Effects of South Asian Free Trade Area (SAFTA) on Intra-Regional Trade and Investment

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Effects of South Asian Free Trade Area (SAFTA) on
Intra-Regional Trade and Investment
ByAyubur Rahman Bhuyan
Organized ByIslamic Economics Research Bureau
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Introduction

• The 15th SAARC Summit of Heads of State and
  Government of the eight member countries
  reiterated the pledges of the three preceding
  Summits to fully implement the SAFTA.
• This paper dwells on the actual and potential
  economic effects of SAFTA on member economies in
  terms of the expansion of intra-regional trade
  and investment.
• It discusses the weaknesses of SAFTA that may
  impede its operationalisation and suggests
  mechanisms to make it useful and effective.

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Introduction Contd/ 1

• SAFTA Agreement was signed at the 12th SAARC
  Summit in January 2004 at Islamabad.
• Originally scheduled to start on 1 January 2006,
  SAFTA actually came into force on 1 July 2006.
• Afghanistan was made the 8th member by a decision
  of the 13th SAARC Summit in Dhaka in November
  2005.
• China , Japan, South Korea, Iran, Mauritius, the
  U.S. and the E.U. have been given observer
  status. Australia and Myanmar have expressed
  desire to be conferred observe status.

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Introduction Contd/ 2

• A major objective of SAFTA is to expand
  intra-regional trade.
• The 13th SAARC Summit pledged to convert the
  free trade area into an economic union by
  2020. The pledge has been reiterated in the 15th
  Summit held on 2-3 August 2008 in Colombo.
• The experience of SAFTA in the two years of its
  coming into force is not very encouraging,
  however.

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Trends in SAARCs Global and Intra-regional Trade
(2000-2006)

• SAARCs share in world trade is small but has
  been increasing.
• In 2006, the regions share was 1.35 in world
  exports and 2.07 in world imports.
• SAARCs intra-regional trade as proportion of its
  total trade is small 5.64 in the case of
  exports, and 3.58 in the case of imports
  (overall 4.41).
• If Afghanistans trade is included, then SAARCs
  intra-exports would be 6.65, and intra-imports
  would be 4.26 of total SAARC trade (overall
  5.18).

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Trends in SAARCs Global and Intra-regional Trade
(2000-2006) Contd/1

• Intra-regional trade of SAARC compares very
  poorly with other regions for example, 65 in
  EU, and 42 in NAFTA.
• For a region that has now the lowest level of
  intra-regional trade, the aspiration to create an
  economic union after the next decade is ambitious
  indeed.
• It is, however, satisfying to note that
  intra-regional trade annually has been increasing
  faster (_at_ 23) than the regions total trade
  (19).

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Asymmetric Pattern of Intra-regional Trade in
SAARC

• A disparate trend in intra-regional export and
  import is noticeable. Indias exports to the
  region have increased very fast, whereas all
  other member countries are net importers from the
  region.
• South Asia has become a fast-growing destination
  for Indias exports but the region remains a
  marginal source of Indias imports.
• This asymmetry owes in some measure to Indias
  restrictive trade policy but it is more due to
  the structural rigidity of the smaller economies,
  which have little to export to India.
• A primary goal of trade cooperation in South Asia
  should therefore be to encourage India to open up
  its market for imports from regional partners.

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Core Elements of SAFTA

• 1. Trade Liberalization Programme

• A Negative List approach is followed in SAFTA
  trade liberalization.
• Non-LDC members shall reduce their existing
  tariff to 20 in two years, and thereafter to
  0-5 over five years. Sri Lanka gets one extra
  year (i.e., till 2014).
• LDC members shall reduce their existing tariffs
  to 30 in two years (by 2008) and thereafter to
  0-5 in eight years (i.e., by 2016).
• Non-LDC members shall reduce their tariff on LDC
  members exports to 0-5 within 3 years.

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Core Elements of SAFTA Contd/1

• 2. Non-tariff Barriers QRs will be removed as
  soon as the tariff levels reach 0-5. There is no
  provision for removing the non-QR NTBs.
• 3. Negative List (Sensitive List in the SAFTA
  terminology) Each country will have its negative
  list of products, which will not be subject to
  tariff reduction.
• 4. Rules of Origin SAFTA rules of origin are CTH
  plus 40 domestic value addition (35 for Sri
  Lanka, and 30 for LDCs). Regional cumulation
  allows the reduction of the domestic value
  addition requirement to 20.

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Core Elements of SAFTA Contd/2
5. SDT provisions for the four LDC member
countries

• Smaller tariff reductions and longer compliance
  period for LDC member countries in the trade
  liberalization programme
• Non-LDC members are to reduce tariff on LDC
  products to 0-5 within three years of the
  Agreement coming into force
• Non-LDC members are expected to be flexible
  towards LDC members in regard to continuing QRs
  or other trade-restrictive measures
• Non-LDCs are required to facilitate LDC exports
  by taking various direct trade measures
• Non-LDCs are to extend technical assistance to
  LDCs on trade-related matters

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Core Elements of SAFTA Contd/3
6. Mechanism for Compensation of Revenue Loss
(MCRL)

• MCRL is the most important SDT provision for LDC
  members.
• Maximum of 5 of the customs duty collected by
  the LDC members from SAARC import in 2005.
  Compensation will be available for 4 years (for
  Maldives 6 years). Sri Lanka will provide
  compensation for three years.
• The rationale for compensation is open to debate.
  Transfer of technology, greater investment flows,
  and better provision of trade facilitation would
  be more beneficial in the long run.

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Core Elements of SAFTA Contd/4

• 7. Safeguard Measures Members shall have the
  right to withdraw preferences to safeguard
  domestic industry against possible injury.
• Safeguards will not apply to an LDC product if
  the share of import from LDCs is less than 5 of
  the total import of the importing country in that
  product.

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Likely Effects of SAFTA Positive Views

• SAFTA will bring significant gains for the small
  economies of the region.
• It will attract foreign capital.
• It will be a step toward better political
  relations and peace.
• Part of the informal trade will be diverted to
  official channels and bring revenue and other
  benefits.
• Elimination of tariffs will increase
  intra-regional trade by 1.6 times the existing
  trade.
• Dynamic gains will be more significant than
  static gains.

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• Likely Effects of SAFTA Negative Views

• SAFTA does not meet the standard economic
  criteria for successful integration (other than
  high pre-FTA tariff and geographical contiguity).
• Other requisite criteria are high levels of
  international trade before the formation of the
  FTA, high degree of trade complementarity, secure
  market access (no tariff, no NTBs).
• Long sensitive lists of members will lower the
  benefits of trade.
• SAFTA will benefit India the most. Some member
  countries may even lose

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Likely Effects of SAFTA Negative Views Contd/1

• Because of similar production structures in
  member countries, the expansion of intra-regional
  trade will be limited.
• SAFTA will lead to trade diversion.
• SAFTA will contribute to the Spaghetti bowl
  phenomenon, where many applicable tariff rates
  and multiple sources of origin will create
  confusion and difficulty among customs officials
  and producers.

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• Potential for Intra-regional Trade Fresh
  Empirical Evidence

• According to a recent ADB-UNCTAD study,
  complementarily indices of the four major
  countries (India, Pakistan, Bangladesh and Sri
  Lanka) have improved between 1991-1993 and
  2003-2005.
• RCA indices of these four countries in major
  products have increased between 1991 and 2004.
• Intra-industry trade indices (Grubel-Lloyd index)
  have also increased significantly.
• While, as indicated by these indices,
  intra-regional trade may increase, the potential
  benefits of trade cooperation may be different
  for different countries.

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• Potential for Intra-regional Trade Fresh
  Empirical
• Evidence Contd/1

• High welfare gains are foreseen for Bangladesh,
  attributable to the complete liberalization of
  tariffs, which generates consumption benefits for
  household consumers as well as user industries.
• A full SAFTA will help both India and Pakistan to
  double their exports to South ASIA.
• Sri Lankas trade gains are not likely to improve
  because it has already close to free access to
  the Indian market.
• Trade gains of Afghanistan, Bhutan, Maldives and
  Nepal (ABMN) are likely to be small because the
  sensitive lists of non-LDCs block the market
  access for their agricultural products.

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• Potential for Intra-regional Trade Fresh
  Empirical
• Evidence Contd/2

• The ABMN may also suffer output and employment
  losses in manufacturing because their
  manufacturing sectors are uncompetitive compared
  to other partners.
• Gravity modeling shows that SAFTA will raise
  intra-regional trade by 120 percent.
• Tariff removal alone will raise trade by 80
  percent. Additional 40 percent increase in
  intra-trade will occur if NTBs and political
  constraints that affect trade are removed.
• All countries will suffer revenue loss, but that
  loss will be compensated by trade creation,
  except Bangladesh and Nepal.

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• Effects on Foreign Direct Investment (FDI)

• SAFTA, by lowering intra-regional tariffs,
  enhances the possibility of increased FDI from
  outside the region.
• Opportunities for intra-regional investment
  increase, too, including joint ventures. Lower
  tariffs among members make FDI attractive.
• SAFTA may act as a spur to Indian investment in
  SAARC countries as the experience of Sri Lanka
  and Nepal indicates.
• SAFTA also brightens the prospect of Indian
  investment in Pakistan.

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• Implications of SAFTA for Bangladesh

• The growing trade imbalance with the region, in
  particular India, is Bangladeshs main concern.
• Bangladeshs trade gap with the region will widen
  if market access is not broadened enough.
• The industry sector feels that SAFTA will hurt
  some domestic industries but benefit a few others
  that obtain their inputs from SAARC sources.
• Economists are generally receptive of the idea of
  SAFTA but are in favour of obtaining sufficient
  safeguards for the protection and development of
  the countrys manufacturing sector.
• Indian and Pakistani investors have expressed
  keen interest in investing in Bangladesh.

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• Implications of SAFTA for Bangladesh Contd/1

• Bangladeshs sensitive list covers about 24 of
  its tariff lines, which account for 51 of its
  dutiable imports and 80 of total customs duty
  collected by Customs. Hence loss of revenue will
  be small.
• However, immediate gains from SAFTA are also
  small because most major items of Bangladesh
  exports are in the partner countries Sensitive
  Lists.
• As a small country, the chances of reaping gains
  from SAFTA are high, but the determining factors
  are true market access, shorter lists of
  sensitive products of partners, liberal rules of
  origin, increased intra-regional investment, and
  transfer of technology from the major partner
  countries.

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• Principal Constraints to SAFTA

• Most member countries have not yet notified the
  implementation of the tariff reduction deal.
• Some 80 of intra-regional imports will remain
  outside the SAFTA process because of long
  sensitive lists.
• Two separate sensitive lists by some members, one
  for LDC and the other for non-LDC members, may
  lead to the abuse of the sensitive lists.
• Tariff reduction measures adopted by various
  bilateral and multilateral treaties have not been
  reconciled with SAFTA measures.

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Principal Constraints to SAFTA Contd/1

• Long timeframe may make SAFTA irrelevant because
  other trading arrangements and bilateral FTAs
  within the region will be put into effect well
  before the SAFTA becomes operational.
• There is no clear mechanism in SAFTA to remove
  NTBs.
• There is no provision in the SAFTA treaty
  relating to the removal of non-QR NTBs.
• In the ASEAN, NTBs are removed as soon as tariff
  cuts begin. This has not happened in SAFTA,
  however.

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Principal Constraints to SAFTA Contd/2

• The double criterion of ROO is complicated, for
  which reason even the genuinely competitive LDC
  products may find it difficult to enter the
  regional market.
• Supply-side constraints are a serious impediment
  to the expansion of intra-regional trade.
• There is no provision for investment
  liberalization or for services trade, including
  the movement of labour within the region.

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Principal Constraints to SAFTA Contd/3

• Lack of political will. Pakistans refusal to
  give MFN treatment to India is a case in point.
• Unless these problems are duly addressed, the
  gains from SAFTA will be much less than expected.

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• Concluding Observations

• There have been some welcome developments in the
  recent days, which promise a better future for
  SAFTA.
• The 15th SAARC Summit underscored the need for
  implementing the SMC decision to revise the
  sensitive lists at the earliest, but agreed to
  give special consideration to LDC members.
• The Summit has also strongly urged upon Members
  to remove all non-tariff and para-tariff barriers
  and directed the SAARC Committee of Experts (COE)
  to expeditiously resolve the issues concerning
  these trade barriers.

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• Concluding Observations Contd/1

• Elimination of trade barriers, although a
  necessary condition, is not sufficient for trade
  expansion.
• Trade facilitation measures like standardization
  and harmonization of documentation procedures and
  formalities will be needed for trade expansion.
• The 15th Summit established the South Asian
  Regional Standards Organization (SARSO), which is
  an important step toward trade facilitation and
  greater economic integration in the region.

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Concluding Observations Contd/2

• There should be free flow of investment to the
  less developed member countries. To that end, the
  GEP recommendations for the establishment of a
  SAARC Investment Area, a South Asian Development
  Bank, and a South Asian Development Fund should
  be seriously considered.
• The 15th Summit adopted the SAARC Development
  Fund charter, which shall be an important
  instrument to implement regional projects that
  would yield concrete benefits to member states.
• SAFTA should include trade in services, including
  the movement of labour within the region.

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Concluding Observations Contd/3

• A draft SAFTA Framework Services Trade Agreement
  has very recently (June 2008) been prepared by
  the SAARC Secretariat with a mandate from the
  Third SAFTA Ministerial Council.
• Cooperation in other services, viz., education
  and health is also important.

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Concluding Observations Contd/4

• Coordination of macroeconomic policies fiscal,
  exchange rate and interest rate policies is a
  must
• Policy coordination is important not only in a
  customs union or an economic union but also in a
  free trade area.
• The South Asian business community has a great
  deal at stake in regional cooperation under
  SAFTA.

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Concluding Observations Contd/5

• The interest of trade and industry will be best
  served by a genuine market enlargement, which
  will increase the flow of trade, investment and
  services.
• The South Asian business community, therefore,
  have a vital interest in how the ROO can be
  improved, how the negative list can be shortened,
  and how safeguard measures are designed.
• They should, therefore, advocate and work for the
  implementation of the following recommendations

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Recommendations

• Complete the trade liberalization programme
  within, and, if possible, ahead of, the scheduled
  timeframe
• Remove NTBs within 3 years after the process of
  tariff reduction has begun
• Reduce the size of the Negative List and phase it
  out within a specified time period

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Recommendations Contd/1

• Create the GEP-recommended SAARC Investment Area,
  and the South Asian Development Bank
• Implement the decision of the 15th Summit to set
  up the South Asian Development Fund
• Liberalize services flow, including the movement
  of labour

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Recommendations Contd/2

• Persuade India, the largest and the most rapidly
  growing member country of SAFTA, to serve as a
  growth-pole for the region
• Establish a Standing Committee of SAARC Finance
  Ministers for coordination of macroeconomic
  policies, keeping in mind the goal of creating a
  Customs Union, and then, an Economic Union within
  a time-bound framework.

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• Thank you