India's National Magazine
From the publishers of THE HINDU

Vol. 16 :: No. 02 :: Jan. 16 - 29, 1999

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INDIA & SRI LANKA

Towards freer trade

The signing of the free trade agreement by India and Sri Lanka takes South Asia one step closer to the goal of a free trade area.

SUKUMAR MURALIDHARAN
in New Delhi

THE free trade pact with India was the centrepiece of Sri Lankan President Chandrika Kumaratunga's visit to New Delhi in the last week of December. Negotiating teams had been at work on the pact since the middle of December, without clinching every detail of it. At one stage, External Affairs Minister Jaswant Singh urged the teams to go that extra mile to uphold the principle of free trade. There was, he said, the serious risk that the principle would otherwise be "defeated by details". The high moral ground had been seized and for the officials who insisted that the devil lay in the details, the signal could not have been more unambiguous. Residual areas of friction were quickly ironed out, in time for the pact to be signed during the Sri Lankan President's visit.

In incremental terms, the agreement takes the South Asian region one step closer to the goal of a free trade area. It is a mission in which India, as the most weighty country in the region, has a special responsibility. Since all other South Asian nations need to secure transit and trade agreements through India to boost their mutual transactions, India's role in promoting the concept and practice of free trade is especially pivotal.

Nepal and Bhutan already have preferential trading arrangements with India. Sri Lanka has now joined the league and Bangladesh is keen to gain admission. That would leave out only Pakistan, which presents a unique set of problems on account of long-festering political animosities, and the Maldives, which is in a geographical sense the most detached of the South Asian nations.

FOR Dr. Lal Jayawardena, economic adviser to the Sri Lankan President and Deputy Chairman of the National Development Council, it was very important in a political sense for Sri Lanka to conclude an agreement with India. Bangladesh was also an aspirant for a like status in relation to India and progress on that front might have distracted attention from the claims of the island nation.

SHANKER CHAKRAVARTY
President Chandrika Kumaratunga and Prime Minister Atal Behari Vajpayee signing the agreement to establish a bilateral free trade area, on December 28 in New Delhi.

Dr. Jayawardena was one of the principal architects of the free trade agreement, which represents the fruition of a personal quest that began as far back as 1993. In the preface to an exploratory report authored by the United Nations University and the World Institute for Development Economics Research (UNU/WIDER), of which he was Director, he argued that reciprocal trade concessions between India and Sri Lanka would "make a major contribution to the political and economic stability of Sri Lanka regarding which India has a major stake". They would at the same time "support India's economic reform process by providing an export platform in Sri Lanka for joint ventures involving foreign investment (including Indian investors), serving both the joint Indo-Sri Lankan market and the outside world," he said.

Sri Lanka preceded India by almost a decade and a half in embracing the policies of global integration. The results have been equivocal. Experts today concede that the country missed its opportunities to expand trade dramatically in the manner of the newly industrialising economies of East Asia and South-East Asia. The goal of economic policy as formulated in the early years of the decade was to attain comparable levels of trade, investment and growth by the year 2000. Although little progress was made in the course of the decade, the agreement with India represents a breakthrough in Dr. Jayawardena's view.

Complementarity in industrial structures is fundamental to the success of a free trade agreement. The architecture of the agreement with India is that Sri Lanka will seek to earn foreign exchange through exports of traditional merchandise, which would enable it to import larger quantities of machinery and capital goods from India.

Trade between India and Sri Lanka is currently of rather modest dimensions. India exported goods and commodities worth Rs.1,772 crores to Sri Lanka in 1997-98, while in turn importing merchandise of the value of Rs.121 crores from that country. India's exports showed a preponderance of machinery and transport equipment, drugs and pharmaceuticals, metal manufactures, and textiles and garments. The principal imports from Sri Lanka were ores and metal scrap, natural rubber and spices.

The balance of trade being heavily in India's favour, it is expected that the free trade agreement will have the effect of progressively correcting the skew. India has committed itself to granting duty-free access to all Sri Lankan exports, with the exception of a limited number of goods which would be on the negative list. The number of items eligible to duty-free imports upon entry into force of the agreement would be in the region of 1,000. Around 400 items would be placed on the negative list. For the rest, a 50 per cent margin of preference on duties would be granted on all items, with the exception of textiles and garments, which would only be eligible to a 25 per cent margin. Excluding the latter category again, the margin of preference would be raised from 50 to 100 per cent in two stages, within three years of the entry into force of the agreement.

Sri Lanka in turn will grant duty-free access to around 900 items of import from India. Another 600 items would be provided a 50 per cent margin of preference, to be raised in three stages to full duty exemption at the end of the third year. With the exception of a limited negative list, tariffs on all remaining items would be cut by a minimum of 35 per cent within three years and 70 per cent within six years, before graduating to full duty exemption within eight years.

Reflecting the skew in patterns of trade, Sri Lanka has been granted a rather more liberal time frame for graduating to a regime of duty-free imports. Agreement in principle has been reached on limiting the negative list to certain very sensitive commodities where the two countries are in head-to-head competition in global markets. Preliminary calculations indicate that the commodities which will feature on India's negative list would account for less than one per cent of its total import bill in any year.

The agreement features an elaborate section on "rules of origin", to ensure sufficient value addition in both countries before a commodity is eligible to its special benefits. In the case of raw material originating in third countries, the contracting parties to the agreement must ensure 35 per cent domestic value addition to avail of the free trade benefits. If the contracting countries purchase raw material from each other, then 25 per cent domestic value addition is deemed adequate.

SHANKER CHAKRAVARTY
President Chandrika Kumaratunga with President K.R. Narayanan at Rashtrapati Bhavan.

Sri Lanka sees a high potential in the export of primary commodities such as tea, coconut oil, cloves and other spices. None of these is likely to enjoy a friction-free entry into the Indian market - some may indeed be put on the negative list. The devil is in the details, although there is understood to be a broad acknowledgement from the Indian side that the negative list will not be so expansive as to preclude all the commodity groups that are of special interest to Sri Lanka.

Aside from the direct benefits of growing bilateral trade, further gains are expected to accrue from third-country investment. Japan was once a major prospective investor in Sri Lanka, although that potential has remained largely unrealised. In the context of the agreement with India, there could be renewed investor interest to take advantage of increased export opportunities. But the slump in the East Asian region and the agonising financial restructuring that is under way in Japan could constitute an adverse circumstance.

The specific industry groups where Sri Lanka seems to sense a high investment potential, as a direct inducement of the Indian market, include natural rubber products, wood panel, metal work, ceramics and consumer durables. In return, India is expected to gain from the export of capital goods to Sri Lanka.

The agreement between the South Asian neighbours moves the trade dialogue from a fragmented, commodity oriented framework to a broader and more expansive platform. But when the reckoning of potential benefits is done, there would still seem to be a need for detailed and specific calculations oriented around particular sectors, in order to optimise the gains to both sides. Each of these sectors would also throw up its own problems, which would need to be ironed out through mutual consultations and continual references to the broader picture of economic consolidation.