Abstract
The opening message of the High Commissioner of India in Sri Lanka states:
Since the operationalisation of the India–Sri Lanka Free Trade Agreement (ISFTA) in 2000, trade alone has multiplied by as much as 8 times, crossing the milestone of US$ 5 billion in 2011–12. During this period while Sri Lanka’s exports to India multiplied by over 16 times, India’s exports to Sri Lanka went up by less than 7 times.
The message further underlines an important dimension of bilateral trade between the two countries, namely, while over 70 per cent of Sri Lanka’s exports to India are covered under the free trade agreement (FTA), only 30 per cent of India’s exports to Sri Lanka avail of the preferential route of the FTA. The message thus states that ‘while there could be no doubt that the FTA brought significant benefits to both sides, but more to Sri Lanka’ (p. 3).
The message is followed by a Foreword by Saman Kelegama, the Executive Director of Institute of Policy Studies of Sri Lanka (IPS), which partnered the High Commission of India to bring out the publication. The IPS has played a key role in dissemination of information on the ISFTA via publications, policy briefs and seminars over the years, in some of which I had the pleasure of participating. The Foreword echoes the positive sentiment on ISFTA as brought out in the message. The Foreword rightly states:
While there is quite a lot of information on ISFTA, however they remain scattered. This handbook attempts to bring this scattered information together to assist the business community and other stakeholders to obtain a better understanding of the ISFTA. In addition to a brief analysis on what has happened so far under the ISFTA, the handbook reproduces the Free Trade Agreement and technical details relevant to the Agreement such as negative lists, rules of origin, etc., and agencies dealing with ISFTA. (p. 6)
The process of registering a company to export under the SAFTA agreement and acquiring the Certificate of Origin in both the countries, as well as the documentation requirements for both exports and imports, is neatly laid down for the convenience of traders in both the countries. The modalities of a dispute settlement mechanism have also been laid down (pp. 16–20).
The utility of the handbook is appreciably enhanced by including it in the Indian High Commission’s website as this type of information has not existed in either country’s Department of Commerce websites earlier.
In a background to the agreement, the handbook brings out the rationale for a bilateral FTA. Existing preferential trading arrangements (PTAs), such as the Asia Pacific Trade Agreement (APTA) or the South Asian Preferential Trading Arrangement (SAPTA), did not prove to be effective in stimulating India–Sri Lanka trade as these arrangements were based on the slow-moving positive list approach, with ‘skin-deep’ tariff preferences. While SAPTA/SAFTA recognized asymmetries between least developed countries (LDCs) and non-least developed countries (NLDCs), it did not recognize asymmetries that existed among NLDCs. The ISFTA, based on the negative list approach, provided for special and differential treatment among the two asymmetric trading partners. Besides, right from its inception, ISFTA provided for a time plan for attaining an FTA, with India committing to phase out its duties in three years since the commencement of the agreement, and Sri Lanka being given eight years to attain the same. In contrast, SAPTA did not set any time line to attain an FTA. While SAFTA set a time frame for attaining an FTA, on a differential basis, the contracting states could, if they wished, still retain tariff levels from 0 to 5 per cent at the end of the liberalization plan.
The handbook brings out the advantages of South–South trade that ISFTA could generate. But this can apply to all South–South FTAs and is not limited to the ISFTA. The handbook is however justified in suggesting how the ISFTA could bring in some of the informal trade into the formal trading network by means of trade and tariff liberalization. Nevertheless, the impact is likely to be muted unless accompanied by advances in trade facilitation measures to address non-tariff barriers or to ensure that non-tariff measures do not take the shape of non-tariff barriers.
The handbook is silent on political constraints that have inhibited the expansion of trade under regional trade agreements (RTAs). The ISFTA provided an opportunity for both India and Sri Lanka to move on a faster track of mutual trade liberalization, uninhibited by the political constraints under which the RTAs were functioning in the region. The bilateral agreement enabled the two countries to exchange concessions and design their negative lists much more flexibly and much more attuned to their special needs.
The handbook could have done better in terms of sequencing of offers made by India. For instance, it mentions that ‘The negative list for Sri Lanka with regard to India under SAFTA is 865, which is significantly higher than the 431 tariff lines under ISFTA’ (p. 12). In the subsequent paragraph, it states, ‘India has reduced the number of tariff lines under its negative list for SAFTA Non-Least Developed Contracting States (NLDCs) by 264 items or 30 per cent as of September 2012’. That this translates to only 614 items is what could have been mentioned. Also to be mentioned is that of the 155 textile lines notified for removal in its sensitive list by India for NLDCs, Sri Lankan textiles exports would attract a duty of 5 per cent, against the earlier 11 per cent.
Similarly, Table 2 (p. 13) indicating broad agreement on tariff concessions under Indo-Lanka Free Trade Agreement (ILFTA) states that ‘all eight million pieces would be allowed at zero duty with no fabric conditions’. This should have been stated later as an update on ISFTA concessions rather than in the previous page under the heading ‘Garment Quota’. It follows that 50 per cent tariff concessions would apply for garment imports above the quota.
Considering trade in goods as an outcome of the ISFTA, the handbook states how Sri Lanka’s trade with India changed dramatically following the implementation of the FTA (Table 4, p. 21). The data given in the table, however, present a mixed picture. A close scrutiny of the same reveals two stages in the growth of bilateral trade: Stage 1, covering the period 2000–2005; and Stage 2, covering the period 2005–2010. During Stage 1, the picture was truly optimistic with the trade imbalance (export–import ratios) declining in favour of Sri Lanka. Since the inception of Stage 2, the trade imbalance has started deteriorating, even though not to the extent as in the early 2000s.
One major criticism of the ISFTA is that at the peak of Sri Lanka’s exports to India, only two products, namely, copper and vanaspati (hydrogenated vegetable oil), contributed to nearly half of Sri Lanka’s duty-free exports to India. Sri Lanka is not naturally endowed for mining copper ores, or in growing plants for refining vegetable oil. However, taking advantage of nil or low external tariffs on these products in the country, investors (mainly from India) shifted their manufacturing base to Sri Lanka and with minimal processing, shipped back the finished products, namely, vanaspati and copper/copper products, to the duty-free Indian market. This type of investment flow from India to Sri Lanka can easily be characterized as no more than ‘investment diversion’, with minimal backward linkage with the rest of the Sri Lankan economy.
However, with the onset of the global financial crisis in 2007–2008 when global commodity markets boomeranged, the Indian government, in order to soften the impact on its domestic consumers, drastically cut down its import tariffs on copper ore and vegetable oil (mainly crude palm oil) imports. At the same time, alerted by its domestic stakeholders of the unprecedented surge in imports of copper products and palm oil from neighbouring countries, the Indian government adopted measures for stricter compliance of rules of origin criteria on these products.
Given these two developments, manufacturers/exporters of these two products in Sri Lanka found that they had lost their cost advantage, based primarily on their border tariff arbitrage. As they downed their shutters, Sri Lanka’s bilateral exports to India fell drastically. This illustrated how the two major Sri Lankan exports to India, being based not on their inherent comparative advantage, failed to be sustainable in the longer term.
A closer scrutiny of more recent data obtained from the Indian sources show, quite possibly, that a third stage in India–Sri Lanka relations is emerging. In 2011–2012, India’s imports from Sri Lanka increased to US$721 million, an increase of 44 per cent over the previous year. During the first six months of the Indian fiscal year 2012–2013 (April to September), India’s imports from Sri Lanka was US$529 million. On a pro rata basis, one could expect this figure to touch around US$1 billion this financial year, the largest value that India would be importing from any country in the region, notwithstanding the near total eclipse of vanaspati and copper imports from Sri Lanka!
The growing penetration accompanied by diversification of Sri Lankan exports to India may be illustrated with respect to a few products. For instance, India’s imports of textile products (HS 50–63) almost doubled from US$35 million in 2010–2011 to US$69 million in 2011–2012. In the first six months of 2012–2013 (April–September), these imports aggregated US$50 million, reflecting future sustained access of these products of Sri Lanka to the Indian market.
Figure 8 in the handbook gives an illustration of how high-value items have emerged in Sri Lanka’s export basket for trade with India, such as insulated wires and cables, intimate garments, value-added tea, furniture, tableware, machinery, rubber gloves and refined copper products. The illustration however misses a major non-traditional capital good export of Sri Lanka to the Indian market, namely, ships, boats and floating structures (HS 84). India’s import of these products increased from US$55 million in 2011–2012 to US$120 million within the first six months of 2012–2013, accounting for a little over one-fifth of India’s total imports from Sri Lanka during the latter period.
The handbook further brings out the potential area for trade in services and for investment cooperation, even though there have been no formal agreements in these areas. Enhanced activities in these areas have been either due to unilateral liberalization by the two countries or as an indirect impact of the operation of ISFTA. Tourism is an area offering potential for services trade. In recent years, India has begun to attract a growing number of Sri Lankan students in tertiary education. There is also considerable scope for collaboration between India and Sri Lanka in construction and financial services (pp. 23–25).
Even though special and differential provisions were being incorporated in the services negotiations between the two countries, the absence of an adequate regulatory mechanism in Sri Lanka, as well as apprehensions of Indian dominance, has precluded an agreement on services trade to take shape.
Following the signing of the ISFTA in 1998, Indian investment in Sri Lanka has increased substantially from LKR 916 million in 1999 (18 projects) to LKR 94 billion in 2011 (119 projects). Indian buy-back in duty-free sectors such as rubber has played its part. During this period, the pattern of investment has also changed from predominance of manufacturing investment to investment in services. It is important to note that Sri Lankan investments in India have also increased considerably over the past decade in sectors such as confectionery, apparel and furniture, making investment flows between the two countries a two-way process.
The handbook is silent on the need to pursue negotiations beyond trade in goods and services to include services and investment under a Comprehensive Economic Partnership Agreement (CEPA), stalled since 2008 after 13 rounds of negotiations. In my view, this has been a pragmatic approach, given that reservations have been expressed by certain stakeholders in Sri Lanka on trade in goods.
Now that bilateral trade is based on Sri Lanka’s natural comparative advantage, it is likely to be more sustainable and balanced. India must nevertheless play a proactive role in addressing the incidence of non-tariff barriers on Sri Lankan exports, both perceived and real. I believe a constituency for deeper bilateral integration with India will evolve once the benefits of win-win advantages of bilateral trade becomes apparent and lessons are learnt from the constraints of the past.