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China’s global trading increased with the opening up of its economy in the late 1970s and its accession to the WTO in late 2001. Since the mid-2000s, China has emerged as a global trading power becoming the second largest global trader (after EU) accounting for 11.3% of global trade. It ranked as the number one exporter of the world and the second largest importer of the world in 2012.
These trading figures were a result of China becoming a global manufacturing hub over the years. Moreover, its open trading regime and WTO membership were further enriched by a number of FTAs that China had signed with various countries over the 2001-2013 period and some of these FTAs have now matured into Comprehensive Economic Cooperation Agreements (CECA) or Comprehensive Economic Partnership Agreements (CEPAs) as indicated in Table 1.
China’s trading with Sri Lanka has grown over the years and at present it is the second largest trading partner of Sri Lanka after India. Chinese imports to Sri Lanka amount to 16.4 % of Sri Lankan overall imports while Sri Lankan exports to China amount to 1.3 % of Sri Lankan overall exports, both accounting to $ 3 billion (2013). A disaggregated investigation of Chinese imports to Sri Lanka reveals that machinery electrical items, fabric and cotton top the list while of exports to China, items such as apparel, tea, coir fibre, and rubber tyres and tubes are the key items.
The trade between China and Sri Lanka has been governed by normal individual country trade policy regimes until 2001. However, with China joining the Asia Pacific Trade Agreement (APTA) in 2001, some of the trade in goods between the two countries came to be governed by the preferential tariffs of APTA.
The recent increase in China-Sri Lanka trade may have been due to some of the preferential tariffs of APTA, however no detailed study has been done to examine whether this was actually the case. It has been argued elsewhere that due to low preferential margins of APTA (50%) and most actively traded goods being left out of APTA preferences, the APTA framework did not play a significant role in promoting China-Sri Lanka trade (Business LK, November 2013).
In 2005, a new chapter began in China-Sri Lanka economic cooperation with China becoming a key finance lender to Sri Lanka. The Ministry of Finance and Planning Annual Report of 2012 shows that the Chinese financial assistance to Sri Lanka increased by $ 5.1 billion between 1971 and 2012 and out of this, 94% of the increase came after 2005. Most of these financial flows were for infrastructure development projects and these led to further strengthening of economic links with China with spillovers to trade and investment between the two countries.
In May 2013, during a State visit to China by President Mahinda Rajapaksa, a decision was made with his Chinese counterpart to sign a Free Trade Agreement (FTA) between the two countries. Since then, officials from both Governments have been working out the details of the FTA before finalising it.
For the Sri Lankan side, two areas are of vital importance in working out the FTA, viz., more market access to export products to China including potential products and adequate protection for well-established import substitution industries. Similarly, concerns of more market access to the Sri Lankan market and protecting vital import substitution industries will be prevalent in China although the products will differ.
After all, an FTA is not a one-way street for Sri Lanka where all hopes of Sri Lanka can be fulfilled with nothing for China. If that was the case, there is no need to negotiate among trade officials of both countries. The final aim is to work out a ‘win-win’ situation for both countries.
FTA framework
First, it is essential to get the FTA framework in order and in this context, two general points have to be highlighted at the onset, i.e., the growing trade deficit between the two countries in favour of China and the asymmetry between the two countries with China being an economic giant compared to Sri Lanka.
Some argue that there is a massive trade deficit with China and one of the main objectives of the FTA should be to reduce this deficit in favour of Sri Lanka. This line of thinking is inaccurate since the sole objective of an FTA is to work out a ‘win-win’ situation for both countries by giving the best possible deal to both consumers and producers of both countries.
When this is the case, in fact the trade deficit with China may further increase after the FTA and this should not be a factor to give importance to when designing the FTA. If the objective is to reduce the trade deficit between the two countries via the FTA, then working out a ‘win-win’ outcome will not be possible. In this context, one thing should be clear.
In the current globalised world, no country can have surpluses or zero deficits with all its trading partners. Sri Lanka has trade surpluses with its main export destinations in the West, such as US and EU and trade deficits with its key import sources in the East, such as China, India, and Middle East. This then is the reality.
The FTA between China and Sri Lanka has a similarity with the India-Sri Lanka FTA (ISLFTA), i.e., it is an agreement between a very large and a small country. In the India-Sri Lanka FTA, this asymmetry between the two countries was accommodated by building Special and Differential Treatment (SDT) in favour of Sri Lanka in the FTA by India granting Sri Lanka : (a) a larger Reserved or Negative List; (b) longer tariff liberalisation period (eight years for Sri Lanka compared to three years for India); (c) more Sri Lankan goods and items subject to duty free in India at the start of the FTA compared to that of Indian goods entering duty free to Sri Lanka; (d) high import tariff revenue earners in Sri Lanka such as motor vehicles to be maintained under Sri Lanka’s Negative List, etc.
It is this SDT that assisted both countries to work out a ‘win-win’ situation via the FTA, although there were certain shortcomings in the framework. In the China-Sri Lanka FTA, a similar SDT framework needs to be worked out if Sri Lanka is to benefit from the FTA.
Market access
Five specific aspects need to be highlighted in regard to market access to China. First, a key point to note is that when Sri Lanka and India signed the FTA in 1998, it was the first professional FTA of both countries, although India had informal FTAs with both Bhutan and Nepal at that time. Sri Lanka thus had duty free and preferential market access to India with less competition from other countries in the Indian market (although SAPTA and APTA preferential tariffs were in operation in the Indian market, Sri Lanka too was a beneficiary of these preferential tariffs in the Indian market)
However, when the China-Sri Lanka FTA comes into operation, a number of other countries, viz., Hong Kong, Macau, ASEAN (10 countries), Chile, Pakistan, and New Zealand already enjoy either duty free or preferential market access in China with many more negotiated FTAs being in the pipeline as indicated in Table 1. Moreover, LDCs like Nepal and Bangladesh enjoy ‘goodwill gesture’ duty free status for certain goods in the Chinese market (Nepal – 7,787 and Bangladesh – 5,000 product items). Thus, it is not going to be easy competition in the Chinese market for Sri Lankan goods from day one of the FTA. It will be a challenge for Sri Lankan exports to remain competitive in the Chinese market even after the FTA.
"China’s trading with Sri Lanka has grown over the years and at present it is the second largest trading partner of Sri Lanka after India. Chinese imports to Sri Lanka amount to 16.4 % of Sri Lankan overall imports while Sri Lankan exports to China amount to 1.3 % of Sri Lankan overall exports, both accounting to $ 3 billion (2013)
The China-Sri Lanka FTA should be welcomed but there needs to be caution in designing the framework governing it. The India-Sri Lanka FTA provides practical lessons to where Sri Lanka should be cautious when designing the FTA framework"
Second, a key issue that stood as an impediment for Sri Lankan market access in India under the India-Sri Lanka FTA was Non-Tariff Barriers (NTBs) in India. At the time of signing the ISLFTA, the understanding was that for all goods that tariffs will be reduced, the NTBs will also be removed. However, in practice it did not take place for some goods, although most of these NTBs were gradually removed via subsequent trade negotiations between the two countries. In the China-Sri Lanka FTA, it is essential to ensure that NTB removal with tariff reduction becomes a binding commitment by both parties without being a ‘goodwill’ understanding between both countries as was the case with the ISLFTA.
Third, there should be information dissemination on the FTA, with details on the Rules of Origin, procedures of obtaining the Certificate of Origin, products in the ‘Negative List’, customs procedures in China, etc., for Sri Lankan exporters and importers so that vested interests do not hijack the FTA by spreading false information under the cover of patriotism and nationalism. Moreover, Sri Lankan specialist diplomats working in China should gather market intelligence and feed it back to the local chambers to sensitise Sri Lankan exporters.
Fourth, Sri Lanka should seriously work via the China-Sri Lanka FTA on possible entry into international production networks and supply chains to which China is strongly linked compared to India. Under the China-ASEAN FTA, many ASEAN countries like Thailand have effectively linked into international supply chains via China with effective business networking and producing components of electronic products at competitive rates.
Fifth, Sri Lanka will face the challenge of meeting the supply requirements of China for many export products. The advantages of bulk purchase are well known and Chinese buyers will prefer such purchases. One way of meeting this is to embark on joint ventures with Chinese investors to increase the existing local supply capacity.
Selective protection
In regard to the domestic market in Sri Lanka, the imports from China to Sri Lanka and the Negative List become important as Chinese product items are very competitive compared to those of other developing countries. The reason for this is well known-economies of scale, low labour cost (although this is now diminishing), high productivity, etc.
In the Sri Lankan neighbourhood, China is already the largest trading partner of both India and Bangladesh even without an FTA with China, and China is the largest source of imports for both these countries. China is the largest trading partner of Pakistan, again by gaining the status of the largest source of imports to Pakistan but in this case, China has an FTA with Pakistan that has been in operation since 2006.
Clearly, with the China-Sri Lanka FTA, China may become Sri Lanka’s largest trading partner in a future date and become Sri Lanka’s largest source of imports. Needless to say, industries catering to the domestic market such as cosmetics/lotions, shoes/slippers, biscuits/chocolates, tiles/sanitary ware, etc. will find it difficult to compete with Chinese products under a duty free or low-duty trade regime. This is clear from the severe blow that the Indian toy industry received from Chinese toy imports even without an FTA. Thus, a Negative List in the FTA has to be carefully designed taking into account the existing efficient import substitution industries.
The preparation of this list will remain a challenge given the varied interests in the local economy. For instance, in the ISLFTA, the entire agriculture sector in Sri Lanka was under the Sri Lankan Negative List due to the concerns expressed by rice, potato, onion, chilli, etc., farmers. Will it remain so in the China-Sri Lanka FTA or will there be selective openings in the agriculture sector like in the Pakistan-Sri Lanka FTA for basmati rice, potato, oranges, and grapes?
Investment and services
It is a known fact that trade leads to investment and investment in turn leads to further trade. In the absence of investment liberalisation in the China-Sri Lanka FTA (since it is not a CEPA), it will be trade that will be leading to further Chinese investment in Sri Lanka and vice versa. Chinese investment in Sri Lanka has been increasing since of late; however, the bulk of this investment has been made by Chinese State-owned enterprises.
There are only a few Chinese private sector investments in Sri Lanka (compared to many from Hong Kong – which is a part of China but is still treated separately from China in data compilation). An EPZ earmarked in the city of Mirigama for Chinese FDI in 2008, remained unused till 2013 and the area was taken for another project by the Government. There are reasons to believe that Chinese private investment will increase after the FTA as in the case of the ISLFTA where Indian investments in Sri Lanka increased after the FTA.
The bulk of the Indian investments that came after the FTA was in services, e.g. Apollo Hospitals, ICT Hotels, ICICI Bank, Bharat Airtel, Indian Oil Corporation, etc. This is because India is quite strong in services compared to most other developing countries. Given the fact that China is strong in manufacturing industries, it is expected that the bulk of the Chinese FDI will be in the industrial sector.
When examining Sri Lankan exports to China in detail, it can be observed that some mineral/mining items such as Titanium and Zirconium are exported in raw form from Sri Lanka to China. These mining/mineral industries remain underdeveloped due to the high capital-intensive nature of the industries and the failure of Sri Lanka to attract FDI to develop this sector into value added products. Under the China-Sri Lanka FTA, a concerted effort must be made to develop this sector by having joint ventures with Chinese FDI. The joint venture industries could embark on producing value added Titanium and Zirconium products which will bring in more foreign exchange earnings to Sri Lanka.
With China increasingly focusing on the domestic economy, inter alia, there may be pressure for the Yuan to appreciate and trigger an outflow of Chinese investment as was the case in Japan after the Yen appreciation in the 1980s. In the case of the latter, the key beneficiary of Japanese investment outflows was the ASEAN countries. With the already strong trading and investment foothold in Sri Lanka and given the relatively cheap labour in the country, Sri Lanka is in a position to attract more Chinese FDI in the coming years.
As we can see in Table 1, China has many CEPAs and CECAs with a number of countries where trade in services, investment, etc., are preferentially liberalised. Given this fact, Sri Lanka should not be too optimistic that Chinese investment will come in search of Sri Lanka only when other countries offer better investment and service deals under their CEPAs and CECAs.
With the FTA and promotional work done in China, the air connectivity between the two countries will increase from the existing network (Beijing, Shanghai, Guangzhou, Kunming, and Chong Ging) and consequently, the Chinese tourist inflows to Sri Lanka will also increase. The spending power of Chinese tourists is greater than the usual European tourists and thus attracting them will be beneficial to Sri Lanka.
Concluding remarks
All in all, the China-Sri Lanka FTA should be welcomed but there needs to be caution in designing the framework governing it. The India-Sri Lanka FTA provides practical lessons to where Sri Lanka should be cautious when designing the FTA framework.
Source: Zhang Yunling in Asia’s Free Trade Agreements: How is Business Responding?, in Kawai and Wignaraja (2011), ADBI.
