Economic Watch

The challenge for SAFTA

BY DR. SAMAN Kelegama

SOUTH Asia plans to activate SAFTA (South Asia Free Trade Agreement) in July 2006. Many arguments have been put forward by economists and other commentators to say that there is little scope for economic integration in South Asia.

First, it is said that the received evidence from other countries indicates that South-South economic cooperation does not lead to much gains as North-South cooperation and South Asian economic integration belongs to the former.

Second, there are limited complementarities in the region, consequently there is not much scope for trade; third, at the start of SAFTA, the intra-regional trade is about five per cent which is quite low to bring any substantial gains from a free trade agreement (FTA); fourth, major trading partners of South Asia are in the Northern hemisphere, thus it is better to work out trading agreement with such partners than regionally, and so on.

Perhaps the slow progress of SAPTA with little results after four rounds of tariff reduction during 1996-2003 gave further justification to these arguments.

Pessimistic viewpoints and slow progress of SAPTA have not discouraged South Asian countries from exploring various other avenues to move trade and investment in the region during the past decade.

The best example is the usage of the bilateral free trade agreement option to stimulate trade and investment.

For example, the Indo-Sri Lanka Bilateral Free Trade Agreement (ILBFTA) was worked out in 1998 and came into operation in early 2000 when many arguments against it were put forward, viz., it would be the larger country that would be the key benefactor, it would lead to trade diversion and disruption of the production base in Sri Lanka, and so on.

Five years of the ILBFTA allows us to take a brief look at the outcome. The trade balance in favour of India declined from 15:1 in 1998 to 4:1 in 2004.

In 2004, bilateral trade amounted to US $ 1.73 billion with Indian exports amounting to US $ 1.35 billion and Sri Lankan exports amounting to US $ 382 million.

India which was the 21st destination for Sri Lankan exports in 1998 became the third largest destination in 2004. Exports to India have increased from one per cent in 1998 to seven per cent of total exports in 2004.

India was the largest source of imports to Sri Lanka before the ILBFTA and this position was consolidated after the ILBFTA with Indian imports stabilising around 14-18 per cent of overall imports of Sri Lanka.

India which was mainly exporting agricultural items to Sri Lanka until the late 1980s (sugar, potatoes, onions, chillies, etc.), today is a major supplier of industrial goods and services (petroleum products, pharmaceuticals, iron and steel products, buses, lorries, motor vehicles, etc.).

Indian investment followed trade and over 50 per cent of the Indian investment in the SAARC region today is in Sri Lanka.

India is the fourth largest investor in Sri Lanka after Singapore, UK and Australia. Some of the most visible Indian investments are Apollo Hospitals, Tatas (Taj Hotels, VSNL, etc.), Indian Oil Corporation, Ambuja, Ceat, Ashok Leyland, etc.

Education companies such as ICFAI have also entered the Sri Lankan market. Indian investments have played a key role in invigorating dormant complementarities in the Sri Lankan export production side.

The trade-investment nexus is gradually working for Sri Lanka as well - Ceylon Biscuits and Damro are the most visible Sri Lankan investments in India.

Sri Lanka sees the imbalance in the trade account due to its limited export supply capability getting compensated by investment flows in the capital account.

The enthusiasm for the ILBFTA is sustained through such positive thinking and strong political commitment from both sides.

Following the success of the ILBFTA, both India and Sri Lanka agreed to move towards a Comprehensive Economic Partnership Agreement (CEPA) by March 2006 - already five meetings at inter-governmental level have taken place.

The CEPA will include broadening the ILBFTA by liberalisation of investment and services in addition to deepening the ILBFTA.

Sri Lanka also gained the confidence via its experience with the ILBFTA to work out a bilateral FTA with Pakistan which came into operation in June 2005.

Already over 400 certificates of origin have been issued by the Sri Lankan Department of Commerce for exporters for Pakistan. Besides India, Sri Lanka is the only other South Asian country to have two bilateral FTAs with South Asian countries.

What the Sri Lankan experience shows is that if the regulatory framework in a Bilateral FTA is correctly designed to accommodate the disparity between the countries, then a small country could in fact gain from an FTA - a 'win-win' outcome.

In this case, the time frame of tariff phase-out, rules of origin, and negative list were designed to accommodate the smallness of Sri Lanka's export and production capacity. In other words, special and differential treatment in favour of Sri Lanka was built-in to the bilateral FTA.

The Sri Lankan experience also shows that trading in South Asia cannot be confined to a particular framework like SAPTA or the forthcoming SAFTA if they are weak, slow moving and vulnerable to the fluctuating politics of South Asia.

Under such circumstances, trade and investment will take place via other routes as amply demonstrated by the ILBFTA.

If however SAFTA is to make an impact, it should prove within its first two years of operation that unlike SAPTA it could withstand political shocks and move forward to facilitate trade and investment in the region.

And above all, it should move fast enough to supersede the existing bilateral FTAs in the region and prove to be a dynamic regional trading arrangement. This then is the challenge for SAFTA.