Mahoshada

From the beginning of this year, the countries of the South Asia Association for Regional Co-operation (SAARC) have, in theory, begun to implement a new regional free trade agreement – SAFTA. (SAARC consists of India, Pakistan, Bangladesh, Nepal, Bhutan, Maldives and Sri Lanka, with Afghanistan is expected to join in the near future.)

At the 13th SAARC Summit held in Bangladesh in November 2005, the collected heads of states “stressed the importance of the entry into force of the SAFTA Agreement on the scheduled date, i.e., 1 January 2006. The launching of SAFTA would mark an important milestone on the road to a South Asian Economic Union.” The Dhaka Declaration goes on to recognize “the need to take the process of regional integration further by expanding the scope of SAFTA to include trade in services, enhanced investment and harmonized standards.”

In the pursuit of eventual elimination of the substantial economic barriers that persist between the countries of this region, the political leaders cannot be faulted for not setting their sights high enough. There would appear to be a very ambitious vision held by some of these leaders, aimed at achieving nearly complete economic integration of the South Asia region. This has led, after the failure of an earlier attempt to promote regional trade, the South Asia Preferential Trade Agreement (SAPTA), to the SAFTA, which has been pushed forward by political leaders with a determination not often seen.

Some are already looking beyond SAFTA, perhaps prematurely. There is the stated intention as a next step to expand the agreement to encompass trade in services as well as investment. (SAFTA deals only with the trade in goods.) For there visionaries, the ultimate goal is the achievement of a regional economic union, which would presumably entail a common currency, common external trade policies and the free movement of both capital and labour as well as goods throughout the region.

These are very ambitious goals indeed for a group of countries that currently has the lowest levels of trade amongst themselves of any major geographic region. And given the some of the significant limitations of the SAFTA, discussed below, one has to question the commitment of the countries in the region to genuinely expanding regional trade.

Specifically, What Will SAFTA Entail?
This is actually a very good question, especially for an international agreement that in theory has now been in force for more than a month. Although all but two countries have reportedly already ratified the Agreement (Sri Lanka and Pakistan), there has been very little information released publicly concerning the details that have been agreed.

Broadly, each country will agree to reduce import duty rates in a phased manner, so that within ten years “all” rates will be no more than 5 percent. Under SAFTA, the countries of the region fall into three groups: (i) the “developed countries” – India and Pakistan; (ii) the “least developed countries” – Bangladesh, Nepal and the Maldives; and (iii) Sri Lanka, which has been put into a separate group meant to fall somewhere between the developed and least developed countries.

During the first phase, by 1st January 2008, India, Pakistan and Sri Lanka will reduce their import duty rates to no more than 20 percent, while the LDCs will bring their rates down to no more than 30 percent. During the second phase, India and Pakistan will lower their import duty rates to the zero-5 percent range within five years; Sri Lanka within six years and the LDCs within eight years. Thus, by 1st January 2016, import duties on trade among regional countries should be virtually eliminated.

There are however (at least) two important limitations in this plan to significantly reduce regional trade barriers. The first limitation is that each country will have a “sensitive list” of goods that will be completely excluded from the process of reducing preferential import duty rates. And the numbers of goods that can be included in these sensitive lists can be quite large. While there has been no official announcement yet, it has been reported, for example, that India has put 927 goods on its sensitive list while Pakistan has included 1,183 goods, (the Dawn newspaper of Pakistan). (Note that each country’s list applies to its trade with all other member countries.)

Maybe for some the idea of excluding 900 to 1,000 goods – defined by “lines” in the tariff code – may not seem much of an accommodation if there is to be something approximating free trade is to be achieved in the region. After all, the tariff code covers more than 5,000 different types of goods. It seems reasonable that each country has some ‘sensitive’ industries that should not face increased competition – even from their relatively less competitive neighbors in the region.

But the reality is quite different. Based on recent trade for this country (2001), about two-thirds of imports could be covered by just 100 tariff lines! If Sri Lanka were to follow India’s lead and introduce a sensitive list of 927 goods, this could exclude as much as 93 percent of all imports. And since it appears that all of the countries that have been negotiating the SAFTA have agreed on long sensitive lists, it looks to be virtually certain that SAFTA will be providing preferential tariffs for only a very small share of the trade that could potentially take place in the region.

It is bad enough that SAFTA is to be launched excluding such a large share of potential trade. It is worse that the Agreement does not include any formal mechanism or requirement for countries to progressively reduce the size of their sensitive lists over time. The 2004 SAFTA Accord which established the parameters of the Agreement to be negotiated does call for sensitive lists to be reviewed at least every four years “with a view to reducing the number of items” included. However, this provision is very vague and has no teeth to require any movement from the current positions of member countries. And four years is a long time to wait to see any improvement in what could be a very weak agreement. In four years time, it is quite likely that the rest of the world and many countries in the region will have moved on.

The second major limitation is that for those goods not on the sensitive lists, there are some relatively complicated and restrictive rules that must be met if imports from regional trading partners are to be eligible for the lower import duties. These rules, known as “rules of origin”, are intended to ensure that the goods receiving preferential treatment are actually being produced within the region, and not being brought in from elsewhere. The problem is that meeting the criteria included in the rules can be difficult or impossible even though the good is genuinely produced locally. It can also be costly and time consuming for producers even to demonstrate that the goods they produce comply with the rules.

It appears that the SAFTA rules of origin will generally entail two criteria that must be met: a 30 to 40 percent ‘value added’ test and a change in tariff heading test. (In most trade agreements, it is usually the case that only one of these tests must be met.) Only time will tell how many of the goods eligible for preferential treatment among SAFTA members will be able to meet the rules of origin tests.

Regional Trade Potential
There is no doubt that there is considerable potential for the countries of South Asia to significantly expand trade within the region. Before independence trade barriers were generally very low or non-existent which led to substantial intra-regional trade taking place. During much of the last 60 years since then, most South Asian countries have either looked inwards, trying to develop industrial and agricultural production behind highly protective trade barriers, or, when they began to look outwards, they looked primarily towards the markets of the West for expanding trade opportunities.

Unfortunately, it appears very likely that the SAFTA that is soon to be implemented will in the end do little to help the region realize the potential for a return to much greater levels of trade. But that need not remain the case. It is certainly possible, if there is greater political will and understanding, to substantially strengthen SAFTA so that it can provide a foundation for economic development in the region in the years to come.

Bilateral FTAs a Viable Alternative?
Sri Lanka already has bilateral free trade agreements with the two largest economies in the region: India and Pakistan. And work is underway to both deepen and broaden the agreement with India with the adoption of what is being called a Comprehensive Economic Partnership Agreement (CEPA). This is expected not only to greatly reduce the sensitive lists limiting trade in goods, but also to reduce barriers to trade in services and regional investment.

Elsewhere, India has or is pursuing bilateral trade agreements with Nepal, Bhutan and Bangladesh, in addition to trade agreements outside of the region (such as Thailand, and ASEAN). Furthermore, a number of key countries in SAARC are also engaged in negotiations for another regional trade agreement centered around the Bay of Bengal, a group known as BIMST-EC. This group includes Bangladesh, India, Myanmar, Sri Lanka and Thailand.

These trade initiatives raise concerns that the longstanding political differences between India and Pakistan may be undermining the stated commitment to SAFTA. The net result of these alternative bilateral agreements and BIMST-EC would be something approximating free trade within the region except for Pakistan. This would of course mean compromising many of the political and economic goals intended to be achieved through much greater regional integration. (Now that Afghanistan is to be admitted to SAARC and included in the SAFTA, it may be more difficult to marginalize Pakistan’s role in the regional economic framework.)

Making SAFTA Work
There are many economic and political benefits that can be realized from much greater South Asian integration and SAFTA could be a credible step in this direction. Unfortunately, it seems that the usual bureaucratic and protectionist interests may have led to an agreement that, as it stands will do little to move towards reaping these benefits. The world is littered with failed trade agreements and unless SAFTA is strengthened, there is the likelihood that it will be added to the list. It will be one more lost opportunity for the South Asia region.

SAFTA should be strengthened in at least two important respects. First, through the introduction of a formal mechanism for reducing the sensitive lists to cover much smaller amounts of trade, ideally no more than five or ten percent of imports. Second, much less restrictive rules of origin ought to be introduced. These requirements should not be used to protect domestic interests; they should only ensure that the goods traded by member countries are substantially manufactured within those countries.

But these key parameters in the SAFTA are only half of the story. For SAFTA to make a real contribution to increasing economic growth and expanding trade in the region, much work needs to be done on improving trade facilitation. A great deal of recent research has shown that a wide range of non-tariff barriers exist, raising the costs of trade as much or more than customs duties and other charges. We will look at this ‘other half’ of the SAFTA challenge, much stronger trade facilitation measures, next week.