India-Sri Lanka Bilateral Free Trade
Agreement:
Sri Lankan Perspective and Implications
Saman Kelegama
Institute of Policy Studies of Sri Lanka
Presentation to the ‘Asian Regional Workshop on Free Trade
Agreements: Towards Inclusive Trade Policies in Post-Crisis Asia’,
jointly organized by IDEAS, GSEI, & ITD, Bangkok, 8-9 December
2009
Outline of Presentation
 Introduction
 Recent Trends in Indo-Lanka Economic Relations:

Trade
 Positive
Outcomes
 Negative

Investment

Services
Outcomes
 Role Played by the ILFTA in Crisis Situations
 CEPA: Looking Beyond the FTA
 Opportunities through CEPA
 Conclusion
Introduction
 Economic relations between India and Sri Lanka, which date back to
pre-colonial times, began to pickup in the 1990s with the
liberalization of the Indian economy
 The year 1998 saw the biggest boost in economic relations when
the two countries signed a bilateral Indo-Lanka Free Trade
Agreement (ILFTA), which began implementation in March 2000
 Among other factors, contemporary political forces led to the
signing of the Agreement
 The ILFTA was formulated based on the “negative list” approach;
each country extending concessions/preferences to all commodities
except those indicated in its negative list
 The two countries agreed for preferential treatment on 5112 tariff
lines & an 8-year time table was devised for phasing out tariffs
 NTBs (Indian state taxes) were also to be removed gradually
 Asymmetry between the two countries was accommodated by
special & differential treatment (SDT)
Introduction Cont.
SDT for Sri Lanka
 Larger negative list (SL agriculture sector fully protected)
 The immediate duty-free list (319 items) and 50% preferential duty
list (889 items) were considerably smaller than those offered by
India (1351 items and 2799 items respectively), while the Sri
Lankan negative list (1180 items) was considerably lager than
India’s (196 items)
 Relaxed Rules of Origin (ROO) – 35% (25% if Indian imports used)
 Longer tariff phase-out period (8 yrs for SL & 3 yrs for India)
 Negative list reduction based on SL’s comfort level
 Revenue compensation excluded, but SL insisted that high revenue
import items will not be subject to tariff preferences (M duties = 2%
of GDP revenue)
Recent Trends in Indo-Lanka Economic Relations
Trade
 In the period immediately preceding the Agreement (1995-2000),
average annual exports from SL to India were US$ 39mn & annual
average imports were US$ 509mn
 India was an important source of imports even prior to the
Agreement – by 2000, India was already the second largest source of
imports to SL after Japan
 But India was not a major export market prior to the ILFTA – it was
the 14th rank in export destinations in 2000
 SL’s trade with India changed dramatically following the
implementation of the FTA in 2000
 India fully implemented the Agreement by March 2003, and SL did so
by October 2008 – longer time frame for the latter given economic
asymmetries between the two countries

Outcome of 9 Years: 1999-2008
1999
2005
2008
SL exports to India
1%
9%
5%
SL imports from
India
Import/Export ratio
8.5%
17%
25%
10.5:1
2.6:1
8.2:1
1062
869
Dominated by
vanaspathi &
copper
VA products: insulated
wires & cables, refined
copper products,
rubber gloves, apparel
3
5
16%
14%
No of products from
505
SL
Type of exports
Many primary
products:
pepper, areca
nuts, waste &
scrap, dried
fruit, cloves
Rank of export
14
destination
Ind investment in
Less than 2%
SL (% of total FDI)
Positive Outcomes: Rapid Growth in Overall Trade
 By 2005, Sri Lanka’s exports to India reached a peak of US$ 566.4,
a tenfold increase compared to 2000, and stood at US$ 418.3
million in 2008. India was the 5th largest destination for Sri Lanka’s
exports in 2008
 Imports too have grown at a rapid rate following the
implementation of the FTA. Imports from India which amounted to
US$ 600.1 million in 2000 reached US$ 3443 billion in 2008, a
growth by 5.7 fold
 An aggregate view of trade between India and Sri Lanka since the
FTA came into being thus suggests a very positive picture with
overall trade growing close to six fold and exports from Sri Lanka
growing ten fold
 Furthermore, the increased diversity and greater value addition in
exports from Sri Lanka is a positive development
India-Sri Lanka Trade: 1995-2008
Year
Exports
(US$ Mn)
Imports
(US$ Mn)
Trade Balance
(US$ Mn)
Import/Export
Ratio
1995-1999
average
39
509
-470
13.1:1
2000
58.0
600.1
-542.1
10.3:1
2001
72.0
601.5
-529.5
8.4:1
2002
170.5
852.8
-682.3
5.0:1
2003
245.3
1073.2
-827.9
4.4:1
2004
391.5
1439.1
-1047.6
3.7:1
2005
566.4
1835.4
-1269.0
3.2:1
2006
489.5
2172.9
-1690.4
4.4:1
2007
515.3
2610.1
-2094.8
5.1:1
2008
418.3
3443.0
-3024.7
8.2:1
Source: Central Bank of Sri Lanka
Negative Outcomes: Lopsided Trade
 While an aggregate view of trade between India & SL since the FTA
came into being suggests a very positive picture, a more
disaggregated analysis reveals a not so positive story
 While exports from SL to India peaked at US$ 566.4 Mn in 2005,
these exports were largely concentrated in two products – copper &
vanaspathi (49.66%)
SL's Main Exports to India: 2005
Copper & copper
products
Vanaspathi
Aluminium products
Electrical machinery
& parts
Antibiotics
Cloves
Iron & steel products
Pepper
Negative Outcomes Cont.
 If vanaspathi & copper were excluded from the trade figures, SL’s
exports to India would have increased from US$ 58 Mn in 2000 to
just US$ 278 Mn in 2006 – a five-fold increase compared to the tenfold increase with vanaspathi & copper
 Vanaspathi & copper are a problem since these exports arose not
due to any distinct comparative advantage that SL held, but due to
short-term tariff arbitration by Indian manufacturers investing in SL
 The viability of the industry was only as long as there was a
discrepancy between Indian & SL tariffs on palm oil imports
 In response to the increase in global commodity prices in 2007/08,
India cut import taxes on food imports including palm oil, making
vanaspathi exports from SL unviable
 Accordingly, vanaspathi exports in 2008 were US$ 31.96 Mn, a fall
of 78% from exports in 2007 which amounted to US$ 145.32 Mn
 Vanaspathi exports are expected to be non-existent in 2009
Negative Outcomes Cont.
 Copper exports from SL were also subject to much scrutiny from
India, based on their low domestic value addition, arguing that they
were under-invoiced
 India insisted that pricing should be done based on the London
Metal Exchange Prices, and since then a large proportion of copper
exports were deemed ineligible
 Copper exports were severely affected, with exports falling from
US$ 145 Mn in 2005 to US$ 13 million in 2008
 Both copper & vanaspathi exports were not seen very favourably in
SL as well, since both entailed a high import content, limited
employment creation & environmental concerns
 The collapse of vanaspathi & copper exports in 2008 led to the
substantial decline in total SL exports to India in 2008 to US$ 418
Mn – a 26% fall in export value since the peak in 2005
Sri Lanka’s Top Ten Exports to India: 2006-2008
Description
Value (US$ Mn)
2006
2007
2008
Insulated wire, cable & other
electric conductors
33.145
38.105
40.694
Rubber & articles thereof
19.020
35.440
33.647
Vegetable fats & oil – vanaspathi
79.692
145.320
31.961
Cloves
11.780
8.357
29.116
Boilers & machinery & parts
9.019
9.352
18.118
Pulp
11.494
14.732
17.899
Diamonds & other precious stones
1.226
5.574
16.782
Pepper
11.981
19.229
16.578
Copper & articles thereof
93.253
26.919
12.817
Furniture, lamps & fittings
6.426
8.450
9.574
Source: Sri Lanka Customs
Negative Outcomes: Inherent Weaknesses in the FTA
 Given that the results of the ILFTA have not been entirely positive
from a Sri Lankan perspective, a key question is: why hasn’t there
been a greater positive impact on the SL economy as a result of the
ILFTA?
 Critics of the ILFTA have argued that there are inherent weaknesses
in the Agreement that make it very challenging for SL exporters to
compete in the Indian market, such as:
 TRQs on major exports – tea, garments & textiles which make up
58% of SL’s total exports have been placed under quotas in the FTA
 Rules of Origin – besides stringent ROO within TRQs for garments,
requiring a CTH at the 4-digit level has been burdensome for certain
SL exports
 NTBs – NTBs such as state taxes, quality requirements &
administrative procedures have hindered the entering of SL
exporters into the Indian market
 Unilateral imposition of quotas - in 2006 India unilaterally reduced
the quota on vanaspathi exports to 100000 MT from 250000 MT.
Similar problems have occurred in exports such as bakery
shortenings, pepper & copper
Negative Outcomes Cont.
 Anecdotal evidence also suggests that delays at customs &
bureaucratic red tapes continue to hinder export penetration from SL
to India
 TRQs, ROOs & NTBs have thus diluted the special & differential
treatment (SDT) offered by Indian to SL
 However, SL industrialists are also to be blamed – they have not put
in an extra effort to study the Indian market
 SL has adhered to the spirit of the ILFTA & has not imposed any TRQs
despite pressure from certain SMIs
 However many of these conflicts have been addressed in ensuing
negotiations for the Indo-Lanka CEPA, such as restrictions on ports of
entry & quotas on the export of certain products from SL to India
 Port restrictions on tea imports were removed in June 2007 and 3 Mn
garments were allowed duty free without sourcing requirements
 As a result, garment exports from SL to India have increased from
US$ 0.156 Mn in 2002 to US$ 4.194 Mn in 2007
Expanding Trade Deficit
 Whilst total trade between the two countries has increased
substantially, the absolute trade deficit has also increased
 This has been driven largely by increasing oil prices (which made up
almost a third of import value from India in 2008) & a fall in SL
exports to India (vanaspathi & copper)
India-Sri Lanka Trade: 1 9 9 9 -2 0 0 8
4000
Exports
2000
Imports
1000
Year
20
08
20
07
20
06
20
05
20
04
20
03
20
02
20
01
20
00
0
19
99
US$ Mn
3000
Trade Deficit Cont.
 It is possible that non-petroleum imports from India would also grow
at a faster rate in the coming years with full liberalization of trade
with India (other than items in the negative list) in October 2008
 However, the bulk of Indian imports into SL are not influenced by
the FTA – over 65% of SL’s import value from India is from products
either in the negative list or exempt from MFN duty
 According to the DOC, Sri Lanka’s imports under the FTA were only
about 14% of the country’s total imports from India in 2007
FTA Treatment of Top 10 Imports from India in 2008
HS Code
Product
Status
27
Petroleum
Negative List
87
Vehicles & Parts
Negative List
17019901
Sugar
Negative List
52
Cotton
MFN Duty Free
72
Iron & Steel
Negative List
30
Pharmaceutical products
MFN (0-2.5) Duty
48
Paper & paper board
Negative List
740811
Copper wire
ILFTA duty free
230400
Olicake & other solid residues
ILFTA residual list (70%
duty waiver) until 7th Nov
2008, since then duty free
Source: Ceylon Chamber of Commerce Trade Newsletter & Dept of Commerce
Trade Deficit Cont.
 This analysis suggests that growth of the trade deficit between India &
SL is not largely a result of the FTA
 Normal trade patterns may have resulted in an even wider trade deficit
since the FTA has provided some scope for SL exports to India
 While in general exports to India have been skewed with the dominance
of vanaspathi & copper, there has been rapid growth in exports of a few
other products which have been able to capture niches in the Indian
market
US$ Mn
Selected Exports to India: 2003-2008
45
40
35
30
25
20
15
10
5
0
Rubber & Articles
thereof
Furniture, Lamps &
Fittings
Insulated wire, Cable
& other electrical
conductors
2003 2004 2005 2006 2007 2008
Year
Daimonds & other
precious stones
Investment
 Indian investment into SL has also increased significantly since the
FTA came into operation
 Between 1978 & 1995, Indian investment accounted for 1.2% of
total FDI
 Cumulative Indian investment which was a mere US$ 1.437 Mn in
1998 increased to US$ 125.925 Mn by 2008, contributing to 14% of
total FDI flows to SL
 India is now the second biggest investor in SL, exceeded only by
Malaysia
 The bulk of Indian investment (63%) in SL in recent years has been
in the services sector – telecommunications (Bharti Airtel), health
(Apollo Hospitals), retail services (Lanka Oil Company), energy,
hospitality (Taj Hotels) and air transport services (Jet Airways)
 As of the end of 2007, Indian investment resulted in over 70
projects, employing 6747 individuals
Indian Investment in Sri Lanka: 1993-2007
Source: Samarajiva and Herath (2008)
Investment Cont.
 However much of the investment that came into SL was associated
with products such as vanaspathi & copper, as foreign investors
from India & third parties saw an opportunity to break into India’s
market through SL
 Employment creation was also limited – according to the BOI,
though 5900 jobs were created as a result of Indian investment, this
includes 1500 employees in the Indian Oil Company retail outlets
 This entailed re-hiring staff from the Ceylon Petroleum Cooperationowned outlets, rather than creation of new jobs
 The dominance of services suggests that the impact of the FTA
(which only deals with trade in goods) on the investment decision is
limited
 Yet, the surge of investment between 2000 & 2008 has been
influenced by increased economic ties between the two countries &
increased investor confidence as a result of the FTA
Services
 The extent of commercial services exchange between the two
countries has increased in the post-FTA period as demonstrated by
the following examples:
 Many SL students & patients travel to India to purchase education &
health services each year
 Approximately 70% of Colombo port’s income is from transshipment
earnings from India
 Approximately 40% of SL airlines’ revenue is from the Indian market
(SL Airlines)
 SL IT firms have provided technical solutions to Indian companies
(interblocks sold internet banking solution to Indian banks,
Microimage sold Tamil SMS adaptation to Bharti Airtel)
 SL tourist sector firms such as Aitken Spence & Jetwing have ventured
into the Indian market
 India has become the largest source of tourists to SL
 Tourist arrivals from India grew rapidly at 20.9% per annum during
2000-2007 & accounted for 19.4% of the market share in 2008
Role Played by the ILFTA in Crisis Situations
 After the global financial & food crises & in the context of the ongoing
economic slowdown, it is important to examine whether the ILFTA has
played any role in attenuating the crisis and recovery effects in the SL
economy
 The main role played by the FTA in the face of the crisis has been in
providing cheap Indian imports to SL consumers, such as oil, vehicles,
watches & pharmaceutical products, when prices are on the rise in other
countries
 The fact that the Indian economy has remained relatively unaffected by
the economic downturn has been an additional advantage
 Geographical proximity has enabled savings on transport-related costs
 However, such advantages are prevalent with or without crises – it
appears that the ILFTA has not played any particularly significant role in
mitigating the impacts of the financial & food crises
 It is thus important to look beyond the FTA in order to promote more
cooperation which will enable the two countries to follow more inclusive &
sustainable development policies & provide necessary safeguards against
future crises
CEPA: Looking Beyond the FTA
 Given the early success of the FTA, both parties were aware of the
importance & benefits of broader economic integration
 Based on the recommendations of the JSG report, it was decided to
include trade in services, investment & economic cooperation, along
with further liberalization of the goods sector, under the ambit of a
Comprehensive Economic Partnership Agreement (CEPA)
 Negotiations of the CEPA began in 2005, & after 3 years of
negotiations the CEPA Agreement framework was scheduled to be
signed in July 2008
 But due to reservations expressed by a group of local industrialists & a
political party, the CEPA was not signed & has remained in limbo since
then
 Reservations were based on 2 broad concerns: about the nature of
the CEPA itself & that the drawbacks in the FTA should be dealt with
first, prior to embarking on a CEPA
CEPA Cont.
 But critics failed to take into account the fact that like the FTA, the
CEPA also made room for economic asymmetry between the two
countries & accorded SDT to SL
 The 2nd concern, that the shortcomings in the FTA should be
addressed before CEPA, is counterproductive – the CEPA was
negotiated with the very objective of addressing the shortcomings in
the FTA (removal of port restrictions & ROO requirements in
garments)
 Also, increasing exports to India requires a general change in
perceptions & preferences of SL exporters – a process that will take
time
 With the CEPA negotiations being stopped, the only forum for
addressing the shortcomings of the FTA has closed
 Given the fact of geographic proximity and socio-political and
historical relations between the two countries, economic exchange
is inevitable
Opportunities for Sri Lanka through CEPA
 In the context of Sri Lanka continuing to have a concentrated export
basket, both in terms of destination (US & EU) and products
(garments & tea), export diversification becomes essential
 This necessity has been highlighted in the recent global financial
crisis as Sri Lanka became particularly vulnerable given the
concentration of exports to the most adversely affected markets
 Whilst the US & EU markets have faced a recession, emerging
markets such as India and China have managed to sustain some
degree of economic growth despite the global downturn
 The Indian economy, which grew at 5.3% even in the fourth quarter
of 2008, and is growing at around 7% in 2009, is likely to be among
the least affected by the crisis
 Had Sri Lanka maintained a more diverse export basket, the country
would have been less vulnerable to external shocks
Opportunities through CEPA Cont.
 The ILFTA has somewhat helped in shifting Sri Lanka’s trade towards
alternative emerging markets by encouraging exporters to move
beyond their traditional buyers
 Given Sri Lanka’s proximity and long-standing relationship with India,
the country is in an ideal position to take advantage in the shift in
global economic powers towards the East
 The CEPA should be seen as an attempt to manage Sri Lanka’s
trading relationship with India. The Agreement provides a legal
framework which defines the rules and regulations under which trade
occurs between the two countries
 While countries continue to move ahead with negotiations at various
levels, the multiple and overlapping agreements of such negotiations
can involve considerable transactions costs
 For example, SL has entered into bilateral and regional negotiations
in the South Asian region such as the ILFTA, SAFTA, and APTA, each
involving different rules of origins, tariff preferences, etc
Opportunities through CEPA Cont.
 In the absence of progress in regional frameworks such as SAFTA,
the best option available to Sri Lanka is a bilateral framework within a
rule-based disciplinary framework
 Given the fact that India is currently negotiating and implementing a
number of bilateral trade agreements with much larger economies
such as Japan and the EU, it would be unwise to delay or reopen the
already negotiated CEPA
 Also, given the slow progress of the WTO services negotiations, SL
stands to benefit from early access to the large and growing Indian
services sector by engaging in the CEPA
 It is also possible that access to the Indian market may attract
investment from third parties into Sri Lanka, looking to export
services to Indians through joint ventures with Sri Lankan firms
 Given Sri Lanka’s limited domestic market, the required economies of
scale can never be achieved without sufficient international
integration. In the present climate, there is no better opportunity
than the Indian market
Opportunities through CEPA Cont.
 Several SL firms such as Damro have successfully entered the
Indian market
 It is important to realize that India is becoming increasingly open to
foreign economic integration – in 2007 FDI into SL amounted to
almost US$ 25 Bn & imports were over US$ 180 Bn
 Given that the rest of the world is able to get a foothold in India, SL
firms need to be more positive & look to do the same
 Whilst there will undoubtedly be cases of failure, this has to be
expected given the fact that Indian is not an easy market to enter
 CEPA could be used as an opportunity to deal with such problems
 It is not too late for SL to engage with the Indian market through
CEPA – the agreement is an opportunity not to be wasted
Opportunities through CEPA Cont.
 The experience of the current crisis has stressed the need for more
inclusive and equitable trade and growth policies
 The CEPA is important in this context, as increased importing of
services such as health and education from India at a reasonably low
cost is beneficial to the lower and middle-income Sri Lankans who
face domestic supply constraints
 While wealthy Sri Lankans can obtain these services from Singapore,
Europe and the US, India is the only option for the poorer population
 The most effective trade policy response to high food prices over the
long-term is greater (agricultural) trade liberalization that would allow
new supplies to emerge, particularly in developing countries
 Increased access to new technology and investment is also important
in modernizing and improving productivity in the agricultural sector
 By providing deeper integration of the two economies, the CEPA will
facilitate more investment and technology flows from India to Sri
Lanka, thereby providing scope for development of the agricultural
sector in responding to the food crisis
Conclusion
 It is important to rectify the shortcomings of the FTA & build on its
achievements
 The key opportunity is to tap into the large and dynamic Indian
market, by moving beyond the ILFTA towards broader economic
integration
 The CEPA, implemented with proper regulatory mechanisms in order
to accommodate the disparity between the countries, provides an
opportunity for SL to integrate more closely with the Indian economy
 Deep economic integration with a fast-moving economy like India
could contribute to stimulating growth rates in SL
 Today, as an economic crisis grips Sri Lanka’s traditional export
markets and a food price crisis engulfs the global economy, SL should
view India as an opportunity and not a threat, and strive towards
more meaningful cooperation in facilitating inclusive and equitable
development policies
Thank You
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