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SAFTA : How successful has it been so far ?

Sunday Times, Sri Lanka

SAFTA : How successful has it been so far ?

23 March 2008

The South Asian Free Trade Agreement (SAFTA) signed by the members of the SAARC and implemented in July 2006, has since been a matter of concern for the countries involved, regarding how effective it is in increasing the economic wellbeing of the region in general. When it was initially signed, the goals included forming a common currency for the region and forming a Customs Union (CU) which would eventually lead to Total Economic Integration. The first stage of the agreement has been successful for only certain countries, and Sri Lanka only to some extent. Recently a survey was conducted on the quantification of the benefits of the SAFTA to the region as a whole was undertaken by The ADB and the United Nations Conference on Trade and Development (UNCTAD). The findings were discussed at a forum hosted by the Institute for Policy Studies, with the hope that some of the feedback could be included in the results, which in turn could be presented to the member governments to better their trade policies.

Comparative Advantage and Complementarities

One of the chief queries posed at the implementation of the agreement was as to how economically rational the agreement would be and whether the countries which were mainly agriculture-based economies sharing many similar characteristics could produce competition. According to Rashmi Banga, Chief Economist of the UNCTAD India, the Revealed Comparative Advantage (RCA) Index has shown that the number of items for which countries are more competitive than other countries has increased. This indicates that more trade would be possible within the region. Also, the complementarity indices have shown an increase which means essentially that the compatibility of the exports of each country has increased, as those exports being imported are more likely now.

One of the factors that contributed to this may be the fact that most of the countries have gravitated toward manufacture and industry-based economies.

For a trade agreement to be fully beneficial it should ideally afford some additional access to the country’s existing trading partners, measured by the Effective Additional Market Access or EMEA. So far estimates have shown that EAMA Sri Lanka gains from the agreement in terms of bilateral imports is 0% from India, but close to 66% from the other countries. The main reason for this would be the Indo-Lanka Free Trade Agreement that already has tariffs at an extremely low rate on trade between the two countries.

Possible increases in FDI

The influx of Foreign Direct Investment is set to increase with the agreement for a number of projected reasons : increased regional cooperation would make South Asia more attractive as a destination for investment. If an investor were to settle in one country, the low tariff rates would act as a gateway to expansion of his market. Increased intra-regional trade would reduce the security fears of investors as well. To quote the report by the ADB-UNCTAD, “higher trade openness attracts higher FDI”. The SAFTA benefits on importing intermediate goods too have shown to be healthy for investment as high import of these goods has recorded high inward FDI into the same country. Exports of goods to other areas of the country however do not seem to have any effect on the FDI situation in general.

Costs of the agreement

The survey records the main disadvantage of the SAFTA to be revenue loss caused by the tariffs being cut down to almost 0%-5%. Sri Lanka is budgeted to lose Rs. 100 million worth of revenue as a result of this. Also, the latter phases of the SAFTA (up to 2016) would produce a negative impact on the unskilled employment of the country. While all this was recorded, some of the forum members highlighted other pressing issues that affect the credibility and logic of the agreement as well as the survey.

An economist from the Ceylon Chambers of Commerce, Subhashini Abeysinghe pointed out that to understand fully the cash cost of the agreement, the loss of revenue should be recorded as a percentage of the countries’ annual revenues. She also argued that the FDI in the region had little to do with the SAFTA, and that the main investor- India -invested in the region for obvious advantages like regional dynamics and the presence of niche markets for itself.

SAFTA ignoring non tariff barriers (NTB) was brought to light by Janaka Wijeysiri, Research Economist from the IPS. “Unfortunately, no commitments have been made to remove NTBs from the SAFTA,” he said, adding that when the sensitive lists too were added into the equation, the trade potential within the region was minimized substantially. The lack of binding commitments to reduce or remove the negative lists too is a major barrier, he said.

The credibility of the models used by the ADB and UNCTAD were criticized by Upali Wickremasinghe, Professor of Economics, University of Sri Jayewardenepura, who suggested that the use of models which use past data to a great extent might not be fully beneficial. “The RCA basically analyses what has happened in the past,” he said, adding that the Trade Complementarity Index and the Gravity models used were also of the same type, “using these to project future possibilities may be elusive,” he said. The SMART model that was used from some of the data simulations depends on Infinite Supply Elasticity, which he pointed out would be tough assumption to adopt, especially for countries with supply constraints.

Political black box

The clause “according to political will” is commonly used in the SAFTA, meaning that whatever trade benefits from the tariff reductions are subject to the volatile political atmospheres of the South Asian region. Wickremasinghe referred to the clause as a “safety valve for the academics” and suggested going further into the matter.

He pointed out the animosity between certain countries, particularly India and Pakistan, was only present at tense official-level meetings and that it does not reflect in the business to business dealings or inter-personal encounters. His opinion was that this should be kept in mind, and that the SAFTA should focus on removing barriers like supply constraints instead of concentrating on “the political black box”.

Some of the other main problems faced by the SAFTA are the Trade Restriction Quotas (TRQ) and the Rules of Origin.

The ROO guidelines have been a significant bone of contention in the Indo-Lankan FTA, as many of the local companies have significant foreign ownership, and the solution remains to lower the threshold for foreign ownership.

The Tea and Apparel industries, the largest of the export sector and highest contributors to local GDP have been hampered on the other hand by TRQ’s.

Transport facilitation and Trade in Services

Increasing transport facilitation is seen as one of the main avenues of increasing the trade potential within the region. To quote the ADB-UNCTAD report, “High trade costs such as transportation charges, documentation requirements and clearance delays at the borders have a discouraging impact on trade and production similar to trade restrictions such as tariffs and quotas.”

Simplification of customs barriers and enhancing connectivity is the main objective of the SAFTA transport facilitation programme. Four main projects are underway in this initiative, one of them being the Colombo Port expansion project.

Kavita Iyenger, Regional Cooperation Specialist from the ADB said that when compared to the Jawaharlal Nehru port in Mumbai, India, the Colombo port was ranked highly in 1998 but that the ranking has fallen in 2004. Much of the traffic at the port is trans-shipment traffic and the most of it from the SA region. Currently, the survey has identified that the port requires enhancement of operational efficiency and improvement of infrastructure to reach its full potential. If Sri Lanka can finance the expenditure, the development will result in considerable economic growth in the country.

Including services in the SAFTA has always been a topic of debate and five sectors have been identified to increase trade liberalization - Health Services, Tourism and Travel, Higher Education, Construction and Telecommunications. The SAFTA countries, except Bhutan, have made commitments to liberalize trade under the GATS, and the SAFTA offers them an opportunity to widen their liberalization regionally. Liberalizing trade under the SAFTA would have a more benefits when compared to liberalizing under GATS. For instance, the results are more likely to be seen early regionally because a fewer number of countries are involved, whereas with the GATS, the whole of the WTO would be included.

Also, since trade in services is still a relatively new mechanism, the risk factor would be minimized with a small number of countries that already have Regional Corporation.

What the SAFTA is concentrating now is on Mutual Recognition Agreements. In the context of higher education, this would mean that a group of qualifications will be chosen in each country that is give cross-border recognition, so that students may be able to apply for foreign employment with local qualifications. This should be successful in improving employment and regional relations.