1. 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

2. 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

3. 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)

4. 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 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 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

5. 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 & 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 14 th rank in export destinations in 2000 SLs 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 Trade

6. Outcome of 9 Years: 1999-2008 199920052008 SL exports to India1%9%5% SL imports from India 8.5%17%25% Import/Export ratio10.5:12.6:18.2:1 No of products from SL 5051062869 Type of exportsMany primary products: pepper, areca nuts, waste & scrap, dried fruit, cloves Dominated by vanaspathi & copper VA products: insulated wires & cables, refined copper products, rubber gloves, apparel Rank of export destination 1435 Ind investment in SL (% of total FDI) Less than 2%16%14%

7. 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$ 418.3 million in 2008. India was the 5 th largest destination for Sri Lankas 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

8. India-Sri Lanka Trade: 1995-2008 YearExports (US$ Mn) Imports (US$ Mn) Trade Balance (US$ Mn) Import/Export Ratio 1995-1999 average 39509-47013.1:1 200058.0600.1-542.110.3:1 200172.0601.5-529.58.4:1 2002170.5852.8-682.35.0:1 2003245.31073.2-827.94.4:1 2004391.51439.1-1047.63.7:1 2005566.41835.4-1269.03.2:1 2006489.52172.9-1690.44.4:1 2007515.32610.1-2094.85.1:1 2008418.33443.0-3024.78.2:1 Source: Central Bank of Sri Lanka

9. 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%)

10. Negative Outcomes Cont. If vanaspathi & copper were excluded from the trade figures, SLs 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 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 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

11. 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

12. Sri Lankas Top Ten Exports to India: 2006-2008 DescriptionValue (US$ Mn) 200620072008 Insulated wire, cable & other electric conductors 33.14538.10540.694 Rubber & articles thereof19.02035.44033.647 Vegetable fats & oil – vanaspathi79.692145.32031.961 Cloves11.7808.35729.116 Boilers & machinery & parts9.0199.35218.118 Pulp11.49414.73217.899 Diamonds & other precious stones1.2265.57416.782 Pepper11.98119.22916.578 Copper & articles thereof93.25326.91912.817 Furniture, lamps & fittings6.4268.4509.574 Source: Sri Lanka Customs

13. 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 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 SLs 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

14. 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 – 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 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

15. 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)

16. 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 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

17. FTA Treatment of Top 10 Imports from India in 2008 HS CodeProductStatus 27PetroleumNegative List 87Vehicles & PartsNegative List 17019901SugarNegative List 52CottonMFN Duty Free 72Iron & SteelNegative List 30Pharmaceutical productsMFN (0-2.5) Duty 48Paper & paper boardNegative List 740811Copper wireILFTA duty free 230400Olicake & other solid residuesILFTA residual list (70% duty waiver) until 7 th Nov 2008, since then duty free Source: Ceylon Chamber of Commerce Trade Newsletter & Dept of Commerce

18. 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

19. 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

20. Indian Investment in Sri Lanka: 1993-2007 Source: Samarajiva and Herath (2008)

21. 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 Indias 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 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 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

22. 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 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

23. 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

24. 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

25. 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 2 nd 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

26. 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

27. Opportunities through CEPA Cont. The ILFTA has somewhat helped in shifting Sri Lankas trade towards alternative emerging markets by encouraging exporters to move beyond 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 in global economic powers towards the East The CEPA should be seen as an attempt to manage Sri Lankas 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

28. 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 Lankas 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

29. 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

30. 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

31. 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 Lankas 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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