Indo – Sri Lanka FTA: Myths and realities

by an independent analyst

(August 31, Colombo, Sri Lanka Guardian) This article is written in recognizing the numerous opinions floating around in Sri Lanka in respect of the proposed Comprehensive Economic Partnership Agreement (CEPA) with India. Most of the public discussions and paper articles on CEPA, which we see today, are either based on personal or political sentiments or absolute analysis of numerical figures. The whole purpose of this article is to give a holistic and comparative analysis based on facts and figures explaining the current status of the FTA with India. This article, basically concentrates only on the trade in goods aspect.

Indian FTA - was it a policy mistake?

Initiation of FTA dialogue between Sri Lanka and India started in the mid 90's, shortly after India embarked on open economic policies. Though this exercise was virtually new to both countries, no one can deny the excellent level of intellectuality in both countries in handling this blueprint task. However, one can ask a valid question, whether we made a mistake by taking a policy decision to enter into a FTA with India in the mid 90's. Under the current context, this is totally irrelevant question, because, as to date it is an agreement between two sovereign states with commitments to be honoured. On the other hand, if Sri Lanka views the FTA as so detrimental for her interests, it is fully legal to withdraw from this agreement by giving six months notice to the other party as per the Article XIV of the said Agreement. The policy mistakes, if any, therefore, can be corrected even to day.

What were the commitments?

When negotiating the FTA, policy makers have given due considerations to the asymmetries of the two economies by maintaining comparative 'negative lists' and differential implementation periods for their commitments.

According to the trade liberalization programe envisaged under the FTA, India committed to liberalize their goods market more aggressively than Sri Lanka. As per the agreed programme, with effect from 2003, Sri Lanka is entitled to export more than 4,000 products to India at zero rate of duty. In contrast, Sri Lanka always has had an opportunity to adopt a piecemeal liberalization process, providing adequate time to local industries to adjust themselves to face with the Indian competition. The agreed tariff liberalization programme therefore, allowed Sri Lanka to utilize eight years from 2000 to 2008 to meet her commitment compared to three years granted to India. The same asymmetry is evident, not only in opening up of the markets, but also in the process of protecting domestic interests too. In this regard, Sri Lanka was allowed to keep 1,220 products (which cover most sensitive agricultural and industrial products) without granting any tariff concessions to India while India maintained only 200 products without granting any concessions for Sri Lanka.

Imports from India

There is a grave concern from Sri Lankan side on the staggering increase of import from India during the last few years. The common parlance that this increase has resulted in increase of preferential imports coming from India under the FTA; is largely a misconception arrived through gross approximations, speculations and even may be because of ignorance.

Table 1 suggests that even prior to the FTA, (from 1986 - 1998) there was a prominent increase in imports from India to Sri Lanka. The imports from India, which stood at around 2 billion rupees in 1986 has increased to around 36 billion rupees in year 1998 recording a leaner average growth around 25% per year. During the FTA, (from 2000 - 2007) imports from India has grown an average rate of around 30% per year, which is an obvious and expected outcome of FTAs.

Table1 shows another important dimension of preferential imports from India to Sri Lanka during the FTA period. On average, out of total imports from India to Sri Lanka during the period of 2000-2007, only 15%-20% of imports have entered to Sri Lanka under any form of tariff preference in a given year. This means that out of the total imports from India to Sri Lanka, around 75% to 80% has nothing to do with preferences granted under the FTA. These imports have been made as normal imports by paying respective import duties applicable for respective products accordingly. The harsh economic reality that we largely ignored here is that the India is one of our most preferred countries of importation of products. India has became our best source of supply of products due to her price competitiveness and proximity to the country, helping Sri Lanka to save foreign exchange. To clarify this matter further, let's look at the detailed Indian import composition in 2007 and the applicable preferences granted under the FTA for those imports.

According to Table 2, the above four categories of import products from India represents around 60% of total imports from that country for 2007. The situation is such that in spite of the FTA with India this 60% (Rs. 182 billion) imports would have come to Sri Lanka in any case. The other interesting point is that according to further calculations, the overall rate of non-preferential imports from India would be around 80%.

Export to India

With the implementation of the FTA, preferential exports from Sri Lanka to India have increased remarkably. When compared to 20% of preferential imports from India to Sri Lanka, Sri Lanka has exported more than 80% of total exports in value terms to India utilizing the tariff preferences granted under the FTA.

Even though Sri Lanka's preferential exports to India has increased in an unprecedented manner with the implementation of the FTA, these performances are also being criticized on account of the issue of 'lack of diversification' in Sri Lanka's export portfolio to India.

Table 3 shows Sri Lanka's product diversification efforts with her main 12 export destinations in year 2007. Out of these 12 destinations, eight countries are our traditional developed country markets. If we look into the product concentration among other four developing countries, ratios are 45%, 73%, 91% and 96% for India, UAE, Russia and Iran respectively. Notwithstanding that even with our traditional markets such as Belgium, Italy and Japan, Sri Lanka's product concentration ratio is at 76%, 55% and 40%, respectively. Having considered this scenario one has to appreciate the fact that India is the only developing country, which absorbs substantial amount of imports from Sri Lanka at least maintaining around 45% of product concentration ratio.

It has to be noted that it is not always good practice to analyze matters only through absolute figures. One has to take a comparative and holistic view towards the issue and then only one can identify the real issue as well as the remedies for these issues. The data in Table 3 suggests that the product diversification issue is not a matter only to the Indian market. It is a general condition that prevails in Sri Lanka and has a lot to do with the domestic front to rectify this situation. Though the FTA can contribute to a certain extent towards diversification of export product portfolio of a country, it is not 'the criteria' for export diversification.

Vanaspati, Copper and Pepper

If somebody happened to read or write any literature on FTA with India, both opponents and proponents of the FTA tend to talk about the above three products in such a way to substantiate their arguments. Proponents use these three products to show the positive results of the FTA, while opponents use these products to criticize Indian authority over the FTA. Before digging into this issue further, let's look at the export figures of these three items for the last few years.

According to Table 4, export of Vanaspati from Sri Lanka to India has increased exponentially with the implementation of the FTA. It is said that India had shown their concerns with the respective authorities in Sri Lanka on this abnormal increase in imports at early stages jeopardizing the interests of their domestic suppliers. After detailed consultations, India introduced a cap on export of Vanaspati at 250,000mt per annum with effect from June 2006 to safeguard their domestic industry interests. Here, the questions are, whether India has played the game according to the rule and how far it has affected the Sri Lankan business interests.

According to the rule, i.e. Article VIII (1) of the FTA, says, " If any product, which is the subject of preferential treatment under this Agreement, is imported into the territory of a contracting party in such a manner or in such quantities as to cause or threaten to course, serious injury in the importing contracting party, the importing contacting party may, with prior consultations except in critical circumstances, suspend provisionally without discrimination the preferential treatment accorded under the Agreement". If India really kept to this rule, they had the flexibility to totally remove the preferences granted to Vanspati in light of the Article VIII (1) of the FTA.

However, given the cordial relationship between the two countries and recognizing the smooth operation of FTA, India granted 250,000mt of quota to address the concerns of their domestic industry. With effect from June 2006, Vanaspati exports from Sri Lanka were streamlined and companies operated in Sri Lanka began to utilize the quota allocated to them. The next blow to the Vanaspati industry came at the first quarter of year 2008, where India reduced import duty on crude palm oil and Vanaspati to tame domestic inflationary effects. The reduction of import duty at the Indian side has affected the competitiveness of Sri Lankan exporters as expected and caused natural reduction in export of this product to India. The situation is purely an economic phenomenon, which has occurred as a result of a sovereign decision taken by India.

In the case of pepper, India introduced a cap of 2500mt per annum at the same period for the same reasons i.e. to protect the Indian domestic industry interest. Even though, on the face of it, this seems peculiar to the opponents of the FTA, the ground situation reveals a different story. There are two categories of pepper exports to India under two different channels. The first one is, export of light berries under special licensing scheme at zero rate of duty and the second stream is export of heavy berries under the FTA at zero rate duty. Pepper industry in Sri Lanka would vouch that, out of total pepper exports to India, around 75% is exported under special licensing scheme as light berries at zero rate of duty. This is the very reason that Sri Lanka has exported 6,628mt and 5,361mt of pepper in 2006 and 2007 respectively, even with a voluntary export restriction of export of pepper under FTA channel. The other interesting point is that the pepper industry sees this as a blessing in disguise, as this measure encouraged them to seek better markets for their pepper at a premium prices and the results have been confirmed as a success story by the industry sources.

With regard to copper, there are no such limitations even though there was a substantial increase of export (See Table 4) from Sri Lanka to India under the FTA, where India could invoke provisions under the Article on Safeguard. The copper industry was established as a trade driven industry to utilize the benefit of reduction in high tariff (tariff arbitrage) under FTA and as a matter of fact the industry is now faced with a natural peril due to the overall import tariff reduction at the Indian end.

Non Tariff Measures (NTMs)

This is an area where the countries' policy, politics and business comes into place. In order to address NTMs both countries have to move along with these three dimensions individually and collectively. It is not advisable to conclude the good or bad status of once NTMs regimes in the light of 'pick and choose' cases as it does not apply to the whole system. The writer believes that Sri Lankan authorities have been negotiating some aspects of policy related NTM's at the proposed CEPA agenda with India under the auspicious of 'mutual recognition of certifications'. Further, there is a strong political will and relationship between the two countries to address these issues as expeditiously as possible. Nonetheless, it is ultimately the business decisions that decide the extent to which they have to face with NTMs. Correct business decisions will face less or no barriers for them to enter into that market, while bad business decisions may result in facing barriers unnecessarily.

That is the reason why some companies recognise the support of Indian authorities in their exercise to penetrate market with full page paper advertisements while some others are prone to criticize the same authorities for lack of support and inefficiencies.
- Sri Lanka Guardian