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

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Regional Focus

Salvaging SAFTA

It has been two decades since South Asian Association for Regional Cooperation (SAARC) was established and a decade since the implementation of SAARC Preferential Trading Arrangement (SAPTA).1 However, at a mere 5 percent, the level of intraregional trade in South Asia is far from satisfactory. The region is indeed one of the least economically integrated regions in the world.2 Therefore, is there a case for a substantial increase in intra-regional trade in South Asia or is the proposed South Asian Free Trade Area (SAFTA) just a fad?

Signed on 11 April 1993, SAPTA was enforced on 7 December 1995. Four rounds of negotiations have taken place to deal with around 5,000 commodities in the preferential list. However, members are in the final stages of negotiations to convert SAPTA into SAFTA, which will become a reality from 1 January 2006 and envisions completing the trade liberalisation programme by 2016.

Currently, members are finalising the ‘sensitive list’ (a schedule of products on which members are not required to progressively lower tariffs), ‘rules of origin requirements’, ‘revenue compensation mechanism’ and ‘technical assistance’ to least developed country (LDC) members. Multiple rounds of negotiations have been held, of which the ninth meeting was in Kathmandu in July 2005. Members have not reached consensus on all issues except of some progress in the ‘sensitive list’. When SAFTA is enforced, it would encompass around 25 percent of the products in the sensitive list of most of the members.

Fallacy of trade integration

Is the low coverage of liberalisation merely an inability to negotiate or are there deeper apprehensions among the members on the ability of SAFTA to facilitate regional trade? Some pre-requisites for successful regional trade integration are examined. Pitigala (2005) proposes the hypothesis of “natural trading partners”. 3 A “natural trading partners” situation is characterised by complementarities, i.e., if a country imports what its trading partner exports, the hypothesis of “natural trading partner” is likely to hold. The situation may, however, be influenced by trade policies.

In this regard, countries in South Asia can hardly be said to be “natural trading partners”. For instance, the high percentage of intra-region- al trade of Bhutan and Nepal is primarily due to their preferential trading arrangements with India. Bhutan and Nepal have around 90 and 60 percent of their total trade with India. Hence, trade policies, rather than fulfilling the condition of “natural trading partners”, explain the reason for high levels of intra-regional trade. In the cases of Bangladesh, India, Pakistan, and Sri Lanka, intra- regional trade is around 12, 3, 3 and 13 percent of their total trade respectively.

Furthermore, the “natural trading partner” hypothesis, based on trade volumes approach, suggests that members in a regional agreement should trade disproportionately with each other in order to be a successful block. The bigger nations in South Asia have very low percentage of their total trade in the region, which makes the case for greater economic integration in South Asia weak.

It has been shown by studies that a large volume of intra-regional trade goes unrecorded and some studies have shown big potential for growth in intra-regional trade. Countries in geographical proximity prefer to trade with each other more than with more distant countries. Is SAFTA then going to bring greater economic integration in South Asia?

Trade within South Asian countries is likely to grow in the future but not solely due to SAFTA. Bilateral trading arrangements such as those between Nepal and India, and India and Sri Lanka accord more preferential access to these countries than accorded by SAFTA. Moreover, compared to regional trade agreements (RTAs), it is much easier to negotiate bilateral trade agreements. Prospects for the success of SAFTA are also threatened by the existance of RTAs such as Bay of Bengal Initiative for Multi-Sectoral Technical and Economic Cooperation (BIMSTEC) free trade area, of which Bangladesh, Bhutan, India, Nepal and Sri Lanka are also members. This RTA is more ambitious than SAFTA. In addition to faster and deeper liberalisation in goods, it seeks to liberalise services and investment too. In light of these more progressive bilateral agreements and RTAs, in due course of time, SAFTA could be a low priority for most of the countries in the region. Hence, SAFTA is unlikely to be a strong regional arrangement on the basis of being only a trading agreement for liberalising trade in goods in South Asia. To be of any relevance, regional economic integration efforts in South Asia will also have to include measures to liberalise trade in services, remove barriers to intra-regional investments, improve trade facilitation and enhance cooperation in infrastructure, such as energy and telecommunications.

Services are increasingly playing an important role in the economies of South Asia. The contribution of this sector in gross domestic product of South Asian countries is 40 percent on average, ranging from 38 percent in Nepal to 52 percent in Sri Lanka. These figures are likely to increase as economic development advances. Coupled with liberalisation on investments, services are likely to attract intra-regional investments. Tourism, health, education and business services are potential areas for such investments. It is also believed that investment liberalisation is a prerequisite for increased intra-regional trade in South Asia. RTAs – which liberalise their investment regimes – have seen a rationalisation of investment portfolios of their members. With the gradual reduction in tariffs, trade facilitation is gaining relevance for reducing costs of international trade. Poor transportation facilities, differing custom procedures and requirements and inability to use more economical transit routes hinder regional trade. The contiguous nature of the Indian sub-continent calls for joint efforts for improving surface and sea transport facilities. South Asia has been identified as an energy deficit region. Huge gas reserves in Bangladesh and hydropower potential exists in Nepal (which remain untapped) while a fast industrialising India is facing energy shortages. The International Energy Outlook 2004 projects more than doubling of Indian power demand from 554 Billion Kilowatt hours (BKWh) in 2001 to 1,216 BKWh in 2025.4 Development of regional electricity grid and gas and oil pipelines is also going to benefit countries in South Asia. The geographical proximity makes crosscountry supply of telecommunications services feasible. These are probably more attractive avenues for regional cooperation than merely enhanced trade in goods.

Conclusion

Without considering other complementarities that can boost intra-regional trade, SAFTA would become an incomplete mission. If we fail to understand the deeper apprehensions of members on the potential of SAFTA, which are reflected by their inability to negotiate a manageable ‘sensitive list’, South Asian countries would be wasting time and energy on something that is not going to bear fruit. Unless the mandate of SAFTA is broadened to include measures to liberalise trade in services, increase intra-regional investments, improve trade facilitation and enhance cooperation in infrastructure such as energy and telecommunications as a ‘single undertaking’, it will not help to enhance economic cooperation in South Asia. If these issues are not addressed, SAFTA will remain an incomplete vehicle for regional cooperation and development.

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