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Sri Lanka’s trade policy in recent years is trying to address one of these problems; the narrow market base. The proposed strategy is to sign trade deals with countries in Asia such as China and Japan. This article aims to evaluate the success of this strategy to grow exports by analysing the experience of exporting under the India-Sri Lanka FTA.
The only significant diversification of markets experienced by Sri Lanka during the last two decades had been towards India and this has been possible because of the India-Sri Lanka FTA. The FTA between the two countries came in to operation in 2000. During 2000-2005 as a percentage of total exports of the country the share of exports to India increased from 1% to 9%.
Among export destinations, India graduated from being 11th largest to being the 3rd largest export destination. This in fact is the single largest shift in export market share the country experienced during the last two decades. This led many to applaud India Sri Lanka FTA as a success story.
The export growth story of India-Sri Lanka FTA however was short lived. Exports to India collapsed in 2005 (a steady decline from $ 559 to $ 353 million during 2005-2010) and have been struggling to recover since then. India still continues to be the third largest export destination of Sri Lanka, but the value of exports to India has been stagnating (below the value of exports in 2005) and the share of exports has declined from 9% in 2005 to 5% by 2013.
The India-Sri Lanka FTA story highlight two weaknesses in the strategy of Sri Lanka trying to grow exports through trade deals; first is the failure to recognise the importance of market access for key exportable products, second is the failure to recognise the limitations of growing exports through trade deals without diversifying the product mix.
Growing exports without access to key exportable products
Apparel and tea are the key exportable products of Sri Lanka. Yet exports of apparel and tea from Sri Lanka to India remain insignificant despite having a FTA for over 10 years.
FTAs are expected to improve mar
ket access to exportable products by reducing tariff and non-tariff barriers (e.g. time and cost incurred in complying with standards and certification). Apparel exports from Sri Lanka do not enjoy duty free access to the Indian market. Until mid-2007, duty free access was limited to an annual quota of eight million pieces made out of fabrics from India.
Sri Lankan apparel exporters do not use Indian fabric. Hence, the quota was hardly utilised, until this restriction was lifted after lengthy negotiations between the two governments. The Indians were stingy, the Indian fabric restriction was lifted only for three million pieces in mid-2007, and quota of eight million pieces was not relaxed.
The tenfold increase in the value of apparel exports (HS chapter 61 and 62) from $ 4 million to $ 39 million during the 2007-2012 is a clear indication of the impact the Indian fabric rule had on restricting apparel exports from Sri Lanka. Soon, the three million pieces was being fully utilised even before the end of the year.
After another six years, in 2013, the Indian Government agreed to lift the fabric rule for the remaining five million pieces, but duty free access still remain limited to eight million pieces. Sri Lankan apparel industry sees huge potential in exporting garments to India. Yet, market access restrictions has been a problem faced by the industry since 2000.
Ceylon Tea, the second largest exportable product does not have duty free access to India as well. A quota limits exports to 15 million Kg of tea from Sri Lanka annually and up to the quota limit Sri Lankan tea exports gets a 50% reduction from the applied tariff. Until 2007, tea exports were subject to port restrictions: tea could enter India only through four designated ports, and this restricted market access.
In addition to these restriction built into the FTA, the tea exporters complain of time and cost of complying with various other procedures and requirements of India. As a result, the quota remains unutilised, less than one million kilograms of tea is exported each year to India.
Bilateral trade and economic negotiations between India and Sri Lanka came to a standstill in 2008. That year, Sri Lanka decided not to go ahead with a comprehensive trade deal with India covering services and investment, which was almost finalised and ready to be signed.
With the change in Government in January this year, India-Sri Lanka economic relations seem to take a new turn. If trade negotiations between the two countries are to be revived, it is important to remove the weaknesses in the existing FTA in relation to market access for tea and apparel and other potential exports (e.g. food products).
This will indeed help boost exports in the short to medium term to India. However it will not guarantee growth in export revenue for the country. As indicated in Figure 1, if there is no growth in value or volume of the existing products, simply adding a new market will not generate more export revenue.
Growing exports without diversifying the product mix
FTAs improve market access by bringing down tariff and non-tariff barriers. FTAs will only help grow exports, if tariffs and non-tariff barriers has been the main problem limiting exports.
Although entry of apparel and tea from Sri Lanka have been restricted, the FTA has given Sri Lanka duty free access to over 2000 products (at HS 4 digit level) and imports into India from the world have increased rapidly over the last decade. For example during 2000-2013, imports into India have increased nine times from $ 51 billion to $ 466 billion. India’s share in world imports has increased from less than 1% to 3% during the same period.
Sri Lanka however has been unable to capitalise on the duty free access, proximity to the market and the high growth in imports into India. This shows, that access has not been the main problem Sri Lanka face when entering a new market. Lack of exportable products that is demanded by India has been the main problem.
With the current export product composition of the country, growing exports without access to key products is challenging. Although exports to India are recovering, the recovery is slow and the value has failed to exceed 2005 level even after eight years.
The key products exported to India at present are spices like pepper and cloves, natural rubber, coconut, scrap paper, animal feed, copper wire, glass products and furniture. The agricultural exports like pepper, cloves, natural rubber, coconut will not add to total export revenue of the country, since this is a mere shift in markets with very little value addition and/or volume growth.
The top 10 exports to India accounts for 48% of total exports to India. These products are not among the leading exports of the country, they account for only 5% of total exports. Further most of these products are exported only to India. Both these factors raise questions about the competitive and comparative advantage Sri Lanka has in exporting these products in the absence of the duty advantage they currently enjoy over its competitors in the Indian market.
For exports to lead to overall growth in export revenue of the country, the growth in value, volume and variety of products is critical (refer Figure 2). For export growth to be sustainable in the long run, the products need to develop a competitive and a comparative advantage that goes beyond differences in import duty between Sri Lankan products and competitors’ products offered through the FTA.
Conclusion
If Sri Lanka is planning to grow exports by signing trade deals; the experience the country has with the India-Sri Lanka FTA sheds valuable insights. With the current product base, where export growth depends on few products, in the short run, having access to these key products is critical to grow exports.
However, it is time for Sri Lanka to realise the limitations of FTAs as a strategy to grow exports in a sustainable manner. As a lower middle income economy, diversifying products by adding value to existing products (e.g. diversifying from low end to high end products) and adding new products and services to the export portfolio is critical to revive exports and there is little FTAs can do in this regard.
(The writer is the Head of Economic Research of Verité Research, a think tank based in Colombo.)
