South Asia Watch on Trade, Economics & Environment (SAWTEE)

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Tariff reduction under SAFTA
Published: The Kathmandu Post, 09 January 2004
By: Ratnakar Adhikari

Looks like SAARC is finally becoming serious. One of the landmark achievements made during the 12th SAARC Summit is the signing of South Asian Free Trade Agreement (SAFTA), which was in gestation for quite a while. Skeptics argue that SAFTA may not be beneficial to Nepal. However, I beg to differ with them. One of the points raised by the skeptics is that implementation of SAFTA could lead to reduction in our tariff revenue. This might be true in some sense, but not in its entirety. Due to the autonomous liberalisation measures initiated by Nepal in the past decade or so, Nepal already has the lowest level of tariff in South Asia. Therefore, there may not be significant reduction in tariff revenue even after the implementation of SAFTA.

Implementation of SAFTA does not mean that we have to reduce tariff on all the products we import from within the region to zero. Like any other regional integration arrangement, there is a provision for phase-wise reduction of tariff in the case of SAFTA. For the least developed countries (LDCs) - Nepal, Bangladesh, Bhutan and the Maldives - the relevant deadline for reduction of tariff to zero to five percent is 2016.

By then, realising the benefits of freer trade, Nepal will have in any case reduced its tariff to the level proposed by SAFTA. Moreover, there are likely to be serious negotiations within the World Trade Organisation (WTO) on tariff reduction, not only due to mandated negotiations on agriculture, but also due to what is known as Non Agricultural Market Access (NAMA) negotiations. The countries, which have acceded to the WTO, are demanding that they be exempted from tariff reduction commitment, but no decision to this effect has been taken as yet.

Most of our trade within South Asia is with India, and we already have a free trade agreement with India. Agricultural items constitute around 20 percent of our imports from India, which attract zero tariff. The Agriculture Reform Fee (ARF), which is currently being imposed at 10 percent on all agricultural imports from India, is anyway going to be phased out within two to 10 years because of the requirement to phase out all the other duties and charges (ODCs), including ARF as a part of our WTO accession deal. In such a situation, it is naïve to assume that we are going to lose much of our tariffs or para-tariffs revenue because of the implementation of SAFTA.

However, one needs to take cognisance of the fact that reduction in tariff revenue is going to be more than offset by the gains to our consumers. Their surplus can come back to the economy in the form of increased consumption, thus providing a boost to our industries at least in those areas in which we have comparative advantage.

Moreover, dependence on tariff as the major source of revenue is least efficient because that distorts trade and shuts the market for the supply of the most efficiently manufactured goods at the victimisation of our consumers. Since consumers are the ones, who ultimately pay for the tariff, they might as well pay value added tax (VAT), which is the most efficient system of indirect tax. Despite criticisms, the institutionalisation of VAT is in tune with the global trade liberalisation envisaged by the WTO and regional opening up of the market envisaged by SAFTA.

In the present era, it is dangerous to have a mercantilist approach to trade liberalisation – a theory that views all the exports as good and all the imports as bad for the economy. What is the use of export revenue, if that cannot be used for importing the products our industry as well as consumers need? Here, an analogy can be drawn from the household income. What is the use of our income, if we cannot spend it on consumption, which helps us increase our standard of living and enhance the quality of our life?

The wave of regionalism, which has spurred due to the failure of global trade talks at Cancun last September, should have been taken as a clarion call by South Asia. It is a matter of pride for us that we did. Had we not been able to achieve this breakthrough in Islamabad, we would have been a net loser.

Freer trade, whether done through unilateral means without any quid pro quo (like Singapore), bilateral means (like India and Nepal), regional means (like SAFTA) and global means (like WTO) are beneficial in the long run for the countries concerned. One does not need to be reminded of the Sachs and Warner (1995) study, which dispels the myth that economies can grow faster under the shield of protectionism. As per the study, developing countries with open economies grew by an average of 4.5 percent per year in the 1970s and 1980s while those with closed economies grew by only 0.7 percent. Protectionism breeds inefficiency, creates massive rents, taxes consumers to death, results in gross misallocation of resources and promotes mal-governance.

What would be the future of world trade, if all the market access barriers were scraped? However, that is not yet the case – neither within the WTO system nor within the SAFTA framework. Free trade does not mean that all the tariff barriers have to be torn down. There will still be some policy space for the governments to provide reasonable degree of protection to genuinely deserving sectors of the economy. There will always be a possibility of protecting vulnerable sectors, which have been nomenclatured as ‘sensitive sectors’ even within SAFTA.

Should the tariff be insufficient to protect the industries/agriculture from the ‘onslaught’ of trade liberalisation (as some would prefer to call it), there will still be a possibility to protecting certain sectors through temporary trade remedy measures – such as imposition of anti-dumping duty and taking recourse to safeguards measures. Moreover, should there be dramatic fall in our foreign exchange reserves due to excessively high imports, we can also take recourse to Balance of Payment (BoP) measures by imposing higher tariff or even quantitative restrictions in order to safeguard our BoP situation.

Signing of SAFTA is historic for one more reason in the sense that economic cooperation will provide peace dividend to the countries of South Asia. Germany and France, after the decades of political rivalry and war, decided to join the European Union (erstwhile European Economic Community) and bury their political differences making another war impossible in Europe. They have been receiving peace dividend since. Similarly, signing of SAFTA and growing economic cooperation in the region are likely to make another war between India and Pakistan, who have fought three wars in the past four decades and have recently turned nuclear, impossible in South Asia.

For the overall economic and political interests of the region and its people, if Nepal will have to forgo some portion of its tariff revenue, it is a price worth paying. Time has come for us to move beyond petty mercantilist interest and have a broader vision – a vision of regional prosperity, which, in the process, ensures prosperity for all the participating nations, Nepal included.

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