is now well known, and consumers understand the diversity of product available under that umbrella, from supermarket “critter wines” like Yellowtail at $5 to $3000/bottle Penfolds Grange. Regional/appellation identities like Barossa Valley, Margaret River, and Rutherglen are understood by consumers within the larger national wine identity.

The lessons that Georgia can learn from this:

  1. Effort invested in negotiating Free Trade Agreements potentially have a bigger effect upon exports, and bigger flow-on effect to grape growers, than subsidies can.
  2. Free-Trade Agreements can affect demand for different product types of different price points in different ways.
  3. Free-Trade Agreements in the short term may, but not always, result in higher FOB prices for exported goods, but volumes sold tend to trend upwards when tariffs are reduced.
  4. Export marketing requires an industry-led approach with government co-operation. National branding is an essential component.

To what extent these conclusions can also be apportioned to other agricultural exports can be argued. East Asia is a major importer of nuts of all types, including hazelnuts, and nut consumption is a pretty good proxy for economic development. Georgia is well positioned to be a major exporter of hazelnuts, walnuts, pecans, almonds and pistachios if it can get its act together, and a diversity of target markets with no import tariffs would make this investment class more attractive to professional investors. Nut orchards are expensive to develop and have terrible cashflow dynamics for the first five years, so it requires patient capital and a professional approach; such investments are more likely to occur if market access is more favourable.

Fresh produce exports are in a state of flux, as both the EU ($12 billion a year) and Turkey ($2.5 billion a year) have lost access to the Russian market, leaving large surpluses of produce heavily discounted in the region. After some adjustment to new market realities, some niche products like Kiwifruit, blueberries, honeyberries and blackberries will no doubt increase market penetration in Europe when GlobalGAP standards are implemented in supply chains and distribution in Europe is sorted out.

The EU DCFTA is an excellent development that may yield incremental gains for Georgian wine exporters, from a low baseline, in a very attractive consumer goods market. However, it should not be seen as an end unto itself, but the first of many Free Trade Agreements negotiated with non-traditional markets. Having gone through the process of DCFTA negotiations, increasing safety standards and dealing with non-compliance to satisfy the EU, Georgia is now institutionally equipped to push through deals not only with China, but with ASEAN, South Korea, Japan, Australia, New Zealand, India and NAFTA.

 

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