11 Operationalizing SAFTA:

Issues and Options

Upali Wickramasinghe*

1. Introduction

I ntra-regional trade in South Asia has been a topic of debate for a long time. In the
present context where South Asia is making an attempt to re-energize regional eco-
nomic integration under the South Asian Free Trade Area (SAFTA), the key points
of the debate and the present state of intra-regional trade are worth revisiting. First,
intra-regional trade as a share of the overall trade was 3.5% in 1970, which declined to
2.4% in 1990, increased slightly to 4.1% in 1995 and since then it has settled at around
4%. Second, the share of intra-regional trade of the three smaller countries – namely,
Bhutan, the Maldives, and Nepal – has been quite significant. For Bangladesh and Sri
Lanka, the shares have risen in the latter part of the 1990s, mainly because of increased
imports from the region. Third, while Pakistan’s share of imports and exports from
* I wish to thank Deepthie Wickrama-
the region is around 2-3%, India’s share of imports from the region has historically singhe for research assistance and
been below 1%, and the country’s share in exports has been in the range of 3-5%. In an anonymous referee for helpful
short, the small countries have a higher share of intra-regional trade in their overall comments on an earlier draft.
trade while the large countries, and the region as a whole, have low intra-regional Any remaining errors are the sole
responsibility of the author.
trade.
1 The figures for Bangladesh, Nepal,
The recent changes are encouraging to some extent. The average share of intra-re- and Sri Lanka in 1990 respectively,
gional imports by Bangladesh, Nepal and Sri Lanka has increased from an un-weighted are: 7%, 11.5%, and 6.6%. For the
same countries in 2003 these are:
share of about 8% in 1990 to 19.4% in 2003. For Pakistan, there has been a marginal 16.6%, 23.9%, and 17.6%.
390 Chapter 11 Operationalizing SAFTA: Issues and Options
2 Bayson et al. (2006).
3 Pitigala (2005).
4 Govindan (1994).
5 Sengupta and Banik (1997).
6 Srinivasan (1998).
7 Jayaraman (1978); Rahman (1997).
8 Srinivasan and Canenero (1975);
DeRoa and Govindan (1995),
(1996); Sengupta and Banik (1997);
Pigato et al. (1997).
increase in this share from 1.6% in 1990 to 2.4% in 2003. On the export front, the
relative importance of the intra-regional exports of Bangladesh has decreased from
3.6% to 1.8% during the corresponding period, while that of Sri Lanka has increased
from 3.1% to 6.8%. Three parallel developments could explain the above trade pat-
tern, namely, (i) the unilateral liberalization that South Asia embraced in the 1990s or
in the immediately preceding years; (ii) the rising share of smaller countries’ imports
from India, but without a corresponding increase in their exports to India owing to
the high level of protection in India; and (iii) the advent of bilateral trade agreements
within the region, like the India-Sri Lanka-Free Trade Agreement (ISLFTA).
The low intensity of intra-regional trade in South Asia has led Pitigala (2005), Bayson
et al. (2006) and others to conclude that South Asia does not correspond to the so-
called ‘natural trading partner’ hypothesis. They argue that SAFTA is largely irrelevant.
Looking at the current level of intra-regional trade as a whole in comparison to global
trade, one may indeed agree with this assertion. However, the micro picture that takes
into account bilateral trade with a particular emphasis on smaller countries may not
necessarily be amenable to this view. The emerging view is that regional trade is im-
portant for both the imports and exports of smaller countries, and that it provides a
‘vent’ for the exports of larger countries. One way to look at this is to estimate trade
intensity indices. Based on such estimates, the trade intensity of Nepal, the Maldives
and Sri Lanka has risen over the recent years, while that of Bangladesh has fluctuated.
Nepal naturally has a higher trade intensity with India given its proximity and trade
treaty with this country. Trade intensity between Pakistan and India has not seen
any improvement. The importance that the South Asian Association for Regional
Cooperation (SAARC) countries have attached to a regional trading arrangement is
therefore not highly irrelevant, this being particularly so given the limited options that
many smaller nations have under the current global trading scenario. As per the view
expressed by the business community in India, SAFTA is a platform to expand trade.
It allows formation of coalitions in economic and political spheres (apart from more
efficient industrial ventures through joint ventures, horizontal and vertical integration)
and provides a better space for small-scale producers.
There is a significant body of literature that analyses the developmental impact of
regional integration in South Asia. These studies have essentially reached five major
conclusions:
(i) Regional integration improves welfare in South Asia, but such gains could be
small and that regional liberalization may help the countries to lock-on to the
process of liberalization.
(ii) There is only a negligible impact on smaller countries or they might even lose in
terms of welfare by entering into a regional arrangement.
(iii) Smaller countries gain more from regional trade agreements but unilateral trade
liberalization is more welfare enhancing.
 South Asian Yearbook 2006 391

(iv) Regional agreements in South Asia are trade diverting but there could be small
efficiency gains or in many instances could lead to efficiency reduction. In this
scenario, unilateral trade liberalization is a better option and thus the economic
case for SAFTA is weak.
(v) Multi-country projects established under regional integration and preferential
treatment have benefited the partner countries (in this case Bangladesh) and are
useful as welfare improving devices.10
Notwithstanding the methodological biases of these conclusions, a main conclusion
that one could deduce is that the economic case for regional integration through
SAFTA is weak; if there are benefits from regional integration, they are low, and that
unilateral liberalization would yield much bigger welfare gains. These studies, howev-
er, do not deny the possibility of benefits through multi-country or regional projects
as has been shown by Pursell (2004) in a study involving the preferential liberaliza-
tion of the cement industry between India and Bangladesh in which gains are derived
mainly through increased competition.
The literature on regional integration must be read in the wider context of how this
scenario would be altered if the supposedly large informal trade in South Asia is
taken into account. Many question the usefulness of official data for measuring in-
tra-regional trade in view of high illegal and informal trade.11 According to avail-
able estimates, Indian informal exports to Pakistan have been estimated at US$100-
500 million in 1996, to Bangladesh in 1992-93 at US$299 million, to Sri Lanka in
2000-01 at US$185 million. Similarly, the estimated informal imports from Bangla-
desh to India in 1992-93 were valued at US$14 million and from Sri Lanka US$21
million in 2000-01. According to other estimates, the informal trade between India
and Pakistan is US$2 billion. Whether the informal trade is large enough even to alter
our perception of intra-regional trade is still an open question. Based on the estimates
presented above, the informal trade would boost intra-regional trade by 10-12% for
Pakistan, 3-4% for Bangladesh and 2-3% for Sri Lanka.12 Since the accuracy of the
informal trade data is open to debate,13 it is difficult to come to a definite conclusion.
However, the available information on the informal trade does not significantly alter
the pattern of intra-regional trade to invalidate the above discussion.
It is also important to keep in mind South Asia’s position in the global economic
landscape while discussing options for regional integration. South Asia covers 3.8% 9 Panagariya (1999); Bandara and Yu
of the land area of the world, yet it is home to 22.8% of the world’ population. The (2001); Baysan et al. (2006).
share of entire South Asia’s GNP in the world is only 2.15%, which in purchasing 10 Pursell (2004).
power parity terms is equivalent to 7.38%. The average per capita income of South 11 Taneja (1999), (2002); Taneja et al.
Asia, which was US$590 in 2004, was lower than that of the Sub-Saharan Africa by a (2003).
margin of US$10. In 2004, South Asia’s total merchandise trade was just under 1.3% 12 The highest known informal trade
of the global trade.14 On a positive note, the share of manufactured goods in the total figures have been used in estimat-
ing these growth rates.
trade has risen in the recent past and now stands at 79%. Although this is encourag-
13 Baysan et al.(2006).
ing, the reality is far starker, as the percentage share of exports coming from the three
basic manufacturing processes – namely, non-metallic mineral manufactures, textiles 14 World Bank (2006).

and clothing – in India is 30%;15 in Sri Lanka, the share of garments and tea in total 15 ADB (2006).
392 Chapter 11 Operationalizing SAFTA: Issues and Options
16 World Bank (2006).
17 The contribution of textiles and
garments explains the structural
shift from primary to manufactured
products as textiles are classified as
manufactured products, particular-
ly in Bangladesh and Sri Lanka. This
opens these countries to many
other problems with the phasing
out of quota systems. While large
countries like India and countries
that could adapt to the changing
environment could tackle the fall-
out from the quota-free regime,
other countries are likely to face
severe adjustment problems.
18 For a detailed discussion on this
see RIS (2004).
19 SAARC (1990), p. 6.
20 SAARC (1990).
exports in 2004 was 58.8%, while in Bangladesh, 71.87% of export income comes
from textiles and textile articles.
South Asia’s high technology exports as a percentage of manufactured exports are
only 4% in 2004.16 The figures for the same year for China and East Asia are 27% and
33%, respectively. Notwithstanding the achievements of India in the area of industrial
development and structural transformation,17 South Asia’s export basket still com-
prises a small share of skill-intensive exports and a high percentage of unskilled labour
and resource-intensive products18. This is not an encouraging sign as the experience
of the newly-industrialized countries (NICs) shows. The more successful exporters
tend to specialize in high and medium technology manufactures and their export suc-
cess is inherently related to technological advancement.
South Asia has made significant progress in a number of areas. For example, the num-
ber of people who earn less than a dollar a day has dropped from 936 million in 1990
to 748 million in 1996 and to 703 million in 2001. Yet, in 2001, South Asia had an
estimated 703 million people out of the total population of 1090 million earning less
than a dollar a day, which is equivalent to 64% of the total population of the region
belonging to this category.
Given this background, it is important to make an assessment of the regional trading
arrangements and examine the issues surrounding SAFTA with a view to understand
the options available to operationalize it. Section 2 of this paper presents the history
of regional cooperation in South Asia, and Section 3 summarises the main features
of SAFTA. Section 4 discusses the main constraints that limit regional integration in
South Asia, while Section 5 discusses future directions and policy options.
2. Historical Progress of Regional Trade Agreements
2.1 Introduction
The creation of a freer trading environment in South Asia has been an overarch-
ing objective of SAARC ever since its inception in the early 1980s. In the inaugural
address of the first Summit held in Dhaka in December 1985, the then President
of Bangladesh, Hussain Muhammad Ershad, indicated that ‘The global economic
compulsions that confront us require a joint and increasingly sophisticated response.
This has to be based on a study of the real ways our economies interact in the world
economy… Governments must examine and recommend concrete ways to broaden
regional economic cooperation and exchange.’19 In the same inaugural speech, Presi-
dent Ershad credited the idea of regional cooperation to President Ziaur Rahman,
who in President Ershad’s words wanted to create ‘a forum for the exchange of views,
a forum for the pooling of expectations, a forum of discussions and for mutual under-
standing’.20 He further elaborated that the primary reasons for the creation of SAARC
were to meet ‘the harsh international economic environment’ and the need for a ‘joint
 South Asian Yearbook 2006 393

and increasingly sophisticated response to the global economic compulsions’.21 As the

Dhaka Declaration issued at the end of the summit states, the leaders were
conscious of their individual and regional strengths, their potential as a huge market,
their substantial human and natural resources and the complementarities of their econo-
mies. They were confident that with effective regional cooperation, they could make
optimum use of these capacities for the benefit of their peoples, accelerate the pace of
their economic development and enhance their national and collective self-reliance.22

The original proposal of Bangladesh to establish some form of regional coopera-

tion arrangement was based on the then rising popularity of regional cooperation
arrangements and their success elsewhere in the world and the belief that regional
cooperation would strengthen the competitive position of countries in South Asia.
The first tangible effort towards the realization of this goal was the setting up of the
SAARC Preferential Trading Arrangement, generally known as South Asian Preferen-
tial Trading Agreement (SAPTA). During the initial phase, many viewed SAPTA with
a certain degree of optimism as a scheme that would transform the South Asian trade
landscape in a significant way and allow greater integration. This optimism began to
wane with the slow progress of SAPTA under several rounds of trade negotiations,
which finally led countries like Sri Lanka to stress the bilateral path as a way of open-
ing up markets. Gathering momentum for bilateral free trade agreements and the
waning enthusiasm for SAPTA gave impetus for establishing SAFTA.
The second SAARC Summit was held in Bangalore in November 1986 and the third
in Kathmandu in December 1987. During 1986 to 1990, several official meetings
were held with a particular focus on economic cooperation. Among other things,
these meetings reiterated the need to cooperate on economic matters and pool re-
sources to meet the adverse economic position facing the region, recognized that
economic asymmetries in the region play a negative role, and recommended under-
taking analytical studies to identify priority issues. The last recommendation led to the
commissioning of a study, completed in 1991, titled ‘Study on Trade, Manufactures
and Services’ (TMS). Economic cooperation, the TMS study stressed, is an inevitable
imperative for promoting the economic development of the region. By this time, the
SAARC Council of Ministers had met eight times, and the ninth meeting was held in
May 1991 in Male. This meeting endorsed the TMS study and established a committee
known as the Committee on Economic Cooperation (CEC) comprising the Com-
merce/Trade Secretaries of the SAARC Member states.
The CEC mandate was quite broad, which espoused the formulation of policies and
programmes to oversee the implementation of measures to strengthen and enhance
intra-regional cooperation in the field of trade and economic relations; assess the
potential for intra-regional cooperation in trade and make recommendations for pro-
moting intra-regional trade, joint ventures, industrial development, investment, mar-
keting and transfer of technology; and evolve joint strategies and common positions
in the international fora. 21 SAARC (1990).
22 SAARC (1990), p.46.
394 Chapter 11 Operationalizing SAFTA: Issues and Options

2.2 SAARC Preferential Trading Arrangement

During the sixth SAARC Summit held in Colombo in 1991, the Sri Lankan Govern-
ment proposed to establish SAPTA by 1997. The prime objective was the expansion
of intra-regional trade through preferential treatment by way of reducing import tar-
iffs on eligible items and special and more favourable treatment to the least devel-
oped countries (LDCs) in the region. The Summit approved the establishment of an
Inter-Governmental Group to formulate the framework for establishing the SAPTA.
The framework agreement was finalized in 1993, and SAPTA formally came into
operation in 1995, two years ahead of the date suggested at the Colombo Summit.
The SAPTA negotiations were conducted on a request-offer mode, and the first two
rounds were conducted on a product-by-product basis. Two rounds of SAPTA had
been completed by 1998, and close to 2126 products were under tariff preferences.
The third round of SAPTA was conducted on chapter-wise basis, and the negotia-
tions were completed by November 1998 which resulted in concessions in product
lines ranging from 211 in Sri Lanka to 2402 in India, and tariff cuts ranging from 5%
to 100%. The consolidated national schedules of concessions after three rounds of
negotiations had a total coverage of 4951 products. By 1998, the political leadership
had realized the inadequacy of tariff concessions and the limitations in the coverage
of goods that are actively traded. The Tenth Summit in Colombo in 1998 thus called
for the following:
(i) Deeper preferential tariff concessions to products which are being actively trad-
ed, or are likely to be traded;
(ii) The removal of discriminatory practices and non-tariff barriers on products
where tariff concessions have been granted earlier; and
(iii) The reduction of domestic content requirements under the SAPTA rules.
The fourth round of SAPTA negotiations took place in October 2002, which resulted
in a coverage of over 5000 tariff line items.23
The SAPTA Agreement had provisions for offering tariff preferences to the Member
countries, special and differential treatment for the LDC Members, ‘regional’ MFN
provision, ‘rules of origin’, and other regular features of a preferential trading arrange-
ment.
Even after three rounds of negotiations, the product coverage of SAPTA remained
limited to such an extent that the arrangement remained ineffective. As Mukherji
(2000) observes, the total number of tariff lines conceded concessions by all Contract-
ing States (CS) during the three rounds of negotiations was 3257 products of which
1356 tariff lines were in favour of LDCs and 1901 in favour of all countries. He fur-
ther estimates that the annual value of all imports that entered the SAARC member
countries under SAPTA amounted to approximately US$480 million at the end of the
1990s. According to his calculations, the proportion of intra-regional imports covered
by the SAPTA preferences was the highest for Pakistan (39.6%), followed by Nepal
23 SAARC (2002).
 South Asian Yearbook 2006 395

(35.2%), India (30%), Bhutan (17%) and Sri Lanka (12%). The import value coverage
of Bangladesh and the Maldives was marginal. The results were far from satisfactory
from the point of view of Sri Lanka as well.24 The slow progress of SAPTA led some
countries to form bilateral free trade agreements or sub-regional initiatives,25 which
include the ISLFTA, the formalization of the Indo-Nepal treaty into a bilateral FTA
in 1996,26 the Growth Quadrangle among Bangladesh, Bhutan, Nepal and India.

2.3 South Asian Free Trade Area (SAFTA)

The idea of a regional FTA was under discussion since the early 1990s as can be seen
from the deliberations within the official SAARC process. The sixteenth session of
the Council of Ministers held in Delhi in December 1995 agreed to work towards the
setting up of SAFTA. As a result, SAARC went through a hectic process of negotia-
tions under several official bodies which it created to formalize the treaty, for ex-
ample the Inter-Governmental Expert Group (IGEG) and the Committee of Experts
(COE). Finally, the SAARC Secretariat was directed to prepare the first working draft
which was ready by the end of 2002. During the period between 2002 and 2004, bilat-
eral negotiations were held on four outstanding issues: indicative Sensitive Lists, draft
SAFTA Rules of Origin, Mechanism for Compensation of Revenue Loss (MCRL)
and Technical Assistance to the LDCs. Finally, the SAFTA Agreement was signed
on January 6, 2004 during the 12th Summit in Islamabad. Since then, the COE has
met twelve times including the last one held in December 2005 and finalized all four
Annexes to the Agreement. The Agreement came into operation on January 1, 2006,
and the formal notification was issued by the SAARC Secretariat on March 22, 2006.
The first round of customs duty reduction under the Trade Liberalization Programme
(TLP) came into operation on July 1, 2006.
As the historical developments show, the discussions on the formation of SAFTA
had begun even before SAPTA became fully operational. For example, the fourth
round of negotiations under SAPTA was completed only in October 2002. By this
time, there had been many official level discussions on the formation of SAFTA, and
the COE had even directed the SAARC Secretariat to prepare the draft treaty. As can
be seen in the Islamabad and Dhaka summit speeches and declarations, discussions
are already underway in forming the South Asian Economic Union (SAEU). The
need to create a SAEU and related pronouncements without proper implementation
of SAFTA could be interpreted as a sign of internal discontent on the progress it has
so far made or the perceived inability to move beyond traditional cooperation areas.

3. Main Features of SAFTA

3.1 Key Instruments
The SAFTA Agreement has 25 articles describing its objectives, institutional arrange- 24 Weerakoon and Wijayasiri (2001).
ments, liberalization programme and other provisions. As stated in the preamble, 25 Kalegama (2004).
the main objective of the agreement is to promote and enhance mutual trade and 26 RIS (2004).
396 Chapter 11 Operationalizing SAFTA: Issues and Options

economic cooperation among the SAARC Member states. The Agreement has clear-
ly identified several interconnected mechanisms to achieve economic integration in
South Asia. The most critical of these are elimination of barriers to trade, facilitation
of cross-border movement of goods and promotion of fair competition. The Agree-
ment has also recognized more practical measures for implementing the provisions
such as joint administration and resolution of disputes. Special care has also been
given to equitable distribution of benefits among the Members and the potential im-
plications of SAFTA arising from the particular level of economic development of
the country.
There are five key instruments of implementation, namely, tariff liberalization, Rules
of Origin, institutional arrangements, consultations and dispute settlement proce-
dures, and safeguard measures. The tariff liberalization is its most elaborate arrange-
ment under which the Members agree to gradually harmonize and eventually bring
down their import tariffs to 5% or less in three phases. In the first phase, the non-
LDC Members agreed to reduce their maximum tariff rates to 20% and the LDCs to
reduce their maximum tariff rates to 30% by January 1, 2008. In the second phase,
which will resume on January 1, 2008, the non-LDC Members agreed to reduce their
import tariffs to 5% or less in 5 years (i.e. by January 1, 2013) with the exception of
Sri Lanka that has six years for compliance, while the LDCs agreed to do the same
in eight years (i.e. by January 1, 2016). Thus the Agreement will become fully opera-
tional only in 2016. The Agreement allows the exclusion of ‘sensitive’ items through
Member-specific negative lists which have been negotiated and are contained in
Annex I. The same article contains provisions for reporting non-tariff barriers
(NTBs), para-tariff and quantitative restrictions on an annual basis. The objective
of these provisions is to examine their compatibility with relevant WTO provisions
and take appropriate measures to eliminate and/or implement them in the least trade
restrictive manner.

3.2 Additional Measures

There are several ‘additional measures’ that have been incorporated into the Agree-
ment to take care of various concerns of the Member states, namely, trade facilita-
tion, customs cooperation and dispute resolution, investment promotion and foreign
exchange and payments. Provisions related to trade facilitation include harmonization
of standards, reciprocal recognition of tests and accreditation of testing laboratories
and certification of products, simplification and harmonization of customs clearance
procedure, harmonization of national customs classification based on the HS coding
system, simplification and harmonization of import licensing and registration proce-
dures, simplification of banking procedures for import financing, transit facilities, de-
velopment of communication systems and transport infrastructure, and simplification
of procedures for business visas. There are also provisions for customs cooperation to
resolve disputes. There are two measures related to the promotion of investment and
the removal of barriers to such investment. Two other areas of additional measures
are related to the removal of foreign exchange restrictions on payments arising from
 South Asian Yearbook 2006 397

trade under SAFTA and the repatriation of profits. The Agreement has provisions
for macroeconomic consultation and the maintenance of the rights and privileges of
Member states under GATT and the Articles of Treaty of the International Monetary
Fund (IMF). The negative (sensitive) lists of products that are exempted from the
preferential treatment have been finalized, and are an integral part of the Agreement.
Non-LDC Members may keep two lists, one for non-LDCs and the other for the
LDCs. Each country’s negative list indicates the number of tariff lines for these two
categories27. The Sensitive Lists are to be reviewed periodically.
The SAFTA Rules of Origin (RoO) have also been finalized, and are contained in
Annex IV. It contains 17 rules, of which 13 are specifically designed to determine
whether a good can be considered for preferential treatment under SAFTA. Rules 8
and 9 are the most relevant provisions of the Agreement. Rule 8 specifies that a prod-
uct will satisfy the Rules of Origin requirements if:
(i) there is a change in tariff heading at the 4-digit level between the final product
and all of its constituents.
(ii) the foreign components input in the product make up no more than 60% of its
Freight on Board Value, and the final manufacturing process must take place in
the exporting country.
Under Rule 9, regional cumulation, the domestic value addition requirement drops to
20% (FOB) if at least 50% (FOB) of foreign inputs are from SAARC Members. Fur-
thermore, the change in tariff heading can be at the 4- or 6-digit level in the HS clas-
sification. They are considered to be of specific interest to the LDCs. The products of
non-LDC members qualify for preferential treatment with 40% domestic value addi-
tion whereas the products from LDCs are qualified with 30% domestic value addition
and the products from Sri Lanka are admitted with 35% domestic value addition.

3.3 Special and Differential Provisions for the LDCs

The existence of four LDCs in South Asia – Bangladesh, Bhutan, Nepal and the
Maldives – adds another critical dimension to the importance of SAFTA from the
development point of view. For, these countries have special development needs
due to their low per capita income, low development of human assets and economic
vulnerability. Regional integration is likely to assist the LDCs only if it expedites the
process of their economic development, which requires them to undergo necessary
structural change to enable increasing returns to scale and external economies, faster
human capital accumulation, and faster acquisition and absorption of technologies 27 The tariff lines offered by countries
for the LDCs and Non-LDCs in that
already in use in other countries.28 If implemented properly, the special and differen-
order are as follows: India 763 and
tial treatment (S&DT) provisions guarantee that trade liberalization under SAFTA 884; Nepal 1300 and 1350; Ban-
will not jeopardize their ability to achieve the general developmental objectives. gladesh 1249 and 1254; Pakistan
1183 items for both; Sri Lanka 1574
Article 2.C specifically recognizes the importance of the levels of economic and in- items in its single sensitive list;
dustrial development in designing principles of reciprocity. Article 2.F is much more Bhutan 259 items; the Maldives
specific; for instance, it states: ‘The special needs of the Least Developed Contracting 671 items for all.
States shall be clearly recognized by adopting concrete preferential measures in their 28 UNCTAD (2006).
398 Chapter 11 Operationalizing SAFTA: Issues and Options
29 India, Pakistan and Sri Lanka are
the three developing countries
in South Asia. However, Sri Lanka
is only small developing country
which is 1/3 of the size of Bangla-
desh in terms of Gross National
Income (GNI).
30 Adhikari (2005).
favour on a non-reciprocal basis.’ As described above, the SAFTA treaty has offered
longer compliance periods and smaller reductions for the LDCs in the tariff liberal-
ization programme, and as per Article 7.6, the non-LDCs are required to reduce their
tariff to 0-5% for the products of LDCs within a timeframe of three years.
Article 11 is the most specific and central as far as S&DT provisions are concerned.
Under this, the non-LDC Members are expected to be flexible towards the LDCs
in continuation of quantitative or other restrictions and in applying anti-dumping or
countervailing measures. With a view to enhancing sustainable exports, non-LDCs
are expected to take direct trade measures such as long- and medium-term contracts
containing imports and supply commitments in respect of specific products, buy-back
arrangements, state trading operations, and government and public procurement to-
wards the LDC Members. Technical assistance is another area of concern where spe-
cial consideration of the LDCs must be taken when trade agreements are negotiated.
The SAFTA Agreement has a Mechanism for Compensation for Revenue Loss
(MCRL) for the LDCs. The amount of compensation is to be determined by the
COE through an agreed formula which is specified in Annex III, and will be paid in
US dollars. This mechanism will remain in force for four years. Under these provi-
sions, compensations are to be provided for a maximum of four years for the LDCs
with two exceptions. Thus the Maldives has been allowed five years of compensation,
and Sri Lanka29 has agreed to provide compensation only for three years for the LDCs
with an extended year for the Maldives.
In the light of these provisions, the SAFTA Agreement has received attention vis-a-
vis other agreements such as BIMSTEC. Whereas the SAFTA treaty has many gener-
ous provisions, agreements like BIMSTEC have totally ignored them.30 Three specific
areas given particular attention in the Agreement are: the MCRL, the provision for
safeguards, and Balance of Payments measures. Moreover, most of the important
provisions are legally binding, not ‘best endeavour’ statements. One example is the
tariff liberalization programme which has specific rates applicable for the LDCs and
specific time periods. Similarly, the three non-LDCs have agreed to reduce their tariff
to 0-5% for the LDCs within three years. These provisions become operational as
soon as Member states start using the SAFTA provisions for intra-regional trading.
It is still pertinent to ask whether S&DT provisions are the best way to deal with de-
velopment problems in South Asia. It is still not clear how the mechanism will actu-
ally be implemented nor is it clear whether this will be successful. The importance of
the MCRL needs to be evaluated with two broad yardsticks: the importance of tariff
revenue for a given country, and the efficiency gains of the country from trade lib-
eralization. If the efficiency gains of trade liberalization outweigh the revenue losses,
the need for compensation for revenue losses might dissipate. Opening up markets
combined with mechanisms for transferring advanced technology in addition to rais-
ing investment flows to the LDCs and better provision of trade facilitation could be
more productive and sustainable in the long run.
 South Asian Yearbook 2006 399

3.4 Institutional Mechanism

The SAFTA Agreement has specified an institutional mechanism and a system to
deal with problems that are likely to arise in the process of implementation. The main
architecture of this process is the SAFTA Ministerial Council (SMC) which will have
wide powers to take decisions. The SMC is supported by a Committee of Experts
(COE) with specific functions: monitoring, reviewing and facilitating implementation
of the Agreement provisions; submitting a report to SMC every six months; and co-
ordinating the process of dispute settlements between Member states.

4. Constraints in Achieving Regional Integration

This paper recognizes several inter-related constraints that limit regional integration
in South Asia. Identification of these constraints and finding solutions to these chal-
lenges is central to promoting regional integration. This section makes an attempt to
identify the main constraints, their possible implications and the ways of overcoming
them.

4.1 Geo-Political and Institutional Issues

South Asia, as many other regions in the world, has its own geo-political tensions
and institutional issues. Some interlinking relationships like language, culture and arts
bring South Asian countries closer to each other, while geo-political tensions force
them far apart. Many of these tensions enter into the domain of economics and in-
ter-state and international relations. As Batra (2005) points out, the political mistrust
between Pakistan and India has blocked trade in the past and still remains a potent
deterrent to trade. Similarly, there is a sense of mistrust latent in the attitude of other
countries towards India given India’s status of power. Batra (2005) cites two exam-
ples. The first involves the low mark reached in the India-Nepal relations that led to
the closing down of most of the border points and subsequent low exports to Nepal.
The second is the boycott of Indian goods in Sri Lanka upon the second anniversary
of signing of India-Sri Lanka Accord in 1990-91.
The success or failure of SAFTA will depend to a greater extent on whether Pakistan
and India can make real progress in their political dialogue and reach a peaceful settle-
ment to the long-standing bilateral dispute over Kashmir. As Kalegama and Adhikari
(2002) put it, ‘the major problem in SAARC is a political problem that seems to cut
across at other areas’ (p. 61). Besides, Pakistan’s refusal to grant the MFN status to
India is a major stumbling block for progress. Although India has granted the MFN
status to Pakistan, Pakistan has so far refused to do so on the ground that the MFN
for India will lead to flooding the Pakistani market with Indian goods without recip-
rocal benefits because of very high tariff rates in India. Pakistan also views its rising
trade deficit with India as cause for concern, although this may be inevitable given
the nature of imports from India to Pakistan. Most of Pakistani imports are high
400 Chapter 11 Operationalizing SAFTA: Issues and Options
31 EPW (2004), January 10-16, p. 119,
as cited by Kalegama (2004).
32 World Bank (2006).
value-added goods such as machinery, engineering goods, pharmaceuticals, iron and
steel products. Pakistan would have to import most of these goods from somewhere
else, probably at a much higher cost, if it does not want to import these goods from
India.
4.2 India’s Role in South Asia
India being the largest country in terms of land area, population, and the size of its
economy and being the most advanced country considering its industrial base can
play a pivotal role in regional integration. But so far India has been reluctant to play
the lead role, perhaps due to her dilemma over such a role because of the possible
conflict that it may create in the SAARC process and the anticipated negative reaction
to such a role by other members. As an editorial of the Economic and Political Weekly
(EPW) stated: ‘It is for India to ensure that smaller members of the region have a
growing stake in regionalism… . This responsibility India has not taken seriously’.31
India seems to have changed its stance recently and has shown willingness to play a
bigger role. The acceptance of the Mechanism for Compensation for Revenue Loss
(MCRL) by India is one such instance. India, being the larger and relatively more
developed economy, knew that it would bear the major chunk of the cost in paying
compensation. India has also agreed to offer additional Tariff Rate Quotas (TRQ) of
two million pieces of garments besides the six million already offered to Bangladesh
without conditions to source fabrics from India and to the proposal of the LDCs for
technical assistance in areas like capacity building in standard, product certification,
training of human resource, improvement of legal system and administration, custom
procedures and trade facilitation.
We need to be cognizant of the limitations in regional cooperation for a country like
India. As Muni (1999) argues, regional cooperation does not promise high economic
incentives for India. Suppose for the sake of argument that all the other countries
in South Asia cease their foreign trade with the rest of the world and that they trade
only with India. But the following data makes it clear that India cannot rely on her
neighbours to absorb all its exports. In 2004, the total combined imports of goods
and services of the four largest countries in South Asia other than India, namely Paki-
stan, Bangladesh, Nepal and Sri Lanka, were US$48,978 million, while Indian exports
were US$115,233 million32. Even if all the South Asian neighbours of India decided
to import goods from India only, the country still needs to export US$66, 255 million
worth of goods and services. As for investment, ASEAN, United States and the EU
are the most prominent investors in India. Thus, SAFTA does not and cannot be the
determining factor for India’s trade policy, and it is natural to expect India to forge
broader trade alliances with larger countries and regions of the world. Within this
background and the global geo-political reasons, its ‘Look East’ policy is not surpris-
ing. It is vital for South Asia to recognize this reality and also that the South Asian
regional integration is not incompatible with India’s ‘Look East’ policy in the sense
that India and for that matter other countries as well could form broader regional alli-
ances but continue with the regional integration to benefit from areas where regional
cooperation is beneficial.
 South Asian Yearbook 2006 401

4.3 Process of Trade Liberalization

South Asia could not achieve adequate progress in the SAPTA initiative due to the
limited preferences offered in the commodities actually traded. The liberalization pro-
cess under SAFTA is not too different from the previous attempt as far as tariff lib-
eralization, the approach towards non-tariff barriers, and other outstanding issues are
concerned. The present tariff liberalization process allows some countries to maintain
high tariffs in some products, leading to tariff peaks and tariff escalation until the
Agreement becomes fully operational. Each country is allowed to decide the peak
tariff levels and their distribution, which opens up the possibility for manoeuvring
the tariff policy for own advantage. It would have been prudent, as Kalegama (2004)
points out, if the tariff convergence was achieved before embarking on lowering the
tariff further. Another major weakness is that the tariff reduction formula does not
apply to the negative list. This has created doubts about the seriousness of the Mem-
ber states regarding regional trade cooperation. The negative list approach could have
been avoided had the Member states adopted the ASEAN FTA Model in which they
have used more of a strategic approach by classifying tariff lines into four catego-
ries: Inclusion List, Temporary Exclusion List, Sensitive List and General Exception
List.33 Moreover, the presence of high value goods in the negative list could dilute the
possible benefits of the Agreement.
The ten-year period that has been agreed upon for SAFTA to become fully operation-
al is too lengthy. It has ignored the most fundamental reason for the desire for closer
economic cooperation in South Asia – that is the need to develop competitiveness
before embarking upon a broader liberalization at the global level under multilateral
trade negotiations. The delay in SAFTA implementation is likely to frustrate those
Members who want to see regional integration taking place at a faster rate. Given the
fact that discussions are already underway on the formation of the South Asian Eco-
nomic Union (SAEU), one may legitimately wonder whether SAFTA will meet the
fate of SAPTA without ever going through the process of proper implementation. In
such an event, South Asia is likely to have an agreement on the formation of SAEU
without even the very basic form of a regional trade integration.

4.4 Eliminating Non-Tariff Barriers

This section reviews South Asia’s non-tariff barriers (NTBs) regime and its impact on
regional integration. Table 11.1 summarizes the known NTBs in South Asia.
Apart from the NTBs directed at India by Pakistan, other NTBs in South Asia mostly
take the form of tariff rate quotas, restricted ports of entry, import bans and the ex-
cessive use of health and sanitary regulations. India justifies the use of NTBs for BOP
reasons under GATT Article XVII-2(b). Although NTBs have come down drastically
since the 1990s, they still play a major role in preventing exports to India. The known
and publicized NTBs in India are: 52 prohibitions at 10-digit HS level tariff lines,
484 lines of direct restrictions, and 32 items of canalized items (channelled through
state trading enterprises). South Asian trading partners have major complaints against 33 Mukherji (2002).
402 Chapter 11 Operationalizing SAFTA: Issues and Options

Table 11.1 Non-tariff barriers and para-tariffs in SAARC countries

Country Non-tariff barriers Para-tariffs

Bangladesh Health, religious, environmental and balance of payments purposes: • Infrastructure development surcharge
• Quantitative restrictions • Supplementary duties
• Quasi- QRs • Regulatory duties
• Import through state trading enterprises (salt) • VAT exemptions for specified domestic products
• Restricted port of entry

Bhutan None None

India • Tariff rate quotas None

• Import through state trading enterprises
• Health and sanitary regulations (quarantine fees)
• Restricted ports of entry and inland customs ports
• Anti-dumping and countervailing duties
• Customs valuation

Nepal None • Special fee

• Local development fee
• Agricultural development fee

Pakistan • Mostly free from NTBs • Income withholding tax

• Exception: ban on imports from India of products not on the • Extra protection for some products through
positive list of 771 items (corresponding to about 1500 sales tax
8-digit HS lines) • Regulatory duties (mostly phased out)
• Local content requirement in the auto industry

Sri Lanka • Import ban (tea and certain spices)

• Import monopoly (wheat)
• Health and sanitary regulations

Sources: World Bank (2004); Pakistan: Burki and Akbar (2005).

34 Rashid (2005).
35 Jayanetti (2005).
36 Some of the main documents
include: customs export declara-
tions, custom transit declarations,
packing list, bill of lading, consign-
ment insurance cover, VAT certifi-
cate of registration, certificate of
origin, export registration certifi-
cate and equipment interchange
receipt (World Bank, 2001 as cited
in Karmacharya, 2005).
37 Karmacharya (2005).
India. For example, Bangladesh alleges that India maintains a costly NTB regime
that includes high documentation requirements, varying methods of assessing duties,
expensive mandatory certificates on technical and health standards that need to be
collected from distant locations such as Kolkata and Delhi, the closure of northeast-
ern ports to Bangladesh for importing various products, and the non-recognition of
Bangladeshi Certification and testing laboratories.34 It is often alleged that a major
impediment in the success of ISLFTA is India’s NTBs which include ad hoc change
of policies regarding various tariff quotas, limited number of designated ports of en-
try and administrative procedures.35 Regional trade in the sub-continent is further
constrained on account of extensive border crossing documentation36 and transit and
transport logistics.37
Article 1 of SAFTA defines NTBs broadly to include ‘any measure, regulation, or
practice, other than tariffs.’ Articles 7.4 and 7.5 cover all possible restrictions includ-
 South Asian Yearbook 2006 403

ing quantitative restrictions which can vary in terms of their nature, purposes and the
manner of using them. The biggest difficulty is to come to terms with what consti-
tutes restrictions and measures of genuine welfare. Under Article 7.4, the Member
countries agree to notify the SAARC Secretariat of all non-tariff and para-tariff mea-
sures to their trade on an annual basis, which will be reviewed by the COE to examine
their compatibility with relevant WTO provisions and recommend the elimination or
implementation of the measures in the least trade restrictive manner. Article 7.5 says
that the Member states shall eliminate all quantitative restrictions pertaining to prod-
ucts included in the Trade Liberalization Programme, i.e. the products that are not
in the negative list. It is vital to recognize that many NTBs are a result of inefficient
institutional structures. Therefore, one way to minimize the use of NTBs is to let the
rules and regulations take their due position. Simplification of border crossings, better
trade facilitation and development of efficient infrastructure including introduction of
modern technology could bring much of these NTBs to a minimum level.

4.5 Multiple and Overlapping Memberships

South Asia is becoming, if not already, a ‘spaghetti bowl’ of trade agreements with
each country having simultaneous membership in a number of regional, sub-regional
and bilateral PTAs.38 There are two views prevailing on the acceptability of such a
‘spaghetti bowl’ for regional integration. According to one view, such arrangements
are not conducive for regional integration as each arrangement tends to develop its
own miniature trade regime, while a single country may develop different rules ap-
plying to different trading partners. Traders’ costs in meeting multiple sets of trade
rules can hamper trade flows.39 However, those subscribing to the other view see the
multiple and overlapping memberships in trade agreements in a positive light. For
example, Batra (2005) sees BIMSTEC as a bridge between South Asia and East Asia.
Mehta and Kumar (2005) are also of the view that South Asia should follow the ‘Look
East’ policy, and continue with their two-track approach, giving primacy to promot-
ing multilateralism and simultaneously exploring the possibility of engaging in welfare
improving RTAs. However, the absence of a mechanism to integrate bilateral FTAs
with SAFTA is a major weakness. Without such a mechanism, bilateral FTAs will
serve the needs of smaller countries to gain access to the Indian market, and SAFTA
is likely to become a dead treaty like its predecessor, relegating the SAFTA process to
a mere dialogue between India and Pakistan.

4.6 Supply-Side Constraints

4.6.1 Production Structure and Trade Complementarity
The South Asian countries have similar production structures with heavy reliance on
a few agricultural commodities and manufacturing industries with similar patterns of
comparative advantage in a relatively narrow range of products. These countries tend
to compete with each other in similar products and in almost the same markets, which
restrains the progress towards regional integration. For trade reforms and regional 38 See RIS (2004) for a review of these
integration to be successful, individual countries also need to undergo substantial arrangements.
structural transformation and deregulation. 39 Burki (2005), p. 190.
404 Chapter 11 Operationalizing SAFTA: Issues and Options
40 UNESCAP (2004).
41 Wickramasinghe (2006).
Successful competition in the international market depends on two major factors:
(i) the ability of firms to produce goods and services required by the importing coun-
tries in the quality and quantity at competitive prices; and (ii) the availability of ef-
ficient mechanisms to ensure that these products and services reach international
markets on time.40 Therefore, the domestic policy environment is as important as
the external trading environment. Unfortunately, most of the countries in South Asia
have given greater prominence to the external trading environments including the
preferential trading environment on the false belief that opening up the foreign mar-
kets will allow them to export to these markets and achieve economic development.
Policy makers have mostly overlooked the primacy of reforming the domestic mar-
kets and strengthening supply capacities. Developing country products cannot find
markets in importing countries not merely because foreign markets are protected, but
they are unable to supply in the quality and quantities that the importers want. There
are several critical factors that determine the supply capacity of firms from the devel-
oping countries. In the case of South Asia, several factors are directly responsible for
poor export expansion. These include the poor enabling policy and regulatory frame-
work, inefficient institutions and poor governance, low productivity, and the factors
that raise the transaction cost of trade.41 South Asia needs to address the most critical
supply-side constraints even to benefit from the existing liberal trading environment
of the world.
It should therefore be emphasised that the poor economic integration in South Asia
is not just due to a lack of market openness in the region’s countries, rather it could
be attributed to a combination of two factors: high trade protection and poor supply
capacity. We need to address both these problems simultaneously to integrate within
South Asia and beyond. The LDCs in particular are unlikely to derive equitable ben-
efits from SAFTA without significant structural changes in their production process.
But the success of domestic structural adjustment would require a parallel process
for reducing its cost and creating a regional business community through schemes
like vertically or horizontally integrated production structures. Such a process would
require the creation of a regional investment fund along the lines of the Report pre-
pared by the Group of Eminent Persons (GEP), which has suggested establishment
of a regional bank for South Asia and strengthening of the South Asian Development
Fund. The SAFTA Agreement has ignored these suggestions altogether.
4.6.2 Weak Regional Demand
Although South Asia is a super mega market with over 1.4 billion people, the poor
effective demand is a problem. As shown earlier, the number of people earning less
than a dollar in South Asia is over 700 million. On the positive side, however, the
middle class in South Asia is estimated at over 300 million people, whose purchasing
power is as good as that of people in the industrialized world. The growing economic
needs of the middle class would be large enough to create the initial impetus for
growth in the region.
 South Asian Yearbook 2006 405

4.6.3 Transaction Costs

As ESCAP (2004) proposed, the improved ability to supply international markets
depends on two key factors: enhanced productive capacity and reduced cost of con-
ducting trade. The foundation of the supply capacity consists of an enabling policy
and regulatory framework, efficient institutions and good governance. Transaction
costs depend on the efficiency of transport and ICT services, marketing services and
contracting, trade procedures and documentation, and trade finance. Improvement
of productivity will have to be implemented in tandem with programmes aiming at
reducing transaction costs for improving the supply capacity. The regulatory frame-
work in South Asia is a major contributory factor for higher transaction costs for
international trade.42
A major challenge facing South Asia in its quest for regional integration and increas-
ing competitiveness is the poor quality of its public infrastructure and inefficient pub-
lic services, which raise production and transport costs and constrain the capacity of
South Asian firms to gain from a liberal trading environment. In addition, the poor
infrastructure raises the hidden cost of ‘lost opportunities’ arising from cancellation
of orders due to delays in delivery. Transport costs often outweigh tariff barriers in
many developing countries.43 In particular, the share of international shipping costs in
the value of trade, defined as ‘transport cost incidence’ for exports, is higher than tar-
iff for many developing countries. The freight costs are also highest among industries
producing goods with a low value-to-weight ratio, and shipping costs of agricultural
and mining products are higher than for manufactured products. As the World Trade
Report44 shows, ‘the effective rate of protection provided by transport costs is in
many cases higher than that provided by tariffs,’ which are affected by factors such
as distance from major markets and the nature of commodities.45 In addition, most
South Asian countries still produce goods with low value-to-weight ratio that have the
highest rates for freight, and land-locked countries face on average 50% higher trans-
port costs than equivalent coastal economies. Also, land transport, which is generally
more expensive than sea transport by a factor of seven,46 is one of the main modes of
transport in the Indian sub-continent and land-locked countries. Nepal and Bhutan,
owing to their terrain and being land-locked, bear extra costs for transporting im-
ported consignments into the country and rely on India for transporting their cargo,
raising their transport costs above and beyond the normal costs for other countries in
the region. The costs of West-bound shipment (i.e. shipments from Asia to Europe or
the US) have fallen while the same is not true for East-bound cargo (from the Pacific
to Asia). Sea freight is the highest for cargo loaded in Asia.47
Another factor that increases the relative transaction costs of trade is the low penetra-
42 Wickramasinghe (2006).
tion of e-commerce and the Internet. As the World Bank’s Enterprise Survey (2006)
43 World Bank (2001).
shows, the use of the Internet for conducting commercial business is only 28.6%
in South Asia, while that in East Asia and the Pacific, and OECD countries is 27% 44 WTO (2004), p. 114.

and 80%, respectively. Among the four South Asian countries which were part of 45 World Bank (2004).
the survey, in India 35.9% firms use the Internet, and the rates for Bangladesh, Sri 46 Limao and Venables (2001).
Lanka and Pakistan are 31%, 29% and 18%, respectively. According to the available 47 WTO (2004).
406 Chapter 11 Operationalizing SAFTA: Issues and Options

data, the current use of the Internet is less than 10 million in South Asia, which is less
than 1% of the region’s total population. At the end of 2001, there had been around
500 million people with access to the Internet. Most of them are from the developed
countries. With e-commerce being viewed as the main vehicle of international com-
merce in the years to come, at least in the area of niche markets, inadequate access to
the Internet will become a major obstacle in promoting trade. Access to basic tele-
communication facilities, let alone access to the Internet, is one of the lowest in South
Asia. It is nevertheless important to recognize that South Asia has made substantial
headway on this front in the recent past, but the progress in relation to population
is inadequate. Notwithstanding the progress being made after restructuring of state-
owned enterprises and privatization, enterprises in South Asia still experience long
delays in getting telephone and electrical connections. For example, according to the
World Bank Enterprise Survey (2006), firms on average still spend 55 days to get an
electrical connection and 64 days to get a telephone connection, whereas firms in East
Asia and the Pacific wait only for 12 and 10 days, respectively.
The efficiency of ports is a significant factor influencing the export competitiveness
of any country. South Asia is well endowed with ports numbering 250, and 25 ports
are in operation.48 The efficiency of the ports measured by the speed of handling cargo
in South Asia is still low in comparison to East Asia. Port infrastructure – maritime
cargo handling, storage facilities, fuelling and watering, and repair facilities – needs to
be improved for South Asia to effectively engage in trade within the region as well as
with the rest of the world.

5. Future Directions and Policy Options

5.1 Future Directions
The success of SAFTA will depend on the extent to which all the SAARC Member
countries could expand their intra-regional trade. The possibility for expanding trade
within the region crucially depends on a number of factors. The existence of comple-
mentarities, the existing production structure and the diversification of trade profiles
are the key. A product-level study, carried out at the SITC heading level, points out
that agricultural commodities and primary materials have dominated intra-regional
trade in South Asia for the last two decades.49 Food and live animals, and crude ma-
terials are the most significant commodities being traded in South Asia. However,
manufacturing products dominate South Asia’s exports to the rest of the world. The
items that dominated South Asian exports in the 1990s were rice from India, jute
from Bangladesh, sugar from Pakistan, and beans and pulses from Nepal. Sri Lanka’s
exports are found to be more diversified than the others.
India’s export structure has begun to change in the recent past. The exports of pri-
48 RIS (2004).
mary products have declined from 23.8% in 1990 to 15.8% in 2002-03. The major
49 Pitigala (2005).
export gainers during 1990 to 2002-03 period had been primary and semi-finished
 South Asian Yearbook 2006 407

iron and steel, plastic and linoleum, man-made yarn and fabrics, electronic goods,
petroleum products, and drugs, pharmaceuticals and chemicals. In addition, services
exports from India have increased. According to Batra (2005), the share of manufac-
tured products from India to the SAARC region has increased recently, particularly
automobiles, pharmaceuticals and agricultural implements. Pitigala (2005) confirms
the new trend:
India and Pakistan are the only countries that have succeeded in exporting a noteworthy
share of manufactured products to the region. India in particular displays a higher regional
orientation for manufactured products spanning a broad array of product groups. India’s
leading regional manufactured exports during this period included motor vehicles, cotton
yarn, medicines, textiles, and apparel.

Another feature that has been identified by this study is the large fluctuation of im-
port demand for basic food products such as rice, vegetables, fruits, pulses, onions,
potatoes, and sugar.
Are South Asian countries important as export destinations for major products of
the SAARC Member countries? This paper examines this question with the help of
a data set from the International Trade Centre, Geneva. In 2003, Bhutan exported
23 products at a 4-digit HS level to India with a 100% market share.50 In the case of
Nepal, 14 product categories have been exported only to India (100%) and another
14 products with export shares ranging from 48% to 99%. For the Maldives, the two
major markets in 2003 were India and Sri Lanka. Bangladesh and India have found
reciprocal markets for two types of products. The products with first or second rank-
ing from India to Bangladesh were rice and soy beans. In return, Bangladesh exported
jute and petroleum products. None of these leading products exported to the South
Asian countries came from the newly-emerging manufactured products. This is com-
pletely different from the process of industrial development and regional cooperation
that took place in East Asia. Many of the new or innovative products of Japan, South
Korea and other countries first found the markets in East Asia before they were ex-
ported to Western countries.
There are several products in which the South Asian countries have a very high level 50 Data for this section were ob-
tained from the web based data
of specialization, measured by using the Revealed Comparative Advantage indices51 maintained by the International
(Table 11.2). Among them textiles and clothing are the two major items. The next Trade Centre, Geneva at http://
two items with a slight change in the RCAs and rank in the South Asian countries www.intracen.org
are: leather goods, basic manufactures and processed food items. Sri Lanka and India 51 The index measures the country’s
have been able to diversify their export structures into a relatively large number of revealed comparative advantage
in exports according to the Balassa
items. Calculations show that these countries compete for almost the same market
formula. The index compares the
segments, with the exception of India that has achieved the highest degree of di- share of a given sector in national
versification. Intra-regional exports are dominated by basic foods and agricultural exports with the share of this
products, while extra-regional exports are mostly manufactured products dominated sector in world exports. Values
by textiles and garments. India is the only exception with some balance between in- above 1 indicate that the country
is specialized in the sector under
tra- and extra-regional trade with a high percentage share of manufactured products, review (ITC, 2006). http://www.
particularly after 2000. intracen.org
408 Chapter 11 Operationalizing SAFTA: Issues and Options

Table 11.2 Revealed Comparative Advantage in South Asia (2003)

Product Bangladesh Bhutan India Sri Lanka The Maldives Nepal Pakistan
category
Rank RCA Rank RCA Rank RCA Rank RCA Rank RCA Rank RCA Rank RCA

Clothing 4 23.58     38 3.09 7 16.17 16 9.29 18 9.2 22 7.99

Textiles 12 2.28 18 2.14 7 4.27 33 1.24 2 10.27 1 18.93

Leather products 23 2.82 29 2.18 53 0.9 50 0.92 26 2.43

Fresh food 113 1.3 85 2.23 73 3.4 35 10.19 120 1.13 95 1.84

Miscellaneous 18 0.09 40 0.8 77 0.42 67 0.54 58 0.63

manufacturing

Chemicals 120 0.08 6 1.98 27 1.06 75 0.46 60 0.6 103 0.2

Basic 4 4.74 40 1.36 95 0.43 34 1.52 116 0.15

manufactures

Wood products 17 3.43 121 0.17 119 0.18 74 0.71

Processed food 30 3.53 109 0.76 129 0.31 15 5.69 56 2.04 127 0.34

Transport 107 0.04 53 0.37

equipment

Electronic 60 0.23 65 0.23 82 0.08

components

IT & Consumer 67 0.1 63 0.13

electronics

Non-electronic 53 0.37 79 0.16

machinery

Minerals         58 2.03 101 0.51         145 0.1

Source: International Trade Centre, Geneva, http://www.intracen.org

The import demand for these products fluctuates widely with domestic supply con-
ditions, and the South Asian governments apply arbitrary policies to maintain stable
domestic prices. Imports are allowed with domestic shortfalls, and restrictions are
imposed on them when the domestic supply is stable.52 With the exception of India,
most of the other countries depend on a few products for export revenue, limiting
the possibility of their export expansion. The import demand depends on the level
of development, and the demand for agricultural products is subject to ad hoc policy
changes depending on domestic supply changes and political circumstances. Export-
ing countries find it difficult to absorb the change in demand, and hence need careful
scrutiny and negotiations at the regional level.
The foregoing discussion implies that the possibility for expanding intra-regional trade
52 Pitigala (2005). is quite limited in South Asia. However, it does not prevent South Asia from evolving
 South Asian Yearbook 2006 409

creative strategies to boost intra-regional exports. Industry and business associations

are highly optimistic about the prospects for industrial development through cooper-
ation. For example, Assocham President Anil K. Agarwal said that future projections
for trade could be achieved if trade competitiveness among SAARC countries was
turned into trade complementarities for which the political will of all countries would
be essential. He proposed that trade complementarities could be created by way of
setting up joint ventures in the SAARC region in which the interests of each partner
should be equally protected. For such ventures, the rules of origin are to be framed in
such a manner that these are neither stringent nor cumbersome in ensuring a smooth-
er movement of goods from one country to another. The areas of cooperation with
high potential to make an impact, according to Assocham-India, are textiles, rubber,
leather, jute and tea blending; harnessing of natural resources for generating energy
requirements of Member countries; and tourism. In a study carried out by the Federa-
tion of Indian Chambers of Commerce and Industry, a similar list of areas for joint
ventures between Pakistan and India is given. The study has recognized six industries,
each having a set of projects that may have potential for cooperation. These include:
information and communication technology, fish processing, drugs and pharmaceu-
ticals, agro-chemicals, chemicals and auto-mobile ancillary.53 Each project suggest-
ed for implementation has the characteristic of adding value through collaboration
between India and Pakistan, and in some instances multinational cooperation involv-
ing the developed countries is required for exporting to markets in the developed
countries.
The GEP Report has identified a number of areas that are vital for regional integra-
tion, where it has proposed a roadmap for the South Asian political and economic
integration that should culminate in the establishment of a SAEU by 2020. Although
the Report has not been adopted officially, its ideas have been incorporated within the
SAARC process including the SAFTA treaty. According to the Report, the formation
of SAFTA is only the first step in this vision, which should be completed by 2016
instead of 2018; the second stage is the creation of a South Asian Customs Union
(SACU), preferably by 2015, and the third stage being the formation of the SAEU by
the year 2020.
The GEP Report further suggests the expansion of export production capacity through
joint ventures54 with funding from the South Asia Development Fund (SADF)55 and
the private sector; trade facilitation and liberalization of trade in services. The areas
for possible cooperation under services include measures to regularize the informal
labour movements that are already taking place, particularly in the Indian sub-conti-
nent; and liberalization of financial services with the objective of promoting regional
53 FICCI (2003) as cited in RIS(2004).
investment; formulation of an investment treaty, called Common Investment Area, to
54 The FICCI (2003) proposal seems
make trade integration more meaningful; and exploration of possibilities for vertical
to follow this suggestion.
integration of different stages of production with specific sectors, thereby exploit-
55 A special fund that has been in
ing economies of scale. Another key area for regional cooperation is infrastructure operation for a long time with
development which has the true potential to convert South Asia into a much more funding from Member states, but
integrated region. Under this component, three areas have been identified, namely, this has not been fully utilized so
far.
410 Chapter 11 Operationalizing SAFTA: Issues and Options

transport network, telecommunication and energy, which are essential for meeting
the global challenges and to uplift the living standards of the people in South Asia.
Macroeconomic policy coordination is yet another area that has been suggested along
with further policy coordination in trade, development policy and foreign debt.
The Islamabad and Dhaka SAARC Summit Declarations and Political Statements
provide a glimpse into the thinking of the political leaders of the region on future
directions of SAARC. The Islamabad Declaration of January 2004 has reiterated the
commitment of the leaders to create a South Asian Economic Union. The Summit
called for the creation of a suitable political and economic environment that would
be conducive to the realization of this objective.56 Indian Prime Minister Manmohan
Singh in his address at the Dhaka Summit in November, 2005 stated that SAFTA
represents only a ‘modest beginning of our goal of a regional economic union.’ As the
Indian Prime Minister stated in 2003, South Asia should move towards a common
currency, which is achievable through monetary cooperation. A process of dialogue is
already taking place under the SAARCFINANCE. The idea of a parallel currency in
South Asia has already been proposed towards the realization of this goal.57

5.2 Integration within the Region

The removal of obstacles to factor market integration can be realized through mini-
mization of sectoral/product exceptions, introduction of liberal Rules of Origin’ that
are also simple and transparent, introduction of clear rules against tariff-rate quotas,
and implementation of MFN-based trade between India and Pakistan. The Member
governments can strengthen economic cooperation in non-controversial areas first,
namely, trade facilitation, harmonization of standards and facilitation of transport in-
frastructure. These initiatives are beneficial to all the countries regardless of size and
the level of economic development. What is missing, however, is a credible mecha-
nism to implement these provisions. Improvement of product safety and quality stan-
dards should also be a priority, not just for promoting SME exports from the Mem-
ber states, but also to penetrate international markets. The argument applies both to
agricultural commodities and manufacturing products. As Baysan et al. (2006) point
out, the mounting pressure on the rich countries to eliminate agricultural protection
and subsidies will result in the adoption of more stringent sanitary and phytosanitary
(SPS) standards by them to protect domestic producers against foreign competition.
Addressing the supply side constraints related to product’s safety and quality stan-
dards could improve the supply capacity of firms in the region as well as outside. A
serious attempt at implementing the provisions of trade facilitation should be made
such that the cost of undertaking trade through official channels becomes much low-
er than the prevailing levels.
Consultations have been undertaken within the SAARC process in the areas of tour-
ism, education and health, distance learning and regularization of informal labour
movement. The informal labour movements have much greater yet untapped poten-
56 SAARC (2004). tial. Much bigger potential exists in several service-related industries which include
57 RIS (2004). energy, cross-border trade in unskilled labour, professional services (e.g. accountancy
 South Asian Yearbook 2006 411

and architecture, printing, and health and education). The opposition to the liberaliza-
tion in many of these areas could be substantial owing to socio-political sensitivities.
Therefore, only those sectors with a real possibility of acceptance such as telecom-
munication and IT-related services could be considered at the initial stage. Other
areas could be considered depending on the changes in socio-political dynamics. Re-
gional cooperation in infrastructure development, particularly the Asian Continental
Highway (ACH) project, could produce tangible benefits for all the countries in the
region including Sri Lanka, which is worth further exploration. The ACH project
alone, if implemented well, has the potential to transform the region in a significant
way. South Asia can also cooperate in strengthening the maritime and air transport
services enabling all the countries in the region to better integrate within and with the
rest of the world.

5.3 Regional Trade Liberalization and Broader Asian FTA

SAFTA could be a vehicle for integration within South Asia and to achieve broader
economic development. As Panagariya (2005) puts it,
There is surely scope for cooperation within South Asia on a project-by-project basis in
areas such as infrastructure and trade facilitation. SAFTA itself contains a host of worth-
while areas of cooperation. But it has been a mistake to put these non-trade issues into
SAFTA since there is no reason to hold progress in one area hostage to progress in other
areas… as the largest country in the region, India needs to think big and focus its efforts
on forging an India-China FTA with the eventual goal of creating an Asia-wide FTA.

Given the limited scope for expansion in intra-regional trade due to rules of origin,
sectoral negative lists, NTBs and lack of trade complementarities, and above all, po-
litical rivalry, the best possible scenario would be to implement inter-country or sub-
regional projects through SAARC and establish a much broader FTA involving India,
China, and East Asia. Forming this kind of a broad FTA is not incompatible with the
ongoing SAARC process and SAFTA process. The cost and political energy for en-
gaging South Asia through the SAARC process is relatively small for India compared
to the possible fallout of not having such a dialogue and the instability it could create.
The better option for South Asia is to continue with the SAARC process in tandem
with the creation of broader FTAs and regional alliances on economic cooperation
with major global players. The SAARC process could be used for achieving limited
objectives within the region, particularly for developing the still dormant supply ca-
pacity while achieving at the same time a broader alliance with the goal of enhancing
South Asia’s quest for growth and development.

6. Conclusion
Intra-regional trade in South Asia and the possibility of regional integration through a
regional agreement has been a topic of discussion for a long time. Historically, South
Asia has been one of the least integrated regions in the world in terms of the share
412 Chapter 11 Operationalizing SAFTA: Issues and Options

of intra-regional trade. The general perception is that regional trade is important for
smaller countries, but for the larger ones it is irrelevant. The low intensity of regional
trade has also given rise to the belief that South Asia does not correspond to the
so-called ‘natural trading partner’ hypothesis. Recent studies based on more detailed
analyses have questioned the validity of this assertion and suggested that SAFTA is
still relevant for economic integration and economic development in the region, but
unilateral trade liberalization will bring more benefits to the region. A general conclu-
sion of most studies on the regional integration of South Asia is that the economic
case for regional integration through SAFTA is weak and that unilateral liberalization
would yield much bigger welfare gains. This general conclusion, however, does not
invalidate the case for SAFTA as long as the countries in the region are willing to
cooperate to create a more competitive, technologically advanced industrial base and
mutually beneficial trade. Although it is difficult to come to a definite conclusion, in-
formal trade does not significantly alter the general pattern of intra-regional trade with
the possible exception of Pakistan.
The creation of a freer trading environment in South Asia has been an overarching
objective of SAARC ever since its inception in the early 1980s, although it took a long
time to see some tangible results. Both SAPTA and SAFTA Agreements contain most
of the major features of the regional trade agreements. The first agreement failed to
create sufficient dynamism for regional integration owing to a number of reasons
which included the inadequacy of tariff concessions, limitations in product coverage
and tariff and non-tariff barriers. These failures led the political leadership to agree to
launch SAFTA which again contains most of the key ingredients of preferential trading
arrangements including tariff liberalization provision, safeguard mechanisms, special
and differential treatment, institutional mechanisms, etc. The legal and institutional ar-
rangement apart, whether this agreement can raise intra-regional trade levels depends
on a number of factors including geo-political dynamics of South Asia, willingness
of India to play a leading role in the process, flexibility in the process of trade liber-
alization, extent to which countries eliminate their NTBs, capacity of South Asia to
benefit from a more liberal trading environment, reduction of high transaction costs,
extent of infrastructure development in the region, and capacity and willingness to be
part of global production structures. The changing economic landscape in the world
demands that South Asia be more dynamic and a country like India cannot rely on a
regional agreement limited to South Asia alone to fulfil her import demand and the
need to find larger markets. The new global reality requires South Asia to forge much
closer economic cooperation within the region but at the same time keep the options
open to engage in a greater Asian cooperation involving East Asia and China.

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