Saman_Kelegama

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India-Sri Lanka Bilateral Free TradeAgreement:Sri Lankan Perspective and Implications

Saman KelegamaInstitute of Policy Studies of Sri Lanka

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

2009


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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


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Introduction

Economic relations between India and Sri Lanka, which date back to

pre-colonial times, began to pickup in the 1990s with theliberalization of the Indian economy

The year 1998 saw the biggest boost in economic relations whenthe 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 thesigning of the Agreement

The ILFTA was formulated based on the negative list approach;each country extending concessions/preferences to all commoditiesexcept those indicated in its negative list

The two countries agreed for preferential treatment on 5112 tarifflines & 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)


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Introduction Cont.

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

Indias (196 items)

Relaxed Rules ofOrigin (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 SLs 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)

SDT for Sri Lanka


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Recent Trends in Indo-Lanka Economic Relations

In the period immediately preceding the Agreement (1995-2000),average annual exports from SL to India were US$ 39mn & annualaverage imports were US$ 509mn

India was an important source of imports even prior to theAgreement by 2000, India was already the second largest source ofimports to SL after Japan

But India was not a major export market prior to the ILFTA it wasthe 14th rank in export destinations in 2000

SLs trade with India changed dramatically following theimplementation of the FTA in 2000

India fully implemented the Agreement by March 2003, and SL did soby October 2008 longer time frame for the latter given economicasymmetries between the two countries

Trade


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Outcome of 9 Years: 1999-2008

1999 2005 2008

SL exports to India 1% 9% 5%

SL imports fromIndia

8.5% 17% 25%

Import/Export ratio 10.5:1 2.6:1 8.2:1

No of products fromSL

505 1062 869

Type of exports Many primaryproducts:pepper, areca

nuts, waste &scrap, driedfruit, cloves

Dominated byvanaspathi &copper

VA products: insulatedwires & cables, refinedcopper products,

rubber gloves, apparel

Rank of exportdestination

14 3 5

Ind investment in

SL (% of total FDI)

Less than 2% 16% 14%


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Positive Outcomes: Rapid Growth in Overall Trade

By 2005, Sri Lankas exports to India reached a peak of US$ 566.4,a tenfold increase compared to 2000, and stood at US$ 418.3million in 2008. India was the 5th largest destination for Sri Lankasexports in 2008

Imports too have grown at a rapid rate following the

implementation of the FTA. Imports from India which amounted toUS$ 600.1 million in 2000 reached US$ 3443 billion in 2008, agrowth by 5.7 fold

An aggregate view of trade between India and Sri Lanka since theFTA came into being thus suggests a very positive picture with

overall trade growing close to six fold and exports from Sri Lankagrowing ten fold

Furthermore, the increased diversity and greater value addition inexports from Sri Lanka is a positive development


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India-Sri Lanka Trade: 1995-2008

Year Exports(US$ Mn)

Imports(US$ Mn)

Trade Balance(US$ Mn)

Import/ExportRatio

1995-1999average

39 509 -470 13.1:1

2000 58.0 600.1 -542.1 10.3:1

2001 72.0 601.5 -529.5 8.4:1

2002 170.5 852.8 -682.3 5.0:1

2003 245.3 1073.2 -827.9 4.4:1

2004 391.5 1439.1 -1047.6 3.7:1

2005 566.4 1835.4 -1269.0 3.2:12006 489.5 2172.9 -1690.4 4.4:1

2007 515.3 2610.1 -2094.8 5.1:1

2008 418.3 3443.0 -3024.7 8.2:1

Source: Central Bank of Sri Lanka


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Negative Outcomes: Lopsided Trade

While an aggregate view of trade between India & SL since the FTAcame into being suggests a very positive picture, a moredisaggregated 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 & copperproducts

Vanaspathi

Aluminium products

Electrical machinery& parts

Antibiotics

Cloves

Iron & steel products

Pepper


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Negative Outcomes Cont.

If vanaspathi & copper were excluded from the trade figures, SLsexports 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 ten-fold 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 toshort-term tariff arbitration by Indian manufacturers investing in SL

The viability of the industry was only as long as there was adiscrepancy 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, makingvanaspathi exports from SL unviable

Accordingly, vanaspathi exports in 2008 were US$ 31.96 Mn, a fallof 78% from exports in 2007 which amounted to US$ 145.32 Mn

Vanaspathi exports are expected to be non-existent in 2009


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Copper exports from SL were also subject to much scrutiny fromIndia, based on their low domestic value addition, arguing that theywere under-invoiced

India insisted that pricing should be done based on the LondonMetal 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 inSL as well, since both entailed a high import content, limited

employment creation & environmental concerns

The collapse of vanaspathi & copper exports in 2008 led to thesubstantial decline in total SL exports to India in 2008 to US$ 418Mn a 26% fall in export value since the peak in 2005


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Sri Lankas Top Ten Exports to India: 2006-2008

Description Value (US$ Mn)2006 2007 2008

Insulated wire, cable & otherelectric conductors

33.145 38.105 40.694

Rubber & articles thereof 19.020 35.440 33.647

Vegetable fats & oil vanaspathi 79.692 145.320 31.961

Cloves 11.780 8.357 29.116

Boilers & machinery & parts 9.019 9.352 18.118

Pulp 11.494 14.732 17.899

Diamonds & other precious stones 1.226 5.574 16.782Pepper 11.981 19.229 16.578

Copper & articles thereof 93.253 26.919 12.817

Furniture, lamps & fittings 6.426 8.450 9.574

Source: Sri Lanka Customs


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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 hasnt therebeen a greater positive impact on the SL economy as a result of theILFTA?

Critics of the ILFTA have argued that there are inherent weaknessesin the Agreement that make it very challenging for SL exporters tocompete in the Indian market, such as:

TRQs on major exports tea, garments & textiles which make up58% of SLs total exports have been placed under quotas in the FTA

Rules ofOrigin besides stringent ROO within TRQs for garments,requiring a CTH at the 4-digit level has been burdensome for certainSL exports

NTBs NTBs such as state taxes, quality requirements &administrative procedures have hindered the entering of SLexporters into the Indian market

Unilateral imposition of quotas - in 2006 India unilaterally reducedthe quota on vanaspathi exports to 100000 MT from 250000 MT.Similar problems have occurred in exports such as bakery

shortenings, pepper & copper


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Anecdotal evidence also suggests that delays at customs &

bureaucratic red tapes continue to hinder export penetration from SLto India

TRQs, ROOs & NTBs have thus diluted the special & differentialtreatment (SDT) offered by Indian to SL

However, SL industrialists are also to be blamed they have not put

in an extra effort to study the Indian market

SL has adhered to the spirit of the ILFTA & has not imposed any TRQsdespite pressure from certain SMIs

However many of these conflicts have been addressed in ensuingnegotiations for the Indo-Lanka CEPA, such as restrictions on ports ofentry & quotas on the export of certain products from SL to India

Port restrictions on tea imports were removed in June 2007 and 3 Mngarments were allowed duty free without sourcing requirements

As a result, garment exports from SL to India have increased fromUS$ 0.156 Mn in 2002 to US$ 4.194 Mn in 2007


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Expanding Trade Deficit

India-Sri Lanka Trade: 199 9- 2008

0

1000

2000

3000

4000

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Year

US$

Mn

Exports

Imports

Whilst total trade between the two countries has increasedsubstantially, the absolute trade deficit has also increased

This has been driven largely by increasing oil prices (which made upalmost a third of import value from India in 2008) & a fall in SLexports to India (vanaspathi & copper)


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Trade Deficit Cont.

It is possible that non-petroleum imports from India would also growat 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 SLs import value from India is from products

either in the negative list or exempt from MFN duty According to the DOC, Sri Lankas imports under the FTA were only

about 14% of the countrys total imports from India in 2007


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FTA Treatment of Top 10 Imports from India in 2008

HS Code Product Status27 Petroleum Negative List

87 Vehicles & Parts Negative List

17019901 Sugar Negative List

52 Cotton MFN Duty Free72 Iron & Steel Negative List

30 Pharmaceutical products MFN (0-2.5) Duty

48 Paper & paper board Negative List

740811 Copper wire ILFTA duty free230400 Olicake & other solid residues ILFTA residual list (70%

duty waiver) until 7th Nov2008, since then duty free

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


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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 dominanceof vanaspathi & copper, there has been rapid growth in exports of a few

other products which have been able to capture niches in the Indianmarket

Selected Exports to India: 2003-2008

0

5

1015

20

25

30

35

4045

2003 2004 2005 2006 2007 2008

Year

US$

Mn

Rubber & Articlesthereof

Furniture, Lamps &Fittings

Insulated wire, Cable& other electrical

conductors

Daimonds & otherprecious stones


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Investment

Indian investment into SL has also increased significantly since theFTA came into operation

Between 1978 & 1995, Indian investment accounted for 1.2% oftotal 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% oftotal FDI flows to SL

India is now the second biggest investor in SL, exceeded only byMalaysia

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 70projects, employing 6747 individuals


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Indian Investment in Sri Lanka: 1993-2007

Source: Samarajiva and Herath (2008)


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Investment Cont.

However much of the investment that came into SL was associatedwith products such as vanaspathi & copper, as foreign investorsfrom India & third parties saw an opportunity to break into Indiasmarket through SL

Employment creation was also limited according to the BOI,though 5900 jobs were created as a result of Indian investment, thisincludes 1500 employees in the Indian Oil Company retail outlets

This entailed re-hiring staff from the Ceylon Petroleum Cooperation-owned 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 islimited

Yet, the surge of investment between 2000 & 2008 has beeninfluenced by increased economic ties between the two countries &increased investor confidence as a result of the FTA


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Services

The extent of commercial services exchange between the two

countries has increased in the post-FTA period as demonstrated bythe following examples:

Many SL students & patients travel to India to purchase education &health services each year

Approximately 70% of Colombo ports 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


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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 hasplayed any role in attenuating the crisis and recovery effects in the SLeconomy

The main role played by the FTA in the face of the crisis has been inproviding cheap Indian imports to SL consumers, such as oil, vehicles,watches & pharmaceutical products, when prices are on the rise in othercountries

The fact that the Indian economy has remained relatively unaffected bythe 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 inmitigating the impacts of the financial & food crises

It is thus important to look beyond the FTA in order to promote morecooperation which will enable the two countries to follow more inclusive &sustainable development policies & provide necessary safeguards against

future crises


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CEPA: Looking Beyond the FTA

Given the early success of the FTA, both parties were aware of theimportance & benefits of broader economic integration

Based on the recommendations of the JSG report, it was decided toinclude trade in services, investment & economic cooperation, alongwith 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 besigned 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 sincethen

Reservations were based on 2 broad concerns: about the nature ofthe CEPA itself & that the drawbacks in the FTA should be dealt withfirst, prior to embarking on a CEPA


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CEPA Cont.

But critics failed to take into account the fact that like the FTA, theCEPA also made room for economic asymmetry between the twocountries & accorded SDT to SL

The 2nd concern, that the shortcomings in the FTA should beaddressed before CEPA, is counterproductive the CEPA wasnegotiated with the very objective of addressing the shortcomings inthe FTA (removal of port restrictions & ROO requirements ingarments)

Also, increasing exports to India requires a general change inperceptions & preferences of SL exporters a process that will taketime

With the CEPA negotiations being stopped, the only forum foraddressing the shortcomings of the FTA has closed

Given the fact of geographic proximity and socio-political andhistorical relations between the two countries, economic exchange isinevitable


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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 quarterof 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


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Opportunities through CEPA Cont.

The ILFTA has somewhat helped in shifting Sri Lankas trade towardsalternative emerging markets by encouraging exporters to movebeyond their traditional buyers

Given Sri Lankas proximity and long-standing relationship with India,the country is in an ideal position to take advantage in the shift inglobal economic powers towards the East

The CEPA should be seen as an attempt to manage Sri Lankastrading relationship with India. The Agreement provides a legalframework which defines the rules and regulations under which tradeoccurs between the two countries

While countries continue to move ahead with negotiations at various

levels, the multiple and overlapping agreements of such negotiationscan involve considerable transactions costs

For example, SL has entered into bilateral and regional negotiationsin the South Asian region such as the ILFTA, SAFTA, and APTA, eachinvolving different rules of origins, tariff preferences, etc


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In the absence of progress in regional frameworks such as SAFTA,the best option available to Sri Lanka is a bilateral framework within arule-based disciplinary framework

Given the fact that India is currently negotiating and implementing anumber of bilateral trade agreements with much larger economiessuch 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 Indianservices 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 exportservices to Indians through joint ventures with Sri Lankan firms

Given Sri Lankas limited domestic market, the required economies ofscale can never be achieved without sufficient internationalintegration. In the present climate, there is no better opportunity

than the Indian market


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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


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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 lowcost is beneficial to the lower and middle-income Sri Lankans whoface 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 thelong-term is greater (agricultural) trade liberalization that would allownew supplies to emerge, particularly in developing countries

Increased access to new technology and investment is also importantin modernizing and improving productivity in the agricultural sector

By providing deeper integration of the two economies, the CEPA willfacilitate more investment and technology flows from India to SriLanka, thereby providing scope for development of the agricultural

sector in responding to the food crisis


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