Introduction

India is Sri Lankas major trading partner globally, while Sri Lanka is Indias prime trading partner in SAARC. It is the number one source of supplies accounting for twenty one percent of Sri Lankas total imports and fifth largest export destination for Sri Lankan products absorbing five percent of total exports. Among tourists, Indian visitors make the largest single group having a share of twenty percent of total arrivals. Sri Lankan Airlines, the national carrier is one of the leading foreign airline operates with 61 weekly flights to 7 cities in India. In the investment field, India is among the top five foreign investors in Sri Lanka. Trade between Sri Lanka and India has grown rapidly after the access into force of the IndoSri Lanka Free Trade Agreement in March 2000. The value of bilateral trade increased from US$658 million in 2000 to US$ 4.1 billion in 2011. Sri Lankas exports growth has mostly been under the ISFTA, whereas Indias exports have remained mostly outside the ISFTA. In average, over 70% of Sri Lankas exports to India continue to be under the ISFTA, while Indias exports to Sri Lanka under the ISFTA remains only around 25%. Sri Lanka could export more than 4000 product lines to the Indian market on duty free basis. The remarkable aspect of the growth of exports under the agreement is the broad product diversification, which took place following the FTA. Major exports from Sri Lanka under the ISFTA includes; apparel, furniture, MDF boards, glass bottles, processed meat products, poultry feed, insulated wires & cables, bottle coolers, pneumatic tires, tiles & ceramics products, rubber gloves, electrical panel boards & enclosures, machinery parts, food preparations and spices etc. India and Sri Lanka also share the membership in other regional and multilateral trading arrangements namely; Asia Pacific Trade Agreement (APTA), South Asia Free Trade Agreement (SAFTA) in the SAARC context, BIMSTEC (Bay of Bengal Initiative for Multicultural Technical and Economic Cooperation), Global System of Trade Preferences (GSTP) and the World Trade Origination (WTO) which were influential in strengthening and further advancing trade and economic ties. To our mutual benefit India is one of the leading investors in Sri Lanka with the presence of major Indian companies including; CEAT Limited Gujarat Glass Limited Indian Oil Corporation Limited

Neelkamal Plastics Limited Gujarat Ambuja Limited Bharti Airtel Limited National Thermal Power Corporation Indian Hotels Co. Limited State Bank of India Indian Bank ICICI bank Indian Overseas Bank Larsen & Toubro Limited Carin India Limited Mphasis

With the entry into force of the Indo- Sri Lanka Free Trade Agreement, the foreign direct investment flow has taken place both-ways. The Sri Lankan investors in India include; Aitken Spence Hotel Managements Bank of Ceylon Brandix India Apparel City Damro Furniture (Pvt) Ltd DSI Tyre India (Pvt) Ltd Hatton National bank hSenid Software (India) Pvt. Ltd JOHN KEELLS LOGISTICS INDIA PVT LTD Multilac Ritzbury India Pvt Ltd Regency International Clothing P Ltd Sri Lankan Airlines Ltd Serene Holidays Pvt Ltd (John Keells Group Company)

Background
Economic links between India and Sri Lanka have a long history with

recorded commercial links going as far back as the 4th century and with both countries falling under British rule during the 19th century, these links strengthened to the point where legal barriers to movement of goods and labor nearly disappeared. But in the early years of the post independence period, even with close political ties economic ties damaged as both countries implemented inward looking economic policies. However, with Sri Lanka initiating a liberalization force in 1977-78 that later encompassed other South Asian countries including India, economic links between the two once again started to build up. This process has been further encouraged by the South Asian regional integration initiatives and by a bilateral free trade agreement (FTA) between the two countries. Sri Lankas central position in the Indian Ocean and its geographic proximity to South India and the resultant cultural and historical ties were factors that influenced the early

development of trade between the two countries. These links persisted till colonial times when economic relations between the two countries were geared very much towards producing goods for the colonial powers and meeting food requirements follow-on from shortages. Existing trade links were strengthened during the colonial period, above all on account of Indian labor that was brought to Sri Lanka to work on the plantations. In 1938, for example, 42.5 percent of Sri Lankas import bill was spent on imports from India and the larger share of such imports was related to plantation labor

(Wanigaratne, 1991). After independence, Sri Lanka made a intensive attempt to diversify such dependence by increasing production of certain previously imported items at home and securing alternative sources from a wider range of countries. By the late 1940s, Sri Lankas imports from India had declined to around 15 percent of its total imports, while exports to India totaled around two percent of all Sri Lankas exports a trend that continued into the 1950s (Kodikara, 1965). The trend towards autarky in both countries around the turn of the 1960s although at different speeds also heralded a steady decline in Indo - Sri Lanka trade.

Bilateral Trade between India & Sri Lanka

Source: Central Bank of Sri Lanka Table 1: Trade between India and Sri Lanka: 2000 January to April 2012 (Values in US $ Millions)

Year

Exports

Imports

Total Trade

Balance of Trade

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 (JanApril)

55.65 70.12 168.86 241.14 385.50 559.26 494.06 516.40 418.08 324.87 466.60 521.65 207.00

600.12 601.50 834.70 1,076.17 1,358.01 1,440.41 1,822.07 2,785.04 3,006.93 1,709.93 2,546.23 4,338.04 1,346.00

655.77 671.62 1,003.56 1,317.31 1,743.51 1,999.67 2,316.13 3,301.44 3,425.01 2,034.8 3,012.83 4,859.69 1553.00

-544.47 -531.38 -665.84 -835.03 -972.51 -881.15 -1,328.01 -2,268.64 -2,588.85 -1,385.06 -2,079.63 -3816.39 -1139.00

Source: Sri Lanka Customs Table -2: Major Exports to India in 2011

Product
Spices Natural Rubber & Rubber products

Value in US$ Mn
67.93 44.51

Poultry Feed Accessories for electrical machinery Copper & Copper based products Refrigerators, freezers and other

44.13 44.81 19.12 refrigerating 24.81

equipment & Machinery Paper & Paper products Ships, Boats and floating structures Cocoa butter Fiber board of wood Furniture, bedding, mattress etc Apparel 39.66 19.15 20.98 17.72 9.28 12.92

Source: Sri Lanka Customs Table 3: Major imports from India in 2011

Product

Value in US$ Mn

Motor Vehicles Mineral fuels & oils Cotton Pharmaceutical products Refrigerators, freezers and other refrigerating equipment & machinery Electric/power generating sets Iron & Steel Articles of paper & paper board Cement

894.21 904.67 217.40 162.33 28.18

39.45 115.29 100.24 137.29

Figure 1: Total Bilateral Trade between India and Sri Lanka for select years prior to FTA and after FTA (US $ million)

Figure 2: India Sri lanka Trade Inbalance

Economic Impacts
Even before the FTA was implemented, India had become a significant source of Sri Lankan imports. In 1999, India accounted for 8.6 percent of Sri Lankas total import basket and was the second highest source of imports (with Japan being the highest). Sri Lankan exports to India were not substantial before the FTA, with total exports in 1999 being a mere US$47 million, around 1 percent of total exports, and India not even being among Sri Lankas top 10 export destinations. Furthermore, in 1999 Sri Lankas trade deficit with India was substantial (US$463 million) with an importexport ratio of 10.5:1. In 1999, Sri Lankas main exports to India were in primary productsmainly agriculture and unprocessed metals. The major exports included pepper, which made up 20 percent, and areca nuts, which made up 11 percent, while such products as waste steel and waste paper made up 8 percent and 5.5 percent, respectively. It is clear from this passage that before the FTA, Sri Lankas trade with India was limited in terms of both value and industrial depth. While the trade balance was weighted toward India, this was not compensated by investment flows. Foreign direct investment (FDI) from India to Sri Lanka was limited, with cumulative investment as of 1998 a mere Sri Lankan Rupees (SL Rs) 165 million (US$2.5 million or 1.3 percent of total FDI). The implementation of the FTA had a dramatic impact on trade relations between the two countries. By 2007, Sri Lankas exports to India had increased to US$515 million (6.6 percent of total exports). India is now Sri Lankas third largest destination for exports and largest source of imports, making up 23 percent of total imports in 2007. The trade balance between the two countries narrowed until 2006 (when the importexport ratio was 4:1 compared with14.3:1 in 1998), as the rate of growth of Sri Lankas exports was greater than that of imports. Furthermore, FDI from India followed trade as cumulative FDI expanded to reach SL Rs 9.5 billion by 2005 (US$191.2 million or 8.3 percent of total FDI). India is now the fifth highest investor in Sri Lanka. The number of products exported from Sri Lanka to India doubled from 505 in 2000 to 1,062by 2005 (Kelegama and Mukherjee 2007), and more important, there was a shift from primary products to processed goods. Vegetable fats and oils, rened copper, wires (copper, aluminum), margarine, rubber, and articles thereof all come ahead of traditional exports such as pepper and spices.

New products such as furniture (exports of which increased from US$1.7 million in 2002 to US$6.4 million in 2006), antibiotics (no exports until 2004 and reaching US$22 million in 2005), and ceramic products (US$0.8 million in 2002 increased to US$22.7 million in 2006) successfully entered the Indian market. The FTA was instrumental in this expansion of trade, as 75 percent of Sri Lankan exports to India received preferential treatment in 2006, compared with 22 percent in 2001.Thus, bilateral market access to India for the smaller South Asian economies is evolving at a much more rapid pace than under the SAFTA framework. The net result of these alternative bilateral and regional agreements in South Asia with India playing a pivotal role eventually may become something approximating free trade within the region. Exports of vanaspati (vegetable oil) improved in 2007 following a fall in 2006 resulting from the imposition of quotas by India. This progress is likely to be all but completely tough in 2008, however, with the decision by India to completely slash Most Favored Nation (MFN) tariffs on palm oil imports. As a result, exporters from Sri Lanka lose their preferential margin and will not be competitive in the Indian market. The outcome of these changes will be significant in terms of Sri Lankas trade with India because export earnings were dominated by copper and vanaspati for the last 3 years.

Factors Inhibiting Growth of Sri Lankan Exports

The dominance of vanaspati and copper in the early years of the FTA is partly due to the fact that Indian entrepreneurs invested significantly in these industries and also to the fact that other exports have failed to expand in the same manner. Several factors contribute to the lack of dynamism in the export of other tariff lines to India. The key factor is that India is not a traditional export market of Sri Lanka. Sri Lankas export basket is dominated by garments, and these items traditionally have been exported to the United States and European Union. This structure has been cemented over several years of developing buyer relationships, establishing markets, and creating supply chains. There is naturally a degree of inertia with regard to producer preferences when these factors are taken into consideration. Nonetheless, even in the garment sector there have been some recent developments in terms of Sri Lankan producers looking to tap the Indian market. MAS, a leading apparel exporter in Sri Lanka, recently launched an intimate wear label Amante, targeting Indias upper-middle class. The product is specially designed to cater to South Asian women. Another important factor is that Sri Lankas traditional export products (garments and tea) until very recently have been hampered by prohibitive ROOs. Garment exports to India were under the negative list except

for a 50 percent margin of preference for 8 million pieces, 6 million of which would need to use Indian fabrics to receive preferences. The sourcing requirement ensured that Sri Lankan garment exports to India were not competitive relative to domestic producers and, as a result, there was less than 1 percent quota utilization. In June 2007, however, Sri Lanka was allowed 3 million garment pieces to enter India free of duty with no sourcing requirement. In the most recent secretary-level meeting of the IndiaLanka CEPA in July 2008, it was agreed that Sri Lanka will be allowed to export 6 million garment pieces to India free of duty with no sourcing requirement and an additional 2 million pieces with a margin of preference of 70 percent. This is yet to be implemented as the requisite administrative processes have not been completed. Nonetheless, the most recent indications suggest that garment exports to India have expanded, taking advantage of the 3 million pieces quota. With regard to tea, given the fact that pure Ceylon tea is more expensive than tea in the Indian domestic market, Sri Lankas primary scope of export to India was realized through the blended tea market. This is why Sri Lanka chose the ports of Kolkata and Cochin as ports of entrythat is, these ports provide easy access to Indian teas to produce a blended tea variety for the Indian market. Unfortunately, with the present agreement, the ROOs are such that blended tea has effectively no chance of penetrating the Indian market. The requirement of a CTF at the fourdigit level is not practically possible. As a result, just 2.7 percent of the 15 million kg quota has been utilized by Sri Lanka (Kelegama and Mukherjee 2007). In June 2007, the port restriction on Sri Lankan imports was eased, but there was no change in the ROOs, and therefore it is unlikely that there will be an expansion of Sri Lankan tea exports to India. In order for tea exports to India to take off, a product - specic ROO that allows a CTF at the six-digit level is required. There have also been concerns about para tariffs, particularly the state level tariffs imposed on any products entering particular Indian states (even from other states) over and above those faced by domestic state producers. For instance, in Tamil Nadu, local producers pay a state tax of 10.5 percent, while producers from foreign countries and other states pay a tax of 21 percent, thereby eroding the preferences obtained through the FTA (Kelegama and Mukherjee 2007). It is argued that, despite the state taxes, Sri Lanka is provided a preferential advantage with respect to other international trading partners. A state like Tamil Nadu (population 66 million) is substantially larger than a country like Sri Lanka (population 20 million), however, and given Tamil Nadus geographic proximity to Sri Lanka, it is a major export market (compared to more distant states where Sri Lankan exports are less competitive

because of transport costs). Therefore, state taxes in Tamil Nadu substantially undermine Sri Lankas competitive export potential to the Indian market. Another problem faced by Sri Lankan exporters is that, despite the insignicance of Sri Lankan exports compared to the size of the overall Indian market, Sri Lankan exports have created turbulence within particular states. For instance, Sri Lankan pepper exports are perceived to have had an adverse impact on price in the state of Kerala. Such issues, along with the surge in vanaspati exports to India, resulted in safeguard measures being adopted by India. Vanaspati imports to India were rst capped and then canalized, resulting in a drastic drop in vanaspati exports from Sri Lanka in 2006. Similar quotas were imposed on pepper exports.

A Way Forward
Despite these bones of contention, both countries have been keen to deepen and broaden economic integration to form a CEPA. In 2003 a Joint Study Group (JSG) was commissioned to examine the potential for further economic integration between the two countries. The ensuing report published in 2004 suggested that trade in services, investment liberalization, and economic cooperation should be added to the further liberalization of trade in goods. In February 2005 the rst round of technical-level negotiations of the IL-CEPA took place and, since then, 12 more technical-level negotiations have taken place as of July 2008. At the same time, negotiations took place at the domestic level as well between sector - specic stakeholders and the negotiating team. Much progress has occurred with draft offers for legally binding commitments being made in the liberalization of investment, trade in services, and reduction of the respective negative lists in the goods sector. Trade-in-services negotiations have taken place on a positive list, request-offer approach akin to the General Agreement on Trade and Services. This approach provides Sri Lanka with the exibility to schedule only those sectors that are within developmental interests and comfort zones. This has been important given the perceptions that services liberalization will result in ooding of the domestic service market by Indian professionals. With the positive list approach, Sri Lanka was able to make draft offers in areas where there are shortages in certain subsectors that have constrained the performance of other sectors. For example, in the maritime services sector certain skilled labor categories were not produced by Sri Lankan training facilities, and Sri Lanka made draft offers to allow the import of Indian labor within

certain limitations in these categories. Furthermore, Sri Lanka recognizes the value of a services agreement in terms of attracting investment. A legally binding commitment to a particular level of liberalization provides investors with the condence that is not available with a unilateral liberalization regime Bilateral Free Trade Agreements in SAARC 99 that can be backtracked overnight. Many economies are at present negotiating agreements with India, recognizing the fact that India will undoubtedly become an economic superpower sooner rather than later. The European Union, Association of Southeast Asian Nations (ASEAN), and countries like the Republic of Korea are in the process of negotiating similar agreements and, unsurprisingly, Singapore beat them all to it. Thus, in terms of export interest as well, it is important from a Sri Lankan perspective to secure legally binding market access to the Indian economy. This applies to trade in goods, services, and investment. The current level of liberalization in any country is contingent on both the domestic and international political economic climate. A shift toward a more protectionist regime could reverse the progress made in economic liberalization. In such a scenario, only a legally binding framework could ensure the continuation of at least the present status quo.

Conclusion
The bilateral trade agreement that Sri Lanka has implemented with India, providing analysis on the structure of the respective agreement and its trade impact. It was found that although the agreement has provided significant market access to Sri Lanka, full advantage has not been taken of this market access for a combination of reasons. Certain impediments to trade remain despite the existence of the FTAs. Furthermore, Sri Lankan entrepreneurs need to be more open to diversifying from traditional export markets in the United States and European Union and need to consider markets in neighboring countries as well. Finally, the bilateral agreement found that the latter requires much improvement to have an impact on trade within the region.