Does Safta Have a Chance?

Free Trade Area in South Asia

Ayubur Rahman Bhuyan

The limited success of SAPTA, in promoting intraregional trade in South Asia prompted the seven SAARC countries to establish a full-fledged free trade area South Asian Free Trade Area (SAFTA) by a treaty signed at the 12th SAARC summit in January 2004. The SAFTA is set to be fully operational in 2006.

Bangladesh attaches great importance to SAFTA because it is the largest regional importer in SAARC. Although Bangladesh exports very little to the region (less than 4 percent of South Asia's intra-regional exports), it obtains as much as 37 percent of the region's intra-regional imports. As a result, Bangladesh has the largest deficit in intra-SAARC trade. It is expected that the SAFTA mechanism, when fully implemented, will provide Bangladesh improved market access, help boost its exports to the region, and improve the country's intra-regional trade balance. SAFTA is expected to generate substantial new trade, the so-called static gains. Studies indicate that the elimination of tariffs under SAFTA and removal of non-tariff barriers should increase intra-regional trade by 1.6 times of the existing level. The dynamic gains could be even higher than the static gains due to the possible expansion in the scale of operation by getting access to the markets of the relatively larger member countries.

SAFTA may generate additional gains for Bangladesh by diverting a substantial portion of informal trade/smuggling (which is believed to be as big as officially recorded trade) to official channels. Informal trade not only leads to substantial revenue loss, it also creates uneven conditions of competition for local firms. In so far as the SAFTA mechanism will bring some of the trade in smuggled goods back into formal channels, there may be revenue and other benefits for the country.

SAFTA may also enhance Bangladesh's prospects for getting larger investment inflows from the more developed partner countries in the region. These investments, whether 100% ownership by regional investors or joint ventures, should help improve the country's export supply capability and boost exports both to the region and to the outside world.

It remains to be seen whether or not SAFTA will bring all the expected benefits to the member countries. The SAFTA Treaty is just a framework agreement, which, of course, has some welcome features, but it has some grey areas as well. Some of the crucially important issues have not been resolved in the treaty but have been left for negotiations in the future.

On the positive side, the treaty provides a clear road map for trade liberalisation. It envisages a trade liberalisation programme (TLP) under three separate lists a negative product list, a list for immediate tariff reduction (0-5%), and a residual list (tariff liberalisation schedule). Under the residual list, non-LDC members shall reduce tariffs to 20% in first 2 years, and to 0-5% in next 5 years. LDC members will bring down tariffs to 30% in first 2 years, and to 0-5% in next 8 years. The number of products in the negative list will be subject to a maximum ceiling that will be mutually agreed upon among the members and reviewed after every four years. All quantitative restrictions (QRs) in respect of products included in the TLP will be eliminated soon as the tariff levels reach 0-5%.

The Treaty gives special emphasis on trade facilitation measures that will encourage trade. It also makes a number of provisions for according special and differential treatment to the LDC members in the region. The Treaty provides an elaborate dispute settlement mechanism. Safeguard measures, their application, duration, withdrawal etc. have been spelt out in considerable detail.

As against these positive features, the SAFTA Treaty has a few drawbacks. Critical issues like the rules of origin, negative list, areas of technical assistance, which are important for the success of SAFTA, are left for future negotiations. There is no deadline for determining the negative list and there is no format for phasing out the negative list over the years. The criteria for designing rules of origin are not clear either. Since many critical items are left for negotiation, the finalization and operationalization of the Treaty can be delayed.

Secondly, it is not clear in the Treaty whether other NTBs will be removed with QRs. The existing Treaty provision is for elimination of only QRs on products included in the trade liberalisation programme (TLP). The Treaty is silent on the removal of para-tariffs and NTBs. Unless these barriers to trade are removed simul-taneously with the reduction of tariffs, it will be difficult to exploit the full gains from various phases of tariff reduction, and the objective of preferential tariffs will be defeated.

Thirdly, the SAFTA Treaty has not devised any modality or mechanism of compensation for possible revenue losses as well as for the identification of technical assistance needs to the relatively less developed and weaker partner countries.

Fourth, the Treaty is silent about how SAFTA will integrate the bilateral free trade agreements (FTAs) that currently exist between some SAARC countries into the SAFTA Treaty.

For the SAFTA to be effective, it must address the problems that were encountered by SAPTA in the expansion of intra-SAARC trade. The progress of SAPTA was slow and inadequate because of (a) its product-by-product or positive approach to trade liberalization, (b) very low margin of tariff preference granted under SAPTA, which was insufficient to allow weaker countries' exports to enter the partners' markets, (c) the prevalence of a wide array of non-tariff and para-tariff barriers, and (d) the highly restrictive rules of origin that prevented the access of many manufactured and semi-processed products to the regional markets. If SAFTA is to be successful, all these impediments that constrained exports under the SAPTA regime will need to be removed.

In particular, the problem of rules of origin will need to be resolved, keeping an eye on the manufacturing /processing capability of the LDCs. The SAFTA rules of origin should be made much more liberal than they were under SAPTA. In fact, the origin rules under SAFTA should be made consistent with the rules of origin that are currently in force in the various bilateral trade agreements within the SAARC region, which happen to be more liberal than the prevailing SAPTA rules.

For the success of SAFTA, a sharp reduction and gradual convergence of the member countries' external tariffs will be essential. Note that a free trade area needs a strict system of proof of origin mainly for preventing trade deflection. Since, however, trade deflections can occur only when there are wide differences in the members' external tariffs, due importance should be given both to reduce the absolute levels of the members' external tariffs and to narrow down the inter-country differences in tariff rates. Wide differences in the members' external tariffs will make the rules of origin difficult to implement. Given the ingenuity of South Asian traders, the rules of origin can open the door for all sorts of abuse, creating tremendous opportunities for corruption, falsification of certificates, and bureaucratic red tape. This problem can be greatly avoided by reducing the dispersion of members' tariff rates.

A reduction of the absolute levels of tariffs by members is also necessary for maintaining international competitiveness of their export products. SAFTA is more likely to foster efficient industries if these are exposed to world-level competition than if they are given the regional market as an exclusive hunting ground. South Asian countries must resist this temptation if SAFTA is to survive economically and politically.

Finally, without significant structural changes in their production pattern, economically poorer and weaker members of SAARC are unlikely to be able to derive the desired benefits from SAFTA. Top priority should therefore be given to augmenting these countries' export supply capability. Even in a completely free trade situation, exports will not increase if the export base and production do not expand. Conscious government policy will therefore be needed to encourage capacity building, diversification of the export base, and improve-ments in productivity, product quality and cost competitiveness, all of which are crucial to export growth.

The success of SAFTA will also call for creating an enabling environment to promote intra-regional investment. The creation of a SAARC Investment Area through an intra-SAARC investment agreement could create such an environment but it has not happened. The SAARC leaders could also consider the establishment of a Regional Fund for the development of infrastructure, human resources, and improvement of export supply capacity of LDCs. As mentioned earlier, without significant structural changes in the production structure, LDCs are unlikely to derive equitable benefits from SAFTA. LDC economies should therefore be assisted to build adequate supply capacity and diversify their production and export capabilities. For that purpose, some kind of co-operation mechanism in the areas of finance, investment and technology transfer could be incorporated in the SAFTA Treaty.

While the strategies suggested in the foregoing would be expected to stimulate intra-regional trade in South Asia, it should be obvious that Bangladesh cannot hope too much to enhance its growth opportunities merely by promoting exports to the regional market. Bangladesh's exports to the South Asian region are very small, and a doubling, trebling, or even a quadru-pling of its intra-regional exports will not lead to any significant expansion in its total exports. Bangladesh thus has a vital interest in improving market access to global markets instead of just to the regional markets of South Asia. While the importance of the larger integrated market of the South Asian countries can hardly be ignored, Bangla-desh must also try to expand its export outlets outside the region, such as the BIMSTC, D-8, and the IOR-ARC, of which Bangladesh is a member. Bangladesh may also seek to improve its trading relations with the ASEAN, which is now the world's most dynamic region. Attempts may also be made to obtain an association status with the ASEAN, which would open enormous opportunities for expanding export to ASEAN countries and also attracting FDI from that region.

The author is a former Professor of Economics, University of Dhaka.

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