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A Dissertation submitted in partial fulfillment of the Import and Export Management Related to Logistics (BSC-LOG- 4104) Module of B Sc in Business

Management (Special) Degree

By K V D H S Kalutarawithana (BSC-UGC-MGT-09-1-041)

National School of Business Management 9th January 2013

ACKNOWLEGEMENT

I appreciate the opportunity given by National School of Business Management to pursue research on this important topic.

Foremost of all I would like to express my indebtedness and special gratitude to Mr. Mahinda Ramanayake (Director-Investor Services, Board of Investment), my supervisor who guided me to become success. His insightful criticism, scholarly comments and academic challenges were an invaluable inspiration in the completion and quality of this Report.

TABLE OF CONTENT

Introduction

4-7

Trade Relation between India and Sri Lanka

8-11

Trade Trends in India-Sri Lanka Free Trade Agreement

12-13

Determinants for the Trade Imbalance of Sri Lanka

14-15

Conclusions and Recommendations

16-17

References

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CHAPTER 1 INTRODUCTION

India-Sri Lanka Free Trade Agreement


The World Trade Organization (WTO) that was established in 1995 introduced rules for international trade and all local measures affecting such trade. These rules are valid for multilateral trade as well as bilateral and regional trade conducted among the member countries. The WTO, in fact, does not endorse regional or bilateral trade agreements among countries unless they allow substantial levels of trade liberalization over reasonable periods of times that go well beyond the commitments of trade liberalization made by countries at the WTO. The Free Trade approach requires countries to give up various measures they use to safeguard interests of the local farmers and industrialists, convert all such measures to an imposable duty and then reduce that imposable duty to zero over a period of time. Therefore the WTO allows bilateral and regional trade agreements only if these agreements result in accelerating the process of duty elimination. The Indo-Lanka Free Trade Agreement (ISFTA), which was signed on 28th December 1998 at the highest political level and its subsequent implementation in 1st March 2000, marked an important milestone in IndiaSri Lanka relations and in trade relations in particular, as it concretized and paved the way for closer economic integration. The agreement covers only trade in goods and requires the two countries to offer market access for each others exports on duty free basis and concessionary tariffs. The ISFTA does not provide for elimination of non tariff barriers.

This report provides a quantitative assessment of the impact of the ISFTA on macroeconomic variables, welfare and trade imbalance on the Sri Lankan economy. In addition, the study investigates the impact of trade liberalization on trade structure, bilateral trade between Sri Lanka and India and trade partners of Sri Lanka. The results indicated that both Sri Lanka and India will experience welfare gains from the ISFTA. Moreover, it was evident that the Indo-Lanka full trade liberalization scenario ensures higher welfare to both the countries than the Indo-Lanka FTA with negative lists. Hence, the scenario with negative lists could be treated as a second best solution as withnegative-lists scenario where both the countries could not reap the maximum benefits under the FTA. The simulations results demonstrate that trade diversion effects are not much significant due to trade liberalization between the two countries. The industry analysis reflected that the industries, such as metal products, paper products and publishing, electronic equipment, chemical, rubber and plastic products, machinery and equipment necessaries and other primary products will benefit due to the ISFTA. However, it could be seen that the industrial sector is benefiting more than the agricultural sector due to trade liberalization between the two countries. The ISFTA 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. Taking into account the asymmetry between the two countries, Sri Lanka was accorded special and differential treatment. Rules of origin (ROO) criteria were also relaxed in Sri Lankas favor.

Trade Liberalization
Under the ISFTA, India and Sri Lanka have agreed to offer Zero duty for all products except those in their negative lists, during a period of 3 year an 8 years respectively. The shorter time frame given to India and longer time frame given to Sri Lanka for lowering their tariffs for each other exporters have been agreed upon taking into account the asymmetries prevalent between the two economics. Similarly, the negative list of India contains only 433 tariffs lines, while Sri Lankas negative list includes over 1200 tariff lines. The ISFTA which follows the trade liberalization rules set by the WTO is considered to be a relatively strong agreement in the Asia-Pacific region with substantial product coverage (about 80 percent of tariff lines coming under the HS product classification code at 6 digit level), significant tariff cuts and relatively simple Rules of Origin. Consequent to the economic sanctions imposed following nuclear tests in 1998, it was India that was keen to sign this agreement to counter its short-lived international isolation. From Sri Lankas perspective, political and economic objectives such as: reducing prevailing political tensions between the two countries; Indias support on the North-East conflict; attracting foreign direct investment from third countries through gaining an effective position in the Indian market; strengthening trade relations with South Asias leading economic power; promoting the transformation of local exports from low value added to high value added goods; and supplying low-income groups with cheap consumer goods from India, appear to have been significant considerations

Comprehensive Economic Partnership Agreement


No sooner was the ISFTA operational, than both governments began drawing plans to convert the Free Trade Agreement into a Comprehensive Economic Partnership Agreement (CEPA). India has pronounced through its Finance Minister that CEPA can only be a winwin situation for both India and Sri Lanka and that common economic prosperity will fortify peace, security and development in the region. Therefore, with the aim of attaining the objectives such as deepening of existing trade integration through reductions in the negative list and the expansion of trade integration with the inclusion of the liberalization of trade in services as well as the liberalization of investment, a Joint Study Group was created in 2003 to pursue the conversion of ISFTA to the Comprehensive Economic Partnership Agreement (CEPA). Their report was released in October 2003. Newly elected governments in both India and Sri Lanka affirmed their support for CEPA in 2004. In 2005 there were five rounds of negotiations on services, financial markets, trade facilitation, economic cooperation and investment. However, trade-related disputes arising from ISFTA adversely affected the negotiation process of CEPA.

CHAPTER 2 TRADE RELATION BETWEEN INDIA AND SRI LANKA

Structure of Bilateral Trade


Sri Lanka was the first country in South Asia to adopt the export-driven growth strategies. The Indian economy too moved towards liberalization since 1980 and following its macroeconomic crisis in 1991, the economy went in for a trade policy reform that focused on liberalization, openness, transparency and globalization. This gradual opening up of the two economies gave a boost to bilateral trade between the countries. Indias exports increased from US$ 277 million in 1992 to US $ 502 in 1999 while total trade went up from US$ 291 million to US$ 546 million. Thus, the total bilateral trade between the two economies nearly doubled during this period.

This bilateral trade grew even rapidly after the entry into force of the India-Sri Lanka Free Trade Agreement in March 2000. The total trade figures rose from US$ 706 million in 2001 to US$ 1733 million in 2004 and stood at US$ 3425 million in 2008. This was the year when the FTA between the two countries got fully implemented. Thus, in the post FTA period, bilateral trade between the two economies increased at the rate of 48% per annum during 2001-2008. Exports from India to Sri Lanka increased from US$ 638 million in 2001 to US $ 3007 million in 2008, while exports from Sri Lanka to India during the same period increased from US$ 68 million to US$ 418 million.

The two economies now enjoy a robust trade and investment relationship, with bilateral trade growing rapidly and a number of leading Indian private sector companies investing in Sri Lanka and establishing a presence in the country. Sri Lanka is India's largest trade partner in South Asia. India in turn is Sri Lanka's largest trade partner globally (Total Trade Value of USD Mn 4870 in 2011)

Sri Lankas Trade with India (1991-2011) [USD Mn] Year 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Exports 12 14 39 31 39 35 42 38 44 46 68 90 192 333 559 494 516 418 325 470 521 Imports 175 277 288 367 400 477 489 437 502 650 638 916 1302 1400 1399 1822 2785 3007 1710 2463 4349 Table 1 Sri Lankas Trade Imbalance 163 263 249 336 361 442 447 399 458 604 570 826 1110 1067 840 1328 2153 2269 1385 1993 3828 Total Trade 187 291 327 398 439 512 531 475 546 696 706 1006 1494 1733 1958 2316 3301 3425 2035 2933 4870

Total Bilateral Trade between India and Sri Lanka prior to FTA and after FTA

4000 3500 3000 2500 2000 1500 1000 500 0 1991 1995 2000 2003 2005 2008 2011

Figure 1
Note: In 2003 India completed the FTA implementation & in 2008 Sri Lanka completed the implementation

Analysis on Total Indian Exports to Sri Lanka Year 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Total Imports (USD Mn) 916.0 1076.2 1358.2 1440.4 1822.1 2785.0 3006.93 1709.93 2463.0 4431.0 Change Compared to Previous Year 43.57% 17.49% 26.2% 6.05% 26.5% 52.8% 7.97% -43.13% 44.04% 79.90% Table 2

Balance of Trade
The balance of trade between India and Sri Lanka, which has always been in favour of India, continued to widen over the years. The bilateral balance of trade exceeded US$ 3828 million in 2011, which was the highest trade gap between the two countries in favor of India. This was mainly due to the increase outlay on major import items from India, such as petroleum products, iron or steel & its' articles, cotton, Import from India in terms of value increased from US$ 2463 million in 2010 to US$ 4349 million in 2011 registering an increase of 79%. Sri Lankas exports however, grew only by 11% from US$ 470 million to US$ 521 million in 2011 resulting in a huge trade gap.

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Major Items which Recorded Export Decrease [USD Mn] Product Category 84 701090 230650 0902 392620 710391 710239 Total Description Boilers, Machinery & Parts Carboys, bottles & Other Containers of Glass Oil-Cake and other Solid Residues Tea Apparel & Clothing Accessories Precious Stones (other than diamonds) Diamonds Table 3 2009 28.00 10.44 3.50 3.20 1.50 4.10 2.90 53.64 2010 19.00 8.00 3.00 1.00 1.00 2.00 0.30 34.3

Import and Export Growth of Sri Lanka in Last 5 Years Year 2007 2008 2009 2010 2011 Change Compare to Previous Year Sri Lankas Export Sri Lankas Import 4.45% 52.8% -18.99% 7.97% -22.25% -43.13% 44.61% 44.04% 10.85% 79.90% Table 4

Import and Export Ratio (2000-2008) Year 1991 1995 1998 2000 2005 2008 2011 Export (USD Mn) Import (USD Mn) 12 175 39 400 38 437 46 650 559 1399 418 3007 521 4349 Table 5 Ratio 1 : 14.6 1 : 10.25 1 : 11.5 1 : 14.1 1 : 2.5 1 : 7.2 1 : 8.3

Note: In 2003 India completed the FTA implementation & in 2008 Sri Lanka completed the implementation

Source - Department of Commerce of Sri Lanka


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CHAPTER 3 TRADE TRENDS IN INDIA-SRI LANKA FREE TRADE AGREEMENT

1. Sri Lankas trade with India changed dramatically following the implementation of the FTA. In the period 1995-2000 immediately preceding the agreement, average annual exports from Sri Lanka to India were US$ 39 million while average imports were US$ 400 million. While India was an important source of imports even prior to the Agreement, it was not a major export market, and in 2000 it ranked 14th in terms of export destinations By 2005, Sri Lankas exports to India reached a peak of US$ 559 million, a tenfold increase compared to 2000, and stood at US$ 418 million in 2008. India was the fifth largest destination for Sri Lankas exports in since 2008.

2. An aggregate view of trade between India and Sri Lanka since the FTA came into being suggests a very positive picture with overall trade growing close to six fold and exports from Sri Lanka growing tenfold. Furthermore, the increased diversity and greater value addition in exports from Sri Lanka is a positive development.

3. Exports from Sri Lanka largely concentrated in two products (Vanaspathi and Copper). 49.66% of Sri Lankas export value was from the export of these two tariff lines. If Vanaspathi and Copper were excluded from the trade figures, Sri Lankas exports to India would have increased from US$ 58 million in 2000 to just US$ 278 million in 2006, an increase of fivefold compared to the tenfold increase with Vanaspathi and Copper. It is thus clear that the narrowing of the trade deficit between the two countries was largely due to these two products.

4. The major cause for the increase in imports was the increased cost of petroleum products in global markets. Import of petroleum products from India is not influenced by the FTA as petroleum imports are in Sri Lankas negative list.

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5. Indian investment into Sri Lanka has also increased substantially since the FTA came into operation. Cumulative Indian investment which was a mere Rs 165 million in 1998 increased to US$ 125.925 million by 2008, contributing to 14% of total FDI flows to Sri Lanka. India is now the second biggest investor in the country, exceeded only by Malaysia. The bulk of Indian investment (63%) in Sri Lanka in recent years has been in the services sector being focused in sectors such as telecommunications (Bharthi Airtel), health (Apollo Hospitals), energy services (Lanka India Oil Company), hospitality (Krrish Apartments) and air transportation (Jet Airways).

6. According to the BOI, 5900 jobs were created as a result of Indian investment. But this includes 1500 employees in the Indian Oil Company retail outlets, which entailed rehiring staff from the Ceylon Petroleum Corporation-owned outlets rather than creation of new jobs.

7. Monetary measurement of trade in services is very limited (due to the intangible nature of services) and therefore exact figures of trade in services are difficult to calculate. However, the extent of commercial services exchange between the two countries has increased.

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CHAPTER 4 DETERMINANTS FOR THE TRADE IMBALANCE OF SRI LANKA

1. Significant Export Decrease


Spurred by the implementation of ISFTA in 2000, exports from Sri Lanka to India have increased over the years except for the years 2006, 2008 & 2009. The value of Sri Lankas exports to India increased from US$ 46 million in 2000, (the year ISFTA became operational) to US$ 521 million in 2011. The decline of Sri Lankas exports to India in 2006 was mainly due to a significant decrease in exports of the two main products, namely, Vanaspathi (HS. 151620) and Copper (HS. 7403).

2. Lack of Stakeholder Participation


A broader issue is that consultations are within and decisions are made by a small network of trade policy specialists who share the same disciplinary tools and the same ideological convictions, and often the same disdain for the opinions of the citizenry. For instance, even representatives of the Central, Southern and Western provincial governments when contacted in the course of field research were reluctant to offer their opinions on the ISFTA through lack of information on it. They also confirmed that no attempt had been made by central government to consult with them in the design and operation of the ISFTA. A section of the local business and industrial community also complained of their exclusion from the ISFTA (and now CEPA) negotiation process and in its monitoring. It transpired in the course of investigation that only a handful of central government officials from the Finance Ministry and Department of Commerce had been engaged in the finalization of the bilateral agreement.

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3. Poor Design, Coordination and Monitoring of the ISFTA


Though there is a powerful lobby to ideologically promote trade liberalization, the ISFTA is poorly coordinated, monitored and implemented. Consequently, there is no central institution that provides data, statistics and analysis of the ISFTA at the moment. Even though the Department of Commerce (DOC) is mandated to play the above role, different functions are seen to be exercised by different institutions. In the absence of an information hub where all relevant information may be gathered, trade statistics have to be collected from a range of locations such as the DOC, the Export Development Board, the Customs Department, the Department of Census and Statistics, the Central Bank, the Board of Investment among others. The Department of Commerce, the Ceylon Chamber of Commerce, and the Institute of Policy Studies, it is observed, conduct analysis from a trade perspective on the bilateral India-Sri Lanka Agreement. However, analysis of the ISFTA and CEPA from a human development and social justice perspective are few and far between. The absence of a central authority with the capacity to sufficiently engage with these diverse approaches and to convert such analysis into policy prescriptions can also be noted in this respect.

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CHAPTER 5 CONCLUSIONS AND RECOMMENDATIONS


In order to achieve sustained growth in the years to come, rebalancing in the structure of global demand is inevitable. Whereas Sri Lanka needs to follow a growth strategy that is not based on debt-expansion but rather on external demand and to change export-led growth patterns into domestic demand creation. The latter can only be achieved by focusing public and labour market policies to increase domestic consumption and investment.

Sri Lanka needs to address high income inequality, using public and social policies, including increases in minimum wage schemes, tax rate increases of high income deciles, income support social schemes, adequate unemployment benefits, health care coverage and access to education, in order to lower incentives of low-income households to take out private debt.

1. Sri Lanka and India has maintained the best economic and political relations in the South Asian region (in spite of short-term frictions) which can be built upon for a lasting and mutually beneficial relationship.

2. Economic relations with India should be strengthened within a rule-based liberalized trade regime which can provide policy environment conducive for strengthened economic relations with clearly defined rules. This would avoid the frictions associated with ad hoc problem solving.

3. Investigate the Impact of the entire Trade Liberalization process

4. Reorient the Role and Mandate of the Department of Commerce

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Grow with Bilateral Relations


There is nothing particularly good or bad about a trade surplus or deficit with a specific country, contrary to populist mercantilist concerns. If Sri Lankan firms are buying low-cost inputs from India to make their higher-value-added exports more competitive or if Indian imports are replacing higher-cost imports from other countries, they are good. Because these conditions are satisfied, increased trade with India, even with increasing deficits is a good thing. The same is true for trade in services. While Sri Lanka has much scope for exporting services to India, thereby contributing to economic growth, employment and the balance of payments, it is necessary to acknowledge the reciprocal importing of services from India as well. Besides, importing of services such as health and education at a reasonably low cost is beneficial to the lower and middle-income Sri Lankans who face domestic supply constraints.

Rule-Based Bilateral Regime


Lack of a rule-based regime to manage bilateral relations is problem, especially for small states. Rule-based regimes are superior to anarchy, even when there is substantial asymmetry of power among the parties and even when the rules are not perfect. Of course, a rule-based regime that is entered into on the basis of principles of fairness and mutual respect, by parties that are equally endowed with knowledge and power, using means of negotiation that are equitable and non-violent, would be best. In the absence of progress on multilateral and regional frameworks, the pragmatic, best available option available to Sri Lanka is a bilateral agreement within a rule-based disciplining framework because there is little forward movement in multilateral agreements such as SAFTA. It is superior to a power-oriented regime, which is what currently exists for economic relations not governed by the FTA, such as India-Sri Lanka services trade.

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CHAPTER 6 REFERENCES

1. Department of Commerce (2012). Trade Statistics 2011. Colombo: Department of Commerce of Sri Lanka.

2. BOI Sri Lanka (2008). Indo-Sri Lanka FTA. Available: http://www.investsrilanka.com/international_agreement/indo_sri_lanka_fta_agreemen t.html. Last accessed 03 Jan 2013.

3. C. Sikdar & D. Chakraborty (2011), The Factor Content of Bilateral Trade between India & Sri Lanka, paper presented at the 19th International Input-output Conference in Alexandria, USA, July 13-17, 2011.

4. R. Samarajiva & P. Herath (2008). 1.2 Trillion Dollar GDP, 1.1 billion People: How Best Can we grow with India? Pathfinder Foundation. [http://www.lirneasia.net/wp-content/uploads/2009/01/india_sanvada_202.pdf].

5. S. Kelegama and I. Mukherji (2007). India-Sri Lanka Bilateral Free Trade Agreement: Six Years Performance and Beyond. RIS Discussion Paper, New Delhi, India.

6. M. Perera & S. Sumudu (2008).Impact of the Indo-Sri Lanka Free Trade Agreement: A Computable General Equilibrium Analysis, South Asia Economic Journal, Vol. 9, No. 1: 1-50.

7. Law and Society Trust Sri Lanka (2010). Ten Years of the India-Sri Lanka Free Trade Agreement (ISFTA). Colombo 08: Forum-Asia.
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