Exports from Sri Lanka to India increased significantly after the Indo-Lanka Free Trade Agreement (ILFTA) went into effect in 2000, reaching US$58 million in 2000 to US$418.3 million in 2008. Similarly, exports from India to Sri Lanka have also accelerated to US$3,443 million in 2008 to US$600.1 million in 2000. At a conference marking 10 years of the ILFTA this week, organized by the Institute of Policy Studies (IPS) in conjunction with the Centre for WTO Studies, the Federation of Chambers of Commerce and Industry of Sri Lanka (FCCISL) and the Indo Lanka Chamber of Commerce and Industry (ILCCI), IPS Executive Director Saman Kelegama said no trade bilateral agreement can be perfect. Problems are bound to emerge as trading progresses over the years.

Dr. Kelegama said regular meetings due to the proximity of India and Sri Lanka in ironing out problems in a cordial manner have been a hallmark of the ILFTA. He described the overall progress as being good although there are still a number of areas that need to be addressed. The ILFTA can be a model of integration between small and large economies to produce a ‘win-win’ situation.

Senior Consultant at the Indian-based Research & Information System (RIS) for developing countries Indra Nath Mukherji said that at the time of signing the agreement, there were deep apprehensions, particularly among stakeholders in Sri Lanka. The fear of small and medium industries and smallholding cultivators being swamped by imports from India was clearly marked. In India in the states of Kerala and Tamil Nadu, there were apprehensions of imports of tea and spices from Sri Lanka threatening the livelihoods of their cultivators. The garment manufacturers in India were apprehensive of garments produced by more modern machinery threatening their business.

In view of these apprehensions, Mr. Mukherji said it took nearly 15 months for both countries to draw up their respective Negative Lists. The size of the Negative lists reflected the nature of these apprehensions and was so designed to allay them. Sri Lanka drew up a long Negative List mainly to protect their agriculture, livestock, rubber and paper products, iron and steel, machinery and electrical items. India’s Negative List sought to protect its garment, plastic and rubber manufacturers.

Though India had a much smaller Negative List, Mr. Mukherji said many products of export interest to Sri Lanka were subject to quotas beyond which most favored nations (MFN) rates would apply. This came as a compromise balancing the interest of the farmers, small scale producers and the consumers. The first six years of the operation of the ILFTA belied the pessimism of the doomsayers as bilateral trade expanded rapidly and in addition, FDI’s from India accelerated. However, he said this euphoria was short lived.

Mr. Mukherji said what went wrong with the ILFTA in subsequent years was that Sri Lanka’s exports to India were narrowly focused on vegetable oil and cooper products which together, accounted for nearly 50% of total Sri Lankan exports to India. These exports to India were not based on the country’s comparative advantage but on vastly differential external tariffs on these products and on raw materials for these products.

Mr. Mukheji explained that in keeping with India’s reform programme and in more recent years, also to meet the threat of spiraling inflation on imported food and raw materials, India reduced its external tariffs on these products. As the tariff differential in the two countries external market eroded, the competitiveness of Sri Lankan exporters to the Indian market through vastly diminished arbitrage opportunities no longer existed.

To illustrate this point, Mr. Mukherji said average tariff rates in India on crude palm oil declined from 75% in 2001 to 2002 to nil in 2008 to 2009 while that of copper scrap declined from 35% to 5% over the same period. This has contributed to a drastic fall in India’s imports from Sri Lanka.

Mr. Mukherji said one positive indirect consequence of the ILFTA has been the substantial increase in Indian investments to Sri Lanka which increased cumulatively from US$4 million in 1998 to US$126 million in 2008. India is now the second largest invesor in Sri Lanka, exceeded only by Malaysia. According to figures presented by the Indian Embassy in Colombo, the cumulative investment by India is even higher at US$400 million. Another US$300 million in Indian investment has been approved by the BOI and is in the pipeline at various stages of investment.

Mr. Mukherji also stated that while limitations have emerged in the operation of the ILFTA in recent years, it is better to address them rather than allow it to stagnate. Despite its limitations, the ILFTA continues to remain the best possible alternative for the two countries to expand their mutual trade. He further noted that given the pace at which comprehensive partnership agreements including trade, investment and services are being worked out under different regional trading arrangements, a move towards a Comprehensive Partnership Agreement should not wait until all the issues in ILFTA are sorted out. Such a delay will result in foregoing a first mover advantage in services trade agreement.

According to a concept note on the 10 years of the ILFTA, the product base of Sri Lanka has diversified during the past decade. In 1999, Sri Lanka exported products to India under 505 tariff lines whereas by 2005, the number of products increased to 1,02 with several value added products. By 2008, apart from the traditional primary products like pepper, waste and scrap steel, areca nuts, dried fruit and cloves, several value added products like insulated wires and cables, pneumatic tyres, ceramics, vegetable fats and oils, apparel, pharmaceutical products and furniture were among the top exports from Sri Lanka to India.

However, aggregate trade figures hide the fact that trade between the two countries has often been concentrated in narrow product ranges. For example, if Vanaspathi (vegetable oil) and copper were excluded from the trade figures, Sri Lanka’s exports to India would have increased to US$278 million in 2006 from US$58 million in 2000. Vanaspathi and copper exports rose not due to any distinct comparative advantage that Sri Lanka held, but due to a short term tariff arbitration by Indian manufacturers investing in Sri Lanka. The viability of the industry was only as long as there was a discrepancy between Indian and Sri Lanka tariffs on palm oil imports. Vanaspathi exports are expected to be non-existent from 2009.

Indian investment into Sri Lanka has also increased significantly, since the implementation of the ILFTA where India contributed 16% to total foreign direct investment (FDI) flows to Sri Lanka between 2001 and 2006. Around 63% of cumulative Indian investment as of end 2007 was in services, which includes sectors like telecommunications, health services, retail, energy, hospitality and air transport services while the investment in services was 30% in 2000. According to the Board of Investment (BOI), Indian investment has resulted in 70 projects employing 6,747 individuals in Sri Lanka as at end 2007.

Critics of the ILFTA have argued that there are inherent weaknesses in the agreement that make it very challenging for Sri Lankan exporters to compete in the Indian market such as quotas, non-tariff barriers and challenging rules of origin requirements in certain products. Many of these issues have been addressed in subsequent negotiations between the two parties during the course of negotiations for the Comprehensive Economic Partnership Agreement (CEPA) such as restrictions on ports of entry and quotas on the export of certain products from Sri Lanka to India.