Going beyond the Indo-Sri Lanka FTA:
An opportunity not a threat
Excerpts from the media release by the Ceylon Chamber of Commerce
In practical terms, improving the quality of life of the people means
focusing upon ways and means of achieving sustained increases in the
incomes of the people on the basis of balanced and inclusive growth of
the economy. In a country of 21 million people, this can only be
achieved by supplementing the domestic market with a sharp focus on
external demand i.e. exports. The transformative successes achieved by
several Asian countries demonstrate this vividly.
Countries varying in size from China to Singapore have gone down this
route. In a context, where multilateral trade negotiations (the Doha
Round) have stalled and regional integration is constrained by tensions
between India and Pakistan, there is a robust case for attaching high
priority to bilateral agreements.
Given the significant competitive advantages associated with
proximity, Sri Lanka needs to deepen and extend the existing FTA with
India. Priority should also be attached to completing the FTA with China
and making greater use of the Agreement with Pakistan. FTAs with other
countries should also be pursued in a systematic way to support
diversification of export markets.
Gap
Sustained improvement of living standards cannot be achieved without
increased investment to drive productivity-linked expansion of economic
activity, particularly exports. The domestic pool of investment is
inadequate to achieve the country's growth target of 8%. There is a
savings and investment gap of about 5% of GDP.
FDI, which is non-debt creating, offers the best option for filling
this gap, with its added benefits of technology, know-how and markets.
It needs to increase from the current disappointing level of $1
billion (2014) to $4 billion. The domestic market is not large enough to
attract this magnitude of FDI.
It would be possible only if the prospects of export growth are
improved. Bilateral arrangements, which promote preferential access to
larger markets and improve the investment climate, are, therefore, a
crucial component of the landscape for attaining an improvement in the
living standards of the people over a decade or more.
Trade agreements
Deepening the ISLFTA (Indo-Sri Lanka Free Trade Agreement) in goods
and extending it to services and investment fits into this narrative.
This article focuses on: the case for bilateral agreements; the need
for a new growth model; deepening and extending the ISLFTA, the need for
refection and a self-critique; the need for urgency as opposed to
procrastination.
In an ideal world global trade should be boosted through multilateral
trade liberalisation. The Doha Round should be completed. The
development dividend, which was promised at the launch of the
negotiations, should be delivered.
One can argue that bilateral and regional trade agreements are
sub-optimal as they lead to trade diversion. They also result in a
spaghetti or noodle bowl of trade agreements which leads to information
asymmetries (it becomes difficult to keep up with the terms and
conditions of various agreements) and increased transaction costs.
However, the political will to complete the Doha Round is unlikely to
materialise in the foreseeable future as concerns regarding unemployment
in Europe and general labour market weakness in the US will prevail for
some time.
In the meantime, all around the world countries are pushing ahead
signing bilateral and regional trade agreements. Sri Lanka is excluded
from major regional trade negotiations currently underway e.g. the Trans
Pacific Partnership (TPP) and the US-EU trade and investment agreement.
There is a strong rationale for Sri Lanka pursuing its trade
interests through bilateral and regional agreements - to deepen existing
ones and sign new ones. In this context, there is a strong case for
giving high priority to build upon the ISLFTA, completing the FTA with
China, making greater use of the FTA with Pakistan, and negotiating with
ASEAN and South Korea.
New growth model
In recent years, growth in Sri Lanka has been driven by foreign
commercial public borrowing led infrastructure development. Headroom for
this model is now severely constrained. Sri Lanka's debt to GDP ratio is
74%. The median for our peers with the same rating is 44%.
The external debt service ratio is 25%. The rule of thumb is that one
enters amber light territory when this number gets over 20%. The total
debt service payments, domestic and foreign, are over 100% of government
revenue. Hence, the infrastructure development growth model financed by
borrowing is no longer viable due to these adverse debt dynamics.
Moreover, the infrastructure led growth model has not translated into
appreciable growth in household income which remain below par in most
homes. Sri Lanka needs to move quickly to strengthen what we have known
for a long time but have not achieved, export-led growth. If not, growth
will slow down.
It is a truism that a country with a population of 21 million can
only attain a growth target of 8% or more on a sustained basis through
export expansion. We have known for several decades that an accelerated
growth trajectory can only be achieved in this way. The slogan 'export
or perish' was first used in the late 1970s.
However, in the intervening four decades, our export record has been
poor. Countries such as Malaysia, Thailand and Vietnam record exports
which amount to over 70% of its GDP. In Sri Lanka, we have gone
backwards. Fifteen years ago, exports amounted to 32% of GDP.
Today, exports of goods amount to about 15% of GDP and services
account for a further 5%. i.e. a total of 20% compared to the 70% plus
achieved by the successful SE Asian countries. This needs to be turned
around quickly because, as mentioned above, Sri Lanka currently lacks a
growth model.
The repeating cycle of stop-go policies, which have characterised the
post-77 era, can only be broken by developing an export-led development
model. This process can be greatly facilitated by signing bilateral
agreements which promote trade and investment. Leveraging our proximity
to and deep ties with India and our friendship with China should be a
major part of this narrative.
It is important to understand the changing landscape within which
these negotiations are taking place. India has reset its relationship
with countries in South Asia.
It has concluded that peace and prosperity in the region would not
only benefit its own development but also create a more conducive
environment for pursuing its ambitions as a rising global power.
It does not want to be distracted by irritations in the neighbourhood.
Significant advances are under way in India's relations with Bangladesh,
Nepal and Bhutan, particularly in the areas of power generation and grid
connectivity and land and rail transit which would boost trade.
Sri Lanka should not be left behind. Modi's visit to Sri Lanka was
the first in 28 years by an Indian PM. It reflects India's changed
stance towards this region.
The debate on the merits of the Indo-Lanka Comprehensive Economic
Partnership Agreement (CEPA), as a means of taking advantage of our
proximity to a resurgent India, seems to divide the protagonists on the
basis of whether India is seen as an 'opportunity' or a 'threat'.
Some of the antipathy to the Indo-Lanka CEPA is based on primordial
fears and insecurities which are not evidence-based or rational. Sadly,
one side of the debate is often characterised by misinterpretation and
misinformation.
Emotion rather than hard-headed calculation based on current
realities seems to dominate thinking. In some instances, individual
corporate interests appear to outweigh the national interest and those
of the people of Sri Lanka. Some critics also fail to take into account
recent improvements in the bilateral trading environment.
Modi clearly signalled the willingness to do more. It would be a
mistake not to take advantage of this. Failure to do so would not be in
the interests of Sri Lanka or its people. Other countries in the region
and much of the rest of the world see India as an increasing
opportunity. It would be a great pity if we ignore what is available at
our door-step.
We need to transcend our narrow-minded fears. The failure to do so
would deprive Sri Lanka from taking advantage of a potentially
transformative opportunity to boost its development prospects.
However, there is also more considered opposition based on the
following argumentation which neeeds careful examination.
Asymmetry
* The asymmetry between the two economies means that the CEPA would
inevitably be detrimental to Sri Lanka's interests resulting in a loss
of output (growth) and employment.
* The ISLFTA has been a failure with more costs than benefits for Sri
Lanka.
The argument that the asymmetry in the size of the two economies
would preclude a mutually beneficial CEPA ignores some important facts.
There are provisions in all trade agreements for negative lists and
safeguards. There can also be differences in the time periods over which
the parties liberalise trade in the items on the positive list.
The Indian authorities have shown an increasing willingness to adopt
the principle of non-reciprocity to take into account the asymmetry of
the two economies i.e. Sri Lanka has room to manoeuvre when it comes to
the negative list, safeguards and the speed of liberalisation.
The focus, therefore, should be on negotiating to maximise the
benefits for Sri Lanka through, among other things, effective use of
these mechanisms.
There are examples from the Asian region where deeper economic links
have yielded substantial benefits despite asymmetry in the size of the
economies involved. Singapore has used its integration with the ASEAN
economies, including Indonesia, to generate positive development
outcomes for itself.
Similarly, Hong Kong has benefited enormously from its link to the
massive Chinese economy. It is also noteworthy that Mexico has benefited
more than the US or Canada from the North Atlantic Free Trade Area
(NAFTA).
Problems
Some have argued that the ISLFTA has failed. They cite negative
experiences regarding Vanaspathi oil and copper and a number of
persistent non-tariff barriers, to make their case. The ISLFTA has
certainly had a number of problems associated with it.
However, it has also provided a framework for addressing these
issues. The trading environment in goods has improved and a number of
sources of friction have already been addressed. There is more to be
done. Indeed Prime Minister Modi alluded to this when he addressed the
Sri Lankan business community during his recent visit.
Sri Lankan exports to India increased from US$56 million in 2000 to
$559 million in 2005. They declined to $418 million in 2008 and $325
million in 2009.
The fall in exports to India during the period 2007-2009 may be
attributed to reduction in vegetable oil, primary copper and pepper as
India eliminated opportunities to arbitrage on tariff differentials.
However, it is noteworthy that the limited basket of exports to India
at the inception of the ISLFTA was diversified during the period 2007-09
with the emergence of new items such as animal feed, electrical
appliances and accessories, vessels, paper products, glass and plastic
products.
This happened despite the significant appreciation in the real
effective exchange rate. Since then, Sri Lankan exports have increased
to $625million in 2014, despite the fact that the Indian economy lost
growth momentum due to policy paralysis.
Imports from India increased from US$ 600 million in 2000 to US$
3,007 million in 2008 and declined to $ 1710 million in 2009.
March-December trade
The decline in 2009 may be explained by the overall slowdown in the
economy and the resulting import compression that year. It increased to
$3,978 million in 2014. Major imports from India include petroleum
products, iron and steel, cotton, motor cycles and motor vehicles.
Sri Lanka's trade deficit with India grew from US$ 544 million in
2000 to $2,589 in 2008. It declined to $1,385 in 2009 and then increased
to $ 3,353 million in 2014. It is important to analyse this growth in
Sri Lanka's trade deficit with India. It is noteworthy that imports
which are on our negative list, such as motor vehicles, petroleum
products, agricultural products and paper products have grown as part of
normal trade (i.e. without the benefit of preferential tariffs).
This implies these imports were internationally competitive and
served to provide Sri Lankans with cheaper goods and reduce the overall
trade deficit by reducing import costs. One cannot, therefore, conclude
that the ISLFTA has caused a sharp increase in the trade deficit with
India.
Much of the deterioration in the trade balance would have happened
even without the ISLFTA as much of the Indian goods have been imported
on MFN terms without the benefit of preferential tariffs. In most years,
over 80% of Indian imports have been outside of the ISLFTA (on MFN
terms) while about 70% of Sri Lankan exports to India have been on a
preferential basis. The ISLFTA has resulted in an increase Sri
Lanka-India trade from US$ 656 million in 2000 to $ 4.6 billion in 2014.
Though exports have grown far less than imports, Sri Lanka has benefited
through expansion aand diversification of the export base to India.
The deterioration in the trade balance would have taken place with or
without the ISLFTA because of the competitiveness of Indian imports
which have provided the people of Sri Lanka with access to cheaper
goods.
There has also been an increase in Indian investment in Sri Lanka. It
has now reached $1 billion. There a further $1 billion in the pipeline.
This may be attributed, at least in part, to the ISLFTA in that it has
created the conditions for increased investment to take advantage of
growing bilateral trade relations.
India has been the largest investor in Sri Lanka in recent years.
Much of this investment has been in services, such as health, education,
fuel distribution, hotels, tourism, IT training, computer software and
professional services.
Despite the increase in trade and investment since the signing of the
ISLFTA, performance is unimpressive when one compares it with what other
countries have achieved in their trade with India even without an FTA.
The ISLFTA provides market access for a wide range of products. At
present, at six digit HS level 36 of the 3,000 product groupings account
for 75% of the exports from Sri Lanka to India via the ISLFTA.
This provides the Sri Lankan private sector with considerable scope
to explore how to take better advantage of the opportunities which are
available but are not being used.
Negotiations
The negotiations with India should focus on the following:
* Addressing the impediments which constrain the full benefits of the
Indo Sri Lanka FTA (ISLFTA). It is encouraging in this respect that the
Indian Prime Minister indicated that priority would be attached to
addressing these issues. It is important to follow-up on this.
* The existing FTA should be deepened by reducing, in particular, the
Indian negative list. India has demonstrated some flexibility regarding
this.
* The agreement in the trade in goods should be extended to include
services and investment. The nomenclature does not matter. One can label
it CEPA, CECA or something else. A combination of misunderstanding,
misinformation and falsehoods has given ‘CEPA’ a bad name. If it is
helpful, the name should be changed.
* There is a strong case for including services and investment in the
agreement.
* As Sri Lanka can no longer leverage low labour costs, there is a
general consensus that it has a better competitive advantage in services
(shipping, aviation, ICT/BPO/KPO and financial services). For instance,
Sri Lanka has a competitive advantage in shipping and logistics.
It is a clear strength because of its location and the relative
efficiency of the Colombo Port. If earnings from providing such services
to India are not increased at a time when its trade volumes are likely
to expand sharply, the prospects for realising the full potential
returns from the large investment made in our ports are likely to be
diminished.
Hence, it would be illogical not to include services, particularly as
India has recognised the principle of non-reciprocity and Sri Lanka
would be opening far less than India. In fact, Sri Lanka will be opening
a little beyond what is already available under existing agreements,
such as the BOI Act.
The alarmist claims that the country will be flooded by
professionals. Sri Lanka will not accept a CEPA agreement which would
permit it. Nor is India asking for this as its interests are not driven
by narrow market access.
There is a strong political dimension based on India re-setting its
relations with countries in the region and the entry of the dragon
(China) into the neighbourhood.
* It is also important to include investment as the trade–investment
nexus is crucial to maximise benefits from trade agreements between
asymmetrical economies. Increased Indian investment to create
competitive supplies to export back to India is also important to
address the trade deficit between the two countries. Increased Indian
investment can also generate more exports to China and Pakistan using
the FTAs with those two countries. Sri Lanka can act as a bridge using
the three agreements to its advantage.
Reflection
Exporting to India is not easy. There are well known NTBs and
bureaucratic hurdles which need to be overcome. However, we need to ask
ourselves the question whether we can use this as the main excuse for
the relatively disappointing outcomes of the ISLFTA.
There are grounds for self-examination and self criticism. During the
period that the FTA has been in existence (2001 – to date) China has
increased its exports to India from $1.5 billion to over $50 billion.
Countries in SE Asia have also been much more successful than Sri
Lanka. They have achieved this without the benefit of an FTA
(India-ASEAN CECA was signed recently). This indicates that the bigger
problem is not the difficulty of exporting to India but rather the lack
of competitive goods and services to be exported from Sri Lanka.
The overall policy framework needs to be more export-friendly and the
private sector needs to learn from countries and companies which have
been more successful in penetrating the Indian market.
The economic asymmetry between Sri Lanka and India would increase in
the future as the latter emerges as a major global player in an
increasingly multi-polar world. This increases the need for a
rules-based regime to manage Sri Lanka’s bilateral trade and investment
relations with India.
This has become particularly important in the absence of progress on
multilateral (Doha Round) and regional (SAFTA) frameworks. As a result,
there is a case for negotiating the CEPA sooner rather than later in a
context where the power relations between the two countries are likely
to become even more asymmetric and India would inevitably continue to be
a major trading partner given the immutable realities of geography.
Delay would also allow others to steal a march over us. India is
pursuing a number of FTAs. The more that are signed before us, the
greater will be the erosion of potential benefits. Others, including our
competitors, are already pressing ahead. They will not wait for us to
get over our irrational primordial fears.
The ASEAN countries which have ratified a Comprehensive Economic
Cooperation Agreement with India, comprise both economies that are
somewhat more developed than Sri Lanka (e.g. Malaysia, Thailand and
Vietnam) and those that are less advanced (e.g. Cambodia, Laos and
Myanmar). Countries as diverse in their economic development as
Singapore and Cambodia/Laos have ratified the CECA with India.
Global interest
They have concluded an agreement which they believe will be
beneficial for their people. If such a range of countries consider it
advantageous to have such an agreement with India, it raises the
question why Sri Lanka should be fearful of the impact of a CEPA on
investment, growth and employment in this country.
India has now become the fastest growing large economy in the world.
It is likely to maintain this position in the coming years. It has
overtaken China from a much lower base. There is growing global interest
in the Indian market.
By procrastinating, we will fall further behind in terms of accessing
the growing Indian market. Seven years have lapsed since a draft CEPA
was ready.
Further delays based on emotion rather than facts would not be in the
interests of the country.
There are two further factors which make the current context more
propitious than 2008. First, Modi’s ‘Make in India’ strategy is likely
to spur manufacturing growth. This can create opportunities for Sri
Lankan companies to plug into new supply chains of Indian companies and
MNCs operating in India i.e. an opportunity to replicate what happened
in the East and SE Asia where the rise first by Japan and then China
pulled up the whole region through supply chains.
Second, in the past, poor infrastructure in India and Sri Lanka made
it difficult to take advantage of geographical proximity by increasing
transport and transaction costs. The improvement in infrastructure in
both countries is addressing this problem and can reinforce the point
regarding supply chains by making it easier to realise the benefits of
proximity.
Another positive development related to trading with India is the
anticipated introduction of a goods and services tax. It will result in
doing away with a number of State level taxes and levies.
This will create better enabling conditions for the creation of a
common market in India which will reduce transaction costs and
significantly improve the prospects of doing business with the country.
An ongoing World Bank study has pointed out that greater trade
integration with India can generate large gains for the smaller
countries in South Asia. A CEPA can offer benefits for both sides. Sri
Lanka can benefit from a larger market that will allow the realisation
of economies of scale, the ability to integrate into large value chains
and access to investment which can bring in technology, markets and
know-how.
India, for its part, can demonstrate the value of a productive
partnership with a neighbour, which, if emulated, has the potential to
stimulate growth and reduce political friction in the neighbourhood – a
priority for India as it pursues its global ambitions.
The proposed Indo–Lanka CEPA can refine the disciplinary framework
for the trade in goods by addressing major issues that have hitherto
constrained benefits from the ISLFTA. These include conformity
assessment procedures and product standards. It can also introduce
rules-based regimes for trade in services and investment and strengthen
the dispute–resolution process at a time when the asymmetry between the
two countries is going to increase as Indian growth accelerates.
The debate on the proposed Indo–Lanka CEPA should be focused on a
hard-nosed assessment of potential benefits and costs rather than on
emotion and primordial fears. It should not be based on the premise that
economic asymmetry precludes mutually beneficial bilateral trading
agreements.
The asymmetry can be addressed through negative lists, safeguards and
differential transitional arrangements, particularly as India has
accepted the principle of non-reciprocity. It is in the interests of
smaller countries to seek a rules-based regime to manage relations with
much larger trading partners.
In the absence of a disciplinary framework everything has to be
negotiated on a case-by-case basis with a much more powerful partner.
The challenge is to negotiate effectively and strive for good faith on
both sides.
Concern is often expressed that a combination of political
interference, vested private sector interests and lack of capacity
constrain the ability of Sri Lankan negotiators to pursue the country’s
objectives effectively in trade negotiations, particularly with a
country as large as India.
A more transparent process, which involves key stakeholders and
mobilises technical expertise, within and outside the government, can
increase Sri Lanka’s ability to achieve favourable outcomes beneficial
to the country and its people through effective negotiations.
In conclusion, it must be re-iterated that it is in the national
interest to advance an Indo–Lanka agreement which deepens the existing
FTA on the trade in goods and extends it to services and investment. |