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South Asia's Free Trade Agreement: Strategies and Options

The implementation of the South Asian Free Trade Area agreement in 2006 suggests that regional economic integration is being seriously pursued in south Asia. Given the economic asymmetry in south Asia and the predominant position of India in the region, the article proposes India as an anchor economy that can connect south Asia with east Asia to form an Asia-wide free trade arrangement. It suggests a review of the existing agreements like the Bangkok Agreement and the Bay of Bengal Initiative for Multi-Sectoral Technical and Economic Cooperation in terms of membership and sectoral coverage as these can act as potent instruments in facilitating the south Asia-east Asia economic integration.

Notes

South Asia’s Free Trade Agreement: Strategiesand Options

The implementation of the South Asian Free Trade Area agreement in 2006 suggests that regional economic integration is being seriously pursued in south Asia. Given the economic asymmetry in south Asia and the predominant position of India in the region, the article proposes India as an anchor economy that can connect south Asia with east Asia to form an Asia-wide free trade arrangement. It suggests a review of the existing agreements like the Bangkok Agreement and the Bay of Bengal Initiative for Multi-Sectoral Technical and Economic Cooperation in terms of membership and sectoral coverage as these can act as potent instruments in facilitating the south Asia-east Asia

economic integration.

AMITA BATRA

T
he intertwining of national interests at the multilateral and regional level has acquired a new intensity in the 1990s. A trend that has rapidly gained momentum is the proliferation of regional and bilateral trade agreements among countries that reduce barriers to trade on a reciprocal and preferential basis for each other. With the emergence of powerful trading blocs like the EU and North American Free Trade Agreement (NAFTA) group, over 60 per cent of world trade is conducted on a preferential basis rather than on a most favoured nation (MFN) basis. The consequent diversion of trade and increasing intra-regional trade has an adverse affect on the growth process in the regions that are not a part of these trading blocs.

Asian countries have followed multilateralism rather faithfully. In south Asia, while the South Asian Preferential Trading Arrangement (SAPTA) has been there for some time, the emphasis was on broader issues of regional cooperation rather than concrete measures of trade liberalisation. The stance has now changed. Regional economic integration in the geographical, social, historical and culturally contiguous south Asia is being pursued seriously. The South Asian Free Trade Area (SAFTA) agreement was implemented in July 2006.

This article undertakes an analysis of south Asia’s free trade agreement (FTA) strategies in the context of the region’s potential for trade and investment expansion. The focus of the paper is on regional agreements in south Asia. The paper also highlights India’s predominant economic position against a profile of south Asia’s economic asymmetry, following which the paper considers the possibility of India as the anchor economy that can connect south and east Asia to constitute an Asia-wide trade bloc that may provide the member countries with a greater economic and strategic advantage than south Asia in isolation.

Intra-Regional Trade in South Asia

For the purpose of this paper, south Asia is defined as comprising the seven South Asian Association for Regional Cooperation (SAARC) member nations, i e, Bangladesh, Bhutan, India, Nepal, Pakistan, Sri Lanka and the Maldives. The economic profile of the region is presented in Table 1. It is evident that south Asia compares reasonably well with other regions in terms of GNI purchasing power parity (PPP) and per cent rate of growth over 2002-03. South Asia has the third largest GNI in PPP terms after east Asia and Latin America and has registered the second highest growth rate next only to east Asia.

Given its growing economic strength, south Asia has the potential to form a regional economic grouping. Intra-regional trade in south Asia has however been very low. As a percentage of total trade volume intra-regional trade has remained around 2 per cent since 1980 [Wilson and Otsuki 2004].1 Among all regions, south Asia is the least integrated when measured as a share of GDP (Figure 1). Intra-regional trade in south Asia is only 0.8 per cent of GDP, a fraction of east Asia’s – nearly 27 per cent of GDP – and is in fact even below that for sub-Saharan Africa.

Intra-regional trade in south Asia has languished owing to a combination of politics and protectionism. In the late 1940s, when most south Asian countries were part of one political entity – British India – trade among them was sizeable. But owing to ensuing political tensions between India and Pakistan, the trade shares declined in the post-independence era. In addition, for a long time all countries in the region have pursued economic development by adopting import substitution rather than export promotion strategies, thus keeping trade as a proportion of national production low.

Both these factors are changing for the better now and countries of south Asia are willing and ready to increase regional cooperation. India and Pakistan are resolving their differences through diplomatic channels. All countries are opening up their eco nomies to global trade. The import substitution strategy was first abandoned by Sri Lanka and then by others in the 1990s. India has significantly reduced trade weighted tariffs in 2005 and 2006 and aims at aligning its tariff structure with that of the Association of South-East Asian Nations (ASEAN).

It has been sometimes argued that the low level of intra-regional trade for south Asia does not augur well for regional economic integration. The intraregional trade level in south Asia does

Figure 1: Intra-Regional Trade as a Share of GDP, 2002 complementarity between India and

30 26.5

25

20

15.3 15

10

5

0 East Asia Europe and Latin central Asia America

6.4 3.5 0.8 5.3

Source: Roy (2005).

not compare well with other successful regional arrangements such as the EU and NAFTA. These arrangements have had levels of intra-regional trade that help characterise these arrangements as “natural trading partners”.2 At the inception of the EU, intra-regional trade was around 65 per cent and for NAFTA it was around 42 per cent. Even for trade blocs that comprise developing countries, such as Mercusor, intra-regional trade stood at 13 per cent prior to the launch of the arrangement in 1991.3

In addition to the fact that there is no a priori theoretical basis to expect that preferential trade agreements (PTAs) with higher initial intra-regional trade are more likely to be welfare improving, there are several other reasons to treat this argument with some caution or maybe even dismiss it. Official trade figures understate the extent of intra-regional trade in south Asia. Several studies point to the considerable amount of “informal” trade taking place in the region not only to evade high tariffs prevalent in the region but also to carry out some trade that would not have been permitted at all. Pitigala (2005) reports that once the informal trade is added, intra-regional trade of Bangladesh jumps from 17.7 to 21.8 per cent in 1995 and for Sri Lanka in the same year the increase is from 11.4 to 14.4 per cent.

Further, Batra (2006a) has used the augmented gravity model to estimate the trade potential for India with its trading partners in the world and specifically within some regional groupings like the SAARC. The model explains bilateral trade as a function of bilateral distance, economic size, contiguity and cultural proxi mity as indicated by a common language and colonial past. The model is estimated using GNP both in terms of PPP and current international US dollar value. For both versions of the model, the estimates indicate positive trade potential for the SAARC region as a whole.

West Asia South Asia Sub-Saharanand Africa North Africa

The positive trade potential is mainly on account of potential trade between India and Pakistan in the former estimation and only on account of India-Pakistan trade potential in the latter. The potential trade between India and Pakistan is estimated to be $ 6.5 billion more than the actual trade between these economies when the model is estimated using GNP current inter national US dollar value.

The success of a regional bloc is also very often considered to be positively related to the diversity in the structure of comparative advantage of member nations. Several earlier studies have analysed the nature and extent of revealed comparative advantage of the south Asian economies. Most of these studies are suggestive of a similarity in the pattern of comparative advantage and export interests across south Asian countries. However, in comparison with other south Asian countries, the range of products over which India has comparative advantage is somewhat broad. According to a Kemal et al (2000) study for the period 1985-95, India has reasonable potential to meet the import needs of countries in the south Asian region. India can export a variety of products ranging from various food items to machinery and transport equipment to other countries in south Asia. The degree of trade complementarity has increased for Bangladesh and India. A reasonable compatibility is also indicated between the trade structures of Sri Lanka and India. Interestingly, relative to other countries in the region,

Table 1: South Asia – Comparative Perspective
Pop(mill) GNI ($bn) GNI (PPP) GNI PC GDP Growth
($) (Per Cent)
2002-03

East Asia 1,855 1988.2 8542 1070 8.1 Europe and central Asia 472 1216.5 3555 2580 5.8 Latin America 533 1747.4 3801 3280 1.6 West Asia and north Africa 312 744.2 1826 2390 5.7 South Asia 1425 733.2 3761 510 7.5 Sub-Saharan Africa 705 351 1236 500 3.9

Source: World Development Indicators, World Bank, 2005.

Pakistan is higher.

Batra and Khan (2005), show that India has comparative advantage in 41 out of 97 sectors of the HS-2 classification. On analysing the correspondence between the structure of revealed comparative advantage for India and imports of the other SAARC member nations, it is evident that India can meet the import demand for the region. There are ample examples to support this – Pakistan imports cereals, milling products, malts, starches, sugars and confectionary, textiles – all commodity groups where India has a high revealed comparative advantage in the global market and Pakistan high imports. However, none of these products are currently being sourced from India.

Gains from regional economic integration are possible through intra-industry trade. Scope for vertical integration of different stages of production among south Asian nations exists in sectors like textiles, leather goods, light engineering, rubber products, automobiles and exploitation of bio-resources.4 The proportion of intraindustry trade in total trade is however low [Kemal et al 2000]. The exception is India-Nepal intra-industry trade that is about 14 per cent of their bilateral trade.

There is potential for efficiency seeking restructuring in south Asia. Illustrative examples of this potential for restructuring in south Asia are available. A recent study by Das (2004) shows how the free trade regime under the India-Nepal bilateral free trade arrangement has facilitated the restructuring of production by certain companies that have shifted production base to Nepal to serve the north Indian market as also for third country exports. Among others, examples include Dabur, India setting up its production unit for fruit juices in Nepal. Evidence towards efficiency seeking restructuring is also evident from the India-Sri Lanka FTA. These include Ceat India, production of auto motive tyres in Sri Lanka for the markets in south Asia and beyond. While these cases are an outcome of India’s bilateral agreements, they help reveal how an FTA with a liberalised investment regime can induce a spate of efficiency seeking industrial restructuring through intra-south Asian foreign direct investment (FDI) flows. Potential for such flows exists in both the textiles and clothing sector.

Regional Economic Integration Attempts

Over the past 15 years, south Asian countries have tried to increase intraregional trade. The increase has, however, been more on account of the changes in the macroeconomic policy of member nations rather than in formal trade agreements. Thus far, there have been two formal agreements at the regional level in south Asia. These are the SAPTA and SAFTA.

South Asian Preferential Trading Arrangement

The SAPTA was signed in April 1993. The agreement became operational in 1995. The SAPTA Agreement provided for the exchange of tariff preferences among member nations without commitment that such exchange would be carried out on a scale that turns the region into a free trade area by a specified date. Therefore, the agreement could not be termed as a south Asian free trade area/ agreement. The agreement made a distinction between least and other developing member countries, provided for special and differential treatment for the least developed countries (LDC) members and also included a regional “MFN” provision. The rules of origin (RoO) provisions have been a contentious issue among member nations. After much debate, the RoO allow for 40 per cent local content requirement for non-LDC members and 30 per cent for LDC members and the “cumulative” origin requirement of 50 per cent.

Following SAPTA’s establishment, three rounds of preferential tariff reductions were implemented. Concluded in 1995, SAPTA-1 covered only 6 per cent of traded goods (226 products at HS-6 digit level). The important issue of non-tariff barriers was deferred. SAPTA-2 concluded in 1997 and was more ambitious as it covered 1,800 products at the HS-6 digit level. It also incorporated provisions about easing non-tariff barriers. SAPTA-3 was signed in 1998 and was most ambitious, covering 2,700 items. The SAPTA-4 round though initiated was put on hold owing to the political situation in Pakistan.

Despite three rounds of preference negotiations, the arrangement has remained ineffective. Two main reasons have been cited for SAPTA’s inability to raise intraregional trade levels by substantial amounts. These are: (a) at the time of implementation of SAPTA, the region was characterised by highly restrictive economic and trading regime; and more importantly (b) the goods for which trade preferences were offered did not constitute a significant proportion of total number of goods traded. Mukherjee (2000) estimates that the proportion of intra-regional imports covered by the SAPTA preferences was the highest for Pakistan (39.6 per cent), followed by Nepal (35.2 per cent), India (30 per cent), Bhutan (17 per cent) and Sri Lanka (12 per cent). The import value coverage for Bangladesh and Maldives was marginal.

Nevertheless, the slow progress of the multilateral negotiation process and the relative success of the India-Sri Lanka bilateral FTA5 has given impetus to a more serious consideration, especially by India, of the regional option for a free trade area in south Asia. The SAFTAAgreement that was ratified in January 2006 and implemented on July 1, 2006 aims at turning the region into a free trade area.

South Asian Free Trade Area Agreement

The SAFTA Agreement covers tariff reductions, RoO, safeguards, institutional structures and dispute settlement. SAFTA members have committed to a 10-year phase out of tariffs beginning July 2006. Reductions will proceed in two stages but at a different speed for the least developed members and non-least developed members. Once the trade liberalisation process is completed, SAFTA shall super-cede SAPTA. Till then, all concessions granted under SAPTA shall remain available to the contracting states.6 The agreement also calls for eliminating quantitative restrictions (QRs) for products on the tariff liberalisation list. No time frame or mechanism has, however, been specified in this regard. While member states have been allowed to develop a list of sensitive items that would not be fully subjected to the stipulated tariff cuts, the number of products would be subject to review every four years.

To achieve its stated objective of strengthening intra-SAARC economic cooperation and realisation of the region’s potential for trade and development of their people, however, the scope of the SAFTA Agreement needs to be enlarged to include investment facilitation and provisions for liberalisation of services. Liberalisation of investment will help exploit the possibilities of intra-industry trade and efficiency seeking industrial relocation in the region as also to use the incentive of the larger markets, particularly the Indian market to stimulate investment from within and outside south Asia for small economies with narrow markets such as Nepal, Bangladesh and Sri Lanka. As far as the services sector is concerned, it has not just acquired increased importance in GDP and exports of member countries but also figures prominently in informal trade in the region. Sectors like education, health and tourism offer considerable scope for cooperation among member nations. Already, health services are being provided on a fairly substantial scale in the region through mode 2 of service provision under the General Agreement on Trade in Services (GATS). This movement is generally oneway, particularly for India. Until now there are no generally agreed upon rules and regulations and procedures at the regional level, for providing services under mode 2. The movement of people in the social sector, in particular, can be facilitated by the gradual conclusion of mutual recognition agreements (MRAs) on standards, qualifications and degrees as well as harmonisation of standards. For tourism existing mechanisms for coordination among the member countries need to be strengthened through both the joint development of tourist infrastructure and a well coordinated plan for promoting cross-country tourism for specific purposes like pilgrimages, etc.

In addition to the enlargement of the scope of the agreement, it is important for policymakers in south Asia to implement measures for trade facilitation. A review of trade facilitation and transport logistics in the region illustrates the continued weakness of south Asian countries in port and transport infrastructure, regulatory environments and service sector infrastructure. Delays at seaports due to congestion and outdated infrastructure, for example, raise costs for exporters throughout the region. In fact, a well-formulated and broadly defined plan for infrastructure development that will link not just the region’s road, rail and port systems but also

Figure 2: India’s Share in Intra-South Asian Trade As the only country that shares its land

80 border with all the other south Asian countries, India accounts for 65 per cent of

70

intra-regional trade in south Asia (2003).

60

Furthermore India is the major trading

50

partner for most south Asian countries

40

$ Billion 8 6 4 2 0 48 per cent 71 73 71 65 per cent per cent per cent per cent Intra Trade India’s Share

Per cent

– the top for Bhutan and Nepal and is

30

among the top 20 for Sri Lanka, the

20

Maldives and Bangladesh. India already

10

has bilateral trade treaties with three south

0

Asian countries – Sri Lanka, Nepal, Bhu

1999 2000 2001 2002 2003

Source: UNCOM Trade.

the electricity, gas and oil grids will go a long way towards the maximisation of the region’s potential for intra-regional trade. This will be further enhanced if granting of transit rights for inter country commerce in south Asia is depoliticised and not conditioned by narrow country interests.

Finally, it is often said that the success of the SAFTA is contingent upon India’s trade policy and its ability to lead the region as has been the case for most successful regional trade arrangements like NAFTA, Mercusor, etc, that have had, at their core, a single large economy. Taking this a little further, in this paper, we propose that India can actually take the SAFTA/south Asia towards a full-fledged Asia-wide FTA. The remainder of the paper explores this option for south Asia.

India-East Asia and Asia-wide FTA

In an economically asymmetric south Asia, India is the predominant economy. India has also, in recent times, emerged as one of the most dynamic economies in the world. Simultaneously, in east Asia, ASEAN has initiated a phase of accelerated economic integration. In the post-1997-98 east Asian financial crisis, ASEAN could actually use the fresh infusion of economic dynamism of India. As it is, trade trends reveal that India is increasingly getting linked with east Asia. In addition, the ASEAN economies are de facto integrated with the plus three economies of China, Japan and Korea through a market-led process of integration. Further, an ASEAN+3+3 economic bloc that is inclusive of India has been envisioned on the lines of the EU as part of the deliberations of Asian leaders at the December 2005 East Asia Summit. And last but certainly not the least, the convergence of economic policies in Asia has led to a rethinking on the earlier strategic assumptions that influenced the emergence of particular regional groupings in Asia. The new world order provides scope for redefining the territorial compass of the groupings of the future. Trade integration between India and east Asia is hence, a practical possibility that we explore in this section of the paper. We suggest that once the dominant south Asian economy is formally integrated with east Asia, the other south Asian economies for which India is the major trading partner may hasten their process of integration with India to gain access to the larger market. An accelerated SAFTA and an eventual south Asia-east Asia trade bloc may emerge. Following a brief profile of the economically asymmetric south Asia, the case for an India-east Asia trade bloc is examined below.

Economic Asymmetry

South Asia is economically asymmetric. India has a central position in south Asia. India is the largest economy with a GDP, which is not just 80 per cent of the south Asian GDP (2003) but also the fourth largest in the world (2004) in PPP terms. Over 75 per cent of the region’s population resides in India. The country has a GDP per capita that is second only to Sri Lanka, and that too only on account of the latter’s smaller population. With a per capita income (current) of $ 546 as against the south Asian average (excluding India) of $ 462 and a burgeoning middle class, the size of which has increased from 14 per cent (113 million) in 1992-93 to 26 per cent (250 million) in 1998-99, India provides a huge market for the region.

tan and negotiations are on with Bangladesh. India is a member of all regional/ sub-regional groupings in south Asia like the Bangkok Agreement,7 the south Asia growth quadrangle, etc.

India’s Growth Story

Over the last decade and a half, India has attained the identity of a dynamic economy in pursuit of a high rate of economic growth through the process of liberalisation and economic reform. The Indian economy has grown at an average rate of

5.8 per cent during the 1980s, at 6 per cent during the 1990s and early years of this decade and more recently at over 8 per cent. India recorded the second highest average growth rate of 6.06 per cent per annum during 1992-2001 after China.

The growth process in India has been accompanied by macroeconomic stability. The coefficient of variation (CV, refer Table 3) in the rate of growth of GDP in India has fallen from 0.4 in 1981-91 to 0.25 during 1992-2005, which is lower than that for other ASEAN member countries like Indonesia (CV = 1.27), Philippines (CV = 0.56), Thailand, etc. The exchange rate in India has also moved within a narrow range. Stability in exchange rate is evident from the coefficient of variation that was 0.33 in the pre-reform period and has since fallen to

0.19 in the post-reform period. Further, the inflationary forces in India have been under control and in fact, inflation has been maintained at single digit levels almost throughout the period of reform and more recently, despite the rise in

Table 2: Economic Profile of South Asia

Country GDP ($ Billion) GDP (PPP) Rog of GDP GDP PC (PPP) Pop (Million)

Bangladesh 51.9 244.4 5.3 1770.2 138.1 Bhutan 0.7 -6.7 0.9 India 600.6 3078.0 8.6 2891.8 1064.4 Maldives 0.7 -9.2 0.3 Nepal 5.9 35.0 3.1 1419.9 24.7 Pakistan 82.3 311.3 5.1 2096.9 148.4 Sri Lanka 18.2 72.7 5.9 3777.8 19.2

Source: World Development Indicators, World Bank 2005.

86 85

decade is in contrast with the growth

fluctuations experienced by east Asia and

south-east Asia.

Further, India’s growth process is

(Per cent)

(Per cent)

81

10

80

5

79

18.1 17.217.6 17.6 17.5 15.1 16.9 17.9 19.9

1995 1996 1997 1998 1999 2000 2001 2002 2003

78 77

regarded as more sustainable relative to

0

other emerging economies of the region. Growth in India is an outcome of a ROW

ASEAN+4 Source: Batra (2006b).

protracted process of liberalisation and economic reform. Domestic private 21 per cent and the share of the proposed the proposed trade bloc is also apparent consumption has been the primary driving ASEAN+4 bloc has increased to about when we look at the increasing divergence force for the growth process. Therefore, 20 per cent. With its share in India’s total between the shares of ASEAN+4 and rest the fear of over-heating, as is the case of trade having increased to equal that of of the world (ROW) in India’s total trade. export-led growth processes adopted in the EU, ASEAN+4 has emerged as the As is evident from Figure 3, there is a many other countries of the region does other dominant partner bloc for India. clear increase in the share of ASEAN+4 not hold for India. Trade with ASEAN+4 vis-a-vis rest of the in India’s total trade at the expense of the

world: India’s trade orientation towards ROW. Over the period 2000-2003, the Economic Rationale for share of ASEAN+4 in India’s total trade

Table 3: Coefficients of Variation

India-East Asia Trade Bloc has increased from 15 to almost 20 per

Country Exchange Rate Growth Rate

cent and that of the ROW has registered

1980-1992-1980-1992-

For the purpose of the analysis in this a fall from 85 per cent to 80 per cent.

1991 2005 1991 2005

section, east Asia is defined as inclusive of As concerns individual member nations,

India 0.33 0.19 0.40 0.25

the ASEAN 10, China, Japan and Korea, three of the ASEAN+4 countries – China,

Indonesia 0.40 0.58 0.37 1.27

i e, the ASEAN+3. As the first part of our Japan and Singapore – feature among the

Japan 0.26 0.09 0.33 –

proposal for an India-east Asia trade bloc, top 10 trading partners for India in 2003.

Korea 0.11 0.21 0.46 – i e, ASEAN+3+1/ ASEAN+4, evidence in Malaysia 0.08 0.19 0.52 0.78 Singapore and China first emerged among Philippines 0.40 0.32 2.50 0.56

support of India’s increasing trade linkages the top 10 trading partners for India in 2000

Singapore 0.07 0.08 0.49 –

with the proposed bloc is presented. and have remained so since then. China

Thailand 0.08 0.23 0.40 1.15Rate of growth of total trade with Vietnam – 0.34 0.32 0.17 has, over the same period, emerged as the

ASEAN+4: The average annual rate of third largest trading partner for India.

Source: International Financial Statistics, IMF 2001,

growth of India’s total trade with ASEAN+4 India as a market for the ASEAN+4:

World Development Indicators, Worldover 1999-2003 is 9.5 per cent. It is Bank 2005. Simultaneous with the increase in the

observed from Table 4 that this is close share of ASEAN+4 in India’s total trade,

Table 4: Rate of Growth of Total Trade

to the rate registered by China and it is observed that there is an increase

with ASEAN+4

greater than that for Japan and Korea (Per cent) in India’s relevance for the ASEAN+4 over the same period. In 2001-03, India nations. Evidence shows that India is

Year India China Japan Korea

has registered the highest annual rate of Rep increasingly being looked at as a marketgrowth of total trade with the proposed for exports (Table 6). Over 1995-2003,

1999-2000 -3.2 33.0 28.3 31.2

bloc in comparison with the plus three India registered the highest rate of growth

2000-2001 11.4 5.4 -9.5 -11.8

economies that are considered as already in the region for Chinese and Indonesian

2001-02 24.8 21.9 5.3 13.2integrated with ASEAN.8 2002-03 37.3 37.4 20.6 23.8 exports. India is second only to ChinaTrade with ASEAN+4 vis-a-vis other re-Average annual as the most attractive market in the gional trade blocs: India’s trade with re-rate of growth 9.5 12.7 3.0 5.3 region for Korean, Malaysian and Thai gional blocs presents an interesting picture Source: Batra (2006b). exports.

(Table 5). In 1995, the EU (15/25) was the most significant trading bloc for India Table 5: Shares of Select Trade Blocs in India’s Total Trade in terms of its share in total trade. Trade (Per cent)

with the EU constituted 28 per cent of

Year EU15 EU25 NAFTA Mercosur ASEAN ASEAN+4 SAARC

India’s total trade. This was followed by

1995 27.4 28.0 14.9 0.8 7.8 18.1 2.9

NAFTA at around 15 per cent and

1999 23.5 24.0 15.2 1.1 8.5 17.5 2.1 ASEAN at 8 per cent. In 2003, the share 2003 20.2 20.7 12.9 0.9 9.3 19.9 3.4

of EU in India’s total trade had fallen to Source: Batra (2006b).

Table 6: India as a Market for ASEAN+4: Comparison with +3 Economies

Markets↓ Bru Dar China India Indonesia Japan Republic of Korea Malaysia Philippines Singapore Thailand

China – – 86.7 13.1 17.9 31.6 27.6 – 29.7 27.5 India – 37.4 – 39.7 -0.6 17.0 22.8 – 7.2 13.5 Japan – 12.1 –2.6 1.2 – 6.1 2.2 – 0.6 2.3 Republic of Korea – 22.3 7.7 5.4 1.3 5.3 9.6 11.0

Note: Figures in the table represent average annual rate of growth of exports to the specific markets over 1999-2003. Source: Batra (2006b).

The fact that India is emerging as an important market for intra-regional exports is corroborated when we look at India’s trade with ASEAN+4. It may be seen from Table 7 that the average annual rate of growth of imports of India from ASEAN+4 exceeds the rate of growth of India’s exports to ASEAN+4. In addition, when compared with the plus three economies, the rate of growth of India’s imports from ASEAN+4 is second to China and significantly higher than that of Japan and Korea.

Having thus presented the case for India’s inclusion in an ASEAN+4 trade bloc, we proceed to establish the economic strength of the proposed bloc.

Economic Strength of India-East Asia Trade Bloc

The proposed ASEAN +3+1/ASEAN+4 region comprising two of the most dynamic economies in the world, i e, India and China has been referred to as the “arc of advantage”. As may be noticed from the available facts presented in Table 8, the GNI of the countries comprising this regional bloc is over $ 7.6 trillion in 2003 and is comparable to the $ 9.4 trillion gross national income of the EU. In terms of PPP, the national income of ASEAN+4 is $ 16 trillion and is more than the national income of NAFTA, which is $ 13 trillion or of the EU, which is $ 11 trillion. The combined total reserves of this region are about $ 2 trillion, and are much larger than that of the EU. Given that the proposed 14 country singular economic entity of ASEAN+4 has a 19 per cent share in total world trade which is almost as much as that of NAFTA and contributes 21 per cent of the global output and is in addition home to about half of the world’s population, it has the potential to impact the global as well as the regional economies.

As evident from Table 9, the trends in intra-bloc trade are encouraging. Intra-bloc trade as a per cent of total trade at an aggregate level for the ASEAN+4 economies along with some selected blocs is shown in Table 9.9 Trade among the member nations of ASEAN+4 as against their trade with the rest of the world has registered an increase in the period 1995-2003 even though there was a fall in 1999, possibly on account of the east Asian crisis. In 2003, intra-bloc trade for ASEAN+4 was 44 per cent. This value of intra-regional trade share is higher than the corresponding share for many of the existing trade blocs in the year of their formation. For example, intra-bloc trade for NAFTA was 42 per cent in 1991 and for Mercusor it was 13 per cent in 1991 [Schiff and Winters 2003].

It is also evident from Table 9 that the potential of ASEAN+4 for regional economic integration is higher than that of the existing regional bloc in Asia, i e, ASEAN. Intra-ASEAN trade is less than that for ASEAN+4. This fact is further corroborated when the trends for intra-bloc exports and imports as shown in Tables 10 and 11 are analysed. There exists a positive difference between the levels of intra-bloc exports and imports for the proposed ASEAN+4 grouping as against the existing ASEAN. In 2003, intra-ASEAN trade – both exports and imports stands at 22 per cent and this is much lower than the 35 per cent and 43 per cent of intra-ASEAN+4 exports and imports respectively.

The strength of the ASEAN+4 as a regional trade bloc may also be inferred from the degree of “trade bias” among member nations evaluated using the index of trade intensity (TI). Table 12 summarises the change in the TI index at three time points and for a comparative picture the TI indices at the same time points are also shown for NAFTA. The TI index as shown in Table 12 exceeds unity. This is indicative of “intense” trade relations within the ASEAN+4 regional grouping. The TI index for ASEAN+4 is comparable to that for NAFTA, particularly at the time of the latter’s coming into effect.10

Road Map to India-East Asia Trade Bloc

Having thus established the economic rationale and strength of an India-east Asia trade bloc we examine the most efficient approach to India’s entry in this bloc and hence the formation of this bloc. Two alternative approaches are evaluated in terms of their efficiency costs – the merger of ASEAN+1 FTAs of the plus four economies against that of the ASEAN+3+1. In the latter case India enters last in a pre-existing ASEAN+3 arrangement.11

Efficiency Costs for Regional Orientation

To ascertain an efficient path to the formation of an India-east Asia trade bloc, an estimate of the extent of production restructuring/adjustment in response to regional orientation is undertaken. Efficiency costs are measured12 as the percentage of sectors where individual countries, even though not comparatively advantageously placed in the global market, reorient themselves towards these possible trade formations – ASEAN+3

Table 7: Rate of Growth of Exports and Imports of the Plus Four Economies: 1995-2003

India China Japan Korea Rep

Imports from

ASEAN+4 10.8 14.6 4.4 4.8 Exports to

ASEAN+4 7.7 10.5 1.7 5.8

Source: Batra (2006b).

Table 8: ASEAN+3+1 Region: Descriptive Statistics

ASEAN+4 NAFTA EU

GNI (trillion $) 7.6 12.5 9.4 National income

(trillion $)PPP 16 13 11 Population (billion) 3.03 0.42 0.45 Total reserves (trillion $) 1.6 0.25 0.52 Share of world trade

(per cent) 19.22 20.27 38.8

Source: World Development Indicators, World Bank, 2005.

Table 9: Intra-Bloc Trade

(Per cent)

Regions 1995 1999 2003

ASEAN 25.5 24.6 25.3 ASEAN+4 42.0 39.5 44.0 NAFTA 45.0 50.1 49.9

Source: Batra (2006b).

Table 10: Intra-Bloc Exports

(Per cent)

Regions 1995 1999 2003

ASEAN 25.5 22.5 22.4 ASEAN+4 35.2 31.1 35.0

Source: Batra (2006b).

Table 11: Intra-Bloc Imports

(Per cent)

Regions 1995 1999 2003

ASEAN 17.5 21.8 22.0 ASEAN+4 38.9 39.8 43.0

Source: Batra (2006b).

Table 12: Intra-Regional Trade Intensity Index

Regions 1995 1999 2003

ASEAN 3.9 4.5 4.4 ASEAN+4 2.1 2.2 2.2 NAFTA 2.4 2.3 2.7

Source: Batra (2006b).

or ASEAN in anticipation of potential gains. Our results show the efficiency costs to be lower for alignment with ASEAN relative to ASEAN+3 for all the plus four economies. The cost of alignment with ASEAN is lowest for China among the plus four economies. In comparison with about 67 per cent for ASEAN+3, only 26 per cent sectors require restructuring in response to increased regional orientation. For India, in about 50 per cent of the sectors, increased export orientation towards ASEAN is observed despite a lack of comparative advantage in the world market in comparison with 54 per cent of such sectors in case of ASEAN+3+1. Corresponding figures for Korea are 68 and 78 per cent for ASEAN and ASEAN+3+1 respectively. Clearly, ASEAN+1 is a more cost efficient arrangement for all the economies (Table 13).13

Efficiency Costs vis-a-vis Multilateral Liberalisation

An assessment of the alignment of the structure of a country’s comparative advantage in the two markets (ASEAN and world or ASEAN+3) with that in the world market has also been undertaken. Closer the structure of comparative advantage in the global and regional formation, lower will be the costs of participation in a particular bloc. The efficiency costs thus estimated are also indicative of the cost of participation in the regional FTA relative to participation in multilateral liberalisation, which according to conventional wisdom, is considered the “first best” solution for attaining the potential benefits of a more open world economy. The alignment of comparative advantage has been examined at the aggregate level (for all sectors) and separately for the main sectors of an economy, i e, agriculture, manufacturing, minerals and fuels, chemicals and plastics and manufactures chiefly by materials and miscellaneous manufactures.14 In the case of India the comparative advantage is similar in regional and global markets. The similarity index is estimated to be around 0.7 in case for both the world and ASEAN+3 as also the world and ASEAN configurations. For the plus three economies, the alignment of their comparative advantage in the global market is marginally higher with that in ASEAN+3 relative to that in ASEAN. The range is, however, such as to indicate high alignment for all the economies.

Our results (Table 14), therefore, show that India’s entry in an ASEAN+4 bloc is efficient and does not imply any major additional costs over and above participation in the multilateral process of liberalisation. A prior alignment with ASEAN in the ASEAN+1 framework is evidently a more efficient or least cost path to entering the ASEAN+4 bloc for all the plus four economies. Regionally oriented export patterns do not imply any significant costs of adjustment of the production structure from those that are consistent with orientation towards the global market. The ASEAN+1 is thus an efficient route towards achieving the India-east Asia trade bloc. The process of ASEAN-India negotiations is already under way. For the south Asian economies for which India is the predominant trade partner, this should lead to an acceleration in their pace of integration with India as this will give them a direct and easy access to the “arc of advantage”.

It may, in the meanwhile, also be useful to explore two existing agreements that have the potential to give a concrete shape to the south Asia-east Asia trade bloc, particularly, given the economic advantage of an Asian bloc that spreads across sub-regions of south and east Asia. These agreements are the Bay of Bengal Initiative for Multi-Sectoral Technical and Economic Cooperation (BIMSTEC) and the Bangkok Agreement. A brief description of the agreements is given below. BIMSTEC: At the sub-regional level, the major initiative is BIMSTEC. BIMSTEC comprises Bangladesh, India, Myanmar, Sri Lanka, Thailand, Bhutan and Nepal. This initiative includes countries from both SAARC and ASEAN and in fact, acts as a bridge between the two. The first ever summit-level meeting for BIMSTEC was held in July 2004 when it acquired its new incarnation – the BIMSTEC. This Bay of Bengal initiative is dynamic and offers the prospect of widening the network for outward oriented growth in this part of Asia. It can emerge as a bridge between the more inward oriented south Asia, and the more outward oriented south-east and east Asia. Through this route India, followed by SAARC, can reach out to the south-east Asian region and beyond to the Asia-Pacific community. The BIM-STEC draft FTA agreement provides for, inter alia, a two-track tariff reduction/ elimination programme, liberalisation of trade in services, investment and cooperation in identified sectors of technology, transportation and communication, energy, tourism and fisheries.15 The timeline for negotiations for tariff reduction and investment and services has been pre-specified. The BIMSTEC Agreement, therefore, holds prospects for a much larger pan-Asian economic cooperation in the long run. Bangkok Agreement: The Bangkok Agreement was signed in 1975. Its members are Bangladesh, China, India, Republic of Korea, Laos and Sri Lanka. The agreement is, at present, limited in scope as it covers only tariff concessions on goods. The agreement was revitalised in 2001 with the entry of China. This agreement is a more potent instrument than the BIMSTEC as a facilitator for south Asia-east Asia economic integration. That China, India and Republic of Korea are already members of this agreement is indicative of the huge market potential inherent in the agreement. Further, the agreement is open to all developing member countries of the Economic and Social Commission for Asia and the Pacific and is consequently, the only truly regional trade agreement in Asia. In terms of its potential membership, this is the only agreement that has the potential to develop into a regional trade

Table 13: Efficiency Costs* for Regional Orientation

ASEAN ASEAN+4

India 50.0 53.6
China 26.1 66.7
Japan 90.9 85.1
Korea 68.3 77.5

Note: * per cent number of sectors. Source: Batra (2006b).

Table 14: Efficiency Costs vis-a-vis Multilateral Liberalisation

India China Japan Korea Rep

All sectors 0.66b 0.72b 0.73b 0.63b 0.73a,b 0.84c 0.79a,b 0.78a,b Agriculture and 0.63b 0.60b 0.59b 0.55b allied 0.74a,b 0.81c 0.67a,b 0.74a,b Manufacturing 0.67b 0.74b 0.72b 0.63b 0.73a,b 0.85c 0.78a,b 0.78a,b Minerals and 0.64b 0.44 0.68b 0.48 mineral fuels 0.82a,b 0.85c 0.89c 0.78a,b

Chemicals and 0.70b 0.75b 0.65b 0.67b plastics 0.75a,b 0.86c 0.73a,b 0.82c Manufacturers 0.69b 0.74b 0.71b 0.61b

chiefly by mat 0.74a,b 0.83c 0.79a,b 0.77a,b Machinery 0.55b 0.72b 0.76b 0.65b 0.57a,b 0.82a,b 0.84c 0.79a,b Misc (HS 90-99) 0.38 0.85c 0.73b 0.60b 0.50a,b 0.85c 0.82c 0.75a,b

Note: a italicised: ASEAN+4; b bold: Moderate; c high: All others: low; All significant. Source: Batra (2006b).

agreement leading to regional economic integration in Asia.

To be more useful for the purpose of regional integration both the agreements call for a review of scope – both in terms of member nations and sectoral coverage. It may be an even better idea to work on these two aspects of the agreements while simultaneously considering the merger of the BIMSTEC and Bangkok Agreement. Ultimately it needs to be realised that an Asian bloc will not just benefit the region and its economies as analysed above16 but can be a potential instrument of changing incentives for the trade blocs in the Americas and Europe and actually make possible multilateral freeing of trade.

EPW

Email: amitabatra@icrier.res.in

Notes

1 Some studies have shown the number to be around 4 per cent. Taking the variation in estimates in intra-regional trade for south Asia across different studies, it can still be said that intra-regional trade as percentage of total regional trade is less than 5 per cent.

2 A series of earlier papers like Wonnacott, Paul and Mark Lutz (1989), Summers, Lawrence (1991), Krugman (1993) and Frankel et al (1995), argue that regional trade agreements with larger pre-trade volumes and geographically proximate countries are likely to be welfare improving.

3 The more robust indicator for intra-regional trade bais like the index of trade intensity (TI) is also very low for the region. However, the TI index for bilateral relationships reveals a positive trend for India and Nepal, Bangladesh and Sri Lanka indicating the region’s intense and increasing dependence on India as a trade partner. In case of other bilateral relationships, the trend is observed to be asymmetric over the 1990s.

4 Global Economic Prospects, 2004, World Bank.

5 India-Sri Lanka FTA has been a landmark bilateral free trade agreement in south Asia. The agreement came into effect in 2000. It has boosted bilateral trade between the two countries. The agreement led to reducing Sri-Lanka’s trade deficit with India from 11:1 in 1999 to 5:1 in 2002. Sri Lankan exports to India accounted for 3.6 per cent of overall exports in 2002 in comparison to 1999, when Sri Lankan exports to India accounted for 1 per cent of overall exports. India has become the fifth largest destination for Sri Lankan exports in 2002 compared to the rank in 20s in the mid-1990s. India is the largest source of imports for Sri Lanka and accounts for 14 per cent of overall imports. Also Sri Lanka has, as a consequence of the FTA become the hot destination for FDI as many countries now see it as door of opportunity to access the huge Indian market. Indo Sri Lanka bilateral FTA has now graduated to an India-Sri Lanka closer economic partnership arrangement (CEPA) where liberalisation of services, more flexible RoO and shorter sensitive lists are to be included.

6 The question of an overlap between the

SAFTA and SAPTA therefore, will not arise. 7 Now the Asia Pacific Trade Agreement. 8 While India’s linkages are growing at the

highest rate, the share of the proposed bloc in total trade of the plus three economies is double that of India’s and trade intensity is consistently above unity, indicating thus existing “intense” trade relations between ASEAN and the plus three economies [Batra 2006b].

9 Data has been presented at four year intervals to reduce the influence of any annual irregular variations such as those on account of fluctuations in commodity prices.

10 This corroborates earlier evidence in favour of the ASEAN+4. Intra-regional trade shares for ASEAN+4 in contrast with that of ASEAN are comparable to that for NAFTA at the time of the latter’s formation.

11 ASEAN+3 has been referred to as the most suitable candidate for east Asian regionalism in the literature [Baldwin 2006; Drysdale 2001]. At this stage, however, the ASEAN+3 group is not a regional trading arrangement. The focus in ASEAN+3 is on financial cooperation only.

12 Over the period 1995-2004.

13 A weak form of this efficiency criterion reveals lower costs of alignment with ASEAN for Japan as well. Refer Batra (2006b)

14 The alignment of the structure of comparative advantage has been undertaken irrespective of the value of the index. Alternately, alignment of only those commodities where countries are comparatively advantageously placed has also been tried. The results do not alter the earlier implications.

15 Economic cooperation in six sectors with designated lead countries: Bangladesh: trade and investment, Sri-Lanka: technology, India: transport and communication, tourism, Myanmar: energy, Thailand: fisheries.

16 This Asia-wide FTA will have many efficient and competitive countries thereby minimising the extent of trade diversion relative to SAFTA.

References

Baldwin, Richard E (2006): ‘Managing the Noodle Bowl: The Fragility of East Asian Regionalism’, Graduate Institute of International Studies, Geneva.

Batra, Amita (2005): ‘India-Country Perspectives’, South Asian Free Trade Area: Opportunities and Challenges, USAID Publication.

  • (2006a): ‘India’s Global Trade Potential: The Gravity Model Approach’, Global Economic Review, Vol 35(3), September.
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    Das, Ram Upendra (2004): ‘Industrial Restructuring and Export Competitiveness of the Textiles and Clothing Sector in SAARC in the Context of MFA Phase-Out’, RISDP#85/2004, RIS, New Delhi.

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    Krugman, P (1993): ‘Regionalism vs Multilateralism: Analytical Notes’ in Jaime de Melo and Arvind Panagariya (eds), New Dimensions in Regional Integration, CEPR.

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    Pitigala, Nihal (2005): ‘What Does Regional Trade in South Asia Reveal about Future Trade Integration? Some Empirical Evidence’, World Bank Policy Research Working Paper 3497.

    Pitigala, Nihal, Garry Pursell and Tercan Baysan (2000): ‘Has Unilateral Trade liberalisation Led to Regional Integration in South Asia?’ mimeo.

    Roy, Jayanta (2005): ‘Potential Consequences and Benefits of Implementing a Multilateral Approach to Trade Facilitation’, Trade Facilitation in South Asia seminar.

    Schiff, Maurice and L Alan Winters (2003): ‘Regional Integration and Development’, World Bank, Washington DC.

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    Wilson, John S, Catherine L Mann and Tsunehiro Otsuki (2004): ‘Assessing the Potential Benefit of Trade Facilitation: A Global Perspective’, World Bank Policy Research Working Paper 3224.

    Wonnacott, Paul and Mark Lutz (1989): ‘Is There a Case for Free Trade Areas?’ in Jeffrey J Schott (ed), Free Trade Areas and US Trade Policy, Institute for International Economics, Washington.

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