Multilateral is better than bilateral
There is a clear danger of alienating the spirit of consensus on which the success of a larger South Asian free trade area will depend.
It is no surprise that in a supposedly globalising economy—under pinned by the rhetoric of free traderegional trade arrangements are proliferating as never before. It is widely argued that the protracted nature of negotiations under the Uruguay Round gave fresh momentum to the formation of regional blocs, increasing their number from a mere 25 in 1990, to more than 80 arrangements of one sort or another by the middle of the 1990s. And, as international commerce becomes more intricate, so have the arguments for and against regional trade groupings. Many economists continue to hold that these lead to inefficiency through trade diversionary effects, rather than promote trade amongst the signatories. But even as the debate remains unresolved, South Asia is marching towards integration into the world economy with its own regionalism.
The commitment of South Asian governments to accelerate the process of regional economic integration is now over a decade old. It began with the intention of establishing a SAARC Preferential Trading Arrangement (SAPTA) through continuous negotiations, to eventually lead to the formation of a South Asian Free Trade Area (SAFTA). But SAPTA—in operation since December 1995—has proved to be an arduous tool to negotiate. Similarly, SAFTA, initially proposed to come into force in 2001, is now unlikely to see the light of day anytime before the year 2008.
Given the strained ties between the two largest economies in South Asia, the political constraints to freeing trade within the framework of a regional arrangement has always been formidable. A consequence of such intransigence has been a slow shift towards bilateral trade agreements amongst the member countries of SAARC. So far, India has signed such agreements with Nepal, Bhutan and Sri Lanka, and is contemplating similar pacts with Bangladesh and the Maldives. Sri Lanka is also contemplating the extension of free trade pacts with Pakistan and Bangladesh at a not-too-distant future. Such agreements are defended on the grounds that they are a means of permitting ´fast-track´ liberalisation, but by the very nature of their exclusivity, there is a danger of alienating the spirit of consensus on which the success of a larger South Asian free trade area will depend.
In the case of Sri Lanka, for example, the relative importance of SAFTA has receded to an extent because its primary reason for supporting SAFTA was to obtain access to the Indian market. Under the Indo-Sri Lanka Free Trade Agreement (FTA), India agreed to remove tariffs on about 1000 products, immediately after the treaty came into force. However, both countries agreed to maintain negative lists to safeguard the domestic industry, agriculture and fisheries. India also agreed to phase out prevailing tariffs on the remaining items over the course of three years—50 percent reduction of Indian customs duties in the first year, 75 percent in the second year and 100 percent the third year. Sri Lanka will, therefore, be able to have duty-free access to the Indian market three years after the FTA becomes operative.
In return, Sri Lanka undertook to grant immediate duty-free access to around 300 Indian products. In addition, duty on a further 600 items are to be phased out over a three-year period. The duty on the balance items (excluding those that do not fall within Sri Lanka´s negative list) are expected to be phased out over an eight-year period—35 percent of the existing duty level by the end of the first three of the eight years; 70 percent by the end of the sixth year; and 100 percent removal of duties by the end of the eighth year.
Under the FTA, products with a domestic value addition of 35 percent will qualify for preferential market access. In the case of Sri Lanka, exports with a minimum 10 percent content of inputs originating from India will also qualify under a reduced total domestic value addition of 25 percent.
The FTA has an equal number of supporters and detractors. Those in favour view the vast Indian consumer market as an entry point to generate export growth in Sri Lanka. The most common argument is that the Accord allows Sri Lankan exporters to take advantage of being the ´first-mover´ into the Indian market before other potential competitors. While there is some merit to this claim, the perceived advantages will depend entirely on the pace of tariff reforms instituted by India over the next couple of years. India is already scheduled to remove its existing non-tariff barriers by 2001 in accordance with its commitments to the WTO. If such a move is complemented by an accelerated reduction in import tariffs, the benefits of an ´early-mover´ advantage for Sri Lanka will clearly be diluted.
Even otherwise, the potential for generating a substantial increase in trade between the two countries is somewhat doubtful. In fact, with the liberalisation of the Sri Lankan economy in the late 1970s, its share of exports to India declined from 3.5 percent of total exports in 1980 to stagnate at around 1 percent in the late 1990s. This was largely due to the emergence of new industrial exports geared to markets in North America and Europe. In turn, India´s exports to Sri Lanka account for an insignificant share of less than 0.1 percent of its total exports. However, in terms of Sri Lanka´s total imports, India has increased its share from around 5 percent in 1980 to around 10 percent in the late 1990s, making it the single largest source of imports. There has been a persistent balance of trade in favour of India which is likely to widen further with the FTA.
For Sri Lanka, the immediate benefits of economic cooperation with India have been—and will continue to be—in terms of increased consumer welfare through cheaper imports. Given the low volume of bilateral export trade between the two countries, the enthusiasm of the architects of the FTA to view it as a means of generating trade dynamism, appears to be over-optimistic. For the most part, the Indian consumer market is portrayed as a market of 300 million middle-class consumers. The vital issue, however, is whether Sri Lanka has the necessary export surplus to meet such a voluminous demand, and whether the middle-class Indian consumer in fact wants the kind of goods Sri Lanka produces. With exposure to the global market, consumer tastes are becoming more sophisticated. Goods produced in the developed world are more likely to appeal to middle-class consumers as incomes rise.
While some Sri Lankan exports (such as rubber slippers, ceramic products and leather goods) that cater to particular niche markets in India enjoy a comparative advantage, and may benefit from tariff liberalisation, the implications on products of small and medium industrial enterprises is less clear. India, for example, has the advantages of a relatively solid industrial and agricultural base and of economy of scale vis-a-vis Sri Lanka. Some of Sri Lanka´s emerging industries, particularly in the light manufacturing sector, will find themselves unable to compete with cheaper imports from Indian companies which have the built-in advantage of technological know-how.
Even for the most important of Sri Lanka´s export items—tea and garments—the FTA has built-in constraints to free trade. When the FTA was signed, the understanding was that India would permit the entry of Sri Lankan tea to India at a preferential duty reduction of 50 percent. However, in response to significant opposition from tea producers in India, the final agreement arrived at, allows Sri Lanka to export only 15 million kg of tea per annum at the concessional duty rate.
The FTA also places quota restrictions on the export of garments, permitting Sri Lanka to export only 8 million pieces of garments at half the existing duty rate. However, 6 million of the allotted quota must have fabric of Indian origin. At present, only about 6 percent of total fabrics imported into Sri Lanka originate from India. The benefits, in terms of net export earnings, are again likely to be fairly limited.
Also, changes in trade policy alone do not necessarily imply that bureaucratic obstacles are immediately addressed. India, for example, has one of the most non-transparent, highly complex and bureaucratic-ridden trade policy regimes in South Asia. It will undoubtedly need more than mere policy changes at the top to facilitate easy access to the Indian market. This has already become apparent in the application of the FTA. Tea exporters argue that the movement of tea into India has been slower than anticipated, primarily due to the fact that the ports assigned by India to take receipt of tea exports under the FTA—Cochin and Calcutta are located in tea producing areas in India, and likely to be unfavourable to tea imports. In another instance, a consignment of chewing gum exported under the FTA was rejected on medical grounds.
Given that the potential benefits of the FTA appear to be somewhat limited, its utility can be questioned. Bilateral agreements between SAARC member states will in time undermine their commitment to a greater South Asian identity. For the smaller South Asian economies, there is always the danger that by negotiating on a one-to-one basis with their larger neighbours, they will inevitably be negotiating from a weaker position. It is time for SAARC to clearly determine the future path of economic integration in South Asia. Inaction within the SAARC framework can only mean the proliferation of further bilateral trade agreements that will ultimately render the SAPTA process obsolete.
Dushni Weerakoon is a research fellow with the Institute of Policy Studies, Colombo