South Asia Free Trade Association: Business Opportunities & Challenges

South Asia Free Trade Association: Business Opportunities & Challenges

 

Speech by Michael Carter

at

Inaugural Session of Conference Organized by

 

FICCI and SAARC Chamber of Commerce and Industry

at

Federation House, New Delhi, on March13, 2006

 

Thank you for inviting me to this conference on 'South Asia Free Trade Association

(SAFTA)--Business Opportunities and Challenges". 

 

In November 2005, the World Bank was a knowledge partner at the SAARC Business Leaders Conclave organized by the SAARC Chamber of Commerce and FICCI. 

 

That conference brought together for the first time, the private sector from all SAARC countries, and the conference was launched by the Prime Minister of India. The theme of that conference was regional integration and growth. I consider the theme today, free trade in South

Asia, as a key pillar of regional integration.

 

South Asia remains one of the least integrated regions in the world. Intra-regional trade as a percentage of GDP is low  for South Asia at less than 2 percent of GDP, compared to more than 20 percent for East Asia.

 

During the first three years of their independence, intra-regional trade among India, Pakistan and Sri Lanka as a percentage of their total trade was in the double digits.

 

Against this background of a fragmented region, SAFTA, which was signed in January 2004, has gathered momentum in recent years. With most countries in the world moving forward with more and more FTAs, there is a sense in the region that it may be falling behind in this race.

 

The region has suffered from the trade diversion generated by the many FTAs in the Americas and EU and its neighbors. SAFTA is also a vehicle of promoting better political ties among neighbors, especially India and Pakistan, just like the European Economic Community (EEC), which joined France and Germany into a tight economic union and made future conflicts between them very costly.

 

Given that the South Asian countries do not trade much with each other, SAFTA will help to bring about greater trade diversification. It will help to switch trade from informal to formal channels, e.g., the bulk of India-Pakistan trade is routed through Dubai, which is costly.

 

While SAFTA is a useful vehicle for increased trade, it also faces many challenges. I will highlight some of the challenges.

 

First, the critical factor in determining whether SAFTA would raise or lower the real incomes of the SAARC countries depends on whether it will be predominantly trade creating or trade diverting.

 

Thus, for example, when Bhutan  allows Indian cement to be imported duty free and this leads the more efficient Indian cement industry to out compete the less efficient Bhutan cement industry, we have trade creation: increased imports into Bhutan represent a shift from high cost Bhutani producers to low-cost Indian producers. 

 

On the other hand, if duty free access to Indian computers into Bhutan allows the less efficient Indian computer manufacturers to displace more efficient Korean suppliers who remain subject to

the duty, we have trade diversion: increased imports from India in this case represent a switch from low-cost outside sources to the high-cost within-union sources of supply.

 

Some characteristics of the South Asia region (e.g., small regional market relative to the world both in terms of GDP and trade flows, high level of protection among SAARC countries) increase the probability that SAFTA is likely to be largely trade diverting. It is, therefore, important that SAARC countries remain as open as possible to the rest of the world.

 

The second challenge is the political economy of the selection of excluded sectors and rules of origin.  When countries are allowed to choose sectors that can be excluded from tariff preference of free trade, domestic lobbies make sure that the sectors in which they may not withstand competition from the union partner are the ones that get excluded. 

 

On the other hand, lobbies go along with free trade in the sectors in which they are competitive and the preference will threaten the imports from outside countries.  In the same vein, lobbies tend to go for tight rules of origin or outright quantitative restrictions in precisely those sectors in which they fear the competition from the partner most. 

 

On the other hand, when the threat is mainly to the imports from outside countries, they are willing to accept greater liberalization.  The rules of origin can also be subject to abuse by the bureaucrat administering them.  In cases where imports from the partner may be threatening an inefficient domestic competitor, bureaucratic discretion may be employed to block entry of the

imports.

 

The third challenge is the "behind-the-border" restrictions. Cross-border trade can not succeed without improved trade facilitation in South Asia. Transport costs of regional trade are high in South Asia because of high inland transport cost, inefficiencies at ports and shipping, and restrictive transport and security procedures.

 

Trade costs are high because of customs procedures, other trade procedures (health, agriculture), banking and payment procedures, and standards. It takes more than 10 days to get customs clearance on a container in South Asia compared to less than 5 days in East Asia. An exporter from India requires more than 250 signatures, 118 copies, and 29 documents, before he or she can export.

 

Improved port efficiency, customs cooperation, exchange of information, and mutual recognition of standards should help to promote increased cross-border trade. Allowing cross-border movement without transshipment would provide major benefits to land locked countries. New transit routes are needed to better connect the South Asia region with Central Asia, China, and NE India.

 

The fourth challenge is the coverage of SAFTA. SAFTA is currently focused only on the trade in goods and overlooks trade in services. Service is the single largest contributor to GDP in South Asia and it accounts for roughly 40-50 percent of GDP.

 

Exports of services are rapidly increasing and they account for nearly 32 percent of total exports from India, for example. There is increasing demand within the region to free up the trade in services. The potential for tourism, and trade in health and education services are huge for South Asia.

 

The fifth challenge is cross-border investments. Intra-regional investment flows are small in South Asia. Trade restrictions within the region also deter FDI inflows from outside the region. Cross country investment flows within the region would benefit from increased regulatory harmonization including joint deregulation of bureaucratic red tape obstacles, financial sector integration, frameworks on competition and infrastructure, and introducing best practice regional investment code.

 

Finally the benefits of SAFTA should be seen to be equitably shared. Smaller countries that are highly dependent on trade revenues are likely to suffer as a result of trade liberalization. The region may want to consider establishing a Trade Compensation Fund that will compensate smaller countries for the loss of trade revenue arising from the implementation of SAFTA.

 

I would like to end by emphasizing that regional integration is important for growth and poverty redcuction in South Asia. Timing for fruitful regional cooperation is also good given the enthusiasm of the private sector.Quantitative benefits of integration can not caputre the potential benefits of a change in mindset/paradigm. The challenge ahead is to make the region and SAFTA more outward oriented, with a view to forging stronger links with ASEAN and the ECO region.

 

Thank You.

 

Michael Carter