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Thursday Dec 12, 2024
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During the recent visit of the President Mahinda Rajapaksa to China, the two countries have decided to sign a free trade deal. Will this help Sri Lanka to diversify its exports into Asian markets? There are compelling arguments for increasing exports to China. The global trade share of Asia is increasing at a rapid rate and by 2025 Asia is expected to be the world’s largest producer of goods and services; it will also be the world’s largest consumer of them.
It is already the most populous region in the world. In the future, it will also be home to the majority of the world’s middle class. China is the country that is at the centre of the shift of global trade to Asia. China is already the second leading importer in the world accounting for 10% of world imports; USA leads accounting for 12%. China is already among the top five export destination of most emerging developing countries (Table 3).
Sri Lanka imports heavily from China and exports little, hence experiencing a widening trade deficit (Chart 1). On top of that countries competing with Sri Lanka in the International market either already have duty free access through to the Chinese market through trade agreement (e.g. ASEAN countries) or are in the process of negotiating duty free access. For example China already has 27 trade agreements; 12 in effect and 15 under negotiation. China’s agreements cover countries from all over the world, Europe, Latin America, Middle East, Asia and Africa.
What can go wrong?
All the above factors undoubtedly make a compelling case for a trade agreement with China. The catch is in the poor track record of existing trade agreements of Sri Lanka which makes one wonder whether a trade agreement with China can be any better. Sri Lanka is already a member of five FTAs including one in which China is also a member country (Table 4).
The success of these agreements to increase exports to partner countries has been poor. The exports to the FTA member countries (other than India) remain very low (table 1). For example as a percentage of total exports Pakistan accounts for just 0.8%, Bangladesh 0.6% Maldives and South Korea just 0.5% each and China 1.2%. Although exports to India have increased due to the FTA, the current trade is far below the potential due to various forms of non tariff barriers faced by exporters. 
The success of the trade agreement with China then depends on the ability of the country to avoid the weaknesses observed in the existing agreements. So what are the reasons behind the poor track record of existing agreements?
Trade barriers: Behind the border, at the border or beyond the border?
Trade barriers can occur within the exporting country and these are known as behind the border barriers. For example high bureaucratic red tape, archaic rules and regulations, poor infrastructure, high energy costs, labour market regulations, etc., can be categorised as behind the border barriers. Trade barriers can occur at the border of the exporting country, when importing inputs/machinery as well as when exporting the final goods.
For example, import duties/export taxes, corruption at customs, inefficiency of other border agencies (e.g. plant quarantine, standards), etc., can be categorised as at the border barriers. Trade barriers can occur when entering the importing country and these are known as beyond the border barriers. Trade agreements address only the trade barriers beyond the border. If this is the main barrier preventing exports to China, a trade agreement can help increase exports. If the main barriers are in fact within the country; behind the border and at the border, then the impact of the trade agreement in increasing exports will be limited.
For example the main barrier faced by most agriculture exports of Sri Lanka from spices, fruits and vegetables is non availability of sufficient quantity of exportable quality products. Therefore, mere removal of trade barriers faced in the other country through a trade agreement is not going to have a major impact on agriculture exports.
Trade barriers beyond the border
There can be several types of trade barriers beyond the border. Import duty is only one such barrier. This may not be the only or the most important barriers to trade. Other rules, regulations, procedures, taxes and bureaucratic red tape can be higher barriers to trade than import duties. The existing FTAs of Sri Lanka only reduce import duties and this is also for a selected number of products. In the case of some agreements like the GSTP and APTA, the number of products covered is low and there is no commitment to eliminate import duties even for the selected products. 
If the main barrier preventing exports to China is high duty on imports, then reducing the same can help increase exports, but if the main barrier is other additional taxes and non tariff barriers, unless the agreement has provisions to reduce these, the exports will not increase. A good example is processed food items exports to India under the India-Sri Lanka FTA. The export to India remain far below potential, despite having duty free access due to delays and bureaucratic red tape experienced in obtaining import permits and quality certification.
Trade Agreements and Rules of Origin (ROO)
To be eligible for tariff concessions offered by a FTA, the exporter has to meet the rules of origin criteria listed in the agreement. This can be domestic value addition, change of HS tariff heading or conditions on how the product is actually produced. Very restrictive rules of origin requirements can effectively block trade.
A good example is the rules of origin listed by India for apparel exports from Sri Lanka. India granted preferential access to eight million pieces of apparel from Sri Lanka under the FTA, provided that this apparel is made using fabrics made in India. Sri Lankan apparel manufactures do not use fabrics made in India, hence, this criteria effectively blocked apparel exports (which account for over 40% of total exports from Sri Lanka) to India.
In 2008 after lengthy negotiations, for three million pieces this restriction was relaxed allowing apparel made from any fabric to be exported to India, as a result, the three million is utilised and balance five million still remain largely underutilised. ROO in the proposed agreement will be a critical determinant of the ability to export duty free.
Concessions received depends on concessions granted
Trade agreements are reciprocal agreements; i.e. Sri Lanka has to reduce trade barriers to imports from China in return for the market access given by China. There is of course the argument of giving due consideration to the asymmetry in the two economies. What this means is that China will grant concessions to Sri Lanka without expecting Sri Lanka to fully reciprocate by granting the same level of concession to Chinese goods, because of the different in the size of the two economies. Even if China agrees to this, Sri Lanka cannot get away without giving any concessions in return.
The existing agreements of Sri Lanka is ineffective partly due to the inability of the member countries (including Sri Lanka) to reduce the barriers to trade due to domestic industry concerns, fear of government revenue erosion and other political economy factors such as protecting the vulnerable and poor farmers. For example the FTA with India is blamed as opening flood gates for cheap Indian products that harm domestic industries and widening trade deficit.
Compared to China, the leading exporter in the world, India is still far behind in terms of exports, 19th place in global ranking in terms of world exports accounting for 1.6% and if Indian goods are cheap, Chinese goods are cheaper. This means many domestic industry sensitive products will have to be carved out of the agreement in order to protect them.
After removing all the domestic industry sensitive, revenue sensitive and politically sensitive items, there will be little left to offer to China in a trade agreement. In trade negotiations, when little is given, little will be received. As a result the agreement will have little economic impact on both economies, as is the case with the existing agreements of Sri Lanka.
Can non-economic factors make FTA with China different from existing FTAs?
Some FTAs are signed for political reasons, even if it is obvious trade benefits are small. Countries like China and USA have bigger political ambitions that go beyond mere economic interests. Political considerations are also a motivation to form FTAs. The United States formed FTAs with Israel and with Jordan to reaffirm American support of those countries and to strengthen relations with them.
Can the FTA with China serve geopolitical interests of China than economic interests? If that is the case, China may be generous in offering greater concessions for Sri Lanka in the trade agreement, and expect these to be paid in other means than reciprocal concessions to Chinese goods. We may gain in trade, but what would be the cost to the country? It is important to remember nothing comes free; from the UN human rights vote to preferential access to Sri Lankan goods, everything comes at a price.
