by Suwendrani Jayaratne, Research Assistant and Anushka Wijesinha, Research Officer – IPS
The India-Sri Lanka Free Trade Agreement (ISFTA) which was signed in 1998 marked an important milestone in India-Sri Lanka relations paving the way to strengthen and broaden trade relations between the two neighbours. In fact this was the first bilateral free trade agreement Sri Lanka entered into.
Although the South Asian Preferential Trading Agreement (SAPTA) signed in 1993 provided preferential access to markets in the region, its limitations and slow progress encouraged the two countries to negotiate a bilateral FTA. Even prior to the agreement, India was a key source of imports to Sri Lanka, accounting for 8.5% of total imports in 1999. Nevertheless, India accounted for a negligible share of total Sri Lankan exports and ranked 14th in the list of export destinations in 1999. However, by 2008, India was Sri Lanka’s 4th most important export market (behind the US, UK and Italy), accounting for 5% of all exports.
As we near the end of the first decade since the implementation of ISFTA in March 2000, this post looks at the recent trends in Indo-Sri Lanka trade and poses some key issues to consider in moving forward.
Background to the ISFTA
To mitigate the risks of a small economy, Sri Lanka, opening up its economy to a large economy, India, the ISFTA was negotiated on the lines of asymmetric treatment. This took into consideration Sri Lanka’s less diversified industrial base and its small economy status. A ‘negative list’ approach was adopted in the negotiations, where all tariff lines apart from those listed in the negative list were subject to zero-duty at the end of implementation. Asymmetry between the countries was accommodated by special and differential treatment accorded to Sri Lanka in terms of the size of the negative list (1180 items for Sri Lanka against 419 for India), immediate duty-free concessions (319 items for Sri Lanka and 1351 items for India), and longer period for implementation (8 years for Sri Lanka against 3 years for India). While India fully implemented the agreement by March 2003, Sri Lanka did so by October 2008.
With the implementation of the ISFTA, trade between the two countries underwent substantial changes (see Table 1). Overall trade between the countries grew by six fold since it came in to effect. Sri Lanka’s exports to India increased at an annual average of 60% during the period 2000-2005 and reached a peak of US$ 566 in 2005, a tenfold increase compared to the export values in 2000. Imports grew at a more modest rate of 27% in the same period.
Table 1: India-Sri Lanka Trade Overview
However, the positive picture that emerges from aggregate figures of trade between the two countries has to be interpreted with care. Much of the increase in trade during 2000-2005 was concentrated in two products – copper and vanaspathi (vegetable oil). These accounted for over half of total exports to India by 2005. Therefore, if copper and vanaspathi were excluded from the trade figures Sri Lanka’s exports to India would have dropped by half during the concerned period. The export of these products increased not necessarily due to Sri Lanka having a particular comparative advantage in the production but due to tariff arbitration by Indian manufacturers who invested in Sri Lanka. There were concerns with regard to the benefits to Sri Lanka, as there was low domestic value addition in these industries and thus, limited employment generation, as well as some environmental issues. Trade disputes led to India restricting the volume of vanaspathi imports by imposing quotas and canalization. As a result, vanaspathi exports from Sri Lanka to India ceased. Copper exports were also scrutinized, and with price regulation imposed by India to prevent the mis-use of rules of origin criteria governing the ISFTA, copper exports fell sharply from US$ 145 million in 2005 to a mere US$ 13 million in 2008. As a result of low exports of vanaspathi and copper in the last few years, Sri Lankan exports to India fell to 5% from a peak of 9% in 2005.
Consequently, the utilization rate of the ISFTA by Sri Lankan exporters too has been declining from as high as 99% and 97% in 2003 and 2005 respectively, to 77% in 2007.
Table 2: Utilization Rates of ISFTA
As for imports into Sri Lanka from India, the numbers have increased steadily from 8.5% in 1999 to 17% in 2005 and 25% in 2008. Nevertheless, this increase in imports is not wholly due to the FTA. The major imports such as vehicles and vehicle parts, mineral fuels and oils are under Sri Lanka’s negative list, and products such as textiles and pharmaceutical items have duty free access under the general tariff regime of Sri Lanka.
The increase of Indian investments to Sri Lanka has been a more visible indirect benefit of the ISFTA. India is now the country’s second largest investor; investing US$ 126 million in 2008, second only to Malaysia (which invested US$ 150 million in 2008). This is a contribution of 14% of total FDI inflows to Sri Lanka, and is a marked increase from the previous investment levels during 1978-1995 which amounted to just 1.2% of total investments. The number of projects too increased from 18 in 1999 to 83 in 2006, with a majority of recent Indian investment being in telecommunications, retail services, energy, hospitality trade and air transport services. An example of a recent Indian investment success story has been the entry of Piramal Glass (acquisition of Ceylon Glass Company), which is now not only catering to the Sri Lankan market but has also begun exporting nearly 70% of their output to the Indian market.
Sri Lankan investments in India too have increased, and include areas such as garments, confectionaries, hotels and furniture, with some of Sri Lanka’s top blue chip companies opening up ventures there (e.g., Brandix, MAS, Aitken Spence, John Keells).
Taking it to the next level – the CEPA
Given the positive outcomes of the ISFTA and emerging services/investment links encouraged both India and Sri Lanka to broaden economic cooperation by including services and investment under a proposed Comprehensive Economic Partnership Agreement (CEPA). Potential areas of cooperation for the CEPA identified by the Joint Study Group included trade in services, investment, and economic cooperation. Although the Framework Agreement was scheduled to be signed on the sidelines of the 15th SAARC Summit in Colombo in 2008, reservations and pressure from some Sri Lankan stakeholders halted the signing of the agreement. The CEPA is expected to provide Sri Lanka access to a fast expanding Indian economy with a rapidly growing middle class, encourage Indian FDI in services, provide greater access to technology, and a more regulated mechanism for the movement of workers. Although many cite the downside risks like higher competition for domestic service providers and the flooding of Indian professionals in to Sri Lanka, the CEPA makes provisions to address many of these concerns which are often misplaced. CEPA negotiations have been on a positive list approach where only specified sectors are liberalized and India’s offers to Sri Lanka has been much more extensive than that of Sri Lanka’s offers.
With India pursuing stronger economic relations with the wider Asian region, closer economic integration with India would no doubt open doors of new opportunities for Sri Lanka. India has already signed Comprehensive Economic Cooperation Agreements (CECAs) with Singapore and South Korea, and a Trade in Goods Agreement with ASEAN (soon to be expanded to an FTA in services). India has also begun negotiations on an FTA with the Gulf Cooperation Council (GCC) and EU (European Union).
Problems with the FTA do exist
Overall, the trade benefits of ISFTA to Sri Lanka remain mixed. Although over 95% of Sri Lanka’s exports to India enter at zero duty under the ISFTA, trading has not been without any predicaments. There were restrictions in terms of access to ports, quotas, stringent rules of origin requirements, and non-tariff barriers when exporting to India. Some issues like port restrictions, however, have been addressed over time. Nevertheless, non –tariff barriers such as state taxes still persist (for example, in the Indian state of Tamil Nadu, local producers pay 10.5% state tax, while importers must pay at the rate 21%).
Delays at customs and bureaucratic red tape have also been cited by Sri Lankan exporters as a serious constraint in dealing with India. However, much of these complaints are purely anecdotal and therefore an urgent need is for closer evaluation accompanied by documented evidence in order to take concrete steps to address them.
Despite these restrictions, India has emerged to be Sri Lanka’s largest, and most balanced, trading partner, with substantial levels of both exports and imports taking place. This is an important development for Sri Lanka in its efforts to diversify its export basket and look towards regional markets like India which are showing strong growth and faster recovery from the global downturn, while Sri Lanka’s traditional Western markets remain in a state of fragile recovery.
Indo-Lanka Trade – The Way Forward
Sri Lanka’s export market penetration to India is far from adequate, and has a long way to progress. At this important juncture, 10 years since the implementation of the ISFTA, some of the key questions that all relevant stakeholders need to ask themselves are:
• What is holding back greater penetration of Sri Lankan exporters into the Indian market?
• What strategies need to be adopted to make Sri Lankan products perform better in the Indian market?
• Has Sri Lanka maximized the benefits accorded in the ISFTA, and if not, where are we lagging behind?
• Do we have strong mechanisms to lobby for the reduction/removal of non-tariff barriers imposed by India, and the various other impediments faced by Sri Lankan exporters to India?
• Are Sri Lankan businesses across the country fully aware of the opportunities available through the FTA, and also the technical nuances of the agreement?
• Do Sri Lankan businesses have an adequate understanding of the Indian market, in order to succeed there?
The final two questions are increasingly important, as highlighted in a recent article* by a business chamber representative which noted that, “Even after a period of ten years, there yet seems to be a lacuna in regard to an understanding of Free Trade Agreements, their mechanism, the advantages as well as connected problems, especially among some members of the business community outside the metropolis…”. As highlighted in this remark, SMEs in Sri Lanka are particularly unaware of the opportunities available through the FTA, and this has been stated repeatedly at many forums.
Additionally, Sri Lankan exporters to India ought to undertake more diversification of product baskets to fully make use of the FTA. This is already taking place to some extent; the number of product lines exported has increased from 505 tariff lines pre-FTA to over 1,050 tariff lines at present. Moreover, Sri Lanka has gradually begun exporting more high value goods as the FTA progressed. Some of the main exports pre-FTA included pepper, waste and scrap steel, areca nuts, dried fruit, cloves, waste paper, etc. Whereas now, in addition to these, value added items like insulated wires and cables, pneumatic tyres, ceramics, wooden furniture, refined copper products, rubber products (gloves), apparel, chemicals, plaster cement and pharmaceuticals have made steady progress.
The Indian domestic market is massive, with a growing middle class, and the opportunities are no doubt extensive. A crucial area Sri Lankan exporters need to focus on now is product branding to cater to the Indian market. There are several Sri Lankan brands that have already made strong headway in penetrating the Indian market, like Amante (lingerie-wear line by garments producer MAS), Lionco (mattresses), Damro (plastic furniture), Janet (herbal beauty products), Siddhalepa (ayurvedic medicinal products), Stone n’ String (gems and jewellery), Dankotuwa Porcelain (tableware), and Munchee (biscuits and confectionaries). The next step for Sri Lankan enterprises should be to leverage the ISFTA to develop strong regional consumer brands.
Moving forward from 2010, it is time to comprehensively review the performance of the ISFTA. In this review process, there is a clear case for greater private-public dialogue in Sri Lanka, on an ongoing and regular basis. Reserving the consultations and discussions purely to the governments and the commerce and trade departments of both countries will not be sufficient. This can ease exporter-importer concerns, demonstrate that challenges in the treaty can be addressed in a participatory manner, and help create broader public awareness of, and confidence in, the opportunities and benefits of the ISFTA.
*“Private sector perspective and experience in free trade agreements: A Sri Lankan case study”,
The Island Financial Review, Tuesday 09 March 2010