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INDO-SRI LANKA FREE

TRADE AGREEMENT

M.U.J.S FERNANDOBSC-UGC-MGT-09-1-034

National School of Business Management


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Introduction

India is one of the worlds most dynamic economies and attractive markets. Sri Lanka has

had strong relations with India by reason of closeness and history. Managing relations with

India, preferably in a way that can allow Sri Lanka to share its energy, is one of the most

important challenges facing Sri Lanka. Since 2000, when the India Sri Lanka Free Trade

Agreement came into effect, India has featured large in Sri Lankas economic relationships,

in trade in goods as well in services, and in terms of investment. The significance of these

relations is documented. The question that has been raised by the held up Comprehensive

Economic Partnership Agreement between the two countries is how best this most important

relationship can be managed, with a disciplinary framework or not. Drawing from theory and

international experience, it is argued that a disciplinary framework that governs goods,

services and investment is essential, especially where unevenness of power exists.

Bilateral trade between the two countries had been expanding rapidly in the 1990s, driven

primarily by unilateral liberalization efforts with trade flows being largely in favor of India.

In fact, India emerged as Sri Lankas pri mary source of imports in 1996, overtaking Japan for

the first tim e. While Indias interests in furthering trade relations could be understood given

its broader industrial base and ability to meet Sri Lankas import needs, the key factors prompting Sri Lankas interests were the prospect of early mover access to a large market

that would help the country to diversify its industrial base and the potential for to raise its

profile as a destination for foreign direct investment(FDI) on the basis of preferential access

to a still relatively protected Indian mark et.

Even though such supposed benefits to Sri Lanka, there was little discussion on the proposed

ISFTA at the domestic level. In fact, the ISFTA was signed peremptorily in December 1998,with both countries agreeing to negotiate and finalize the better points in particular, the

composition of the negative list of items to allow full implementation to begin in February

1999. Opposition to the agreement was voiced from within SriLankas domestic industrial

sector with regards to potential adverse implications from heightened competition from

cheaper imports. However, the agreement came into effect in March 2000 and has since

continued to be implemented according to the schedules that were agreed upon. In the set of

the SAFTA agreement implemented in July 2006, the ISFTA provides useful lessons for

other South Asian economies, both in terms of the initial conditions prior to the negotiation of


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the bilateral agreement and in terms of the progress in strengthening trade and economic

linkages post implementation.

Literature ReviewSri 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 resulting from

shortages. Existing trade links were strengthened during the colonial period, primarily 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 concerted 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 turnoff the 1960s albeit at

different speeds also heralded a steady decline in Indo-Sri Lanka trade.

The adoption of inward looking economic policies, i.e. stringent exchange controls,

increasing state control over all areas of economic activity and reduced opportunities for

private sector participation, and an unfriendly attitude to foreign investment, the ending of

Indian labor inflows all heralded a continuing steady decline in Indo-Sri Lanka economic

links. There were some attempts during this period to revive economic links, but they had

little success. The idea of a formal arrangement to facilitate trade channels between the two

countries was proposed in 1961. This took the form of a bilateral trade agreement, whose

main aim was to promote the highest possible volume of trade between the two countries.

However, the agreement had no noticeable impact on trade flows, prompting the

establishment of an Indo-Sri Lanka Joint Committee on Economic Cooperation in 1968 with

the objective of strengthening cooperation in trade, industry, agriculture and tourism. Despite


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such pronouncements, bilateral trade between India and Sri Lanka remained stagnant for

much of the ensuing two decades. Political tensions between India and Sri Lanka were also

heightened with the outbreak of civil conflict in Sri Lanka in the mid 1980 s that end with

direct military involvement of India. The view of anti Indian sentiment in Sri Lanka raised its

riskiness in the eyes of Indian investors. It also weakens Sri Lankas attractiveness as a

holiday destination for Indians. Taken together, these factors had a dampening impact on

bilateral economic ties.

Trade between India & Sri Lanka

Source: Central Bank of Sri Lanka

Source:Customs/DOC/EDB

Year Exports Imports Total Trade Balance of Trade

2005 559.26 1,440.41 1,999.67 -881.15

2006 494.06 1,822.07 2,316.13 -1,328.01

2007 516.40 2,785.04 3,301.44 -2,268.64

2008 418.08 3,006.93 3,425.01 -2,588.85

2009 324.87 1,709.93 2,034.8 -1,385.06

2010 466.60 2,546.23 3,012.83 -2,079.63

2011 521.65 4,338.04 4,859.69 -3816.39

2012 207.00 1,346.00 1553.00 -1139.00


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Sri Lankas trade pattern in goods changed since the 1990s and particularly after Indo-Lanka

FTA. Sri Lankas exports to India reached USD 515.3 million in 2007, an increase of 838

percent over seven years, compared with a total export growth of 47.5 percent India was the

third largest destination for Sri Lankas exports by 2007.

Sri Lankas imports from India also recorded rapid growth, rea ching USD 2,610 million by

2007. Imports grew by 359.5 percent in 2000-2007, compared with overall growth of 63.2

percent. India has been the largest source of imports to Sri Lanka since 1997.

Trade expansion requires liberalization by both trading partners. This condition, to a large

extent was satisfied in the 1990s with the initiation of trade policy reforms in India. The force

for trade expansion however, also came from bilateral and multilateral trade agreements. The

Indo-Lanka FTA was negotiated in 1998 and implemented in 2000. The FTA increased the

salience of the subject even prior to coming into operation, and significantly reduced tariffs.

Total Sri Lanka-India trade increased from USD 671.6 million in 2001 to USD 3,265.2

million in 2007. Export volumes increasing slower than imports, the bilateral trade balance

increased in favor of India from USD 531 million in 2001 to USD 2,234 million in 2007. But

Sri Lankas exports to India grew fa ster than imports during the initial period of 2001-2005.

During 2006-2007 the deficit increased as a result of increased petroleum imports and

decreased exports of vanaspati and copper .

After 2000 exports to India diversified as well. By 2007, major exports to India included

insulated wires and cables, vegetable fats and oils, articles of stone, plaster, cement & rubber.

This was potential export expansion being limited by port and quota restrictions and the

implementation of the rule of origin. Many of these issues were discussed at the

Comprehensive Economic Partnership Agreement (CEPA) negotiations without which Sri

Lanka would have ended up with no forum even to discuss the bilateral issues .

The rapid growth of imports from India was, however, not essentially a result of the FTA. SriLanka was already sourcing imports from India even prior to the implementation of the FTA.

Country 2000USD mn

2007USD mn

%Change

India 55 515.3 838

Country 2000USD mn

2007USD mn

%Change

India 568 2610 359.5


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Even after the FTA, imports such as motor vehicles, petroleum products, agricultural

products and paper products, which were in the negative list, grew as part of normal trade.

According to the Department of Commerce, Sri Lankas imports under the FTA were only

about 14 percent of the countrys total imports from India in 2007. This suggests that imports

from India would have increased even without the FTA.

Trade between India & Sri Lanka 2001-2007

Trade imbalance between indo-Sri Lanka

The India Sri Lanka relationship has been transformed in the past decade. India, Already the

biggest source of imports also became a major destination for exports. Indian FDI became a

major contributor to Sri Lankas economic development and Employment creation. It has not

been possible to gather systematic data on Sri Lankan investments in India, but there has been

increasing activity on this front as well; with Brandix establishing a large fabric park in

Tamilnadu, Damro well-established in furniture manufacturing and Aitken Spence managing

hotels, for example. Reliable data on service trade are hard to come by. However, the export

of port services, one among the few service sectors for which some data are available, is


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illustrative of Sri Lankas significant service exports to India. Indians export business

services to Sri Lanka, though of course, this is very difficult to document. Health and

Education services are also exported by India. Sri Lanka has long been consumer of tourism

services in India, but has begun to supply tourism services to India since 2002, there are those

who seek to draw conclusions, generally negative, about increasing trade deficits, increasing

incoming FDI and increasing foreign investments by local form. There is nothing particularly

good or bad about a trade surplus or deficit with a specific country, different to these populist

mercantilist concerns. If Sri Lankan firmware buying more low cost inputs from countries

like India to make our higher value added exports more competitive or if the Indian imports

are replacing higher cost imports from other countries, they are good; if not, they are bad. In

general appears that increased trade with India, even with increasing deficits is a good thing.

The critical event during the decade of change was the FTA which contributed to the growth

of exports to India as well as In dian investment in Sri Lanka. The fact that it was Indias first

FTA, would have raised Sri Lankas profile within the Indian business community,

contributing to these outcomes. If not for the fast growth of exports, in some cases from

Indian owned firms, Sri Lanka may have an even greater trade

Deficit than what exists today.

South Asian Free Trade Area (SAFTA)

SAPTA was envisaged primarily as the first step towards the transition to a South Asian Free

Trade Area (SAFTA) leading subsequently towards a Customs Union, Common Market and

Economic Union. In 1995, the Sixteenth session of the Council of Ministers agreed on the

need to strive for the realization of SAFTA and to this end an Inter-Governmental Expert

Group (IGEG) was set up in 1996 to identify the necessary steps for progressing to a free

trade area. The Tenth SAARC Summit decided to set up a Committee of Experts (COE) to

draft a comprehensive treaty framework for creating a free trade area within the region,

taking into consideration the asymmetries in development within the region and bearing in

mind the need to fix realistic and achievable targets.

The SAFTA Agreement was signed on 6 January 2004 during Twelfth SAARC Summit held

in Islamabad, Pakistan. The Agreement entered into force on 1 January 2006, and the Trade

Liberalization Programmed commenced from 1 stJuly 2006. Following the Agreement coming

into force the SAFTA Ministerial Council (SMC) has been established comprising theCommerce Ministers of the Member States. To assist the SMC, a SAFTA Committee of


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Experts (SCOE) has been formed. SCOE is expected to submit its report to SMC every six

months. The SAFTA Agreement states that the the SMC shall meet at least once every year

or more often as and when considered necessary by the Contracting States.

Conclusion

The key opportunity for Sri Lanka 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 Sri Lanka to integrate more closely with the Indian

economy and accrue some of the benefits that would undoubtedly be enjoyed by India.

Today, as an economic crisis grips Sri Lankas traditional export markets and a food pricecrisis engulfs the global economy, Sri Lanka should view India as an opportunity and not

threat, and strive towards more meaningful cooperation in facilitating inclusive and equitable

development policies.

Recommendation

Redesign taxation policy in indo- Lanka free trade agreement

Increasing more opportunities for export industry in Sri Lanka

Attracting more foreign investments to Sri Lanka

Establishing domestic companies in India for industrial sectors

Reduce unnecessary volumes of imports from India to Sri Lanka

Utilizing natural resources of Sri Lanka to startup new business in different industry

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