Integration through Trade and Investment: Experience of South Asia

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Integration through Trade and Investment
Experience of South Asia

• Rashmi Banga
• Senior Economist
• UNCTAD-India
• Asian Experience of Integration through Trade,
  Aid and Investment South Asia
• India International Centre,
• 5-6 November, 2009

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• South Asia is one of the economically most
  underdeveloped region of the world.
• South Asia has 4 LDCs, 2 Small Vulnerable
  Economies and 2 Developing Countries
• While the population of South Asia is 27 of the
  developing world, its share is 40 in the total
  number of absolute poor, 45 in the total number
  of adult illiterate females and 49 in the total
  number of malnourished children

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• Regional cooperation is seen as a step towards
  boosting growth and development in the region.
• While the steps towards regional cooperation
  began with the setting up of SAARC, they did not
  cover issues pertaining to greater economic
  cooperation and integration.
• The South Asian Free Trade Agreement (SAFTA)
  signed by the members of the SAARC and
  implemented in July 2006,

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The Agreement on SAFTA has six core elements

• Trade liberalization Programme
• Sensitive Lists
• Rules of Origin
• Non-tariff and para-tariff barriers
• Revenue Compensation Mechanism for the LDCs
• Technical Assistance for LDCs
• Inclusion of services is envisaged by 2010

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Contents

• Experience so far of regional integration in
  South Asia in terms of trade and FDI
• Economic Rationale of SAFTA
• Potential of Trade and Investments
• Challenges faced in integration through trade in
  Services
• Role of India in regional integration

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Experience so far
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• South Asia as a region has lacked behind in terms
  of its openness to trade.
• Intra-regional trade share in 2008 in the case of
  South Asia was 4.31 as against 27.06 in case of
  ASEAN.
• India has the largest share in total intra-SAARC
  exports, i.e., 74.4 percent

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Intra-Regional FDI Flows

• Though in terms of FDI inflows to the region,
  there has been significant improvement (It
  increased by 40 in 2008 as compared to 2007),
  around 80of to goes to India.
• In terms of intra-regional FDI, India is the
  largest investor in South Asia

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Intra-Regional FDI Inflows ( of country total)
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Share of Top Five Countries in South Asia
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Economic Rationale of SAFTA
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Does SAFTA make an Economic Sense?

• There exists a vast literature (e.g.,
  Samaratunga 1999 and Kemal et al. 2000) which
  show that the countries in South Asia have an
  almost an identical pattern of comparative
  advantage in a relatively narrow band of
  commodities.
• Estimated complementarity indices found that
  there is a lack of strong trade complementarity
  in the bilateral trade structures of South Asia.
• Lack of trade complementarities and similar
  competitiveness raised questions on the future
  prospects of SAFTA.

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UNCTAD-ADB Study (2008) Potential Gains from
SAFTA
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• Estimates and compares the RCAs, IIT and
  complementarity indices for two time periods,
  i.e., 1991-93 and 2004-06 for four major trading
  member countries of SAFTA, i.e., Bangladesh,
  India, Pakistan and Sri Lanka at SITC five digit
  level.
• All indices showed a substantial increase in
  2004-2006 as compared to 1991-93 indicating the
  changing realties and growing rationale for
  SAFTA.
• To estimate the gains in terms of trade by SAFTA
  the study estimated augmented gravity model

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Estimate of Potential gains in Trade

• Gravity Model has been estimated
• Log Tijt ß0 ß1 log (GDPitGDPjt) ß2 log
  Dijt ß3 log (POPit POPjt ) ß4 log (1
  Tariffjit) ß4 log (1 Tariffijt) eijt.
• Tariffs have been included in the model.
• Panel data for seven countries for a ten year
  period, i.e., 1995-2005 is used to estimate Fixed
  Effects.
• We use two step method to estimate the effects
  of distance and other dummies.
• The potential trade is difference between
  estimated bilateral trade and actual trade.

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Trade Potential in SAFTA (US Bn ) 1995-2005.

• Increase in trade which can be directly
  attributed to removal of tariffs under SAFTA is
  80 of the actual intra-regional trade from the
  predicted intra-regional trade of 120.
• This implies that apart from tariffs there exist
  other barriers to trade. Intra-regional trade may
  rise by further 40 if other factors affecting
  trade are addressed like non-tariff barriers,
  political constraints, etc.

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Impact of SAFTA on Inward FDI into South Asia.

• To capture the impact of SAFTA on inward FDI, we
  use weighted average of MFN tariffs of each
  member country with respect to other member
  countries as a group.
• To test whether FDI into the region may follow
  product fragmentation or not we estimate impact
  of other trade-related variables on inward FDI.
  These are
• exports of each member country of SAFTA to other
  member countries as a group and
• imports of each member country of SAFTA from
  other member countries as a group.

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Trade Variables used

• If higher share of SAARC in trade of a country
  attracts higher FDI it indicates that FDI may
  seek economies of scale and choose to locate in
  the country with higher access to the SAARC
  market.
• However, since the exports and imports may be of
  finished goods it may not reflect
  vertically-integrated FDI.
• We estimate the impact of imports of
  intermediate goods in a country from other member
  countries on inward FDI into the country.
• Positive impact here will indicate that a country
  which has higher share of imports from SAARC in
  its total imports will attract vertically-integrat
  ed FDI which may choose it as its destination

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Equation Estimated

• Inward FDI it a ß1 Growth of domestic market
  it ( Log GDP) ß2 Skill availability it
  (Literacy rates) ß3 Labour Cost (Efficiency
  wages) ß4 Tariffs vis-à-vis other SAFTA Members
  it ß5 Exports to other SAFTA Members it ß6
  Imports from other SAFTA Members it ß7 Number
  of BITs signed e
• A panel data for seven member countries of SAFTA
  for the period 1980-2006

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Empirical Results

• Apart from Economic fundamentals, higher trade
  openness attracts higher FDI.
• Lowering of Tariffs with respect to other SAFTA
  member may explain 30 of the rise in inward FDI.
• The imports of intermediate goods in the host
  country have a significant impact on inward FDI.
  SAFTA may therefore encourage vertically-integrate
  d FDI.

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Trade in Services in South Asia
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Composition of Trade in Services in South Asia.

• Since 2007 total exports of services have become
  higher than the total imports of services in the
  region-mainly due to India.
• Almost all South Asian countries are net
  exporters of communication services.
• Travel services are found to be an important
  service in terms of exports for almost all South
  Asian countries (apart from Bangladesh and
  Pakistan).
• All the South Asian countries are net importers
  of transport services, with India being the
  biggest importer followed by Pakistan.
• India and Pakistan are also net importers of
  insurance, financial and other business services.
  

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Economic Rationale for Boosting Inter-Regional
Trade in Services in SAFTA

• South Asian countries have comparative advantages
  in different services sectors.
• In transport services, Pakistan and Sri Lanka
  have competitive advantage.
• India has a competitive advantage in construction
  services, computer and information services and
  other commercial services.
• Maldives and Nepal are found to be more
  competitive in travel services
• Bangladesh has a higher competitive edge in
  financial services.
• Cultural and historical ties-trade in services
  easier.

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Mode Wise Competitiveness in South Asia.

• Competitiveness in Mode 4 is strongest
• South Asian countries are labour abundant
  countries
• The region is one of the most important exporters
  of services through the movement of natural
  persons (or temporary migration of workers) -
  both high skilled and low skilled (Mode 4 under
  GATS).
• In 2005, South Asia received US 32 billion as
  remittances. Across all the countries,
  remittances constitute between 2 to 12 percent of
  GDP with Nepal receiving 12.1, Sri Lanka 8.1
  and Bangladesh 5.5 of the GDP.

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Need for Improving Inter-Regional Trade in Mode 4

• At present, trade in Mode 4 is considerable small
  within the region.
• Lack of Mutual Recognition Agreements (MRAs).
  But considerable scope for MRAs within the
  region
• Five sectors have been identified by UNCTAD-ADB
  study which have considerable scope for MRAs.
• These are construction and related engineering
  services, tourism and travel related services,
  higher education services, telecommunication
  services and health services,

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Challenges in Liberalisation in Mode 3

• Provision of many services like transports,
  infrastructure, etc has been under state
  monopolies for a long time in South Asian
  countries and only in the last decade or so
  privatization of these services has taken place.
  T
• This makes provision of services by foreign
  services providers an extremely sensitive issue
  as it entails the risk of eroding not so
  competitive domestic investments in these
  services.
• Not being able to regulate the quality and prices
  of the services provided.
• With FDI, another issue of concern is the impact
  on employment in these sectors.

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Other Reasons for remaining restrictive on FDI in
services

• Countries without the necessary regulatory
  framework may lose by rushing into
  liberalization, particularly when a reversal of
  the liberalization is hard to achieve or when
  liberalization has systemic implications, as in
  the case of the financial industry.
• Entry by large service TNCs involves competition
  policy considerations, and many host countries
  may not feel ready to deal with the technical and
  legal issues involved.
• Further, it is difficult to assess the impact of
  liberalization of a particular service sector,
  especially if it employs a large number of
  unskilled people.
• Finally, it is frequently difficult to put in
  place domestic regulations
• Need to address these issues within the region.

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Benefits from Liberalisation of Services (Mode 3)
under SAFTA

• Economies of scale if firms are able to set up
  base in one country and provide services to other
  countries in the region.
• For example, in higher education services,
  intra-regional cooperation in movement of
  students and professionals can attract renowned
  universities and professional colleges to open
  campuses in any one country in South Asia.
• India can be a hub for higher education and IT
  services
• Lowers risk as compared to opening Mode 3
  multilaterally.

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Benefits from Liberalisation of Services (Mode 3)
under SAFTA

• This can provide an important learning to these
  countries in terms of binding their commitments
  in GATS. For example, opening up to the region
  i.e., in a limited way initially, may help these
  countries to adjust their domestic regulations in
  a way that assures better quality of services
  provided at competent prices.
• Given the similar levels of structural
  development, geographical proximity and cultural
  ties, it will be easier for South Asian countries
  to negotiate MRAs in services
• The impact on the economy in terms of employment
  and prices can also be examined before any
  commitment is undertaken in GATS.

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Benefits from Liberalisation of services under
SAFTA

• Finally, regional cooperation in services can
  lead to flying geese phenomenon in South Asia
  where countries specialize in different stage of
  value-chain and in the process exports of all
  concerned countries rise along with the
  specialization of the region.
• Such a value chain can be formed in information
  and technology enabled services (ITES) like BPO
  and outsourcing with countries like Bangladesh,
  Sri Lanka, Pakistan and India specializing in
  different ends of the value-chain.
• Land-locked countries like Nepal and Bhutan, can
  also be tapped in future to include them in this
  process.

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Domestic Regulations needed

• It may also lead to higher prices of services
  that were earlier available at a subsidized rate
  under public-private ownership.
• These rises in prices may translate into higher
  inflationary pressures reducing the overall
  welfare of the economies.
• To circumvent such spirals it is important for
  the region to have appropriate domestic
  regulations in place, which will assure better
  quality of services at affordable prices.
• Clear domestic regulations will also increase
  the transparency in the system and encourage
  foreign direct investments.
• Over-regulations need to be avoided in sectors
  where FDI is required, i.e., where domestic
  service-providers do not have the capability and
  capacity to fulfill excess demand,

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Role of India in Regional Integration

• Experience so far highlights the dominant role
  played by India in the region in terms of both
  trade and investments.
• India is the largest investor in the region and
  has the largest share in intra-regional exports.
• It receives the largest inflow under Mode 4
  within the region

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• Indias dominant role has led to increased
  resilience of the region towards external shocks,
  e.g., global economic crisis.
• In 2009, FDI inflows to the region did not
  decline (till March 2009) mainly because of
  India. FDI rose in 2008 as compared to 2007 in
  Pakistan, Bangladesh and Sri Lanka.
• Large potential of forming supply chains in
  Textiles and Textile Products, Auto components
  and Leather products within the region.

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Indias role in Regional Integration in Services

• Such a value chain can be formed in information
  and technology enabled services (ITES) like BPO
  and outsourcing with countries like Bangladesh,
  Sri Lanka, Pakistan and India specializing in
  different ends of the value-chain.
• Land-locked countries like Nepal and Bhutan, can
  also be tapped in future to include them in this
  process.

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But can India act as the Flying Geese of the
region given the political situation is a ?