Critical Analysis of the India Sri Lanka Fta

Introduction

The growth of regional trade blocs has been one of the major developments in international relations in recent years. During the 1990s, regionalism was conceived as a developmental option in itself that would promote the competitiveness of trade bloc members and help their fast integration into the international economy. As per the World Bank report on Global Economic Prospects, the number of Regional Trade Agreements (RTAs) has more than quadrupled since 1990 rising to around 230 by late 2004 and the trade between RTA partners now constitutes nearly 40% of total global trade.

Quoting, World Trade Organisation (WTO) this report estimates another 60 agreements at various stages of negotiations. The World Bank report points out that the boom in Regional Trade Agreements (RTAs) reflects changes in certain countries' trade policy objectives, the changing perceptions of the multilateral liberalization process, and the reintegration into the global economy of countries in transition from socialism. Regional agreements vary widely, but all have the objective of reducing barriers to trade between member countries which implies discrimination against trade with other countries.

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At their simplest, these agreements merely remove tariffs on intra bloc trade in goods, but many go beyond that to cover non-tariff barriers and to extend liberalization to investment and other policies. At their deepest, they have the goal of economic union and involve the construction of shared executive, judicial, and legislative institutions. Among the seven member countries of the South Asian Association of Regional Cooperation (SAARC), India and Sri Lanka account for the largest bilateral trade flow in the region.

Thanks to the India-Sri Lanka Free Trade Agreement (ISFTA) that was signed between the two countries in December 1998 and operationalized in March 2000. However, almost at the same time in 1993, the agreement on the South Asian Preferential Trading Arrangement (SAPTA) was signed among the seven member countries of SAARC. The objective was to promote and sustain trade and economic cooperation within the SAARC region through the exchange of concessions. This pushed the agenda for promoting bilateral trade between India and Sri Lanka to the background.

However, the negotiations under SAPTA progressed at a very slow pace and became a time-consuming process. The failure of SAPTA brought about the desire for a free trade agreement with India to the forefront from the Sri Lankan side. It was felt that such an agreement would give much-needed market access to the exporters from Sri Lanka. India was also keen to acquire the South Asian markets and expressed its willingness to consider bilateral free trade agreements with its South Asian neighbors.

Accordingly, the India-Sri Lanka Free Trade Agreement (ISFTA) was signed between the two countries on 28 December 1998 in New Delhi, India, and came into operation on 1 March 2000. India and Sri Lanka look upon regional/bilateral FTAs as a complement to the multilateral trading system by ensuring the compatibility of the FTAs with the rules laid down by the WTO. Also, both countries are members of the South Asian Association for Regional Co-operation (SAARC) which envisaged the formation of a South Asian Free Trading Arrangement (SAFTA) through successive rounds of tariff concessions between member countries.

However, the efforts of member countries have not yielded the expected results. A Joint Study Group with representatives from both countries was set up which submitted its report in October 2003 which paved the way for negotiations on the Comprehensive Economic Partnership Agreement (CEPA). In the present context of Indo-Sri Lanka trade, the services agreement aims to remove/reduce market access and national treatment barriers and promote co-operation between the services sectors of the two countries.

Historical overview

Trade relations between Sri Lanka and India date back to pre-colonial times. Under British rule, trade between the two countries was geared to fulfill the needs of the colonial power in the occupying territory and was dominated by imports and exports of food-related items. After independence in 1947 and 1948 for India and Sri Lanka respectively, both national governments adopted inward-looking policies centered on the concepts of “self-reliance” and import substitution industrialization. Consequentially, a very modest level of trading took place between what became two virtually closed economies. In 1977, Sri Lanka became the first South Asian country to liberalize its economy, opening it up to the rest of the world.

However, substandard products from India – the result of excessive inward-looking policies were not competitive against the goods from East Asia that flooded the Sri Lankan market. With partial liberalization of the Indian economy during the 1980s and further liberalization in 1991, trade began to pick up, particularly in favor of India. Between 1993 and 1996, there was a doubling of two-way trade, and between 1990 and 1996 imports of Indian goods to Sri Lanka grew by 556 percent. In 1995, India replaced Japan as the largest source of imports to Sri Lanka, accounting for 8-9 percent of total imports.

For Sri Lanka, it became evident that trade with the SAARC region ultimately amounted to trade with India owing to the sheer size of the latter’s rapidly emerging economy and expanding middle-class population. Hence, the perceived mutual benefits of free trade between the two countries became increasingly clear. Sri Lanka’s private sector – frustrated by the slow progress of the SAPTA to boost regional trade – pressurized the government to enter into a free trade agreement (FTA) with the Indian government that would increase market access for Sri Lankan exporters.

Birth of the ISFTA (India – Sri Lanka Free Trade Agreement)

Politics was ultimately the major player in the move toward free trade. Sri Lanka entertained the hope of clearing away the political tensions of the 1980s and engaging India’s assistance once more in solving the North/East conflict of the country. India was propelled by an immediate need to acquire South Asian markets following economic sanctions imposed on the country for the nuclear tests conducted in May 1998. Among other factors, these political forces led to the signing of the Indo-Sri Lanka Bilateral Free Trade Agreement (ILBFTA) on December 28, 1998.

The Commerce Secretary of India and Finance Secretary of Sri Lanka exchanged letters that operationalize the India-Sri Lanka Free Trade Agreement (ISFTA) between India and Sri Lanka signed in New Delhi on 28 December 1998 by H. E. the President of Sri Lanka and the Honorable Prime Minister of India with effect from 1st March 2000. The economic objectives of Sri Lanka were to increase Trade ties with South Asia’s dominant economic power, to induce the transformation of Sri Lanka’s exports from low-value-added goods to high-value-added goods aimed at niche markets, and to provide low-income groups with cheap consumer imports from India.

Moreover, Sri Lanka hoped to attract more export-oriented foreign direct investment (FDI) from third countries by promoting itself as an effective entry point into the Indian market. With the Board of Investment (BOI) being made a “one-stop shop” in the early 1990s, Sri Lanka has long been a relatively appealing location for foreign investors compared to its more bureaucratized South Asian neighbors.  Thus, the agreement with effect from 1st March 2000, aimed to provide duty-free as well as duty-preference access for the goods manufactured in the two countries.

Both countries had listed products for immediate duty-free entry into each other's territories. India has agreed to phase out its tariffs on a large number of items within a period of three years. Sri Lanka, likewise to do so in eight years. Both the countries had drawn up ‘Negative Lists’ in respect of which no duty concessions will apply. These Lists would include items on which protection of local industry had been considered essential. Both countries intended to reduce the items on the Negative List through periodic consultations.  The Agreement sets out the ‘Rules of Origin’ criteria for eligibility for preferential access.

Products having a domestic value addition of 35% will qualify for preferential market access. Sri Lanka’s exports with a domestic value addition content of 25% will also qualify for entry to the Indian market if they have a minimum of 10% Indian content.

Conceptualization of the ISFTA

The conceptualization phase of the ISFTA occurred between December 1998 and March 2000 and was based on several previous studies and recommendations. The agreement was intended to supersede the existing economic partnership under the SAARC, viz., SAPTA. Bilateral free trade agreements are traditionally formulated using the “positive list” approach, whereby each participating country catalogs the individual commodities for which it would grant preferences to the other. Nonetheless, owing to the time-consuming nature of such a method, the ISFTA was formulated on the “negative list” approach; with each country extending concessions/ preferences to all commodities except those indicated in its “negative” list, namely items of a sensitive nature with regard to protecting national interests. The two countries agreed to preferential treatment on 5112 tariff lines (by 6-digit HS Code).

An 8-year time table was devised for phasing out tariffs. Non-tariff barriers, such as Indian State taxes and customs- level procedures (e.g., landing tax), were to be gradually removed as well. Taking into account the asymmetry between the two countries, Sri Lanka was accorded special and differential treatment; the immediate duty- free list (319 items) and 50 percent preferential duty list (889 items) were considerably smaller than those offered by India (1,351 items and 2,799 items, respectively), while the Sri Lankan negative list (1,180 items) was considerably larger than India’s (196 items).

Among others, the agricultural sector of Sri Lanka was not subject to liberalization and was included in the negative list. The majority of Indian exports were initially granted only a 35 percent duty concession with an 8-year tariff reduction period, while Sri Lankan exports were granted a 50 percent concession with a 3-year tariff reduction period. Moreover, Sri Lanka was granted the freedom to reduce its negative list at her comfort level, instead of a pre-determined formula. Rules of origin (ROO) criteria were also relaxed in Sri Lanka’s favor.

Preferential treatment requires a minimum of 35 percent domestic value addition, or 25 percent when Indian inputs comprise 10 percent. In addition, although the agreement does not feature revenue compensation, Sri Lanka maintained that tariff concessions would not be granted for high-duty imports such as automobiles; import duties are an important source of government revenue and comprise 2 percent of Sri Lankan GDP. Some aspects of the agreement were deferred for subsequent negotiation; these include the number of entry ports, Indian state-level taxes, customs procedures, and the specifics of phasing out non-tariff barriers.  The agreement included mechanisms for review and consultation, as well as settlement of disputes above and beyond the protection afforded to both countries under the safeguards clause.

Characteristics of the ISFTA

The ILFTA between India and Sri Lanka is a landmark in the bilateral relations between the two countries. It is expected to bring about enhanced trade between the two countries as well as to expand and diversify cooperation in a range of economic spheres, including investments. This is the first such Agreement in the South Asian region which could serve as a model for similar bilateral Agreements in the region.

It has an institutional framework in the form of the Indo-Lanka Joint Commission, a dispute settlement mechanism, and so forth. Its significance further lies in that it can be implemented more expeditiously and also more flexibly, unlike the protracted nature of negotiations generally associated with multilateral arrangements. =The following features characterize the Indo-Sri Lanka Free Trade Agreement:

Elimination of Tariffs:

1. By India

• Zero duty on items upon entering into force of the Agreement – the list is to be finalized within 60 days of the signing of the Agreement.
• Concessions on Textile items are restricted to 25%. Four Chapters under the Textile sector retained in the negative list: 528 products.
• Garments covering Chapters 61&62 while remaining in the negative list, will be given 50% tariff concessions on a fixed basis, subject to an annual restriction of eight million pieces, of which six million shall be extended the concession only if made of Indian fabric, provided that no category of garments shall exceed one and half million ieces per annum (GAM).
• 50% tariff preference on five tea items, subject to a quota of 15 million Kg. Per year (TEA): 5 products. • 50% margin of preference upon coming into force of this Agreement on all items, except for those on the negative list. To be phased out to zero duty in three years (IR): 2799 products.
• A negative list of 429 items to be retained (D I): 429 products

2. By Sri Lanka

• Zero duty on about 319 items upon entering into force of the Agreement (F I): 319 products. Phasing out of tariffs on items with 50% margin of preference on 889 products upon coming into force of the Agreement, with up to 70% at the end of the 1st year, up to 90% at the end of the 2nd year and 100% at the end of 3rd year (F II): 889 products.
• For the remaining items, (except for those on the negative list), which is the Residual List, preference would be not less than 35% before the expiry of three years, 70% before the expiry of six years, and 100% before the expiry of the eighth year. (SLR): 2724 products. A negative list of 1180 items (DII): 1180 products.

The Objectives adopted are:

• Analyze how much of the bilateral trade – both imports and exports are covered under different categories of concessions offered and received by India and Sri Lanka over the past five years.
• To analyze, in terms of 21 HS Sections, the distribution of trade under each category.
• To analyze the top products in terms of 8-digit HS Classification for India and 6-digit classification for Sri Lanka under each category to identify the success stories. To ascertain the trade potential between the two countries and assess the same in terms of products offered concessions under different categories. This exercise is based on the last year of data availability. The concessions offered by the Contracting States have been at 6-digit HS classification. In order to attain the aforementioned objectives, the bilateral trade data is analyzed at the highest level of desegregation for India.

Assessment of trade under the ISFTA

The India-Sri Lanka FTA was signed in 1998 and became operational in March 2000. Mutual phased tariff concessions on different products on 6 digit Harmonized Classification (HS Code) basis have been granted by both partners. Each side is having its negative lists, positive list, and residual lists as per the framework of ISLFTA. The preferential trade under the FTA is governed by Rules of Origin, which specify the criteria for a product to qualify for tariff concessions from the importing member.

After the signing of ISFTA, trade between India and Sri Lanka has increased manifold. India‘s import from Sri Lanka was US$ 45 million (0. 10% of total imports) in 1999, which increased to US$ 499 million (0. 29%) in 2006; India‘s export to Sri Lanka was US$ 482 million (1. 4% of total exports), which became US$ 2110 (1. 74%) in 2006. Similarly, Sri Lanka‘s import form India in 1998 was 538 million (9. 49%), which increased to US$ 1804 million (18. 46% rank 1) in 2006. Sri Lanka‘s exports to India has grown from US$ 35 million (0. 5%) in 1998 to US$ 490 million (7. 26%, ranking 3) in the year 2006. In this way, India became the major trading partner for Sri Lanka after the signing of the Agreement.

The number of Sri Lanka‘s export items to India increased from 505 in 1996 to 1,062 in 2006 items on 6 digits of HS classification. There is a visible shift in Sri Lanka‘s exports from agricultural products to manufacturing goods The major products exported by Sri Lanka to India in 2006 included – Fats and Oils (22. 3%), Copper, and Articles of Copper (8. 6%), Electrical Machinery (8. %) and Spices, Coffee, Tea (6. 2%). Similarly, India exported Mineral Fuel, Oil (22. 44%), Vehicles (18. 08%), Iron and Steel (4. 54%), Machinery, Reactors, Boilers (4. 22%), and Pharmaceutical Products (4. 13%) to Sri Lanka. There has been an increase in the total share of imports of Sri Lankan goods from 0. 10% in 1999 to 0. 29% in 2006.

The import from Sri Lanka has also increased in the items on the residual list from 0. 2% in 1996 to 0. 47% in 2006. It is noteworthy that there has been an increase in the imports even in the negative list items from 0. % in 2001 to 1. 19 % in 2006. This could be mainly due to the increased awareness of the partner's market, smoothening of customs issues, and improved access to ports of entry due to the increased engagement of partner countries on products having preferential tariffs on the residual list, the so-called border effects. By 2008, the ISFTA entered full force. Both governments were pleased with the results achieved through the Free Trade Agreement and proclaim that it had facilitated the expansion of two-way trade between India and Sri Lanka.

India, which was once the second largest exporter to Sri Lanka pre-ISLFTA, has now become the island‘s largest source of imports. Meanwhile, India has become the third largest export destination for Sri Lankan products (after the United States of America and the European Union). The argument is that, given the asymmetrical proportions of the economies of the two countries, if not for the ISLFTA, Sri Lankan exports would not have been able to achieve their current level of market penetration. The bilateral import-export ratio had been 10. :1 in 2000 had improved in Sri Lanka‘s favour to 5. 3:1 by 2007. According to the then Indian High Commissioner to Colombo, the ratio may have been as skewed as 40:1 (to India‘s advantage, of course) had the ISLFTA not been in operation. Over the ten years in which the ISLFTA has been in operation, Indian foreign direct investment in Sri Lanka has also expanded exponentially, most recently in telecommunications (Bharti Airtel) and glass-manufacturing (Piramal Glass), and biscuits and sweets.

In 2009, India was the island‘s third largest foreign investor with inflows of US$78 million and was largely attracted to the telecommunications, energy, and power sectors. The Institute of Policy Studies has estimated that Indian foreign direct investment has expanded from a cumulative total of LKR165 million in 1998 to LKR19. 5 billion in 2005. However, the causal connection between the commencement of the ISLFTA and the spiral in inward foreign direct investment from India is asserted rather than demonstrated and may have more to do with aggressive Indian investment strategies since that country‘s economic boom, than the existence of the Free Trade Agreement.

Impact of the FTA

Despite its importance in the South Asian region, not many empirical studies have been conducted to access the impact of ISFTA. One study that attempted to analyze the impact of this FTA was conducted by Kelegema and Mukherjee in February 2007. Their study is based on the bilateral trade flows under different categories of products.

Sector-wise imports and exports figures are compared before and after the FTA. They have concluded that the two countries have displayed the political will to forge ahead towards economic integration and the considerable size disparity between the two economies does not hinder bilateral free trade when appropriate special and differential treatment is accorded to the smaller country. Some new goods from Sri Lanka have found entry into the Indian market following the exchange of preferences.

Finally, they have concluded that the economic benefits of free trade can and do override political problems.  Another report on evaluating the economic performance of the FTA is the Joint Study Group on India –Sri Lanka Comprehensive Economic Partnership Agreement constituted by the partner Governments. JSG has concluded that ISLFTA promoted a 48% increase in bilateral trade between 2001 and 2002, and at present India is the largest source of imports into Sri Lanka, accounting for 14% of Sri Lanka‘s global imports.

India is the fifth largest export destination for Sri Lankan goods accounting for 3. 6% of Sri Lanka‘s global exports. Based on the success of ISFTA, the JSG has recommended that the two countries enter into a Comprehensive Economic Partnership Agreement covering trade in services and investment and build upon the ISLFTA by deepening and widening the coverage and binding of trade in goods.

Looking beyond FTA: CEPA

The decision to work towards a Comprehensive Economic Partnership Agreement was taken in June 2002.

During the visit of the Sri Lankan Prime Minister to India in June 2002, the Prime Ministers of India and Sri Lanka discussed the profound changes in the international economic and political arena that have been generated by the process of globalization, on the one hand, and the emergence of closer regional economic associations, on the other. They agreed on the need to widen the ambit of the ISLFTA to go beyond trade in goods to include services and to facilitate greater investment flow between the two countries.

Accordingly, a Joint Study Group (JSG) was set up to make recommendations on how to take the two economies beyond trade towards greater integration and to impart renewed impetus and synergy to the bilateral economic interaction, through the conclusion of a Comprehensive Economic Partnership Agreement (CEPA).  Both sides have committed to an agreement consistent with the rules of the WTO. While the numerous shortcomings of the existing FTA must be remedied, its evident achievements can be built upon with relative ease to formulate the new agreement.

The required institutional support is already in place with the Federation of Indian Chambers of Commerce and Industry and the Ceylon Chamber of Commerce, which function as the focal points for economic cooperation, as well as the Indo-Lanka Joint Commission and the FTA’s Working Group on Customs. The first round of technical-level negotiations on the CEPA commenced in February 2005, somewhat delayed after changes in government in both countries. Seven rounds of negotiations have been completed by 2006. The CEPA is to cover trade in goods and services, investment liberalization, and economic cooperation.

The negotiations on goods focus primarily on reducing the ISFTA’s negative lists, relaxing ROO criteria, signing mutual recognition agreements (MRAs) on product standards and certification procedures, and concluding the Memorandum of Understanding (MOU) on consumer protection and legal metrology. Particular attention will be given to developing the supply side of the Sri Lankan economy. The CEPA will be notified under the GATT’s Article, which covers substantial trade instead of under the “Enabling Clause” which provides more flexibility to determine the trade coverage between developing countries. In a nutshell, the main objectives of the CEPA are to:

1. Deepen existing preferential trade between the two countries
2. Reduce the negative lists of the ILBFTA
3. Relax ROO criteria
4. Liberalize the services sector beyond the coverage of the General Agreement on Trade in Services (GATS)
5. Liberalize investment
6. Facilitate economic cooperation as an impetus for liberalization of the services and investment sectors, with the Indian Line of Credit playing a crucial role.

Conclusion

The operationalization of the ISFTA in 2000 was an important step taken by the two countries to harness the economic complementarities between them. As expected, post ­ISFTA bilateral trade performance between India and Sri Lanka indicates that exports and imports have grown considerably, accompanied by significant product diversification. Despite the fact that the ISFTA was confined to trade in goods, increases in trade links between India and Sri Lanka have been further triggered by large investment flows as well as services integration between the two countries over time.

Nevertheless, investment flows have been mostly one-sided as would be expected, flowing from India to Sri Lanka, where the bulk of Indian investment in manufacturing in the post ­ ISFTA phase has come from Indian investors keen to take advantage of preferential duty access to the Indian market in key sectors such as Vanaspathi and copper. Nevertheless, the potential for greater linkages in investment and services has been fairly obvious based on recent performance, and in part has encouraged both countries to further deepen integration in these areas under the CEPA framework.

It is evident from a detailed analysis of post­ISFTA trade flows that Sri Lanka’s exports to India have expanded significantly. However, it is also clear that the overwhelming share of the increase has originated in a few commodities, raising concerns about the sustainability of the growth momentum in the long term. The bulk of the exports have been concentrated in two items, namely the vegetable fats and oils and copper and articles of copper, which are not considered to be sustainable in the long run.

It is by resolving these issues that the movement toward CEPA could be put on the fast track to make it a reality. CEPA has the potential to break new ground in South Asia’s forward movement towards economic prosperity.

BIBLIOGRAPHY

1. Mukherjee, I. N. , T. Jayawardena and S. Kelegama (2002), ‘India-Sri Lanka Free Trade Agreement: An Assessment of Potential and Impact’, SANEI completed study (www. saneinetwork. net ).
2. The Graduate Institute Geneva, HEID Working Paper No: 04/2010: An Econometric Analysis of the India-Sri Lanka Free Trade Agreement.
3. Kelegama, S. nd Mukherji I. N. (2007), India-Sri Lanka Bilateral Free Trade Agreement: Six Years Performance and Beyond, RIS DP# 119, February 2007, Research and Information System for Developing Countries, New Delhi.
4. JSG (2003), India-Sri Lanka Comprehensive Economic Partnership Agreement, Joint Study Group, October 2003, http://www. ips. lk/publications/etc/cepa_reprot/islcepa. pdf
5. Jayawardena, L. et al. (1993), Indo-Sri Lanka Economic Cooperation: Facilitating Trade Expansion through a Reciprocal Preference Scheme, The United Nations University, WIDER, Helsinki.
6. An Act of Faith? ” ten years of the India-Sri Lanka FTA, Law & Society Trust, Sri Lanka, March 2010 (PDF File)
7.  “India – Sri Lanka FTA: Lessons for SAFTA”, CUTS International, Dushni Weerakoon, Jayanthi Thennakoon. (PDF File)
8.  Panchamukhi, V. R. et al. (1992), Indo-Sri Lanka Economic Cooperation: An Operational Programme, the United Nations University, WIDER, Helsinki.
9. Taneja, N. , A. Mukherjee, S. Jayanetti, and T. Jayawardena (2004), ‘Indo-Sri Lanka Trade in Services: FTA II and Beyond’, SANEI completed study (www. saneinetwork. net ).

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