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com From: Paranjoy Guha Thakurta Dated: Thursday February 15, 2007 Introduction: In contrast to India’s political relations with Sri Lanka that have encountered difficult times, economic relations between the two countries have expanded impressively in recent years. Despite a number of problems, the free trade agreement between India and Sri Lanka has become a model of economic cooperation that has benefited the smaller partner relatively more than the larger one. India’s political relations with its southern neighbour Sri Lanka has had its share of difficulties: Colombo has occasionally accused New Delhi of turning a blind eye to the overt and covert material and moral support given to the Liberation Tigers of Tamil Eelam by supporters of the separatist organization in Tamil Nadu in southern India, Indian fishermen have been frequently arrested for fishing in Sri Lankan waters and there are outstanding issues relating to the settlement of Sri Lankan refugees in Tamil Nadu and the granting of citizenship to Tamil speaking persons of Indian origin in Sri Lanka. On the economic front, however, relations between the two neighbours have been on a far more even keel. In fact, India-Sri Lanka trade and investment links have deepened and widened considerably over the last seven years despite areas of contention and dispute. The signing of a free trade agreement (FTA) between the two countries that became operational in March 2000 marked a turning point in economic relations between the two countries. The FTA is considered to be a model of economic cooperation in Asia: while it has helped both countries expand trade, Sri Lanka has gained relatively more. This is arguably the most noteworthy aspect of the FTA although there have been surges in the movement of specific tradable items such as cement, copper, pepper and vegetable oil that have disrupted industries – and jobs -- in both countries. Given their geographical proximity and cultural affinities, India and Sri Lanka has historically had close economic ties. During colonial rule, the production structures of both countries were subservient to British interests. Unlike India, which started opening its economy to the rest of the world from the late-1980s and early-1990s, this process began in Sri Lanka much earlier. In 1977, the Sri Lankan rupee was unified and subjected to a managed float and this was followed by privatization and deregulation of various segments of the economy. Moreover, unlike India, international trade accounts for a substantial segment of Sri Lanka’s economy. Foreign trade as a proportion of gross domestic product (GDP) is barely one-fifth in India against three-fourth in Sri Lanka. From the late-1960s till the end of the 1990s, there were a number of inter-government joint committees or commissions to facilitate trade, investment and technical cooperation between the two countries. While the India Sri Lanka FTA was signed on December 28,
1998 by Indian Prime Minister Atal Behari Vajpayee and Sri Lankan President Chandrika Kumaratunga, it has since then, by and large, received the support of the political class in both countries even after the respective governments at that time were voted out of power. Whereas the bargaining process leading to the finalization of ‘negative lists’ of items – that is, the list of items that would be excluded from the FTA – was supposed to last only two months, the process took much longer and the FTA became operational 14 months later on March 1, 2000. During the bargaining period, fears were expressed that the Sri Lankan economy might be swamped by exports from India. In particular, Colombo appeared reluctant to give up revenues that accrued from imports of automobiles. As far as India was concerned, there were apprehensions that ‘cheap’ tea from Sri Lanka would ruin the fortunes of tea plantations, especially those in south India, and similar fears were raised about the fate of units manufacturing garments. Eventually, tariff rate quotas were imposed on trade in tea and garments – in other words, duty concessions were allowed on trade in garments and tea subject to quotas – and rules of origin were specified that were broadly aimed at encouraging the two countries to source raw materials needed for exports from each other rather than from third countries. Sri Lanka agreed to increase the ‘margin of preference’ for bulk imports of cement from India and India agreed to offer more ports of entry for Sri Lankan tea and garments. India, which was mainly exporting agricultural items to Sri Lanka until the late-1980s, is currently a major supplier of industrial goods and services. The main exports from India to Sri Lanka are transport equipment, cotton yarn , fabrics, made-up garments, primary and semi-finished iron and steel, sugar, man-made yarn, fabrics, machinery, instruments, pharmaceuticals, fine chemicals, wheat, glass and glassware, ceramics, refractories, cement and paper and wood products. India’s principal imports from Sri Lanka are nonferrous metals (mainly copper), spices (mainly pepper), refined vegetable oil or vanaspati, electronic goods, electrical machinery, scrap metal, paper pulp and chemicals. For India, Sri Lanka is a relatively small market accounting for roughly two per cent of total Indian exports and less than one per cent of total imports. India used to be the 21st destination for Sri Lankan exports in 1998 and the 16th destination in 2000 but became the 4th largest destination by 2004 and the 3rd largest the year after. Sri Lanka’s top two export destinations are the US and the UK to which countries mainly tea, garments and gems and jewellery are exported. After the implementation of the ISLFTA, Sri Lanka’s imports from India have stabilized at around 15 per cent of total imports – India is the largest source of imports for Sri Lanka followed by Singapore, Hong Kong and Iran. The most impressive outcome of the FTA agreement has been the sharp rise in the total volume of trade. Total bilateral trade between India and Sri Lanka had been more or less stagnant at around US$ 500 million a year during the second half of the 1990s. This figure doubled to $1 billion by 2002 and nearly doubled again to almost $2 billion by 2005. Close to 90 per cent of Sri Lanka’s exports to India and roughly 45 per cent of India’s exports to Sri Lanka are covered by the FTA agreement.
India’s exports to Sri Lanka rose from Indian Rupees (INR) 22.58 billion in 1999 (before the ISLFTA agreement) to INR 59.53 billion in 2004 or an annual increase of 40 per cent, while imports rose from INR 2.16 billion to INR 16.84 billion at a rate of nearly 170 per cent per year. Thus, in this five year period, India’s exports to Sri Lanka doubled while India’s imports from Sri Lankan went up fivefold. The dramatic manner in which the pattern of trade between the two countries changed is evident from the fact that the trade balance in favour of India declined from 15:1 in 1998 to 3.5:1 in 2004 (see Table 1). Despite the overall gains that accrued from the FTA, problems cropped with respect to trade in specific items. There was a spurt in exports of cement from India to Sri Lanka from INR 692 million in 2000-01 (year ending March 31) to INR 1,250 million in 200304 or more than 80 per cent in three years. The Indian market has been flooded with three commodities that can be imported duty-free under the FTA: copper, pepper and vanaspati (a cooking medium made out of vegetable oil) (see Table 2). At present, more than half of Sri Lanka’s exports to India comprise copper and copper products. Copper imports have risen from nothing to INR 4.8 billion in 2005-06. Sri Lanka now has more than 80 per cent share in India’s total imports of copper. Imports of pepper have gone up 2.8 times from INR 160.5 million in 2000-01 to INR 445.6 million in 2005-06 -- Sri Lanka’s share in total imports of pepper by India increased from 26 per cent to 37 per cent in this period. Contrary to initial expectations, exports of tea and garments have not surged. Imports of both these items are less than five per cent of the quotas specified in the FTA. In fact, Sri Lanka’s exports of tea to India have actually come down from INR 87 million in 19992000 to INR 38.9 million in 2005-06. Sri Lanka’s share of total tea imports by India crashed from 34 per cent to barely 3.7 per cent in this period. This was indeed an unexpected development. India is the world’s largest producer of black tea and Sri Lanka is the world’s largest exporter – together the two countries account for roughly 60 per cent of world tea exports. The most contentious issue that has plagued the FTA has been exports of vanaspati from Sri Lanka to India. Since Sri Lanka does not levy any customs duty on imported palm oil that is used in the manufacture of vanaspati, margarine and bakery shortening, ten manufacturing units came up in Sri Lanka (with an investment of around $ 100 million) after the FTA became operational to specifically export these items to India at low prices. Interestingly, most of these units were set up Indian businessmen. Exports of vanaspati went up from 80,000 tonnes in 2002 to 165,000 tonnes in 2005 – by which year Sri Lankan vanaspati was accounting for around one-sixth of India’s total annual vanaspati market of 1.4 million tonnes. In value terms, vanaspati exports from Sri Lanka to India rose from INR 0.12 million in 2001-02 to INR 6.59 billion in 2005-06 -- Sri Lanka’s share in total imports of vanaspati by India jumped from nothing to 63 per cent in 200506. In June 2006, after more than 100,000 tonnes of vanasapati had been exported, the Indian government decided to canalize all imports through the National Agricultural
Cooperative Marketing Federation (or NAFED). The ten vanaspati units shut down operations and the owners raised a hue and cry about the Indian government’s “unilateral” decision to raise this non-tariff barrier in “violation of the spirit of the FTA”. The FTA specifies that up to a limit of 250,000 tonnes of vanaspati can be exported from Sri Lanka to India. While the Commerce Ministry in New Delhi contends that this quantity is adequate to ensure capacity utilization, vanaspati manufacturers in Sri Lanka claim the quota can be finished in six months. This dispute remains unresolved and could crop up again. The other major problem that remains pending is a subsidy claim of INR 7 billion made by LankaIOC, the Sri Lankan affiliate of the government-owned Indian Oil Corporation, one of India’s largest public sector corporations. The subsidy claim made by LankaIOC – that controls roughly one-third of retail sales of petroleum products in that country – is being disputed by the Sri Lankan government and no solution appears to be in sight. Sri Lankan Commerce Minister Jeyraj Fernandopulle has voiced complaints from his country’s exporters about local taxes (entry tax and additional sales tax) that have been imposed by the Tamil Nadu government and corruption among Indian customs officials. India’s High Commissioner to Sri Lanka Nirupama Rao has hoped that the quality of Indian investments in Sri Lanka would improve to create more jobs. A study conducted by the New Delhi think-tank, Indian Council for Research on International Economic Relations (ICRIER) has pointed out some of the problems Indian investors face in Sri Lanka – these include political instability, high licence fees, local staffing requirements, shortage of skilled personnel, bureaucratic delays and restrictions on importing equipment. Despite these glitches, there is much to be lauded about India’s economic relations with Sri Lanka. India became the largest foreign direct investor in Sri Lanka in 2003 and 2004 with investments of around $ 200 million and is currently in 4th position after Singapore, the UK and Australia. (Sri Lanka’s Board of Investment has approved over 140 projects involving an investment in excess of $ 400 million.) Major Indian investments in Sri Lanka include a 300 megawatt power plant being established by two large Indian stateowned enterprises, National Thermal Power Corporation and Bharat Heavy Electricals Limited (at Colombo’s invitation). India’s Oil & Natural Gas Corporation, the Ministry of Railways and the Delhi Metro Rail Corporation are looking at possible collaborative ventures. India is also engaged in building various hospitals and educational institutions in Sri Lanka and was expeditious in providing relief and assistance to those in Sri Lanka affected by the December 2005 tsunami. Sri Lankan investments in India are relatively smaller but have taken place in units producing biscuits, apparel, pre-fabricated furniture and stainless steel. Motor vehicles and fuel oils each account for roughly one-fifth of India’s exports to Sri Lanka. India hopes to include small cars in the FTA in the hope of stepping up sales of passenger vehicles with an engine capacity of up to 1,300 cc to Sri Lanka once such exports become duty free.
It is argued that India could reap re-export benefits through Sri Lanka that has been granted “GSP plus” – GSP stands for generalized scheme of preferences – status by Europe thereby enabling it to export at relatively low duty rates. Further, the FTA between Pakistan and Sri Lanka (that came into operation in June 2005) could help Sri Lanka position itself as a conduit for much of India-Pakistan trade that gets surreptitiously diverted through Dubai and Singapore. By the middle of 2007, India and Sri Lanka hope to sign a comprehensive economic partnership agreement (CEPA) that would incorporate existing bilateral agreements on avoidance of double taxation and investment protection, besides cooperation in air services, tourism, small enterprises, space, information technology and agriculture. In addition, the proposed CEPA would expand the scope of the FTA and include in its purview, investments and trade in services. Towards this end, the ICRIER report has suggested relaxation of the visa regime, reduction in telecommunication charges and encouragement of greater movement of professionals. What is clear is that the trade and investments baskets need to be diversified. Automotive components and pharmaceuticals are two areas offering investment opportunities for Indian firms in Sri Lanka. Overall trade could pick up through introduction of new ferry services between Tuticorin and Colombo. Referring to the India-Sri Lanka FTA, Indian Prime Minister Manmohan Singh has stated that “smaller and poorer countries benefit more from RTAs (regional trade agreements) as their trade becomes more balanced”. At a time when multilateral trade negotiations at the World Trade Organization are stuck -- primarily on account of deep divisions between the US and Europe on the one hand and developing countries on the other, on the issue of reduction in trade-distorting agricultural subsidies – it is not surprising that more RTAs are becoming operational. In South and South-East Asia, FTAs are slowly but surely becoming more popular despite making halting progress on account of individual governments remaining protectionist, especially with regard to trade in items of common export interest in a highly-competitive market environment. The case of the India Sri Lanka FTA indicates that such agreements could result in more opportunities being created rather than threats. (Research assistance for this article was provided by Pratibha Mahindru.) (Ends.) Word count: 2,428
Table 1: Sri Lanka's Trade with India: Before and After the FTA Year Imports Exports Import/Export Ratio (Rs/Million) (Rs/Milion) 1998 35,522.9 2,279.4 15.0 : 1 2000 45,477.1 4,217.3 11.0 : 1 2001 53,750.0 6,265.7 8.6 : 1 2002 79,847.1 16,152.9 4.9 : 1 2003 103,871.7 23,275.1 4.5 : 1 2004 137,403.9 39,004.4 3.5 : 1
Source: Sri Lanka Customs
Table 2: India’s Imports from Sri Lanka: Selected Items
Pepper Imports (Rs Mn) Sri Lanka Total Imports % Share Tea Imports (Rs Mn) Sri Lanka Total Imports % Share Copper Imports (Rs Mn) Sri Lanka Total Imports % Share 3,371.6 0 0.00 916.56 0.00 199900 0.00 200001 0.00 20001-02 152.64 631.92 24.15 2002-03 2003-04 2004-05 2005-06 335.60 3,368.35 4,722.91 4,807.0 0 1,135.50 4,833.64 5,819.84 8,024.59 29.55 69.69 81.15 59.90 199900 87.33 255.43 34.19 200001 70.98 424.21 16.73 20001-02 114.61 661.14 17.33 2002-03 42.875 1,234.78 3.47 2003-04 31.687 630.10 5.03 2004-05 49.115 1,453.35 3.38 2005-06 38.978 1,071.18 3.64 199900 307.69 513.63 59.91 200001 279.07 609.99 45.75 2001-02 160.51 607.52 26.42 2002-03 570.54 1,338.20 42.63 2003-04 352.57 1,123.14 31.39 2004-05 357.85 1,084.58 32.99 2005-06 445.54 1,210.15 36.82
Vegetable Oil/Vanaspati 19992000Imports (Rs Mn) 00 01 Sri Lanka Total Imports % Share
2001-02 0.12 2,820.17 0.00
2002-03 0.00 1,523.89 0.00
2003-04 0.00 1,197.96 0.00
2004-05 869.14 2,216.75 39.21
2005-06 6,588.47 10,467.04 62.94
Source: Ministry of Commerce, Government of India
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