ETCA: Separating wheat from the chaff

In assessing the proposed Economic and Technical Cooperation Agreement (ETCA), it is important to place any analysis within the overall context of the options for accelerated development available to a country like Sri Lanka. 

The need to prioritise faster growth and employment generation is reinforced by the fact that: (i) Sri Lanka has slipped from being second to Japan in Asia on most socioeconomic indicators at the time of independence to a position much further down in the ranking of countries in this region; and (ii) tens of thousands of young people have been killed in the two Southern insurrections largely due to a mismatch between opportunities and expectations. This was also an important causal factor for the separatist movement in the North and East. 

Given this legacy, it is imperative that the highest priority has to be given to growth and employment creation. During the last 10-years, the public service has increased by 700,000 persons. The current budget and debt dynamics mean that such a course of action can no longer be continued. Similarly, the previous external commercial borrowing financed growth model has also run out of headroom. This means that growth and employment will have to be driven by private investment. The savings and investment gap in Sri Lanka is such that FDI, as a non-debt creating inflow, will have to play a crucial role in filling this gap and generating the desired growth and employment.

In a country of 21 million people, sustained increases in employment and incomes of the people on the basis of balanced and inclusive growth of the economy can only be achieved by supplementing the domestic market with a sharp focus on external demand i.e. exports. The transformative successes achieved by several Asian countries demonstrate this vividly. It is noteworthy that countries varying in size from China to Singapore have gone down this route.

In a context where multilateral trade negotiations (the Doha Round) have stalled and South Asian regional integration is constrained by tensions between India and Pakistan, there is a robust case for attaching high priority to bilateral agreements. 

Furthermore, there is a global tendency towards increased bilateral and regional trade agreements. It would be unwise for Sri Lanka to be left behind. In this connection, given the significant competitive advantages associated with proximity, Sri Lanka needs to deepen and extend the existing FTA with India, by common consent the fastest growing large economy in the coming years. Priority should also be attached to completing the FTA with China and making greater use of the agreement with Pakistan. FTAs with other countries should also be pursued in a systematic way to support diversification of export markets.

One should also recognize that while bilateral trade agreements are important for increasing market access for existing Sri Lankan exporters, they are even more important for the benefits that are generated through the nexus between trade and investment. Preferential access to larger markets can incentivise foreign investment into Sri Lanka. This not only attracts FDI to fill the savings - investment gap but also provides access to technology, know-how and markets. In the process, competitive pressures also assist Sri Lankan enterprises to increase productivity and enhance their overall performance.

This is the big picture within which one should locate the discussion on the proposed ETCA with India. One needs to assess the ETCA in terms of whether it is beneficial for increasing growth, employment, incomes, FDI and exports. The debate on the merits of the ETCA, as a means of taking advantage of our proximity to the fast-growing Indian economy, to meet these objectives divides the protagonists on the basis of whether India is seen as an ‘opportunity’ or a ‘threat.’ Some of the antipathy to the ETCA is based on primordial fears and insecurities as well as narrow insularity. These are not evidence - based or rational. However, there is also more considered opposition based on the following arguments, which require careful consideration.

• The asymmetry of the two economies means that the ETCA would inevitably be detrimental to Sri Lanka’s interests resulting in a loss of output (growth) and employment.
• The current Indo – Lanka FTA has been a failure with more costs than benefits for Sri Lanka.
• The problems with the existing FTA should be addressed before embarking upon the ETCA.
• Questions have been raised as to what the draft framework agreement entails in relation to the final ETCA.
• The ETCA would inevitably lead to greater Indian intrusion into the domestic affairs of Sri Lanka leading to an erosion of sovereignty.
• The fisheries issue should be resolved before entering into an ETCA.
• Why should an ETCA be signed early?
• Sri Lanka does not have the quality of negotiators needed to deal effectively with their Indian counterparts.
• Our regulatory house should be put in order first.

Asymmetry between the two economies

There is clearly a very large asymmetry between the economies of Sri Lanka and India. However, there are well known mechanisms for addressing this. A combination of judicious negative/positive lists, safeguards and transitional arrangements can result in an ETCA, which provides a framework for taking advantage of the proximity to the growing Indian economy in a predictable and stable environment. 

Furthermore, one can argue that there is a strong case for putting the increasingly asymmetrical trade and investment relationship between Sri Lanka and India within a rules – based framework. It is generally recognised that it is in the interests of smaller countries to negotiate a rules-based regime to manage bilateral relations with much larger economic partners. 

The challenge is to ensure that the rules serve to maximize Sri Lanka’s interests and that there is a robust dispute settlement mechanism in place. The prospects of achieving this are increased by the fact that both sides have accepted the principles of non-reciprocity and special and differential treatment.

The Indo - Sri Lanka Free Trade Agreement

 It has been argued that the existing FTA has been a failure. The negative experiences regarding Vanaspati Oil and Copper, as well as a number of non-tariff barriers have been cited to make this case. The FTA has certainly had a number of problems associated with it. However, it is also important to recognise that it has served to improve the trading environment in goods and some sources of friction have already been addressed e.g. the issues regarding entry through a single port,  processed food, etc.

Furthermore, the sharp increase in Sri Lanka’s trade deficit with India has been used as a reason for concluding that the FTA has been inimical to Sri Lanka’s interests. The facts are that our exports to India increased from $55 mn in 2000 to $ $624.65 mn in 2014. Furthermore, there has been the emergence of new items such as animal feed, electrical appliances and accessories, vessels, paper products, glass and plastic products. This has meant that there has been both an increase in the value and diversification of exports. At the same time, imports from India have increased from $600 mn in 2000 to $4023 mn in 2014. The major imports from India include petroleum products, iron and steel, cotton, motorcycles and motor vehicles.

 As a result, Sri Lanka’s trade deficit with India has grown from $ 544 mn in 2000 to $3353 in 2014. However, the overall trade flows are misleading. In assessing the Indo – Lanka FTA, it is important to focus only on the trade, which takes place on preferential terms under its provisions. In this respect, in any given year, 65 percent – 80 percent of Sri Lanka’s exports to India take place on preferential terms. At the same time, only 20 percent – 25 percent of imports from India enter the Sri Lankan market under the preferences provided by the FTA.

A significant majority of imports from India come into this country simply because they are internationally competitive i.e. the most cost-effective sources of supply. Hence, one can conclude that: (i) the trade deficit on preferential items is far smaller than the total bilateral trade deficit; and (ii) Sri Lanka’s overall trade deficit would have been higher if the non-preferential imports from India were obtained from other more expensive sources.

It is also important to point out that there has been an increase in Indian investment in Sri Lanka. This may be partially attributed to the FTA. Much of this investment has been in services, such as health, education, fuel distribution, hotels, tourism and computer software and professional services.

Problems with existing FTA should be addressed before embarking upon the ETCA

 It has been reported that the government has already initiated action to obtain an ‘early harvest’ in addressing non-tariff barriers, which have been impediments to Sri Lankan exports into the Indian market. 

The recent visit of a group of senior Indian officials to conduct a workshop to assist Sri Lankan exporters to understand Indian non-tariff measures (not barriers), such as customs procedures, standards, labelling requirements, etc. was part of the effort being made to address some of the problems confronted by Sri Lankan exporters. Steps are also being taken to negotiate a mutual recognition agreement and establish a nodal point in the Indian system to assist Sri Lankan exporters.

ETCA negotiating process and transparency issues

Questions have been raised as to the relationship between the Draft Framework Agreement, which is expected to be signed shortly and the final ETCA, which is to be negotiated over the next six months. The Framework Agreement merely sets out the scope of the proposed ETCA. 
The current FTA is an agreement in goods. The Framework Agreement indicates that this is to be extended by widening and deepening the agreement in goods; and extending it to include services, investment, technology and training.

The main focus on the goods front should be reducing the Indian negative list (however, it should be noted that Sri Lanka’s negative list is significantly longer than India’s). A case can also be made that it is in Sri Lanka’s interest to extend the existing agreement to cover services as this is the sector, which offers the greatest promise for this country.

Within services, there has been a great deal of controversy and emotion regarding the opening up of professional services (i.e. the natural movement of persons: Mode 4). The government has indicated that it would not be opening up Mode 4. However, it is in Sri Lanka’s interest to open up very specific categories of skills which are in short supply and are thereby constraining growth in sectors with considerable potential e.g. IT – enabled services and specialized skills for ship-building. In such instances, the industry concerned should be permitted to specify the skills it requires along with detailed specifications regarding qualifications, experience, etc. It is noteworthy that in 2008 while Sri Lanka offered to open up 2 items under Mode 4 (IT - enabled services and ship building), India had close to 80 items on its positive list.

 As mentioned above, accelerating investment is crucial for growth, employment and higher incomes. Hence, strengthening the investment agreement between the two countries will create a more conducive environment for enabling higher levels of investment from India.
India can play a significant role in building capacity and enhancing the competitiveness of Sri Lankan businesses, particularly SMEs and human capital. There is, therefore, a case that can be made to incorporate technology and training into the ETCA.

As for the whole process of negotiation, there often seems to be a misunderstanding between the Framework Agreement and the final ETCA. It is important to differentiate between the two and to ensure that there is transparency in the entire process. It is understood that the government has made the Draft Framework Agreement available to all the political parties in the parliament as well as business associations and professional organizations. This is to be welcomed. 

However, there is merit in making the document available more widely through the media, including though a dedicated website. The government has also indicated that the negotiations on the final ETCA would be a transparent process involving all stakeholders. It is crucial that the government abides by this commitment. In addition, parliament should also be included in this process.
 

ETCA would lead to Indian intrusion into Sri Lankan domestic affairs

 It has been argued that ETCA will result in Sri Lanka coming under increasing Indian dominance. India is undoubtedly a rising global power. It is a member of the G20 and has received support from some major countries for a permanent seat on the UN Security Council. This means that the Indo – Lanka power relationship will become even more asymmetric in the future. It is important to recognise that India’s strategic geopolitical interests vis-à-vis Sri Lanka are based on a geographical reality that is immutable. 

Hence, India can well intervene if it perceives that its geopolitical interests are threatened. It is likely to do so regardless of whether or not there is an ETCA in place. The ‘Parippu’ drop is a vivid example of this. In such a context, understanding India’s geopolitical sensitivities would serve to protect and strengthen Sri Lanka’s sovereignty. In this context the ETCA can serve to deepen economic ties and strengthen mutual interest in a stable and prosperous bilateral relationship.
 

Fisheries issue should be resolved before entering into ETCA

It is extremely clear that India has failed to live up to its obligations under international law on the fisheries issue. It is disappointing that neither the current government nor its predecessor has been able to prevail upon the Indian authorities to prevent illegal fishing in Sri Lankan waters. It is important that the Sri Lankan government attaches the highest priority to resolving this issue, which adversely affects poor fisher folk, particularly in the conflict–affected areas.
However, it is difficult to understand the logic of linking the fisheries issue with the ETCA. They are separate issues. The ETCA should be assessed on its own merits. If it’s beneficial to the interests of Sri Lanka and its people, the agreement should be finalized. The negative effects of the fisheries problem should not be compounded by foregoing the potential benefits of the ETCA as well.
 

Why should an ETCA be signed early?

As mentioned above, India has now become the fastest growing large economy in the world. It is likely to maintain this position in the coming years. There is growing global interest in the Indian market. Preferential access to it can be leveraged to attract investment, create jobs and increase income.
Delaying the process would allow others to steal a march over us. India has already signed a number of FTAs. More are under negotiation. The more that are signed before us the greater will be the erosion of potential benefits. Others including our competitors, are pressing ahead. They are not going to wait for us to get over our irrational, primordial fears and insecurity.
There are further factors which make the current landscape propitious for completing the ETCA. First, the ‘Make in India’ strategy can create opportunities for Sri Lankan companies to plug into new value chains of domestic companies and multinationals operating in India. Secondly, in the past, poor infrastructure in both India and Sri Lanka made it difficult to take advantage of geographical proximity due to high transport / transaction costs. The improving infrastructure in both countries is creating a better enabling environment for taking advantage for our proximity to a large and increasing market.
Another positive development would be the introduction of a goods and services tax. It has currently stalled in the Indian parliament. If it is implemented, the results will be the elimination of a number of state level taxes and tariffs. This will create better enabling conditions for the emergence of a common market in India, which will reduce transaction costs and significantly improve the prospects for our exporters doing business in that economy.
 

Weakness of our negotiators

It has been argued that Sri Lanka does not possess adequate capacity among its negotiators to deal effectively with their Indian counterparts. Even if one accepts this as a valid argument, it is not sufficient to derail the negotiating process. As mentioned above, the entire process should be transparent and involve relevant stakeholders. This would mean that the hand of our negotiators would be strengthened considerably through consultations drawing upon the collective wisdom of all relevant sectors. It is difficult to understand how Sri Lanka’s position cannot be developed to advance its national interest if such a course of action is pursued.
 

Putting House in order

 It has been argued that Sri Lanka’s regulatory environment is too weak to enable the signing of Free Trade Agreements with much larger countries. In this connection, the government has already initiated the enactment of anti – dumping legislation, which is expected to be presented to parliament in the near future. 
In addition, it is reported that it has also offered professional associations support to introduce formal registration mechanisms as a means of maintaining the standards of persons operating in these fields. These are positive initiatives. It is important that the concerted action is taken to ensure that they are brought to a conclusive fruition as early as possible.
 

Conclusion

The debate on the proposed ETCA should be focused on a hard-nosed assessment of potential benefits and costs rather than on emotion and primordial fears. This article argues that economic asymmetry can be addressed through negative and positive lists, safeguards and differential transitional arrangements. Furthermore, it is in the interest of small countries to seek a rules – based regime to manage relations with much larger economic partners. In the absence, of a disciplinary framework, everything would have to be negotiated on a case – by – case basis with a much more powerful partner.

There are a number of other legitimate issues, which have been raised in the debate on the ETCA. This article has sought to address a number of the more considered concerns. Of course, emotion and irrational thinking cannot be countered through rational discussion. The article also points out that a transparent process, which involves key stakeholders and mobilizes technical expertise, both within and outside the government, can increase Sri Lanka’s capability to achieve favourable outcomes, which are beneficial to the country and its people through effective negotiations.

(This is issued by Pathfinder Foundation: Centre for Indo – Lanka Initiatives, Comments are welcome at pm@pathfinderfoundation.org)