Saarc

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Saarc

  1. 1. EXPORT-IMPORT BANK OF INDIA OCCASIONAL PAPER NO. 123 SAARC: AN EMERGING TRADE BLOC EXIM Bank’s Occasional Paper Series is an attempt to disseminate the findings of research studies carried out in the Bank. The results of research studies can interest exporters, policy makers, industrialists, export promotion agencies as well as researchers. However, views expressed do not necessarily reflect those of the Bank. While reasonable care has been taken to ensure authenticity of information and data, EXIM Bank accepts no responsibility for authenticity, accuracy or completeness of such items. © Export-Import Bank of India Published by Quest Publications June 2008
  2. 2. CONTENTS Page No. List of Tables 5 List of Figures 7 Executive Summary 9 1. Introduction 18 2. South Asian Association for Regional Cooperation (SAARC): 23 Evolution, Objectives and Economic Agenda 3. Economic Profile of SAARC Member Countries 27 4. Trend in Foreign Trade and Trade Policies in the 37 SAARC Region 5. Foreign Direct Investment and Investment Policies in 51 the SAARC Region 6. India’s Trade and Investment Relations with SAARC 61 7. An Empirical Examination of Trade Flows in the 74 SAARC Region 8. Summary and Recommendations 80 References 85 Annexures 1. List of Indian Joint Ventures and Wholly Owned Subsidiaries 87 Approved in SAARC Member Countries 2. India’s Bilateral Trade Agreements in the SAARC Region 93 3. Exim Bank Supported Project Export Contracts in 95 the SAARC Region 3 Project Team: Mr. David L. Sinate, General Manager Dr. P. R. Madhusoodanan, Manager
  3. 3. List of Tables Table Title Pg. No. No. 3.1 Select Economic Indicators of SAARC Countries 35 4.1 SAARC’s Global Exports during 2000-2006 37 4.2 SAARC’s Global Imports during 2000-2006 38 4.3 Intra-SAARC Exports during 2000-2006 39 4.4 Intra-SAARC Imports during 2000-2006 39 4.5 Average Tariff in the SAARC Countries, 2006 45 4.6 Planned Phased Tariff Cuts on Intra-SAFTA Trade 50 5.1 Trend in FDI Inflows into SAARC Countries, 2000-2006 52 5.2 Trend in FDI Outflows from SAARC Countries, 2000-2006 53 5.3 Sectors Attracting Highest FDI Equity Inflows into India, 54 April 2000-February 2008 5.4 Foreign Investment Inflows into Pakistan (1997-98 to 2004-05) 55 5.5 Foreign Investment Inflows into Bangladesh (1991-96 to 2004-05) 55 5.6 FDI as a Percentage of GDP in Sri Lanka, 1990-2005 56 5.7 FDI Inflows into Nepal, 1989-94 to 2002 56 5.8 Foreign Investment Policies of South Asia 57 6.1 Trend in India’s exports to SAARC Countries, 2002-03 to 2007-08 61 6.2 Trend in India’s Imports from SAARC Countries, 2002-03 to 2007-08 62 6.3 India’s Exports to Afghanistan – Principal Commodities, 2006-07 63 6.4 India’s Imports from Afghanistan – Principal Commodities, 2006-07 64 6.5 India’s Exports to Bangladesh – Principal Commodities, 2006-07 64 6.6 India’s Imports from Bangladesh – Principal Commodities, 2006-07 65 6.7 India’s Exports to Bhutan – Principal Commodities, 2006-07 65 6.8 India’s Imports from Bhutan – Principal Commodities, 2006-07 66 6.9 India’s Exports to Maldives – Principal Commodities, 2006-07 66 6.10 India’s Imports from Maldives – Principal Commodities, 2006-07 66 6.11 India’s Exports to Nepal – Principal Commodities, 2006-07 67 6.12 India’s Imports from Nepal – Principal Commodities, 2006-07 67 6.13 India’s Exports to Pakistan – Principal Commodities, 2006-07 68 6.14 India’s Imports from Pakistan – Principal Commodities, 2006-07 68 6.15 India’s Exports to Sri Lanka – Principal Commodities, 2006-07 69 6.16 India’s Imports from Sri Lanka – Principal Commodities, 2006-07 69 6.17 Approvals of Indian Direct Investments in Joint Ventures (JVs) 70 and Wholly Owned Subsidiaries (WOSs) in SAARC Countries, April 1996 to December 2007 6.18 Foreign Direct Investments from SAARC Countries, 72 April 2000 to February 2008 7.1 Multicollinearity Test 77 7.2 Results of Gravity Model Regression Estimation 78 5
  4. 4. List of Figures No. Title Pg. No. 3.1 Trend in GDP Growth – Afghanistan 27 3.2 Trend in GDP Growth – Bangladesh 28 3.3 Trend in GDP Growth – Bhutan 29 3.4 Trend in GDP Growth – India 30 3.5 Trend in GDP Growth – Maldives 31 3.6 Trend in GDP Growth – Nepal 32 3.7 Trend in GDP Growth – Pakistan 33 3.8 Trend in GDP Growth – Sri Lanka 34 4.1 Trends in Intra-SAARC Trade and SAARC’s Global Trade 40 7
  5. 5. 9 Regional Integration Agree- ments (RIAs) have been around for hundreds of years. Most of the countries of the world are members of a bloc, and many belong to more than one. In South Asia, South Asian Association for Regional Cooperation (SAARC) is an emerging trading bloc. The total trade of the bloc has improved after the creation of the agreement. Quite apart from the general opening up, the countries in the region also began to see increased cooperation and trade among themselves as a key objective. This was reflected partially in the founding of the SAARC in 1985 by a group of seven South Asian countries, namely, Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan and Sri Lanka. Later on, Afghanistan also joined as a full member of SAARC on April 3, 2007. The worldwide proliferation of preferential trade arrangements in the last decade has now led to a change in thinking in the region, especially in India, which has begun to negotiate a series of preferential trade agreements of its own. Within the region, this has led to the signing of the South Asian Free Trade Area (SAFTA)Agreement with the ultimate objective of turning South Asia into a full-fledged free trade area (FTA) with the internal liberalisation beginning in 2006. Against the background, the aim of the present study is to examine the trade opportunities and challenges of the SAARC trading bloc. Thus, the objectives of the study are: (a) To examine the emergence of SAARC as a trade bloc (b) To present the brief profile of SAARC countries (c) To analyse trade, investment, and recent developments in the SAARC region (d) To examine briefly India’s trade and Investment relation with SAARC region with special reference to Exim Bank (e) To empirically examine the trade potential in SAARC region, and (f) To recommend relevant policy suggestions. EXECUTIVE SUMMARY
  6. 6. 10 SAARC: EVOLUTION, OBJECTIVES AND ECONOMIC AGENDA Evolution The idea of regional cooperation in SouthAsia was first mooted in May 1980. The foreign secretaries of the seven countries met for the first time in Colombo in April 1981. This was followed by a meeting in Colombo in August – September 1981, which identified five broad areas for regional cooperation. At their first meeting in New Delhi inAugust 1983, the Foreign Ministers of South Asia adopted the Declaration on SouthAsian Regional Cooperation (SARC) formally launching the Integrated Programme of Action (IPA) in five areas of cooperation, namely, Agriculture, Rural Development, Telecommu- nications, Meteorology, Health and Public Activities. At the first SAARC Summit in Dhaka in December 1985, the heads of State or Government adopted the Charter formally establishing the South Asian Association for Regional Cooperation (SAARC). 8th December every year is observed as the SAARC Charter Day in member states. Objectives The objectives of the SAARC are: (a) To promote the welfare of the peoples of South Asia and to improve their quality of life; (b) To accelerate economic growth, social progress and cultural development in the region and to provide all individuals the opportunity to live in dignity and to realise their full potential; (c) To promote and strengthen collective self- reliance among the countries of South Asia; (d) To contribute to mutual trust, understanding and appreciation of one another’s problems; (e) To promote active collaboration and mutual assistance in the economic, social, cultural, technical and scientific fields; (f) To strengthen cooperation with other developing countries; (g) To strengthen cooperation among themselves in international fora on matters of common interests; and (h) To cooperate with international and regional organisations with similar aims and purposes. Economic Agenda The main economic agenda of SAARC include: a) SAARC Preferential Trading Agreement (SAPTA) The Agreement on SAPTA was signed on 11 April 1993 and entered into force on 7 December 1995. The Agreement reflected the desire of the Member States to promote and sustain mutual trade and economic
  7. 7. 11 cooperation within the SAARC region through the exchange of concessions. b) South Asian Free Trade Area (SAFTA) The Agreement on South Asian Free Trade Area (SAFTA) was signed on 6 January 2004 during the Twelfth SAARC Summit in Islamabad. The Agreement came into force on 1 January 2006. c) South Asian Economic Union The Eleventh Summit (Kathmandu, 4-6 January 2002) provided further impetus to the regional economic cooperation to give effect to the shared aspirations for a more prosperous South Asia. At the Summit, the Leaders agreed to accelerate cooperation in the core areas of trade, finance and investment to realise the goal of an integrated South Asian economy in a step-by-step manner. They also agreed to the vision of a phased and planned process eventually leading to a South Asian Economic Union. Economic Profile of the SAARC Member Countries In Afghanistan, GDP growth is estimated to have reached 13.9% in 2007, owing to a strong rebound in agricultural production (from the prior-year’s drought). Industry and services remained dynamic, with estimated growth of 13.3% and 12.4%, respectively. Construction, up by 20.0%, was industry’s main driver. GDP growth in FY2007 (ended June 2007) decelerated to 6.5% in Bangladesh, largely reflecting agriculture’s moderation from the postflood outturn of the previous year. It was underpinned by steady expansion in manufacturing and continued buoyancy in services, on the base of rising domestic and external demand. Rapid growth in manufacturing and foreign trade aided services. Bhutan’s GDP growth in FY2007 (ended June 2007) is estimated to have doubled to 17.0%. This was driven by the power sector (with a GDP share of 11.3% in FY2006) due to the commissioning of the 1,020 megawatt (MW) Tala hydropower station, which has been phased in since July 2006. In India, the impressive economic performance of the past few years continued, with a real GDP growth of 9.0% in 2007- 08, as compared to 9.6% in the previous period. Economy of Maldives grew by 6.6% in 2007, reverting to its historical growth path after the post- tsunami contraction in 2005 and the rebound in 2006. Tourism, the leading sector with a near one-third share of GDP, grew by 10.0% as a result of growing tourist arrivals that, in 2007, finally exceeded the pre-tsunami peak level of 2004. Overall GDP growth of Nepal stood at to 2.3% in FY2007 (ended mid-
  8. 8. 12 July 2007) from 3.1% in FY2006, due primarily to poor weather conditions which impacted agriculture and industry. At 7.0%, GDP growth of Pakistan was strong in FY2007 (ended June 2007) for the fourth consecutive year. Services remained strong (especially telecommuni- cations, finance, international port services, and logistics), contributing 64% of GDP growth in 2007 despite slowdown in tourism. TREND IN FOREIGN TRADE AND TRADE POLICIES SAARC’s Global Trade During the year 2000 to 2006, the total exports of SAARC countries increased more than two and half fold from US$ 63.5 billion to US$ 161.4 billion. Among all the member countries, India is the largest exporter followed by Pakistan and Bangladesh. The total imports of SAARC countries also increased from US$ 79.5 billion in 2000 to US$ 255.3 billion in 2006, depicting more than a three-fold rise during the period. India is the largest importer in the SAARC region followed by Pakistan and Bangladesh. Intra-SAARC Trade As regards intra-SAARC trade, total intra-SAARC exports increased from US$ 2.8 billion in 2000 to US$ 10.8 billion in 2006, registering almost four-fold rise during the period. Exports among the SAARC countries are dominated by India, followed by Pakistan and Sri Lanka. The total intra-SAARC imports increased from US$ 3.0 billion in 2000 to US$ 9.6 billion in 2006. The intra-SAARC imports are dominated by Sri Lanka, followed by India. Trade Policies Trade liberalisation in SouthAsia started with a series of sweeping reforms in Sri Lanka in 1977/78. For the rest of SouthAsia, the 1980s and 1990s saw substantial reductions of tariffs and phasing out of quantitative restrictions (QRs), along with liberali- sation of the exchange regimes. With respect to SAARC, in the first phase, the Least Developed Countries (LDCs) in SAFTA will reduce their maximum tariff rates to 30% within two years from the date of coming into force of the Agreement. The non-LDC members will reduce their maximum rates to 20% within the same time frame. In the second phase, from January 1, 2008, the non-LDC members will reduce their import tariffs to the 0- 5% range in 5 years, while the LDCs will do the same in 8 years. With a view to further enhance regional trade and co-operation in the SAARC region, on January 01, 2008, India has reduced import duty on all items other than those in the negative list to zero. During the third SAFTA Ministerial Council meeting in New Delhi, on March 03, 2008, India also announced the pruning of
  9. 9. 13 negative list from 744 items to around 500 items for the least developed country members of the SAARC. Further, the third SAFTA Ministerial Council Meeting also directed the drafting of SAARC Framework Agreement on Trade in Services (SAFAS) under SAFTA Agreement. DEVELOPMENTS IN SAARC TRADE INTEGRATION SAARC Preferential Trade Agreement (SAPTA) was signed at the seventh SAARC summit in 1993, in Dhaka. The agreement provides a framework and institutional base for trade liberalisation and economic cooperation between the seven SAARC member countries. The agreement also provides for the exchange of concessions between SAPTA members on tariffs, para- tariff and non-tariff barriers. It envisages four basic approaches to the exchange of trade preferences: (1) product-by-product; (2) across- the-board; (3) sectoral ; and (4) “direct trade” measures. South Asian Free Trade Agreement (SAFTA) has been ratified and entered into force on January 1, 2006. SAFTA builds on the provisions of SAPTA, and extends the scope of SAPTA to include trade facilitation elements and switches the tariff liberalisation process from a positive to a negative list approach. FOREIGN DIRECT INVESTMENT IN THE SAARC REGION The total FDI inflows into the SAARC region increased from US$ 5.6 billion in 2000 to US$ 22.3 billion in 2006. Growth in private capital flows to South Asia was largely driven by India, which received the majority of capital flows to the region. FDI flows into Pakistan, Bangladesh and Sri Lanka has also increased faster during the period. FDI outflows from the SAARC region increased from US$ 351.0 mn in 2000 to US$ 9.8 billion in 2006. Out of all eight-member countries, FDI outflow from India is the highest with US$ 9.7 billion in 2006, followed by Pakistan US$ 107 mn and Sri Lanka US$ 29 mn. INDIA’S TRADE AND INVESTMENT RELATIONS WITH SAARC Trade Relations India’s exports to the SAARC region increased from US$ 2.8 billion in 2002-03 to US$ 6.5 billion in 2006- 07. Amongst the SAARC members, Sri Lanka has the largest market, accounting for 35% of India’s total exports in the SAARC region during 2006-07, followed by Bangladesh (25%), Pakistan (21%) and Nepal (14%). An analysis of the trend in India’s exports to the SAARC region during the period 2002-03 to 2006- 07 reveals that, while exports to all
  10. 10. 14 the SAARC members have registered a rise, India’s imports to Pakistan, Afghanistan and Nepal have exhibited distinct buoyancy. While India’s exports to Pakistan registered a six-fold rise during the five-year period, exports to Afghanistan and to Nepal also rose three-fold and two and half-fold, respectively, during the period. India’s imports from the SAARC region have also risen from US$ 531.5 mn in 2002-03 to US$ 1.5 billion in 2006-07, depicting almost a three-fold rise during the period. Sri Lanka is again the leading partner, accounting for 31% of India’s total imports from the region during 2006-07, followed by Pakistan (21%), Nepal (20%), Bangladesh (15%) and Bhutan (9%). The robust rise in India’s total imports from the SAARC during the period 2002-03 to 2006-07 has been underpinned by the sharp increase in imports from Pakistan, Sri Lanka, Bhutan and Bangladesh. India generally maintains a positive trade balance with the other SAARC member countries with the surplus having risen from US$2.3 billion in 2002-03 to US$ 5.0 billion in 2006-07. Investment Relations The total foreign direct investments from India to other SAARC countries amounted to US$ 312.4 mn during April 1996 to December 2007.Among the SAARC countries, Sri Lanka (US$ 153.1 mn) is the major destination of Indian investment followed by Nepal (US$ 87.2 mn). During January 2005 to December 2007, 33 JVs and 42 WOSs have been approved in the SAARC countries. Most of these approvals were in engineering goods, electrical equipments, pesticides, readymade garments, cables and wires, plastic products, rubber products, automobile components, financial services, and tourism & travels. As regards investments flows from other SAARC members into India, total investment into India amounted to US$ 11.7 mn during April 2000 to February 2008. Among the SAARC countries, Sri Lanka is the largest source of FDI with US$ 8.5 mn during the period, followed by Maldives (US$ 3.1 mn). The investment flows between India and Sri Lanka have increased mainly after the implementation of India Sri Lanka Free Trade Agreement (ISLFTA). EXIM BANK IN THE SAARC REGION Export-Import Bank of India (Exim Bank) operates a comprehensive range of financing, advisory and support programmes to promote and facilitate India’s trade and investment relations with the SAARC region.
  11. 11. 15 In the SAARC region, the Bank has supported several Indian project exporters to execute contracts in countries such as: Hydroelectric project, tunnel house and dam construction in Bhutan; Road improvement projects, railway construction and maintenance, gas turbine power plant project, electrical substations, cement plant project, transmission line project, conveyor belt project in Bangladesh; Steel, local telephone network, transmission lines, sub-stations, out door LED video system for cricket matches and diesel fired power project in Sri Lanka; Transmission lines and substations, optic fibre cable project, hydro electric projects and irrigation projects in Nepal, and Airconditioning & electro mechanical work at Male Airport in Maldives. The Bank, in order to help Indian companies in their internationa- lisation efforts, provides term loans to them, both for equity investment in their ventures overseas. Besides, Exim Bank also undertakes direct equity stake in Indian ventures abroad, to enable Indian companies to supplement their equity with Exim Bank’s contribution. To facilitate Indian presence in the SAARC region, the Bank has supported joint ventures by Indian companies in several sectors including: Textiles, pharmaceuticals, steel, glass sectors in Sri Lanka; Electrical sector in Bangladesh, and Engineering goods and textile sector in Nepal. Exim Bank extends Lines of Credit (LOCs) to overseas financial institutions, foreign governments and their agencies, enabling them to import eligible goods from India. Bank’s LOCs in the region include LOCs extended to Government of Sri Lanka, Ceylon Petroleum Corporation, Hatton National Bank, Sri Lanka, and Government of Nepal. Bank has also sought to develop useful relationships, both structured and informal, with multilateral agencies, other export credit agencies, trade and investment promotion bodies, Indian Missions abroad, commercial banks and financial institutions to help create an enabling environment to support two- way transfer of technology, trade and investment. The Bank has linkages with institutions in SAARC countries, which include: Afghanistan Investment Support Agency (AISA), Afghanistan;
  12. 12. 16 Industrial Promotion and Development Co. of Bangladesh Ltd., Bangladesh, and Board of Investment of Sri Lanka, Hatton Bank Ltd., and Ceylon Chamber of Commerce, Sri Lanka. EMPIRICAL EXAMINATION OF TRADE FLOWS IN THE SAARC REGION The analysis has been carried out within the gravity model framework. The test for multicollinearity reveals the presence of no multicollinearity among the variables. The coefficients of GDP of both exporters and importers are positive and significant at 1% and 5% respectively. For 1% increase in GDP of exporting (importing) country, bilateral export flow would increase by 0.88% (0.79%). This approximate proportional relationship between bilateral export flows and size of the economy (either exporter or importer) indicates that intra-SAARC trade could rise if the SAARC counties could maintain strong economic growth. GDP per capita of country i and country j are also statistically significant and have positive signs. GDP per capita of both exporting and importing countries are significant at 1% level. This implies that countries with high per capita income are likely to trade more. The coefficient of Import-GDP ratio of importing country is positive and statistically significant. For 1% increase in openness, bilateral export flow increases by 1.16%. This indicates that it is possible that increased openness of the SAARC member countries could boost intra-regional trade in the region. Further, in extra-SAARC trade context, it reveals the absence of trade diversion in the SAARC region. Exchange rate parameter has a positive effect on export flows since the bilateral exchange rate is defined as units of domestic currency per one unit of foreign currency. If exchange rate increases (domestic currency depreciation) by 1%, export increases by 0.67%. The Rijt coefficient is positive and significant. This shows the importance of specialization in the region based on the principle of comparative advantage. The presence of bilateral trade agreements in the SAARC countries increases trade by 152.2%. The common border demonstrates positive and statistically significant effect. If two countries share a common border, export flow between them increases by 32.4% than the otherwise. POLICY IMPLICATIONS OF THE STUDY a) More emphasis could be given to boost exports in order to reduce the global trade deficit experienced by the SAARC region.
  13. 13. 17 b) SAARC countries are mainly exporting agricultural commodities and agro-based products. Further, among the SAARC countries trade is highly competitive and which are mostly in identical commodities. Therefore, more diversification is essential based on the comparative advantage. c) The tariff level in SAARC countries is still high. Therefore, to reap the fullest benefit of the trade bloc tariff could be reduced further. d) Though foreign direct investment inflow is increasing in the SAARC region, it is still low in volumes. Therefore, adequate steps could be taken to attract more FDI into the region. e) The direct relationship between bilateral exports and GDP in the SAARC region reveals the potential for export-led growth in the region. f) When the openness of an economy increases, bilateral exports within the SAARC region also show a corresponding increase. Since, this reveals absence of trade diversion in the region, SAARC countries could adopt more open trade policies. g) There is a significant and positive relation between the bilateral trade agreement and bilateral export flows in the SAARC region. Therefore, study supports the creation of bilateral agreements in the region. h) SAARC countries could adopt cautious exchange rate policies as this may have adverse impact on the terms of trade. This is because, since SAARC countries are mainly exporting agro based commodities, a devaluation of currency may exert adverse terms of trade. i) Since there is a positive and significant relation between the difference in relative factor endowments and bilateral export growth, specialisation could be promoted based on the principle of comparative advantage. Factor endowment shows whether the country is labour using or capital using. Given the factor endowments and available resources countries can specialise in various commodities. j) Stronger economic relations can serve to improved political relations in the region, especially the key relationship between India and Pakistan. k) An effective and vibrant South Asian trade bloc could also serve to enhance the South Asian regions’ bargaining position in multilateral negotiations on trade with other regions and regional groupings.
  14. 14. 18 The growth of regional trade blocs has been one of the major developments in international relations in recent years. Virtually all countries are members of a bloc, and many belong to more than one. Regional agreements vary widely, but all have the objective of reducing barriers to trade between member countries. At their simplest, these agreements merely remove tariffs on intra-bloc trade in goods, but many go beyond that to cover non-tariff barriers and to extend liberalisation to investment and other policies. At their deepest, they have the goal of economic union and involve the construction of shared executive, judicial, and legislative institutions. The past decade also witnessed qualitative changes in Regional IntegrationAgreements (RIA). There have been three major developments: 1. The move from “closed regionalism” to a more open model, in line with prevailing views about national economic policy. Many of the trade blocs that were formed between developing countries in the 1960s and 1970s were based on a model of import- substituting development, and regional agreements with high external trade barriers were used as a way of implementing this model. New-wave RIAs (some of which are old agreements resurrected) are generally more outward looking and more committed to boosting rather than controlling international commerce. 2. The recognition that effective integration requires more than simply reducing tariffs and quotas. Many other types of barriers have the effect of segmenting markets and impeding the free flow of goods, services, investments, and ideas, and wideranging policy measures—going well beyond traditional trade policies—are needed to remove them. Such “deep integration” was first actively pursued in the Single Market Programme of the European Union (EU), but its elements are now finding their way into the debate on other regional agreements. 1. INTRODUCTION
  15. 15. 19 3. The advent of “North-South” trade blocs in which high- income countries and developing countries are equal partners. Perhaps the most important example is the North American Free Trade Agreement (NAFTA), formed in 1994 when the Canada–United States Free Trade Agreement (CUSFTA) was extended to Mexico. The EU also has North-South arrangements, including the Europe Agreements that link the EU with the transition economies of Eastern Europe, a customs union with Turkey, and agreements with many Mediterranean countries. In addition, the EU is committed to negotiating reciprocal trade agreements (economic partnership agreements, or EPAs) with the African, Caribbean, and Pacific (ACP) countries. NEED FOR REGIONAL INTEGRATION Many factors lay behind the recent spurt in regionalism. The important among them are as follows. Governments’ wish to bind themselves to better policies— including democracy—and to signal such bindings to domestic and foreign investors. A desire to obtain more secure access to major markets The pressures of globalisation, forcing firms and countries to seek efficiency through larger markets, increased competition, and access to foreign technologies and investment Governments’ desire to maintain sovereignty by pooling it with others in areas of economic management where most nationstates are too small to act alone RTAs convey advantages as well as limitations. By reducing the number of participants in the negotiation they can help expand the discussion to include more dimensions of economic integration. Compared with unilateral liberalisation, political support for RTAs also seems to be greater given the perception of reciprocity from other member countries. Although RTAs have varied components, these agreements include some or all of the following eight elements (Bhagwati and Panagariya, 1996 provide an overview): (i) a tariff liberalisation program—TLP (transformation of nontariff barriers, e.g. quotas, to their tariff equivalent and the sequential reduction of tariffs; special considerations to least developed countries are not uncommon); (ii) sensitive lists (goods or services
  16. 16. 20 to be exempt from the tariff reduction program);1 (iii) rules of origin—ROO (prevention of the application of the preferential tariffs to non regional goods or services as defined by the agreement);2 (iv) institutional arrangements (establishment of a council or administrative committee responsible for the administration and implementation of the agreement); (v) trade facilitation policies (collection of instruments to reduce transaction costs of importing and exporting, including homogenization of customs practices and technical assistance especially to the least-developed members); (vi) dispute settlement mechanism (procedures to report and deal with violations to the agreement); (vii) safeguards measures (suspension of preferential treatment on grounds that imports are causing or threatening to cause serious injury to the domestic industrial base); and (viii) parallel reduction in foreign investment barriers and/or trade in services. THE CONTEXT Apart from the general opening up, the countries in the SAARC region also since the 1970s, began to see increased cooperation and trade among themselves as a key objective. This was reflected partially in the founding of the South Asian Association for Regional Cooperation (SAARC) in 1985 to promote dialogue and cooperation. Though the actual exchange of preferences remained extremely limited, the process of negotiation kept the dialogue among the member countries alive. But the worldwide proliferation of preferential trade arrangements in the last decade has led to a change in thinking in the region, with more focus on enhanced regional trade. Within the region, this has led to the signing of the South Asian Free TradeArea (SAFTA)Agreement with the ultimate objective of turning South Asia into a full-fledged FTA with the internal liberalisation beginning in 2006. This agreement has come in the wake of a bilateral FTA agreement between India and Sri Lanka in 1998 that became operational on March 1, 2000. Further, South Asia has experienced unprecedented growth, averaging close to 6% per annum since the 1990s. This growth is impressive because many developing countries grew more slowly during this period. As India accounts for more than three 1 They take the form of positive (inclusions) or negative (exclusions) lists. 2 Examples include percentage of value added in member country(ies) and specific content requirements.
  17. 17. 21 quarters of the region’s gross domestic product (GDP), its growth has had a decisive impact on the overall regional growth. India grew at 3.2% during 1965-81, accelerated to 5.1% during 1981-87, then to 6% during 1987-2004, and during 2005- 2007 registered an average growth rate of 9.2%. While India has led the way, the other South Asian countries including Bangladesh and Pakistan have also shown remarkable improvements in economic growth (Ahmed, 2006). It is this steady rise in growth that has attracted the world’s attention to the South Asia region. In light of the above, the study attempts to examine various opportunities and challenges facing the SAARC countries. Thus, the objectives of the study are: a) To examine the emergence of SAARC as a trade bloc b) To present the brief profile of SAARC countries c) To analyse trade, investment and recent developments in the SAARC region d) To examine briefly India’s trade and Investment relation with SAARC region, with special reference to Exim Bank e) To empirically examine the trade nexus in the SAARC region, and f) To recommend suggestions and policy implications of the study METHODOLOGY AND DATA Augmented Gravity Model has been adopted to examine the causing factors for trade and the degree of trade in the SAARC region. The use of models is expected to help improve policy-making. Economic models provide a theoretically consistent, rigorous and quantitative way of evaluating different trade policies. Data on different variables incorporated in the model have been retrieved from various reliable sources.3 SCHEME OF THE STUDY The study consists of eight chapters. The first chapter introduces the historical background, context, objectives, methodology and data, and scheme of the study. The evolution, objectives and economic agenda of the SAARC are presented in chapter two. The economic profile of SAARC member countries are presented in chapter three. The fourth chapter presents trends in foreign trade of the region 3 Details of model and data are explained in the analytical chapter (Chapter VII).
  18. 18. 22 (intra and extra), trade policies and recent developments. The flow of foreign investment and investment policies are underlined in chapter five. A brief examination of India’s trade and investment relation with SAARC countries with special reference to Exim Bank is presented in chapter six. An empirical examination of trade nexus in the SAARC region is presented in chapter seven. Summary, conclusions and policy recommendations are delineated in chapter eight.
  19. 19. 23 The present chapter provides profile of the SAARC region in general, as also the objectives and principles, and economic agenda of SAARC. South Asian Association for Regional Cooperation (SAARC) comprises eight countries of South Asia, viz. Afghanistan4, Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan and Sri Lanka. It is an association based on the premise that in an increasingly interdependent world, the objectives of peace, freedom, social justice and economic prosperity in South Asia are best achieved by fostering mutual understanding, good neighbourly relations and meaningful cooperation amongst the countries in the region. The idea of regional cooperation in SouthAsia was first mooted in May 1980 and the foreign secretaries of the seven countries met for the first time in Colombo in April 1981. This was followed by a meeting in Colombo in August – September 1981, which identified five broad areas for regional cooperation. At their first meeting in New Delhi inAugust 1983, the Foreign Ministers of South Asia adopted the Declaration on SouthAsian Regional Cooperation (SARC) formally launching the Integrated Programme of Action (IPA) in five areas of cooperation, namely, Agriculture, Rural Development, Telecommu- nications, Meteorology, Health and Public Activities. At their first SAARC Summit in Dhaka in December 1985, the heads of State or Government adopted the Charter formally establishing the SouthAsianAssociation for Regional Cooperation (SAARC). 8th December every year is observed as the SAARC Charter Day in member states. The objectives, principles and general provisions contained in the SAARC Charter are as follows: OBJECTIVES (a) To promote the welfare of the peoples of South Asia and to improve their quality of life; (b) To accelerate economic growth, social progress and cultural 2. SOUTH ASIAN ASSOCIATION FOR REGIONAL COOPERATION (SAARC): EVOLUTION, OBJECTIVES AND ECONOMIC AGENDA 4 Afghanistan joined as a full member of SAARC on April 3, 2007.
  20. 20. 24 development in the region and to provide all individuals the opportunity to live in dignity and to realise their full potential; (c) To promote and strengthen collective self- reliance among the countries of South Asia; (d) To contribute to mutual trust, understanding and appreciation of one another’s problems; (e) To promote active collaboration and mutual assistance in the economic, social, cultural, technical and scientific fields; (f) To strengthen cooperation with other developing countries; (g) To strengthen cooperation among themselves in international forums on matters of common interests; and (h) To cooperate with international and regional organisations with similar aims and purposes. PRINCIPLES (a) Cooperation within the framework of the Association is based on respect for the principles of sovereign equality, territorial integrity, political independence, non-interference in the internal affairs of other states and mutual benefit; (b) Such cooperation is to complement and not to substitute bilateral or multilateral cooperation; and (c) Such cooperation should be consistent with bilateral and multilateral obligations of member states GENERAL PROVISIONS (a) Decisions at all levels in SAARC are to be taken on the basis of unanimity; and (b) Bilateral and contentious issues are to be excluded from the deliberations of the association THE SUMMIT The highest authority of the Association rests with the Heads of States or Government, who meet annually at the Summit level. To date fourteen Summits have been held: Dhaka (1985), Bangalore (1986), Kathmandu (1987), Islamabad (1988), Male (1990), Colombo (1991), Dhaka (1993), New Delhi (1995), Male (1997), Colombo (1998), Kathmandu (2002), Islamabad (2004), Dhaka (2005) and New Delhi (2007). The fifteenth summit is scheduled to be held in August 2008 at Colombo. ECONOMIC AGENDA Cooperation in the core economic areas amongst Member Countries was initiated following the completion of the Study on Trade, Manufactures and Services (TMS) in June 1991. Among other things, the TMS Study recognised economic cooperation as an imperative for promoting all-round development of South Asia.
  21. 21. 25 Following are the main economic agenda of the SAARC. a) SAARC Preferential Trading Agreement (SAPTA) In December 1991, the Sixth Summit held in Colombo approved the establishment of an Inter- Governmental Group (IGG) to formulate an agreement to establish a SAARC Preferential Trading Arrangement (SAPTA) by 1997. Given the consensus within SAARC, the Agreement on SAPTA was signed on 11 April 1993 and entered into force on 7 December 1995 well in advance of the date stipulated by the Colombo Summit. The Agreement reflected the desire of the Member States to promote and sustain mutual trade and economic cooperation within the SAARC region through the exchange of concessions. The basic principles underlying SAPTA are: a. overall reciprocity and mutuality of advantages so as to benefit equitably all Contracting States, taking into account their respective level of economic and industrial development, the pattern of their external trade, and trade and tariff policies and systems; b. negotiation of tariff reform step by step, improved and extended in successive stages through periodic reviews; c. recognition of the special needs of the Least Developed Contracting States and agreement on concrete preferential measures in their favour; and d. inclusion of all products, manufactures and commodities in their raw, semi-processed and processed forms. So far, four rounds of trade negotiations have been concluded under SAPTA covering over 5000 commodities. Each Round contributed to an incremental trend in the product coverage and the deepening of tariff concessions over previous Rounds. The Member States are in the process of completing the necessary procedural formalities to give effect to the concessions extended in the Fourth Round. b) South Asian Free Trade Area (SAFTA) SAPTA was envisaged primarily as the first step towards the transition to a South Asian Free Trade Area (SAFTA) leading subsequently towards a Customs Union, Common Market and Economic Union. In 1995, the Sixteenth session of the Council of Ministers (New Delhi, 18- 19 December) agreed on the need to strive for the realisation of SAFTA and to this end an Inter- Governmental Expert Group (IGEG) was set up in 1996 to identify the necessary steps for progressing to
  22. 22. 26 a free trade area. The Tenth SAARC Summit (Colombo, 29-31 July 1998) decided to set up a Committee of Experts (COE) to draft a comprehensive treaty framework for creating a free trade area within the region, taking into consideration the asymmetries in development within the region and bearing in mind the need to fix realistic and achievable targets. The Agreement on South Asian Free TradeArea (SAFTA), drafted by the COE, was signed on 6 January 2004 during the Twelfth SAARC Summit in Islamabad. The Agreement entered into force on 1 January 2006. Under the Trade Liberalisation Programme scheduled for completion in ten years by 2016, the customs duties on products from the region will be progressively reduced. However, under an early harvest programme for the Least Developed Member States, India, Pakistan and Sri Lanka are to bring down their customs duties to 0-5 % by 1 January 2009 for the products from such Member States. The Least Developed Member States are expected to benefit from additional measures under the special and differential treatment accorded to them under the Agreement. c) South Asian Economic Union The Eleventh Summit (Kathmandu, 4-6 January 2002) provided further impetus to the regional economic cooperation to give effect to the shared aspirations for a more prosperous South Asia. At the Summit, the Leaders agreed to accelerate cooperation in the core areas of trade, finance and investment to realise the goal of an integrated South Asian economy in a step-by-step manner. They also agreed to the vision of a phased and planned process eventually leading to a South Asian Economic Union. At the Twelfth SAARC Summit (Islamabad, 4-6 January 2004) the SAARCFINANCE was given the responsibility to study and make recommendations on the early and eventual realisation of a South Asian Economic Union (SAEU). It was also tasked with examining the concept of a SouthAsian Development Bank.
  23. 23. 15.1 9.4 16.4 6.1 13.9 0 5 10 15 20 Percent 2003 2004 2005 2006 2007
  24. 24. 6.3 6.0 6.6 6.5 5.3 0 1 2 3 4 5 6 7 Percent 2003 2004 2005 2006 2007
  25. 25. 9.0 7.0 6.9 7.8 17.0 0 5 10 15 20 Percent 2003 2004 2005 2006 2007
  26. 26. 8.5 7.5 9.4 9.6 9.0 0 2 4 6 8 10 Percent 2003 2004 2005 2006 2007
  27. 27. 3.8 4.4 2.9 3.1 2.3 0 1 2 3 4 5 Percent 2003 2004 2005 2006 2007
  28. 28. 4.7 7.5 9.0 6.6 7.0 0 2 4 6 8 10 Percent 2003 2004 2005 2006 2007
  29. 29. 5.9 5.4 6.2 7.7 6.7 0 1 2 3 4 5 6 7 8 Percent 2003 2004 2005 2006 2007
  30. 30. 35 Table3.1: SELECTECONOMICINDICATORSOFSAARCCOUNTRIES IndicatorsYearAfghanistanBangladeshBhutanIndiaMaldivesNepalPakistanSriLanka GDPGrowth(%)20066.16.67.89.619.13.16.67.7 200713.96.517.09.06.62.37.06.7 2008*9.06.014.48.08.03.86.36.0 2009*9.06.57.28.57.04.36.56.0 Inflation(%)20065.17.24.95.43.58.07.99.6 20079.87.25.24.47.46.47.820.2 2008*10.29.04.54.56.07.08.016.2 2009*7.28.04.54.56.06.56.514.0 ExportsGrowthrate(%)20060.421.547.221.839.42.614.98.5 20073.315.864.518.12.84.34.412.5 2008*8.012.033.916.0–6.18.08.0 2009*8.715.09.018.0–4.310.09.0 ImportsGrowthrate(%)200610.012.1-5.621.824.417.833.315.7 200715.016.615.128.514.811.38.010.2 2008*13.220.019.522.0–14.013.09.5 2009*-1.416.023.424.0–14.510.09.0 contd...
  31. 31. 36 Contd... IndicatorsYearAfghanistanBangladeshBhutanIndiaMaldivesNepalPakistanSriLanka TradeBalance(US$mn)2006-4,942-2,889-123-63,171-590-1,531-8,441-3,370 2007-5,893-3,45813-94,510-704-1,765-9,711-3,555 2008*-6,765-5,11488-124,377–-2,08311,837-4,009 2009*-6,465-6,06711-164,753–-2,482-13,021-4,370 CurrentA/CBal.(US$mn)2006-444824-38-9,766-369198-4,990-1,497 2007-119952114-22,072-472506,878-1,373 2008*-50543141-29,483-541––-1,546 2009*-15086338-40,443-544––-1,631 Externaldebt(US$mn)200612,08318,603677169,6295743,24935,65512,235 20071,88319,703756190,516–3,21838,69916,130 Exchangerate(:US$1)200649.967.144.745.312.871.959.9104.0 200750.169.044.240.212.870.660.6110.6 Foreignex.reserves20062,0643,484479199,1792321,83410,7602,515 (US$mn)20072,3355,077599306,4883092,40113,3453,100 Fiscalbal.ofCentralGovt.2006-3.1-3.2-0.8-6.4-6.7-1.6-4.3-8.1 (%ofGDP)2007-2.9-3.2-3.4-5.5-7.9-2.0-5.8-7.7 *-forecasts SOURCE:AsianDevelopmentOutlook2008,AsianDevelopmentBank.
  32. 32. 37 Trend in SAARC’s global trade as also intra-SAARC trade in recent years are presented in this chapter. Further, trade developments in each SAARC member countries as also developments in SAARC trade integration are also presented in the chapter. SAARC’s GLOBAL TRADE During the period 2000 to 2006, the total exports of SAARC countries increased from US$ 63.5 billion to US$ 161.4 billion. The growth rate of exports also increased from 3.9% in 2001 to 23.9% in 2006. Among all the member countries, India is the largest exporter followed by Pakistan and Bangladesh. Table 4.1 presents the trend in SAARC’s global exports. The total global imports of SAARC countries also increased from US$ 79.5 billion in 2000 to US$ 255.3 billion in 2006, registering more than a three-fold rise during the 4. TREND IN FOREIGN TRADE AND TRADE POLICIES IN THE SAARC REGION Table 4.1: SAARC’S GLOBAL EXPORTS DURING 2000-2006 (US$ billion) Countries Year 2000 2001 2002 2003 2004 2005 2006 Afghanistan 0.1 0.1 0.1 0.2 0.2 0.2 0.3 Bangladesh 5.6 5.7 5.4 6.2 7.6 8.5 12.7 Bhutan 0.10 0.1 0.1 0.1 0.2 0.3 – India 42.6 45.2 50.5 61.1 75.4 97.9 122.7 Maldives 0.1 0.1 0.1 0.1 0.1 0.1 0.2 Nepal 0.7 0.8 0.6 0.6 0.7 0.8 0.8 Pakistan 8.9 9.2 9.9 11.9 13.3 16.0 17.2 Sri Lanka 5.5 4.7 4.7 5.1 5.8 6.4 7.5 Total 63.5 66.0 71.4 85.4 103.2 130.3 161.4 – (3.9) (8.2) (19.6) (20.8) (26.3) (23.9) SOURCE: Direction of Trade Statistics Year Book 2007, IMF. NOTE: Values in parentheses show percentage growth.
  33. 33. 38 period. India is the largest importer in the SAARC region followed by Pakistan and Bangladesh. Thus, data on exports and imports reveal that SAARC as a trade bloc experienced trade deficit of US$ 93.9 billion with the world in 2006. Table 4.2 presents the trend in SAARC’s global imports. INTRA-SAARC TRADE Table 4.3 presents the trend in intra-SAARC exports during 2000- 2006. The total intra SAARC exports increased from US$ 2.8 billion in 2000 to US$ 10.8 billion in 2006, registering nearly a four-fold rise during the period. Exports among the SAARC countries are dominated by India, followed by Pakistan and Sri Lanka. The trend in intra-SAARC imports is presented in Table 4.4. The table shows that total imports increased from US$ 3.0 billion in 2000 to US$ 9.6 billion in 2006, depicting a three-fold rise. The intra- SAARC imports are dominated by Sri Lanka, followed by India. The growth rate of intra-SAARC imports increased from 13.0% in 2001 to US$ 11.6% in 2006. Figure 4.1 depicts the trend in intra-SAARC trade (exports plus imports), vis-a-vis trend in SAARC’s global trade. A comparison of the trends would help to highlight the buoyancy in intra-SAARC trade especially after 2003, as compared to SAARC’s global trade. Table 4.2: SAARC’S GLOBAL IMPORTS DURING 2000-2006 (US$ billion) Countries Year 2000 2001 2002 2003 2004 2005 2006 Afghanistan 0.6 0.6 1.0 1.6 2.0 3.0 3.8 Bangladesh 9.0 9.0 7.8 9.8 11.6 13.9 17.8 Bhutan 0.2 0.2 0.2 0.2 0.4 0.4 – India 50.3 59.0 58.9 74.0 99.8 134.7 185.0 Maldives 0.4 0.4 0.4 0.5 0.6 0.7 0.9 Nepal 1.6 1.6 1.4 1.6 1.8 2.0 2.4 Pakistan 10.7 10.2 11.2 13.0 17.8 25.4 33.8 Sri Lanka 6.7 5.7 6.0 6.7 8.0 8.9 11.6 Total 79.5 86.7 87.1 107.4 142.0 189.90 255.3 – (9.1) (0.46) (23.3) (32.2) (33.01) (35.2) SOURCE: Direction of Trade Statistics Year Book 2007, IMF. NOTE: Values in parentheses show percentage growth.
  34. 34. 39 Table 4.3: INTRA-SAARC EXPORTS DURING 2000-2006 (US$ mn) Countries Year 2000 2001 2002 2003 2004 2005 2006 Afghanistan 60.3 49 44.4 64.1 87.4 102.1 125.3 Bangladesh 93.6 97.7 78.4 112.5 126.5 187.3 228.5 Bhutan 24.5 27.1 33.3 50.8 57.1 95.4 117.0 India 1822 2082 2601 3918 4416 5273 6789.0 Maldives 13.8 17 14.1 15.7 15.6 17.2 21.2 Nepal 222.9 243.8 279.0 265.3 302.2 343.7 568.8 Pakistan 404 407 452 751 959 1797 2191.0 Sri Lanka 189.9 157.8 256.8 350.6 507.9 655.5 808.6 Total 2831.0 3081.3 3759.0 5527.9 6471.7 8471.1 10849.5 – (8.8) (22.0) (47.1) (17.1) (30.9) (27.1) SOURCE: Direction of Trade Statistics Year Book 2007, IMF. NOTE: Values in parentheses show percentage growth. Table 4.4: INTRA-SAARC IMPORTS DURING 2000-2006 (US$ mn) Countries Year 2000 2001 2002 2003 2004 2005 2006 Afghanistan 169.5 196.9 307.9 590.2 684.8 1333.0 1648.6 Bangladesh 1058.9 1299.1 1221.1 1612.2 1887.4 2121.9 1036.5 Bhutan 3.9 4.5 32.4 79.4 88.6 99.3 122.1 India 473.0 533.0 544.0 664.0 891.0 1297.0 1763.0 Maldives 89.6 93.2 103.0 114.2 136.5 129.3 159.9 Nepal 163.1 179.2 355.8 659.0 793.8 921.6 1486.3 Pakistan 291.0 321.0 259.0 345.0 599.0 765.0 945.0 Sri Lanka 707.3 712.5 933.1 1175.7 1574.8 1981.3 2448.7 Total 2956.2 3339.3 3756.2 5239.6 6655.9 8648.4 9610.1 – (13.0) (12.5) (39.5) (27.0) (29.9) (11.6) SOURCE: Direction of Trade Statistics Year Book 2007, IMF. NOTE: Values in parentheses show percentage growth.
  35. 35. 5.8 20.5 143.0 416.7 0.0 5.0 10.0 15.0 20.0 25.0 2000 2001 2002 2003 2004 2005 2006 0.0 50.0 100.0 150.0 200.0 250.0 300.0 350.0 400.0 450.0 500.0 SAARC's Global Trade Intra-SAARC Trade
  36. 36. 41 previous year. The imports of the country also increased by 28.1% to US$ 17.8 billion in 2006 from US$ 13.9 billion due to growing import bill for oil. Thus, Bangladesh experienced a trade deficit of US$ 5.1 billion in 2006. Imports are expected to continue to grow in both volume and value terms as demand for capital goods and some industrial raw materials remains strong. The main export items of Bangladesh in 2006 were garments (63.9% of total exports), fish & prawns (4.9% of total exports), jute goods (3.2% of total exports), and leather & hides (3.1% of total exports). The important imports in 2006 were capital goods (24.7% of total imports), textiles (20.5% of total imports), petroleum & petroleum products (11.6% of total imports), and cereal and dairy products (3.7% of total imports). The major export destinations of Bangladesh in 2006 were the US (24.2% of total exports), Germany (13.2% of total exports), and the UK (10.6% of total exports). The major import sources were India (14.7% of total imports), China (14.6% of total imports), and Kuwait (8.0% of total imports). India India’s exports increased by 25.3% to US$ 122.7 billion in 2006 from US$ 97.9 billion in 2005 due mainly to sharp increase in the export of manufactured goods. The imports have also increased by 37.3% to US$ 185.0 billion in 2006 from US$ 134.7 billion in 2005. Hence, India experienced a trade deficit of US$ 62.3 billion in 2006. The major items of India’s exports in 2006 were engineering goods (22.0% of total exports), textiles and textile products (16.4% of total exports), gems and jewellery (15.9% of total exports), and chemicals and chemical products (14.8% of total exports). The important import items of India in 2006 were petroleum products (32.6% of total imports) and capital goods (23.5% of total imports). The major destinations of India’s exports in 2006 were the USA (17.6% of total exports), the UAE (8.8% total exports), China (6.9% of total exports), Singapore (5.7% of total exports), and Hong Kong (4.6% of total exports). The main sources of imports in 2006 were China (8.0% of total imports), the USA (5.8% of total imports), Switzerland (4.9% of total imports), Germany (4.3% of total imports),Australia (3.6% of total imports), Belgium (3.5% of total imports), South Korea (3.2% of total imports) and the UAE (3.2% of total imports). Maldives The exports of Maldives have increased to US$ 0.2 billion in 2006 from US$ 0.1 billion in 2005. The Maldives is an import-dependent country, bringing in everything from staple foods to resort supplies, construction materials and petroleum
  37. 37. 42 products. The average ratio of imports to GDP in 2000–2005 was about 60%, while that for merchandise exports was about 20%. The imports have increased by 28.6% in 2006 to US$ 0.9 billion from US$ 0.7 billion in 2005 as both private sector and public sector imports grew. Marine products constitute the lion share of Maldives’ exports. The major import items of Maldives in 2006 were mineral fuels, mineral oils & products (16.0% of total imports), electrical machinery & equipments (15.0% of total imports), machinery & mechanical appliances (11.0% of total imports), and base metal & articles of base metal (8% of total imports). The major destinations of Maldives exports in 2006 were Thailand (21.8% of total exports), Japan (21.6% of total exports), Sri Lanka (15.5% of total exports), the UK (13.8% total exports). The important sources of country’s imports in 2006 were Singapore (25.1% of total imports), Sri Lanka (10.7% of total imports), the UAE (10.4% total imports) and India (10.3% of total imports). Nepal The total exports of Nepal was US$ 0.8 billion in 2006, same as in 2005, as a result of sharp growth in exports to India. Exports to other countries improved by 1.8%. Performance in export sector underlined the facts that the country’s export base is not well diversified and that traditionally large earners such as garments, as well as carpets and pashmina shawls, face stiffer competition, which has eroded sales both to India and to the rest of the world. The imports of Nepal increased by 20.0% to US$ 2.4 billion in 2006 from US$ 1.9 billion in 2005. Oil-product imports accounted for about one quarter of the increase and remittance- financed consumption expenditure most of the rest. The major export items of Nepal in 2006 were garments (13.3% of total exports), woolen carpets (12.5% of total exports), vegetable ghee (8.3% of total exports), polyester yarn (7.5% of total exports) and jute goods (5.7% of total exports). The main imports of the country in 2006 were petroleum products (24.0% of total imports), vehicles & spares (3.7% of total imports), medicine (3.1% of toal imports), crude palm oil (2.8% of total imports) and mild steel billets (2.7% of total imports). The major destinations of Nepal’s exports in 2006 were India (66.9% of total exports), the USA (12.8% of total exports) and Germany (5.3% of total exports). The main sources of Nepal’s imports in 2006 were India (59.0% of total imports), China (5.7% of total imports), Singapore (5.3% of total imports) and Indonesia (3.6% of total imports).
  38. 38. 43 Pakistan The total exports of Pakistan increased in 2006 to US$ 30.1 billion from US$ 17.2 billion in 2005 as a result of export in cotton textiles. Over the past 5 years, merchandise exports have benefited from an enabling policy environment, low inflation, the low cost of credit, and general upturn in economic activity. The main issue is exports’ heavy reliance on textiles as well as limited geographic diversification. Between them, textiles and clothing, cotton, leather, rice, and sports goods account for over three quarters of total exports—textiles and clothing alone for three fifths. Thus a downturn in these segments has a significant overall impact. Further, textile exports have come under competitive pressure from Bangladesh, People’s Republic of China, and India, specifically in the higher value-added categories that have traditionally not been a strength of the Pakistani textile sector. The imports of Pakistan also increased by 33.1% in 2006 to US$ 33.8 billion from US$ 25.4 billion in 2005 due to high oil prices and rising imports. Thus, the trade deficit of Pakistan has increased from US$ 9.4 billion in 2005 to US$ 16.6 billion in 2006. The major export items of Pakistan in 2006 were cotton fabrics (11.6% of total exports), knitwear (10.2% of total exports), bedwear (9.0% of total exports), cottonyarn & thread (6.6% of total exports) and rice (5.8% of total exports). The important imports of Pakistan in 2006 were machinery & transport equipments (23.4% of total imports), mineral fuels (16.9% of total imports), chemicals (14.2% of total imports), manufactures (8.9% of total imports) and food & live animals (4.3% of total imports). The major destinations of Pakistan’s exports in 2006 were the USA (24.0 % of total exports), the UAE (7.6% of total exports), the UK (6.2% of total exports), Afghanistan (5.2% of total exports) and Germany (4.8% of total exports). The main sources of imports of the country in 2006 were Saudi Arabia (12.3% of total imports), China (8.9% of total imports), the UAE (8.3% of total imports), the USA (7.6% of total imports) and Japan (7.0% of total imports). Sri Lanka The total exports of Sri Lanka increased by 17.2% in 2006 to US$ 7.5 billion from US$ 6.4 billion in 2005 due to increase in the export of garments. Exports of garments are expected to grow, but strong domestic demand, particularly for infrastructure investment goods and military hardware, will also suck in imports. The imports also increased by 30.3% in 2006 to US$ 11.6 billion from US$ 8.9 billion in 2005. As a result, the trade deficit of Sri Lanka has increased from US$ 2.5 billion in 2005 to US$ 4.1 billion in 2005. The cost of oil imports is expected
  39. 39. 44 to remain relatively high, although Sri Lanka’s oil import bill will be eased by falling global petroleum prices. The volume of oil imports could also be driven up if power shortages, caused by poor rains affecting hydropower generation, lead to increased use of generators. The major items of Sri Lanka’s exports in 2006 were textiles & garments (48.4% of total exports), tea (13.8% of total exports), diamond & jewellery (4.9% of total exports), and petroleum (2.9% of total exports). The main imports in 2006 were machinery & transport equipment (24.5% of total imports), mineral products (23.4% of total imports), textiles (17.5% of total imports) and base metals (9.2% of total imports). The major destinations of Sri Lanka’s exports in 2006 were the USA (28.2% of total exports), the UK (11.5 of total exports), India (9.0% of total exports) and Germany (4.1% of total exports). The important sources of the country’s imports in 2006 were India (18.5% of total imports), China (10.5% of total imports), Singapore (8.7% of total imports) and Hong Kong (4.2% of total imports). POTENTIAL COMMODITIES FOR TRADE Export Potential SAARC has potential for exports and imports in a number of commodities. The region has potential for exports in commodities namely; textiles, gems & jewellery, jute goods, handicrafts, fish & fish products, and engineering goods. Textile is the major commodity with export potential in the SAARC region. This constitutes around 40.0% of the total exports of the region. The main textile items with export potential are articles of apparel and clothing accessories and cotton yarn fabric madeups. Gems & jewellery is another major commodity with export potential in the SAARC region. India and Sri Lanka are the major exporters. Jute goods, handicrafts, fish & fish products are the other important commodities with potential for export. Fish products include mainly commodities such as fish and crustaceans, molluscs and other aquatic invertebrates. India is a major exporter of engineering goods. Import Potential Petroleum & petroleum products and capital goods are the main items having import potential. Petroleum & petroleum products constitute more than 20% of the total imports of SAARC. Among the capital goods, machinery & mechanical appliances and electrical machinery and appliances are the commodities with highest import potential. The other important import commodities with potential are
  40. 40. 45 organic chemicals, iron & steel, cotton and edible vegetables. The import of these commodities increased sizably during the recent years. Region’s import of drugs & pharmaceuticals also increased faster during the recent years showing more potential for imports. TRADE POLICIES IN SAARC COUNTRIES Trade liberalisation in SouthAsia started with a series of sweeping reforms in Sri Lanka in 1977/78, followed by a new second phase of trade liberalisation during the 1990s. For the rest of South Asia, the 1980s and 1990s saw substantial reductions of tariffs and phasing out of QRs, along with liberalisation of the exchange regimes. The average tariff in the SAARC region is presented in Table 4.5. SAFTA-RECENT POLICY INITIATIVES As regards SAARC, India is in the process of identifying the barriers and removing them as far as possible. Recently the government of India has taken a decision to waive the stipulation for testing and certification of products by Indian laboratories as a precondition for imports. Instead of testing and certification by the Indian entities, it would now be enough if the job was done by laboratories in the SAARC countries accredited by the Bureau of Indian Standards. With a view to further enhance regional trade and co-operation in the SAARC region, a number of measures has been effected in recent period which would include: (a) With effect from January 01, 2008, the import duty on all Table 4.5: AVERAGE TARIFF IN THE SAARC COUNTRIES, 2006 (Per cent) Countries Tariff Level Afghanistan 5.7 Bangladesh 15.2 Bhutan 22.1 India 15.8* Maldives 20.2 Nepal 13.9 Pakistan 14.3 Sri Lanka 11.2 SAARC 15.5 SOURCE: World Tariff Profiles 2006, WTO; * Trade Policy Review 2007, WTO.
  41. 41. 46 items other than those in the negative list has been reduced to zero; (b) During the 3rd SAFTA Ministerial Council meeting in New Delhi, on March 03, 2008, India announced the pruning of negative list from 744 items to around 500 items for the least developed country members of the South Asian Association for Regional cooperation (SAARC) such as Bangladesh, Bhutan, Nepal and Maldives, thereby enlarging the scope of duty- free entry to the export items from these countries. (c) The 3rd Ministerial Council also supported the creation of SAARC Development Fund, the South Asian University and the SAARC Food Bank. (d) Moreover, the meeting set an intra-trade target of US$ 40 billion in the next 3-5 years, from the present US$ 20 billion; (e) Further, recognising the importance of Trade in Services in the region, the third SAFTA Ministerial Council Meeting also directed the drafting of SAARC Framework Agreement on Trade in Services (SAFAS) under SAFTA Agreement. DEVELOPMENTS IN SAARC TRADE INTEGRATION SAARC Preferential Trade Agreement (SAPTA) A notion that deeper trade interaction can create functional spillovers that would help build stronger general ties has long been in the minds of South Asian policy makers.Although the acceleration of economic growth through regional cooperation was incorporated as an objective in the SAARC Charter in 1985, it was not until 1987 that an explicit commitment to cooperation in the area of economic development was adopted. This eventually led to the signing of SAPTA at the seventh SAARC summit in 1993, in Dhaka. The agreement provides a framework and institutional base for trade liberalisation and economic cooperation between the seven SAARC member countries. The agreement provides for the exchange of concessions between SAPTA members on tariffs, para- tariff5 and non-tariff barriers. It envisages four basic approaches to the exchange of trade preferences: (1) product-by-product; (2) across- the-board; (3) sectoral ; and 5 Border and other taxes having the equivalent or similar protective effects as Customs duties.
  42. 42. 47 (4) “direct trade” measures.6 Key aspects of the agreement are the following: “Special and Favourable Treatment”. As done by the UN agencies and the WTO, SAPTA distinguishes between its members according to their level of economic development. Bangladesh, Nepal, Bhutan and the Maldives are defined as “Least Developed Countries” (LDCs) and are treated differently from the three “non-LDC” members, India, Pakistan and Sri Lanka. The agreement provides for “Special and Favourable Treatment” for the LDCs by the non-LDCs, including deeper and wider tariff preferences; favorable terms for technical assistance; the provision of special facilities with regard to shipping; assistance with the preparation and establishment of industrial and agriculture projects; training facilities; and support in marketing. Regional MFN principle. A unique feature of SAPTA is the application of a regional MFN principle with regard to its members. Under this principle, tariff or other concessions accorded by a non-LDC to another non-LDC are extended unconditionally to all member countries. However, concessions extended by a non-LDC to an LDC are automatically applied only to other LDC members. Rules of Origin. The SAPTA rules of origin (ROOs) distinguish between goods that are “wholly produced or obtained” and goods that are not “wholly produced or obtained” in an exporting SAPTA country. The former includes domestic raw materials, agricultural products, fish, waste and scrap, and products wholly obtained from these inputs. As regards the latter, the agreement initially provided that the total value of the materials, parts or produce originating from non- contracting states or of undetermined origin and used in the production of the exported product, should not exceed 50% of the f.o.b. value, and that the final process of manufacture was performed within the territory of the exporting member state. The non-local inputs are valued at their cif prices where obtainable, or otherwise at “the earliest ascertainable price” paid for them in the exporting country. In 6 “Product-by-product” means negotiating at HS 6-digit tariff line level. “Across the Board” means a uniform reduction applying to all products under negotiations. “Sectoral basis” means agreements on groups of products which are closely related in end use or in production. “Direct trade measures” means such things as long and medium term contracts containing import and supply commitments in respect of specific products, buyback arrangements, state trading operations, and government and public sector procurement.
  43. 43. 48 order to encourage regional value addition, the agreement also includes a “cumulative” rule of origin which initially laid that goods processed in more than one member country can be eligible for concessions provided that the value added in SAPTA countries was at least 60% of the fob value. At the SAARC Council of Ministers meeting held in March 1999, the local content requirement was reduced to 40% for non-LDCs and to 30% for the four LDCs, and the “cumulative” origin requirement was reduced to 50%.7 South Asian Free Trade Agreement (SAFTA) South Asian Free Trade Agreement (SAFTA) has been ratified and entered into force in mid- 2006. SAFTA builds on the provisions of SAPTA. SAFTA extends the scope of SAPTA to include trade facilitation elements and switches the tariff liberalisation process from a positive to a negative list approach.Aspecial consideration in SAFTA is the compensation for revenue losses for small countries in the event of tariff reductions. For these countries SAFTA proposes that “until alternative domestic arrangements are formulated to address this situation, the Contracting States agree to establish an appropriate mechanism to compensate the Least Developed Contracting States…” (SAARC Secretariat, 2006). With the coming into force of the Agreement, the SAFTA Ministerial Council (SMC) and the SAFTA Committee of Experts (COE) have also been established under Article 10 of theAgreement. The SMC is the highest decision-making body and is responsible for implementation of the Agreement. It consists of Commerce/Trade Ministers of the Member States and is required to meet at least once annually or more often as and when considered necessary. The COE, consisting of one nominee from each Member State at the level of senior economic official, is to support the SMC and monitor, review and facilitate implementation of the Agreement. The COE is to meet once every six months or more often as necessary. The Twelfth Meeting of the Committee of Experts (COE) on SAFTA held at the SAARC Secretariat, Kathmandu on 29 November – 1 December 2005 successfully concluded the negotiations on the following issues which now form an integral part of the Agreement: i. Sensitive Lists - of products that would be temporarily exempt from reduction in 7 This issue was discussed during the third negotiating round.
  44. 44. 49 customs tariffs to be applied across the board for all other products. ii. Rules of Origin - specifying the conditions that would have to be met by products to qualify for application of reduced customs tariffs on export to another SAARC Member State; iii. Mechanism for Compensation of Revenue Loss for least developed country (LDC) Member States in the event of revenue loss resulting from lowering of customs tariffs in terms of the Agreement; and iv. Technical Assistance to the LDC Member States. In the first phase, the LDCs in SAFTA will reduce their maximum tariff rates to 30% within two years from the date of coming into force of the Agreement. The non-LDC members will reduce their maximum rates to 20% within the same time frame. In the second phase, which will resume on January 1, 2008, the non-LDC members will reduce their import tariffs to the 0-5% range in 5 years, while the LDCs will do the same in 8 years (Table 4.6). The described tariff reduction schedule may not apply to items on the ‘Sensitive Lists’, which are to be negotiated among the contracting members.
  45. 45. 50 Table 4.6: PLANNED PHASED TARIFF CUTS ON INTRA-SAFTA TRADE SAARC Countries: First Phase Second Phase/a (two years)/a January 1, 2006- January 1, 2008- January 1, 2008- January 1, 2008 January 1, 2013 January 1, 2016 For LDCs: Reduce maximum Reduce tariffs (Bangladesh, Nepal, tariff to 30% to the 0-5% Bhutan, Maldives) range in 8 years. (Equal annual reductions recommended, but not less than 10%) For non-LDCs: Reduce maximum Reduce tariffs to the (India, Pakistan, tariff rate to 20% 0-5 % range in Sri Lanka) 5 years; (Sri Lanka: in 6 years) (It is recommended that reductions be done in equal installments-at least 15% reduction each year) Reduce tariffs to 0-5 % for products of the LDCs within a timeframe of 3 years) /a: These phased tariff cuts for intra-SAFTA trade may not apply to items on each country’s ‘Sensitive Lists’. SOURCE: World Bank8 8 Trade Policies in South Asia: An Overview, Vol II, September 7, 2004.
  46. 46. 51 The chapter examines the trend in foreign direct investment (FDI) in the SAARC region. In addition to examining the trend in inflows and outflows of FDI, sources and sectors attracting FDI are also presented. Further, the chapter discusses the FDI policies followed in the member countries also. One of the remarkable features of globalisation in the 1990s was the flow of private capital in the form of foreign direct investment. FDI is an important source of development financing, and contributes to productivity gains by providing new investment, better technology, management expertise and export markets. Given resource constraints and lack of investment in developing countries, there has been increasing reliance on the market forces and private sector as the engine of economic growth (Sahoo, 2006). Net private capital flows to developing countries reached a record high of US$ 491 billion in 2005, driven by privatisations, mergers and acquisitions, external debt refinancing, and strong investor interest in local-currency bond markets in Asia and Latin America (Global Development Finance Report, 2006). The surging flows, including record bank lending and bond issuance, among others, coincided with 6.4% economic growth in the developing world last year, more than double the 2.8% growth in developed countries. TREND IN FDI INFLOWS FDI inflows to South Asia have continuously increased over the years and particularly since 2000. An improving economic situation and a more open FDI climate encouraged inflows to India, at record levels. The total FDI inflows to India amounted to US$ 58.1 billion during April 2000 to February 2008. Cross-border M&As in India rose in this period, as the telecommunications, business process outsourcing and pharmaceutical industries saw an increase in large deals. The improved investment environment and the privatisation of assets in Pakistan and Bangladesh contributed to increased FDI inflows to those countries. Table 5.1 reveals that apart from India, FDI flows into Pakistan, 5. FOREIGN DIRECT INVESTMENT AND INVESTMENT POLICIES IN THE SAARC REGION
  47. 47. 52 Bangladesh and Sri Lanka also has increased faster during the period. The total FDI inflow into the SAARC region increased from US$ 5.6 billion in 2000 to US$ 22.3 billion in 2006. TREND IN FDI OUTFLOWS The recent trend in FDI outflows from SAARC region is presented in Table 5.2. FDI outflows from the SAARC region increased from US$ 350.0 mn in 2000 to US$ 9.8 billion in 2006. Out of all eight-member countries, FDI outflow from India is the highest with US$ 9.7 billion in 2006, followed by Pakistan (US$ 107 mn) and Sri Lanka (US$ 29 mn). Sources of FDI and Sectors Attracting FDI in Select SAARC Countries Though the South Asian countries have lagged behind in attracting FDI compared to their counterparts in East and Southeast Asia, in recent years they have managed to consistently step up their FDI inflows mostly from the developed countries. The sources of FDI to SAARC countries are discussed below. India – Sector-wise Inflows: The sectors that received the highest cumulative inflows of FDI over the period April 2000 to February 2008 (see Table 5.3) are services sector (22.4%), computer software & hardware (14.0%), telecommuni- cations (7.2%), and construction activities (5.5). Similarly, in 2006-07 the sectors that received the most FDI were services (US$ 4.7 billion), electrical equipment (US$ 2.7 billion), construction activities (US$ 1 billion) and telecommunications (US$ 0.5 billion). Investment rose in industries such as cement, sugar, plastics and rubber, and hotels. Table 5.1: TREND IN FDI INFLOWS INTO SAARC COUNTRIES, 2000-2006 (US$ billion) Countries Year 2000 2001 2002 2003 2004 2005 2006 Afghanistan – – – 0.002 0.001 0.004 0.002 Bangladesh 2.800 0.700 0.520 0.350 0.460 0.690 0.620 Bhutan – – – 0.001 0.003 0.009 0.006 India 2.300 3.400 3.400 4.600 5.770 6.670 16.880 Maldives – – – 0.014 0.015 0.009 0.014 Nepal – 0.019 0.006 0.015 0.010 0.002 – Pakistan 0.300 0.380 .820 0.530 1.120 2.200 4.270 Sri Lanka 0.170 0.170 0.190 0.230 0.230 0.270 0.480 Total 5.570 4.669 4.936 5.740 7.608 9.850 22.270 SOURCE: Various issues of World Investment Reports, UNCTAD.
  48. 48. 53 Table 5.2: TREND IN FDI OUTFLOWS FROM SAARC REGION, 2000-2006 (US$ billion) Countries Year 2000 2001 2002 2003 2004 2005 2006 Afghanistan – – – – – – – Bangladesh 0.002 0.021 0.004 0.006 0.006 0.020 0.008 Bhutan – – – – – – – India 0.336 0.757 0.431 1.300 2.180 2.490 9.670 Maldives – – – – – – – Nepal – – – – – – – Pakistan 0.011 0.031 0.017 0.019 0.056 0.044 0.107 Sri Lanka 0.002 – 0.011 0.027 0.006 0.038 0.029 Total 0.351 0.809 0.463 1.352 2.248 2.592 9.814 SOURCE: Various issues of World Investment Report, UNCTAD. The major sources of FDI inflows into India are Mauritius, USA, UK, the Netherlands, Japan, Germany, Singapore and France. Pakistan — Sources of FDI and sectors: In Pakistan, privatisation and resource-related FDI led to a doubling of foreign investment from US$ 1.1 billion in 2004 to US$ 2.2 billion in 2005, and further to US$ 4.3 billion in 2006. The US, UAE, UK, Saudi Arabia, Switzerland and the Netherlands are among the major investors in Pakistan. Among the sectors attracting foreign investment, power, chemicals and pharmaceuticals, telecommunications and mining and quarrying are the leading sectors. This can be attributed to the increasing needs and demand for energy in Pakistan and natural resource advantages in the case of pharmaceuticals and mining. (See Table 5.4) Bangladesh — Sources of FDI and sectors: In Bangladesh, the Board of Investment (BoI) plays a key role in facilitating investment into the country. The services sector has attracted the greatest investment, followed by IT and engineering and manufactured goods. Agro-based industries have also attracted investment, as Bangladesh is a predominantly agrarian economy, and the second most important industry in the country is textiles. The U.K. is the leading investor in Bangladesh, followed by Canada, Malaysia, the U.S., Singapore, India, Thailand, Hong Kong, China, PRC, Germany, and Republic of Korea. (See Table 5.5)
  49. 49. 54 Table 5.3: SECTORS ATTRACTING HIGHEST FDI EQUITY INFLOWS INTO INDIA, APRIL 2000-FEBRUARY 2008, AMOUNT RUPEES IN CRORE Ranks Sector Cumulative Inflows % with total (from April 2000 to Inflows February 2008) (In terms of rupees) 1 Services Sector 51162 (financial & non-financial) (11934) 22.4 2 Computer software & Hardware 32020 (7241) 14.0 3 Telecommunications 16491 (radio paging, cellular mobile, (3778) 7.2 basic telephone services) 4 Construction activities 12515 (including roads & highways) (2947) 5.5 5 Housing & Real estate 9598 (2324) 4.2 6 Automobile industry 9363 (2115) 4.1 7 Power 7755 (1741) 3.4 8 Metallurgical industries 6519 (1557) 2.9 9 Chemicals (other than fertilizers) 6091 (1373) 2.7 10 Drugs & Pharmaceuticals 5607 (1276) 2.5 NOTE: Values in brackets show amount in US dollar million. SOURCE: Department of Industrial Policy and Promotion, Government of India. manufacturing, followed by services and agriculture. Nepal — Sources of FDI and sectors : Tertiary sectors, hotels and restaurants and transport, etc., have attracted the maximum investment. It is basically the U.S., PRC, Japan and India that are the major investors in Nepal. Table 5.79 Sri Lanka — Sources of FDI and sectors : Developed countries such as Singapore, UK and Japan are among the leading investors in Sri Lanka. Table 5.6 shows FDI as a percentage of GDP in Sri Lanka (1990-2005). The maximum number of FDI projects has been in the area of 9 There are slight differences between investment data provided by World Investment Report and the Investment Policy Review of Nepal.
  50. 50. 55 shows trend in FDI inflows into Nepal. POTENTIAL FOR INVESTMENT SAARC countries have investment potential in various sectors. The investment potential varies from countries to countries. Manufacturing sector is the largest sector attracting FDI to the region. In the manufacturing sector, electrical equipment, chemicals and pharmaceuticals, and engineering goods are the fields attracting the major share of investment. Services sector is the next sector having potential and receiving large direct Table 5.4: FOREIGN INVESTMENT INFLOWS INTO PAKISTAN (1997–98 TO 2004–05), (US$ mn) 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 Total Foreign Investment 822.6 403.3 543.4 182 474.6 820.1 921.7 1676.6 Portfolio 221.3 27.3 73.5 -140.4 -10.1 22.1 -27.7 152.6 Investment Foreign 601.3 376 469.9 322.4 484.7 798 949.4 1524 Direct Investment SOURCE: Board of Investment, Pakistan Table 5.5: FOREIGN INVESTMENT INFLOWS INTO BANGLADESH (1991–96 TO 2004–05) (US$ mn) Year Inflows 1991-96 961 1996-97 1516 1997-98 1054 1998-99 3440 1999-00 1926 2000-01 2119 2001-02 1271 2002-03 302 2003-04 359 2004-05 509 SOURCE: Board of Investment (BOI), Bangladesh.
  51. 51. 56 Table 5.7: FDI INFLOWS INTO NEPAL, 1989-94 TO 2002 (US$ mn) Year FDI Inflow 1989-94 4 1995 8 1996 19 1997 23 1998 12 1999 4 2000 0 2001 21 2002 10 SOURCE: Investment Policy Review of Nepal. Table 5.6: FDI AS A PERCENTAGE OF GDP IN SRI LANKA, 1990-2005 Year % of GDP 1990 22.2 2001 22.0 2002 21.3 2003 22.1 2004 25.0 2005 26.5 SOURCE: Board of Investment, Sri Lanka. investment from outside. In addition to the above, power sector, mining and quarrying, IT & telecommu- nication are the other major sectors having investment potential in the SAARC region. FOREIGN DIRECT INVESTMENT POLICY IN SELECT SAARC COUNTRIES A summary of FDI policy frameworks in South Asia is presented in Table 5.8. With a view to attracting investments, the countries in the SAARC region have effected measures initiatives also. India Most of the sectors/activities are under theAutomaticApproval Route, except for a few sectors where there are additional restrictions on FDI such as equity caps, divestment conditions, lockin periods on
  52. 52. 57 Table5.8: FOREIGNINVESTMENTPOLICIESOFSOUTHASIA INDIAPAKISTANNEPALSRILANKABANGLADESH RestrictedSectorsi.Arms&ammunitionsi.Arms&ammunitionsi.Cottageindustriesi.Nonbankmoneyi.Arms&ammunitions ii.Defenceaircrafts&ii.Highexplosivesii.Personalbusinessserviceslendingii.Productionof warshipsiii.Radioactivesubstancesiii.Arms&ammunitionsii.Pawnbrokingnuclearenergy iii.Atomicenergyiv.Securityprinting,iv.Consultativeservicesiii.Retailtradewithaiii.Securityprinting& iv.Railwayscurrency&mintcapitalinvestmentofminting v.Newunitsofalcohollessthan$1mniv.Forestryinreserved manufacturingexceptforestareas industrialalcoholisv.Railways banned 100%equityForcertainsectors,sectoralYes,forallsectorsYes,exceptrestrictedsectorsYes,exceptafewsectorsYes capsexistsuchastelecom,education, masstransportation,mining etc. IncentivesYes,centralgovtgivesforIncentivesareindustryYes,withexportrequirementYes,withexportYes.Itvaries R&Dmeasures.Stategovtsspecificbuthaslocalcontent&localcontentrequirementrequirementandminimumdependinguponthe giveawidevarietyofrequirementinvestmentlocationofindustries incentives RestrictionsinNo,butcertainminimumNoNoNoNo.Theconditionis royaltyorconditionstobemetsuchthatitshouldnot technologyaslumpsumpaymentsnotexceed6%of transferpaymentsexceedingUS$2billionetc.previousyear’ssales PerformanceYes,specificrulesforNo.(OnlyforeligibilityNo.(OnlyforeligibilityNo.(OnlyforeligibilityNo requirementsautomobilesectorsofincentives)ofincentives)ofincentives) EPZincentivesYesYes,completeexemptionofNoNo.IndustrialProcessingYes taxationfromfederal,Zonesforbetterland provincial&municipalbodiesallocation AutomaticYes,byRBIYesNo.ApprovalisgivenbyYes,byBoardofYes,byBOI&BEPZ approvalIndustrialPromotionBoardInvestment (IPB)authority NationaltreatmentYesYesContracttermsaregivenYesYes precedenceoverNepalilaw ininvestmentsvaluedatmore thanNepalirupees500mn MIGAsignatoryYesYesYesYesYes TaxholidaysYesNo,onlycustomsduty&IncomeearnedfromexportsYesYes salestaxexemptionisfreefromIncometax SOURCE:AdoptedfromPravakarSahoo,ForeignDirectInvestmentinSouthAsia:Policy,Trends,ImpactsandDeterminants,ADBInstituteDiscussionPaperNo.56.
  53. 53. 58 investment, etc. These restrictions have been imposed in view of sectoral requirements, security and strategic concerns and in the interest of the domestic investments. There are only a few sectors where FDI is not permitted. Industrial Licensing: Industrial licensing policies and procedures have also been liberalised from time to time. All industrial undertakings are exempt from obtaining an industrial license to manufacture, except for: (i) industries retained under compulsory licensing,10 (ii) items of manufacture reserved for the small-scale sector; and (iii) when the proposed location attracts locational restriction.11 Pakistan In November 1997, the government of Pakistan announced the New Investment Policy that included major policy initiatives to attract FDI, which had earlier been restricted to the manufacturing sector. Sectors like services and agriculture, which constitute three fourths of GNP have been opened to FDI. The main objective of the new policy is to enhance the level of foreign investment in the fields of industrial base expansion, infrastructure and software development, electronics, engineering, agri-food, value-added textile items, tourism and construction industries. Foreign investment on a repatriable basis is also allowed in agriculture, services, infrastructure and social sectors, subject to the following conditions: (a) the basis for joint venture is (60:40), (b) foreign equity will be at least US$ 1 mn, (c) foreign companies registered in Pakistan will be allowed to invest; and (iv) for social sector and infrastructure projects, the joint venture requirement is waived (100% foreign equity may be allowed). Investment in the manufacturing sector and non-manufacturing sector : Foreign investors are allowed to hold up to 100% equity of industrial projects without any permission from the government except in certain fields of activity such as: (a) arms and ammunition (b) high explosives (c) radioactive substances (d) security printing, currency and mint; and (e) alcoholic beverages and liquors. Foreign investment at 100% equity on a repatriable basis is allowed in the service, infrastructure and social and agricultural sectors 10 These industries are liquor, tobacco, defense equipment, industrial explosives and hazardous chemicals. Statutory environmental clearances are required. 11 Restricted related to setting up business in urban area and designated “industrial areas.”
  54. 54. 59 subject to certain conditions including registration of company with the Security and Exchange Commission of Pakistan (SECP) and also intimation to the State Bank of Pakistan. Foreign equity of 100% is allowed in the service sector, infrastructure projects and social sector projects on a repatriable basis. FDI is also actively encouraged in tourism, housing and construction, information technology, etc. Sri Lanka The most important feature of FDI policy measure in Sri Lanka was the establishment in 1992 of the Board of Investment (BOI), with wide powers of tax relief and administrative discretion in all matters related to FDI. FDI is permitted in most sectors, subject to a negative list where FDI is barred completely or where foreign investors may only take a minority stake in an enterprise. However, there are a few areas reserved for Sri Lankans, such as money lending, pawn broking, retail trade investment, providing personal services other than for the export of tourism sectors, coastal fishing, education of students and award of local educational degrees. However, there are regulated areas such as the growing and processing of primary commodities, mining, timber-based industries, education, etc., where foreign investment is restricted to 40% and approval by the BOI is required. In a few cases, FDI entry and incentives are subject to performance requirements.12 Bangladesh Foreign direct investment is encouraged in all industrial activities in Bangladesh excluding those on the list of reserved industries such as production of arms and ammunitions; forest plantation and mechanised extraction within the bounds of a reserved forest, production of nuclear energy and printing and minting fresh currency notes. Such investments may be undertaken either independently or through joint ventures, either with the local, private or public sector. The capital market also remains open for portfolio investment. The policy framework for foreign investment in Bangladesh is based on the Foreign Private Investment (Promotion and Protection)Act, 1980, which provides measures for the non-discriminatory treatment and protection of foreign investment. Incentives to foreign investment: The government has liberalised its industrial and investment policies in recent years by reducing controls 12 The general condition is that the manufacturing enterprises have to export 80% of output while the service sector has to export 70% of its output.
  55. 55. 60 over private investment and opening up many areas. Some of the major incentives are tax exemptions for power generation, import duty exemptions for export processing, an exemption of import duties for export oriented industries, and tax holidays for different industries. Facilities for the full repatriation of invested capital, profit and dividend exist. Concessionary duty on imported capital machinery: An import duty, at the rate of 5% ad valorem, is payable on capital machinery and spares imported for initial installation. For 100% export oriented industries, no import duty is charged in the case of capital machinery and spares. Duties and taxes on the import of goods that are produced locally are higher than those applicable to imports of raw materials for the production of such goods. Nepal Most sectors have been opened up to foreign investors, allowing 100% equity or joint ventures with Nepalese investors. The sectors that have been opened up to foreign investment are manufacturing, energy based industries, tourism, mineral resource based industries, and agro based industries and services. However, there are a few industries where investment is prohibited, including national security; cottage (i.e. craft) industries; personal services of a kind that would normally be performed by self-employed people; and real estate. FDI is also not permitted in the retail business; travel agencies; cigarette, tobacco and alcohol production other than for export; a range of small tourist related activities, including tourist lodging, etc. Investment incentives: The government of Nepal provides several incentives to industries that are set up for export purposes. They include an income tax exemption on export income, exemption on foreign investor’s interest income earned abroad, and a relaxation of taxes on specific industries.
  56. 56. 61 This chapter presents recent trends in India’s trade and investment relations with the SAARC countries. TRADE RELATIONS WITH SAARC COUNTRIES India’s Exports to SAARC Countries Table 6.1 presents recent trends in India’s exports to SAARC countries. India’s total exports to the region increased from US$ 2.8 billion in 2002-03 to US$ 6.5 billion in 2006- 07. Amongst the SAARC members, Sri Lanka has the largest market, accounting for 35% of India’s total exports in the SAARC region during 2006-07, followed by Bangladesh (25%), Pakistan (21%) and Nepal (14%). An analysis of the trend in India’s exports to the SAARC region during the period 2002-03 to 2006-07 would 6. INDIA’S TRADE AND INVESTMENT RELATIONS WITH SAARC Table 6.1: TREND IN INDIA’S EXPORTS TO SAARC COUNTRIES, 2002-03 TO 2007-08* (US$ mn) Countries Year 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08* Afghanistan 60.89 145.57 165.37 142.65 181.57 175.70 Bangladesh 1178.32 1741.94 1630.45 1664.12 1627.48 1600.20 Bhutan 39.12 89.55 84.55 99.15 58.64 62.70 Maldives 31.65 42.37 47.59 67.57 68.56 61.40 Nepal 351.05 669.81 742.83 859.84 930.82 914.10 Pakistan 206.57 287.13 520.84 689.13 1347.41 1320.90 Sri Lanka 922.80 1320.10 1412.60 2024.37 2252.59 1917.00 Total 2790.40 4296.47 4604.23 5546.83 6467.07 6052.10 – (53.97) (7.16) (20.47) (16.6) (12.2) SOURCE: Ministry of Commerce & Industry (MOCI), Government of India. NOTE: Values in parentheses show growth in percentage, * – April-Dec. 2007.
  57. 57. 62 reveal that, while exports to all the SAARC members have registered a rise, India’s imports to Pakistan, Afghanistan and Nepal have exhibited distinct buoyancy. While India’s exports to Pakistan registered a six-fold rise during the five-year period, exports to Afghanistan and to Nepal also rose three-fold and two and half-fold, respectively, during the period. India’s Imports from SAARC Countries India’s imports from the SAARC region have also risen from US$ 531.5 mn in 2002-03 to US$ 1.5 billion in 2006-07, depicting almost a three-fold rise during the period. Sri Lanka is again the leading partner, accounting for 31% of India’s total imports from the region during 2006-07, followed by Pakistan (21%), Nepal (20%), Bangladesh (15%) and Bhutan (9%) (Table 6.2). The robust rise in India’s total imports from the SAARC during the period 2002-03 to 2006-07 has been underpinned by the sharp increase in imports from Pakistan, Sri Lanka, Bhutan and Bangladesh. In the case of Pakistan, India’s imports from the country increased seven-fold during the period, followed by Sri Lanka (five-fold rise), Bhutan (four and half - fold rise) and Bangladesh (three and half - fold rise). India generally maintains a positive trade balance with the other SAARC member countries with the surplus having risen from US$2.3 billion in 2002-03 to US$ 5.0 billion in 2006-07. In the case of Bhutan, Table 6.2: TREND IN INDIA’S IMPORTS FROM SAARC COUNTRIES, 2002-03 TO 2007-08* (US$ mn) Countries Year 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08* Afghanistan 18.49 40.54 46.99 58.41 34.48 74.10 Bangladesh 62.17 77.68 59.35 127.01 228.15 193.10 Bhutan 32.22 52.41 70.97 88.76 141.34 154.10 Maldives 0.33 0.37 0.61 1.98 3.05 2.80 Nepal 282.32 286.24 345.69 379.79 305.81 312.10 Pakistan 44.94 57.69 94.94 179.53 322.97 212.00 Sri Lanka 91.00 194.87 378.24 577.62 470.20 330.70 Total 531.47 709.80 996.79 1413.10 1506.00 1278.90 – (33.55) (40.43) (41.76) (6.60) (28.7) SOURCE: Ministry of Commerce & Industry (MOCI), Government of India. NOTE: Values in parentheses show growth in percentage, * – April-Dec. 2007.
  58. 58. 63 however, the trade balance have moved in favour of the country, with India’s trade surplus with Bhutan turning into deficit in 2006-07, reflecting the sharp rise in imports from Bhutan during the year. COMMODITY WISE TRADE WITH SAARC COUNTRIES Afghanistan The commodity wise exports and imports of India with respect to Afghanistan are presented in Table 6.3 and Table 6.4, respectively. In 2006-07, pharmaceutical products (US$ 40.93 mn) are the major export item of India toAfghanistan, followed by manmade yarn fabrics madeups (US$ 29.45 mn), and manufactures of metals (US$ 19.23 mn). As regards imports, spices (US$ 18.27 mn) are the main import items from Afghanistan, followed by fruits & nuts (US$ 15.44 mn), and non- electrical machinery (US$ 0.12 mn). Bangladesh Important export items of India to Bangladesh are presented in Table 6.5. Cotton yarn fabrics madeups etc. (US$ 226.25 mn) are the major export items to Bangladesh, followed by non- basmati rice (US$ 108.97), and sugar (US$ 92.81 mn) Inorganic chemicals (US$ 41.43 mn) are the major import item of India from Bangladesh (see Table 6.6). Fertiliser manufactured (US$ 29.90 mn), and juite (US$ 24.93 mn) are the other two major import items. Bhutan Machinery & Instruments (US$ 8.85 mn) are the major export item of India to Bhutan in 2006-07. The other two important export items are Table 6.3: INDIA’S EXPORTS TO AFGHANISTAN – PRINCIPAL COMMODITIES, 2006-07 (US$ mn) Sl. No. Commodities Value 1 Pharmaceutical products 40.93 2 Manmade yarn fabrics madeups 29.45 3 Manufactures of metals 19.23 4 Tobacco manufactured 8.94 5 Readymade garments of other textile materials 8.68 6 Machinery & instruments 7.48 7 Readymade garments cotton incl. accessories 7.43 8 Plastic & linoleum products 5.63 SOURCE: Ministry of Commerce & Industry, Government of India.
  59. 59. 64 transport equipment (US$ 7.28 mn), and articles of manufactures of metals (US$ 7.1) (see Table 6.7). The major import items of India to Bhutan are presented in Table 6.8. Table reveals non-ferrous metals (US$ 57.95 mn) as the major item of imports, followed by vegetable oils (US$ 26.90 mn), and primary steel pig iron based items (US$ 14.28 mn). Maldives Ores & minerals (US$ 9.15 mn) are the main export item of India to Bhutan in 2006-07. Plastic & linoleum products (US$ 4.99 mn), Table 6.5: INDIA’S EXPORTS TO BANGLADESH – PRINCIPAL COMMODITIES, 2006-07 (US$ mn) Sl. No. Commodities Value 1 Cotton yarn fabrics madeups etc. 226.25 2 Non-basmati rice 108.97 3 Sugar 92.81 4 Transport equipment 88.21 5 Oil meals 81.62 6 Primary & semi-finished iron & steel 71.92 7 Fresh vegetables 70.78 8 Drugs, pharmaceuticals & fine chemicals 67.52 SOURCE: Ministry of Commerce & Industry, Government of India. Table 6.4: INDIA’S IMPORTS FROM AFGHANISTAN – PRINCIPAL COMMODITIES, 2006-07 (US$ mn) Sl. No. Commodities Value 1 Spices 18.27 2 Fruits & nuts 15.44 3 Non-electrical machinery 0.12 4 Electronic goods 0.11 5 Pulp & waste paper 0.07 6 Non-ferrous metals 0.04 7 Cotton yarn & fabrics 0.03 8 Other textile yarn, fabrics, madeups articles 0.02 SOURCE: Ministry of Commerce & Industry, Government of India.
  60. 60. 65 Table 6.7: INDIA’S EXPORTS TO BHUTAN – PRINCIPAL COMMODITIES, 2006-07 (US$ mn) Sl. No. Commodities Value 1 Machinery & instruments 8.85 2 Transport equipment 7.28 3 Manufactures of metals 7.10 4 Petroleum products 4.85 5 Primary & semi-finished iron & steel 4.21 6 Electronic goods 2.94 7 Non-basmati rice 2.76 8 Other ores & minerals 2.76 SOURCE: Ministry of Commerce & Industry, Government of India. Table 6.6: INDIA’S IMPORTS FROM BANGLADESH – PRINCIPAL COMMODITIES, 2006-07 (US$ mn) Sl. No. Commodities Value 1 Inorganic chemicals 41.43 2 Fertiliser manufactured 29.90 3 Jute raw 24.93 4 Madeup textile articles 19.32 5 Other textile yarn, fabrics, madeups articles 17.32 6 Electrical machinery 12.51 7 Petroleum crude 12.09 8 Metaliferrous ores & metal scrap 7.59 SOURCE: Ministry of Commerce & Industry, Government of India. and manufactures of metals (US$ 4.49 mn)aretheothertwomajorexport item. Table 6.9 provides the list of principal export commodities of India to Maldives. As regards imports, metaliferous ores and metal scrap are the major item from Maldives (US$ 2.96 mn), followed by electronic goods (US$ 0.05 mn) (see Table 6.10). Nepal Table 6.11 provides the list of principal export commodities of India to Nepal in 2006-07. Petroleum products (US$ 369.53 mn) are the
  61. 61. 66 Table 6.9: INDIA’S EXPORTS TO MALDIVES – PRINCIPAL COMMODITIES, 2006-07 (US$ mn) Sl. No. Commodities Value 1 Ores & minerals 9.15 2 Plastic & linoleum products 4.99 3 Manufactures of metals 4.49 4 Machinery & instruments 4.48 5 Non-basmati rice 4.39 6 Pharmaceutical products 4.19 7 Paper/wood products 4.10 8 Primary & semi-finished iron & steel 4.08 SOURCE: Ministry of Commerce & Industry, Government of India. Table 6.10: INDIA’S IMPORTS FROM MALDIVES – PRINCIPAL COMMODITIES, 2006-07 (US$ mn) Sl. No. Commodities Value 1 Metaliferrous ores & metal scrap 2.96 2 Electronic goods 0.05 SOURCE: Ministry of Commerce & Industry, Government of India. Table 6.8: INDIA’S IMPORTS FROM BHUTAN – PRINCIPAL COMMODITIES, 2006-07 (US$ mn) Sl. No. Commodities Value 1 Non-ferrous metals 57.95 2 Vegetable oils (edible) 26.90 3 Primary steel pig iron based items 14.28 4 Iron & steel 12.65 5 Inorganic chemicals 11.87 6 Wood & wood products 5.17 7 Manmade filament/spun yarn (incl.waste) 5.02 8 Professional inst, optical goods etc. 1.30 SOURCE: Ministry of Commerce & Industry, Government of India.

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