Integration through Trade and Investment: Experience of South Asia

1. Integration through Trade and Investment: Experience of South Asia Rashmi Banga Senior Economist UNCTAD-India Asian Experience of Integration through Trade, Aid and Investment: South Asia India International Centre, 5-6 November, 2009

2. South Asia is one of the economically most underdeveloped region of the world. • South Asia has 4 LDCs, 2 Small & Vulnerable Economies and 2 Developing Countries • While the population of South Asia is 27% of the developing world, its share is 40% in the total number of absolute poor, 45 % in the total number of adult illiterate females and 49% in the total number of malnourished children

3. Regional cooperation is seen as a step towards boosting growth and development in the region. • While the steps towards regional cooperation began with the setting up of SAARC, they did not cover issues pertaining to greater economic cooperation and integration. • The South Asian Free Trade Agreement (SAFTA) signed by the members of the SAARC and implemented in July 2006,

4. The Agreement on SAFTA has six core elements: • Trade liberalization Programme • Sensitive Lists • Rules of Origin • Non-tariff and para-tariff barriers • Revenue Compensation Mechanism for the LDCs • Technical Assistance for LDCs • Inclusion of services is envisaged by 2010

5. Contents • Experience so far of regional integration in South Asia in terms of trade and FDI • Economic Rationale of SAFTA • Potential of Trade and Investments • Challenges faced in integration through trade in Services • Role of India in regional integration

6. Experience so far…

7. South Asia as a region has lacked behind in terms of its openness to trade. • Intra-regional trade share in 2008 in the case of South Asia was 4.31% as against 27.06% in case of ASEAN. • India has the largest share in total intra-SAARC exports, i.e., 74.4 percent

9. Intra-Regional FDI Flows • Though in terms of FDI inflows to the region, there has been significant improvement (It increased by 40% in 2008 as compared to 2007), around 80%of to goes to India. • In terms of intra-regional FDI, India is the largest investor in South Asia

12. Intra-Regional FDI Inflows (% of country total)

13. Share of Top Five Countries in South Asia

14. Economic Rationale of SAFTA

15. Does SAFTA make an Economic Sense? • There exists a vast literature (e.g., Samaratunga 1999 and Kemal et al. 2000) which show that the countries in South Asia have an almost an identical pattern of comparative advantage in a relatively narrow band of commodities. • Estimated complementarity indices found that there is a lack of strong trade complementarity in the bilateral trade structures of South Asia. • Lack of trade complementarities and similar competitiveness raised questions on the future prospects of SAFTA.

16. UNCTAD-ADB Study (2008): Potential Gains from SAFTA

17. Estimates and compares the RCAs, IIT and complementarity indices for two time periods, i.e., 1991-93 and 2004-06 for four major trading member countries of SAFTA, i.e., Bangladesh, India, Pakistan and Sri Lanka at SITC five digit level. • All indices showed a substantial increase in 2004-2006 as compared to 1991-93 indicating the changing realties and growing rationale for SAFTA. • To estimate the gains in terms of trade by SAFTA the study estimated augmented gravity model

18. Estimate of Potential gains in Trade • Gravity Model has been estimated • Log Tijt = β0 + β1 log (GDPit*GDPjt) + β2 log Dijt + β3 log (POPit* POPjt ) + β4 log (1+ Tariffjit) + β4 log (1+ Tariffijt) + eijt. • Tariffs have been included in the model. • Panel data for seven countries for a ten year period, i.e., 1995-2005 is used to estimate Fixed Effects. • We use two step method to estimate the effects of distance and other dummies. • The potential trade is difference between estimated bilateral trade and actual trade.

19. Increase in trade which can be directly attributed to removal of tariffs under SAFTA is 80% of the actual intra-regional trade from the predicted intra-regional trade of 120%. This implies that apart from tariffs there exist other barriers to trade. Intra-regional trade may rise by further 40% if other factors affecting trade are addressed like non-tariff barriers, political constraints, etc. Trade Potential in SAFTA (US Bn $): 1995-2005.

20. Impact of SAFTA on Inward FDI into South Asia. • To capture the impact of SAFTA on inward FDI, we use weighted average of MFN tariffs of each member country with respect to other member countries as a group. • To test whether FDI into the region may follow product fragmentation or not we estimate impact of other trade-related variables on inward FDI. These are: • exports of each member country of SAFTA to other member countries as a group and • imports of each member country of SAFTA from other member countries as a group.

21. Empirical Results • Apart from Economic fundamentals, higher trade openness attracts higher FDI. • Lowering of Tariffs with respect to other SAFTA member may explain 30% of the rise in inward FDI. • The imports of intermediate goods in the host country have a significant impact on inward FDI. SAFTA may therefore encourage vertically-integrated FDI.

22. Trade in Services in South Asia

23. Composition of Trade in Services in South Asia. • Since 2007 total exports of services have become higher than the total imports of services in the region-mainly due to India. • Almost all South Asian countries are net exporters of communication services. • Travel services are found to be an important service in terms of exports for almost all South Asian countries (apart from Bangladesh and Pakistan). • All the South Asian countries are net importers of transport services, with India being the biggest importer followed by Pakistan. • India and Pakistan are also net importers of insurance, financial and other business services.

24. Economic Rationale for Boosting Inter-Regional Trade in Services in SAFTA • South Asian countries have comparative advantages in different services sectors. • In transport services, Pakistan and Sri Lanka have competitive advantage. • India has a competitive advantage in construction services, computer and information services and other commercial services. • Maldives and Nepal are found to be more competitive in travel services • Bangladesh has a higher competitive edge in financial services. • Cultural and historical ties-trade in services easier.

25. Mode –Wise Competitiveness in South Asia. • Competitiveness in Mode 4 is strongest • South Asian countries are labour abundant countries • The region is one of the most important exporters of services through the movement of natural persons (or temporary migration of workers) - both high skilled and low skilled (Mode 4 under GATS). • In 2005, South Asia received US $ 32 billion as remittances. Across all the countries, remittances constitute between 2 to 12 percent of GDP with Nepal receiving 12.1%, Sri Lanka 8.1% and Bangladesh 5.5% of the GDP.

26. Need for Improving Inter-Regional Trade in Mode 4 • At present, trade in Mode 4 is considerable small within the region. • Lack of Mutual Recognition Agreements (MRAs). But considerable scope for MRAs within the region • Five sectors have been identified by UNCTAD-ADB study which have considerable scope for MRAs. • These are: construction and related engineering services, tourism and travel related services, higher education services, telecommunication services and health services,

27. Challenges in Liberalisation in Mode 3 • Provision of many services like transports, infrastructure, etc has been under state monopolies for a long time in South Asian countries and only in the last decade or so privatization of these services has taken place. T • This makes provision of services by foreign services providers an extremely sensitive issue as it entails the risk of eroding not so competitive domestic investments in these services. • Not being able to regulate the quality and prices of the services provided. • With FDI, another issue of concern is the impact on employment in these sectors.

28. Other Reasons for remaining restrictive on FDI in services • Countries without the necessary regulatory framework may lose by rushing into liberalization, particularly when a reversal of the liberalization is hard to achieve or when liberalization has “systemic implications”, as in the case of the financial industry. • Entry by large service TNCs involves competition policy considerations, and many host countries may not feel ready to deal with the technical and legal issues involved. • Further, it is difficult to assess the impact of liberalization of a particular service sector, especially if it employs a large number of unskilled people. • Finally, it is frequently difficult to put in place domestic regulations • Need to address these issues within the region.

29. Benefits from Liberalisation of Services (Mode 3) under SAFTA • Economies of scale if firms are able to set up base in one country and provide services to other countries in the region. • For example, in higher education services, intra-regional cooperation in movement of students and professionals can attract renowned universities and professional colleges to open campuses in any one country in South Asia. • India can be a hub for higher education and IT services • Lowers risk as compared to opening Mode 3 multilaterally.

30. Benefits from Liberalisation of Services (Mode 3) under SAFTA • This can provide an important learning to these countries in terms of binding their commitments in GATS. For example, opening up to the region i.e., in a limited way initially, may help these countries to adjust their domestic regulations in a way that assures better quality of services provided at competent prices. • Given the similar levels of structural development, geographical proximity and cultural ties, it will be easier for South Asian countries to negotiate MRAs in services • The impact on the economy in terms of employment and prices can also be examined before any commitment is undertaken in GATS.

31. Benefits from Liberalisation of services under SAFTA • Finally, regional cooperation in services can lead to “flying geese” phenomenon in South Asia where countries specialize in different stage of value-chain and in the process exports of all concerned countries rise along with the specialization of the region. • Such a value chain can be formed in information and technology enabled services (ITES) like BPO and outsourcing with countries like Bangladesh, Sri Lanka, Pakistan and India specializing in different ends of the value-chain. • Land-locked countries like Nepal and Bhutan, can also be tapped in future to include them in this process.

32. Domestic Regulations needed • It may also lead to higher prices of services that were earlier available at a subsidized rate under public-private ownership. • These rises in prices may translate into higher inflationary pressures reducing the overall welfare of the economies. • To circumvent such spirals it is important for the region to have appropriate domestic regulations in place, which will assure better quality of services at affordable prices. • Clear domestic regulations will also increase the transparency in the system and encourage foreign direct investments. • Over-regulations need to be avoided in sectors where FDI is required, i.e., where domestic service-providers do not have the capability and capacity to fulfill excess demand,

33. Role of India in Regional Integration • Experience so far highlights the dominant role played by India in the region in terms of both trade and investments. • India is the largest investor in the region and has the largest share in intra-regional exports. • It receives the largest inflow under Mode 4 within the region

34. India’s dominant role has led to increased resilience of the region towards external shocks, e.g., global economic crisis. • In 2009, FDI inflows to the region did not decline (till March 2009); mainly because of India. FDI rose in 2008 as compared to 2007 in –Pakistan, Bangladesh and Sri Lanka. • Large potential of forming supply chains in Textiles and Textile Products, Auto components and Leather products within the region.

35. India’s role in Regional Integration in Services • Such a value chain can be formed in information and technology enabled services (ITES) like BPO and outsourcing with countries like Bangladesh, Sri Lanka, Pakistan and India specializing in different ends of the value-chain. • Land-locked countries like Nepal and Bhutan, can also be tapped in future to include them in this process.

36. But can India act as the “Flying Geese” of the region given the political situation is a ?