India-Sri Lanka Bilateral Free Trade Agreement: Sri Lankan Perspective and Implications

Saman Kelegama Institute of Policy Studies of Sri Lanka

Presentation to the Asian Regional Workshop on Free Trade Agreements: Towards Inclusive Trade Policies in Post-Crisis Asia , jointly organized by IDEAS, GSEI, & ITD, Bangkok, 8-9 December 2009

Outline of Presentation
 Introduction  Recent Trends in Indo-Lanka Economic Relations:


Trade  Positive Outcomes  Negative Outcomes

Investment  Services


 Role Played by the ILFTA in Crisis Situations  CEPA: Looking Beyond the FTA  Opportunities through CEPA  Conclusion

Introduction
 Economic relations between India and Sri Lanka, which date back to pre-colonial times, began to pickup in the 1990s with the liberalization of the Indian economy  The year 1998 saw the biggest boost in economic relations when the two countries signed a bilateral Indo-Lanka Free Trade Agreement (ILFTA), which began implementation in March 2000  Among other factors, contemporary political forces led to the signing of the Agreement  The ILFTA was formulated based on the negative list approach; each country extending concessions/preferences to all commodities except those indicated in its negative list  The two countries agreed for preferential treatment on 5112 tariff lines & an 8-year time table was devised for phasing out tariffs  NTBs (Indian state taxes) were also to be removed gradually  Asymmetry between the two countries was accommodated by special & differential treatment (SDT)

Introduction Cont.

SDT for Sri Lanka

 Larger negative list (SL agriculture sector fully protected)  The immediate duty-free list (319 items) and 50% preferential duty list (889 items) were considerably smaller than those offered by India (1351 items and 2799 items respectively), while the Sri Lankan negative list (1180 items) was considerably lager than India s (196 items)  Relaxed Rules of Origin (ROO) 35% (25% if Indian imports used)  Longer tariff phase-out period (8 yrs for SL & 3 yrs for India)  Negative list reduction based on SL s comfort level  Revenue compensation excluded, but SL insisted that high revenue import items will not be subject to tariff preferences (M duties = 2% of GDP revenue)

Recent Trends in Indo-Lanka Economic Relations

Trade
 In the period immediately preceding the Agreement (1995-2000), average annual exports from SL to India were US$ 39mn & annual average imports were US$ 509mn  India was an important source of imports even prior to the Agreement by 2000, India was already the second largest source of imports to SL after Japan  But India was not a major export market prior to the ILFTA it was the 14th rank in export destinations in 2000  SL s trade with India changed dramatically following the implementation of the FTA in 2000  India fully implemented the Agreement by March 2003, and SL did so by October 2008 longer time frame for the latter given economic asymmetries between the two countries 

Outcome of 9 Years: 1999-2008

1999 SL exports to India SL imports from India Import/Export ratio 1% 8.5% 10.5:1 2005 9% 17% 2.6:1 1062 Dominated by vanaspathi & copper 2008 5% 25% 8.2:1 869 VA products: insulated wires & cables, refined copper products, rubber gloves, apparel

No of products from 505 SL Type of exports Many primary products: pepper, areca nuts, waste & scrap, dried fruit, cloves Rank of export 14 destination Ind investment in Less than 2% SL (% of total FDI)

3 16%

5 14%

Positive Outcomes: Rapid Growth in Overall Trade

 By 2005, Sri Lanka s exports to India reached a peak of US$ 566.4, a tenfold increase compared to 2000, and stood at US$ 418.3 million in 2008. India was the 5th largest destination for Sri Lanka s exports in 2008  Imports too have grown at a rapid rate following the implementation of the FTA. Imports from India which amounted to US$ 600.1 million in 2000 reached US$ 3443 billion in 2008, a growth by 5.7 fold  An aggregate view of trade between India and Sri Lanka since the FTA came into being thus suggests a very positive picture with overall trade growing close to six fold and exports from Sri Lanka growing ten fold  Furthermore, the increased diversity and greater value addition in exports from Sri Lanka is a positive development

India-Sri Lanka Trade: 1995-2008

Year 1995-1999 average 2000 2001 2002 2003 2004 2005 2006 2007 2008 Exports (US$ Mn) 39 58.0 72.0 170.5 245.3 391.5 566.4 489.5 515.3 418.3 Imports (US$ Mn) 509 600.1 601.5 852.8 1073.2 1439.1 1835.4 2172.9 2610.1 3443.0 Trade Balance (US$ Mn) -470 -542.1 -529.5 -682.3 -827.9 -1047.6 -1269.0 -1690.4 -2094.8 -3024.7 Import/Export Ratio 13.1:1 10.3:1 8.4:1 5.0:1 4.4:1 3.7:1 3.2:1 4.4:1 5.1:1 8.2:1

Source: Central Bank of Sri Lanka

Negative Outcomes: Lopsided Trade

 While an aggregate view of trade between India & SL since the FTA came into being suggests a very positive picture, a more disaggregated analysis reveals a not so positive story  While exports from SL to India peaked at US$ 566.4 Mn in 2005, these exports were largely concentrated in two products copper & vanaspathi (49.66%)
SL's Main Exports to India: 2005
Copper & copper products Vanaspathi Aluminium products Electrical machinery & parts Antibiotics Cloves Iron & steel products Pepper

Negative Outcomes Cont.  If vanaspathi & copper were excluded from the trade figures, SL s exports to India would have increased from US$ 58 Mn in 2000 to just US$ 278 Mn in 2006 a five-fold increase compared to the tenfold increase with vanaspathi & copper  Vanaspathi & copper are a problem since these exports arose not due to any distinct comparative advantage that SL held, but due to short-term tariff arbitration by Indian manufacturers investing in SL  The viability of the industry was only as long as there was a discrepancy between Indian & SL tariffs on palm oil imports  In response to the increase in global commodity prices in 2007/08, India cut import taxes on food imports including palm oil, making vanaspathi exports from SL unviable  Accordingly, vanaspathi exports in 2008 were US$ 31.96 Mn, a fall of 78% from exports in 2007 which amounted to US$ 145.32 Mn  Vanaspathi exports are expected to be non-existent in 2009

Negative Outcomes Cont.  Copper exports from SL were also subject to much scrutiny from India, based on their low domestic value addition, arguing that they were under-invoiced  India insisted that pricing should be done based on the London Metal Exchange Prices, and since then a large proportion of copper exports were deemed ineligible  Copper exports were severely affected, with exports falling from US$ 145 Mn in 2005 to US$ 13 million in 2008  Both copper & vanaspathi exports were not seen very favourably in SL as well, since both entailed a high import content, limited employment creation & environmental concerns  The collapse of vanaspathi & copper exports in 2008 led to the substantial decline in total SL exports to India in 2008 to US$ 418 Mn a 26% fall in export value since the peak in 2005

Sri Lanka s Top Ten Exports to India: 2006-2008

Description 2006 Insulated wire, cable & other electric conductors Rubber & articles thereof Vegetable fats & oil Cloves Boilers & machinery & parts Pulp Diamonds & other precious stones Pepper Copper & articles thereof Furniture, lamps & fittings
Source: Sri Lanka Customs

Value (US$ Mn) 2007 38.105 35.440 145.320 8.357 9.352 14.732 5.574 19.229 26.919 8.450 2008 40.694 33.647 31.961 29.116 18.118 17.899 16.782 16.578 12.817 9.574 33.145 19.020 79.692 11.780 9.019 11.494 1.226 11.981 93.253 6.426

vanaspathi

Negative Outcomes: Inherent Weaknesses in the FTA

 Given that the results of the ILFTA have not been entirely positive from a Sri Lankan perspective, a key question is: why hasn t there been a greater positive impact on the SL economy as a result of the ILFTA?  Critics of the ILFTA have argued that there are inherent weaknesses in the Agreement that make it very challenging for SL exporters to compete in the Indian market, such as:  TRQs on major exports tea, garments & textiles which make up 58% of SL s total exports have been placed under quotas in the FTA  Rules of Origin besides stringent ROO within TRQs for garments, requiring a CTH at the 4-digit level has been burdensome for certain SL exports  NTBs NTBs such as state taxes, quality requirements & administrative procedures have hindered the entering of SL exporters into the Indian market  Unilateral imposition of quotas - in 2006 India unilaterally reduced the quota on vanaspathi exports to 100000 MT from 250000 MT. Similar problems have occurred in exports such as bakery shortenings, pepper & copper

Negative Outcomes Cont.  Anecdotal evidence also suggests that delays at customs & bureaucratic red tapes continue to hinder export penetration from SL to India  TRQs, ROOs & NTBs have thus diluted the special & differential treatment (SDT) offered by Indian to SL  However, SL industrialists are also to be blamed in an extra effort to study the Indian market they have not put

 SL has adhered to the spirit of the ILFTA & has not imposed any TRQs despite pressure from certain SMIs  However many of these conflicts have been addressed in ensuing negotiations for the Indo-Lanka CEPA, such as restrictions on ports of entry & quotas on the export of certain products from SL to India  Port restrictions on tea imports were removed in June 2007 and 3 Mn garments were allowed duty free without sourcing requirements  As a result, garment exports from SL to India have increased from US$ 0.156 Mn in 2002 to US$ 4.194 Mn in 2007

Expanding Trade Deficit

 Whilst total trade between the two countries has increased substantially, the absolute trade deficit has also increased  This has been driven largely by increasing oil prices (which made up almost a third of import value from India in 2008) & a fall in SL exports to India (vanaspathi & copper)
India- Sri Lanka Trade : 1 99 9- 20 08
4000 3000 US$ Mn 2000 1000 0 Exports Imports

19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08
Year

Trade Deficit Cont.  It is possible that non-petroleum imports from India would also grow at a faster rate in the coming years with full liberalization of trade with India (other than items in the negative list) in October 2008  However, the bulk of Indian imports into SL are not influenced by the FTA over 65% of SL s import value from India is from products either in the negative list or exempt from MFN duty  According to the DOC, Sri Lanka s imports under the FTA were only about 14% of the country s total imports from India in 2007

FTA Treatment of Top 10 Imports from India in 2008

HS Code 27 87 17019901 52 72 30 48 740811 230400 Petroleum Vehicles & Parts Sugar Cotton Iron & Steel Pharmaceutical products Paper & paper board Copper wire Olicake & other solid residues Product Status Negative List Negative List Negative List MFN Duty Free Negative List MFN (0-2.5) Duty Negative List ILFTA duty free ILFTA residual list (70% duty waiver) until 7th Nov 2008, since then duty free

Source: Ceylon Chamber of Commerce Trade Newsletter & Dept of Commerce

Trade Deficit Cont.

 This analysis suggests that growth of the trade deficit between India & SL is not largely a result of the FTA  Normal trade patterns may have resulted in an even wider trade deficit since the FTA has provided some scope for SL exports to India  While in general exports to India have been skewed with the dominance of vanaspathi & copper, there has been rapid growth in exports of a few other products which have been able to capture niches in the Indian market
Selected Exports to India: 2003-2008
45 40 35 30 25 20 15 10 5 0 2003 2004 2005 2006 2007 2008 Year Rubber & Articles thereof Furniture, Lamps & Fittings Insulated wire, Cable & other electrical conductors Daimonds & other precious stones

US$ Mn

Investment
 Indian investment into SL has also increased significantly since the FTA came into operation  Between 1978 & 1995, Indian investment accounted for 1.2% of total FDI  Cumulative Indian investment which was a mere US$ 1.437 Mn in 1998 increased to US$ 125.925 Mn by 2008, contributing to 14% of total FDI flows to SL  India is now the second biggest investor in SL, exceeded only by Malaysia  The bulk of Indian investment (63%) in SL in recent years has been in the services sector telecommunications (Bharti Airtel), health (Apollo Hospitals), retail services (Lanka Oil Company), energy, hospitality (Taj Hotels) and air transport services (Jet Airways)  As of the end of 2007, Indian investment resulted in over 70 projects, employing 6747 individuals

Indian Investment in Sri Lanka: 1993-2007

Source: Samarajiva and Herath (2008)

Investment Cont.  However much of the investment that came into SL was associated with products such as vanaspathi & copper, as foreign investors from India & third parties saw an opportunity to break into India s market through SL  Employment creation was also limited according to the BOI, though 5900 jobs were created as a result of Indian investment, this includes 1500 employees in the Indian Oil Company retail outlets  This entailed re-hiring staff from the Ceylon Petroleum Cooperationowned outlets, rather than creation of new jobs  The dominance of services suggests that the impact of the FTA (which only deals with trade in goods) on the investment decision is limited  Yet, the surge of investment between 2000 & 2008 has been influenced by increased economic ties between the two countries & increased investor confidence as a result of the FTA

Services
 The extent of commercial services exchange between the two countries has increased in the post-FTA period as demonstrated by the following examples:  Many SL students & patients travel to India to purchase education & health services each year  Approximately 70% of Colombo port s income is from transshipment earnings from India  Approximately 40% of SL airlines revenue is from the Indian market (SL Airlines)  SL IT firms have provided technical solutions to Indian companies (interblocks sold internet banking solution to Indian banks, Microimage sold Tamil SMS adaptation to Bharti Airtel)  SL tourist sector firms such as Aitken Spence & Jetwing have ventured into the Indian market  India has become the largest source of tourists to SL  Tourist arrivals from India grew rapidly at 20.9% per annum during 2000-2007 & accounted for 19.4% of the market share in 2008

Role Played by the ILFTA in Crisis Situations

 After the global financial & food crises & in the context of the ongoing economic slowdown, it is important to examine whether the ILFTA has played any role in attenuating the crisis and recovery effects in the SL economy  The main role played by the FTA in the face of the crisis has been in providing cheap Indian imports to SL consumers, such as oil, vehicles, watches & pharmaceutical products, when prices are on the rise in other countries  The fact that the Indian economy has remained relatively unaffected by the economic downturn has been an additional advantage  Geographical proximity has enabled savings on transport-related costs  However, such advantages are prevalent with or without crises it appears that the ILFTA has not played any particularly significant role in mitigating the impacts of the financial & food crises  It is thus important to look beyond the FTA in order to promote more cooperation which will enable the two countries to follow more inclusive & sustainable development policies & provide necessary safeguards against future crises

CEPA: Looking Beyond the FTA

 Given the early success of the FTA, both parties were aware of the importance & benefits of broader economic integration  Based on the recommendations of the JSG report, it was decided to include trade in services, investment & economic cooperation, along with further liberalization of the goods sector, under the ambit of a Comprehensive Economic Partnership Agreement (CEPA)  Negotiations of the CEPA began in 2005, & after 3 years of negotiations the CEPA Agreement framework was scheduled to be signed in July 2008  But due to reservations expressed by a group of local industrialists & a political party, the CEPA was not signed & has remained in limbo since then  Reservations were based on 2 broad concerns: about the nature of the CEPA itself & that the drawbacks in the FTA should be dealt with first, prior to embarking on a CEPA

CEPA Cont.  But critics failed to take into account the fact that like the FTA, the CEPA also made room for economic asymmetry between the two countries & accorded SDT to SL  The 2nd concern, that the shortcomings in the FTA should be addressed before CEPA, is counterproductive the CEPA was negotiated with the very objective of addressing the shortcomings in the FTA (removal of port restrictions & ROO requirements in garments)  Also, increasing exports to India requires a general change in perceptions & preferences of SL exporters a process that will take time  With the CEPA negotiations being stopped, the only forum for addressing the shortcomings of the FTA has closed  Given the fact of geographic proximity and socio-political and historical relations between the two countries, economic exchange is inevitable

Opportunities for Sri Lanka through CEPA

 In the context of Sri Lanka continuing to have a concentrated export basket, both in terms of destination (US & EU) and products (garments & tea), export diversification becomes essential  This necessity has been highlighted in the recent global financial crisis as Sri Lanka became particularly vulnerable given the concentration of exports to the most adversely affected markets  Whilst the US & EU markets have faced a recession, emerging markets such as India and China have managed to sustain some degree of economic growth despite the global downturn  The Indian economy, which grew at 5.3% even in the fourth quarter of 2008, and is growing at around 7% in 2009, is likely to be among the least affected by the crisis  Had Sri Lanka maintained a more diverse export basket, the country would have been less vulnerable to external shocks

Opportunities through CEPA Cont.  The ILFTA has somewhat helped in shifting Sri Lanka s trade towards alternative emerging markets by encouraging exporters to move beyond their traditional buyers  Given Sri Lanka s proximity and long-standing relationship with India, the country is in an ideal position to take advantage in the shift in global economic powers towards the East  The CEPA should be seen as an attempt to manage Sri Lanka s trading relationship with India. The Agreement provides a legal framework which defines the rules and regulations under which trade occurs between the two countries  While countries continue to move ahead with negotiations at various levels, the multiple and overlapping agreements of such negotiations can involve considerable transactions costs  For example, SL has entered into bilateral and regional negotiations in the South Asian region such as the ILFTA, SAFTA, and APTA, each involving different rules of origins, tariff preferences, etc

Opportunities through CEPA Cont.  In the absence of progress in regional frameworks such as SAFTA, the best option available to Sri Lanka is a bilateral framework within a rule-based disciplinary framework  Given the fact that India is currently negotiating and implementing a number of bilateral trade agreements with much larger economies such as Japan and the EU, it would be unwise to delay or reopen the already negotiated CEPA  Also, given the slow progress of the WTO services negotiations, SL stands to benefit from early access to the large and growing Indian services sector by engaging in the CEPA  It is also possible that access to the Indian market may attract investment from third parties into Sri Lanka, looking to export services to Indians through joint ventures with Sri Lankan firms  Given Sri Lanka s limited domestic market, the required economies of scale can never be achieved without sufficient international integration. In the present climate, there is no better opportunity than the Indian market

Opportunities through CEPA Cont.

 Several SL firms such as Damro have successfully entered the Indian market  It is important to realize that India is becoming increasingly open to foreign economic integration in 2007 FDI into SL amounted to almost US$ 25 Bn & imports were over US$ 180 Bn  Given that the rest of the world is able to get a foothold in India, SL firms need to be more positive & look to do the same  Whilst there will undoubtedly be cases of failure, this has to be expected given the fact that Indian is not an easy market to enter  CEPA could be used as an opportunity to deal with such problems  It is not too late for SL to engage with the Indian market through CEPA the agreement is an opportunity not to be wasted

Opportunities through CEPA Cont.  The experience of the current crisis has stressed the need for more inclusive and equitable trade and growth policies  The CEPA is important in this context, as increased importing of services such as health and education from India at a reasonably low cost is beneficial to the lower and middle-income Sri Lankans who face domestic supply constraints  While wealthy Sri Lankans can obtain these services from Singapore, Europe and the US, India is the only option for the poorer population  The most effective trade policy response to high food prices over the long-term is greater (agricultural) trade liberalization that would allow new supplies to emerge, particularly in developing countries  Increased access to new technology and investment is also important in modernizing and improving productivity in the agricultural sector  By providing deeper integration of the two economies, the CEPA will facilitate more investment and technology flows from India to Sri Lanka, thereby providing scope for development of the agricultural sector in responding to the food crisis

Conclusion
 It is important to rectify the shortcomings of the FTA & build on its achievements  The key opportunity is to tap into the large and dynamic Indian market, by moving beyond the ILFTA towards broader economic integration  The CEPA, implemented with proper regulatory mechanisms in order to accommodate the disparity between the countries, provides an opportunity for SL to integrate more closely with the Indian economy  Deep economic integration with a fast-moving economy like India could contribute to stimulating growth rates in SL  Today, as an economic crisis grips Sri Lanka s traditional export markets and a food price crisis engulfs the global economy, SL should view India as an opportunity and not a threat, and strive towards more meaningful cooperation in facilitating inclusive and equitable development policies

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