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Integration through Trade and
Investment: Experience of South
Asia
Rashmi Banga
Senior Economist
UNCTAD-India
Asian Experience of Integration through Trade, Aid and Investment:
South Asia
India International Centre,
5-6 November, 2009
• South Asia is one of the economically most
underdeveloped region of the world.
• South Asia has 4 LDCs, 2 Small & Vulnerable
Economies and 2 Developing Countries
• While the population of South Asia is 27% of the
developing world, its share is 40% in the total
number of absolute poor, 45 % in the total
number of adult illiterate females and 49% in the
total number of malnourished children
Regional cooperation is seen as a step towards
boosting growth and development in the region.
While the steps towards regional cooperation
began with the setting up of SAARC, they did
not cover issues pertaining to greater economic
cooperation and integration.
The South Asian Free Trade Agreement
(SAFTA) signed by the members of the SAARC
and implemented in July 2006,
The Agreement on SAFTA has six
core elements:
• Trade liberalization Programme
• Sensitive Lists
• Rules of Origin
• Non-tariff and para-tariff barriers
• Revenue Compensation Mechanism for the
LDCs
• Technical Assistance for LDCs
Inclusion of services is envisaged by 2010
Contents
• Experience so far of regional integration in
South Asia in terms of trade and FDI
• Economic Rationale of SAFTA
• Potential of Trade and Investments
• Challenges faced in integration through
trade in Services
• Role of India in regional integration
Experience so far…
• South Asia as a region has lacked behind
in terms of its openness to trade.
• Intra-regional trade share in 2008 in the
case of South Asia was 4.31% as against
27.06% in case of ASEAN.
• India has the largest share in total intra-
SAARC exports, i.e., 74.4 percent
Country-wise Share (%) in Intra-SAARC
Exports in 2008 Bangladesh
Bhutan
India
Maldives
Nepal
Pakistan
Sri Lanka
Intra-Regional FDI Flows
• Though in terms of FDI inflows to the
region, there has been significant
improvement (It increased by 40% in 2008
as compared to 2007), around 80%of to
goes to India.
• In terms of intra-regional FDI, India is the
largest investor in South Asia
Inward FDI Flows in South Asia (USD Mn)
60,000
50,000
40,000
30,000
20,000
10,000
0
80
82
84
86
88
90
92
94
96
98
00
02
04
06
08
19
19
19
19
19
19
19
19
19
19
20
20
20
20
20
Share of Countries in Inward FDI Flows in 2007
Afghanistan
Bangladesh
18% 1% 0%
2% 2% Bhutan
0%
India
Maldives
77% Nepal
Pakistan
Sri Lanka
Intra-Regional FDI Inflows
(% of country total)
Hosts of FDI Intra Regional FDI (US$ million) in 2006
Sources of
FDI India Pakistan Sri Lanka Bangladesh Nepal
India n.a. 6.0 (2.6%) 0.99 (0.2%) 5.1 (51%)
Pakistan n.a. (0.6%) 0.59 (0.1%) (0.03%)
Sri Lanka (0.01%) n.a. 0.52 (0.1%) n.a.
0.79 0.41
0.59 (0.08 (0.18
Bangladesh (0.01%) %) %) n.a.
n.a. n.a. n.a. n.a.
Nepal
Share of South
Asia 0.04% n.a. 2.1% 0.4% 37.6%
Share of Top Five Countries in South Asia
Economic Rationale of SAFTA
Does SAFTA make an Economic Sense?
• There exists a vast literature (e.g., Samaratunga 1999
and Kemal et al. 2000) which show that the countries in
South Asia have an almost an identical pattern of
comparative advantage in a relatively narrow band of
commodities.
• Estimated complementarity indices found that there is a
lack of strong trade complementarity in the bilateral trade
structures of South Asia.
• Lack of trade complementarities and similar
competitiveness raised questions on the future prospects
of SAFTA.
UNCTAD-ADB Study (2008): Potential
Gains from SAFTA
• Estimates and compares the RCAs, IIT and
complementarity indices for two time periods, i.e.,
1991-93 and 2004-06 for four major trading
member countries of SAFTA, i.e., Bangladesh,
India, Pakistan and Sri Lanka at SITC five digit
level.
• All indices showed a substantial increase in
2004-2006 as compared to 1991-93 indicating
the changing realties and growing rationale for
SAFTA.
• To estimate the gains in terms of trade by
SAFTA the study estimated augmented gravity
model
Estimate of Potential gains in Trade
• Gravity Model has been estimated
• Log Tijt = β0 + β1 log (GDPit*GDPjt) + β2 log Dijt + β3 log
(POPit* POPjt ) + β4 log (1+ Tariffjit) + β4 log (1+ Tariffijt)
+ eijt.
• Tariffs have been included in the model.
• Panel data for seven countries for a ten year period, i.e.,
1995-2005 is used to estimate Fixed Effects.
• We use two step method to estimate the effects of
distance and other dummies.
• The potential trade is difference between estimated
bilateral trade and actual trade.
Trade Potential in SAFTA (US Bn $): 1995-2005.
Actual GAP
Estimated Trade (% of Actual
Trade Trade)
Using 85.1 38.5 120%
Coefficients of
Equation 2
(without tariffs)
Using Coefficients 54.0 38.5 40%
of Equation 1
(with tariffs)
For the year 2004 9.0 5.8 55%
• Increase in trade which can be directly attributed to removal of
tariffs under SAFTA is 80% of the actual intra-regional trade from the
predicted intra-regional trade of 120%.
• This implies that apart from tariffs there exist other barriers to trade.
Intra-regional trade may rise by further 40% if other factors affecting
trade are addressed like non-tariff barriers, political constraints, etc.
Impact of SAFTA on Inward FDI into South Asia.
• To capture the impact of SAFTA on inward FDI, we use
weighted average of MFN tariffs of each member country
with respect to other member countries as a group.
• To test whether FDI into the region may follow product
fragmentation or not we estimate impact of other trade-
related variables on inward FDI. These are:
exports of each member country of SAFTA to other
member countries as a group and
imports of each member country of SAFTA from other
member countries as a group.
Empirical Results
• Apart from Economic fundamentals, higher trade
openness attracts higher FDI.
• Lowering of Tariffs with respect to other SAFTA
member may explain 30% of the rise in inward
FDI.
• The imports of intermediate goods in the host
country have a significant impact on inward FDI.
SAFTA may therefore encourage vertically-
integrated FDI.
Trade in Services in South Asia
Composition of Trade in Services in
South Asia.
Since 2007 total exports of services have become higher
than the total imports of services in the region-mainly
due to India.
Almost all South Asian countries are net exporters of
communication services.
Travel services are found to be an important service in
terms of exports for almost all South Asian countries
(apart from Bangladesh and Pakistan).
All the South Asian countries are net importers of
transport services, with India being the biggest importer
followed by Pakistan.
India and Pakistan are also net importers of insurance,
financial and other business services.
Economic Rationale for Boosting Inter-
Regional Trade in Services in SAFTA
• South Asian countries have comparative advantages
in different services sectors.
In transport services, Pakistan and Sri Lanka have
competitive advantage.
India has a competitive advantage in construction
services, computer and information services and
other commercial services.
Maldives and Nepal are found to be more
competitive in travel services
Bangladesh has a higher competitive edge in
financial services.
Cultural and historical ties-trade in services easier.
Mode –Wise Competitiveness in
South Asia.
• Competitiveness in Mode 4 is strongest
• South Asian countries are labour abundant countries
• The region is one of the most important exporters of
services through the movement of natural persons (or
temporary migration of workers) - both high skilled and
low skilled (Mode 4 under GATS).
• In 2005, South Asia received US $ 32 billion as
remittances. Across all the countries, remittances
constitute between 2 to 12 percent of GDP with Nepal
receiving 12.1%, Sri Lanka 8.1% and Bangladesh 5.5%
of the GDP.
Need for Improving Inter-Regional
Trade in Mode 4
• At present, trade in Mode 4 is considerable small within
the region.
• Lack of Mutual Recognition Agreements (MRAs). But
considerable scope for MRAs within the region
• Five sectors have been identified by UNCTAD-ADB
study which have considerable scope for MRAs.
• These are: construction and related engineering
services, tourism and travel related services, higher
education services, telecommunication services and
health services,
Challenges in Liberalisation in Mode 3
• Provision of many services like transports, infrastructure,
etc has been under state monopolies for a long time in
South Asian countries and only in the last decade or so
privatization of these services has taken place. T
• This makes provision of services by foreign services
providers an extremely sensitive issue as it entails the
risk of eroding not so competitive domestic investments
in these services.
• Not being able to regulate the quality and prices of the
services provided.
• With FDI, another issue of concern is the impact on
employment in these sectors.
Other Reasons for remaining
restrictive on FDI in services
• Countries without the necessary regulatory framework
may lose by rushing into liberalization, particularly when
a reversal of the liberalization is hard to achieve or when
liberalization has “systemic implications”, as in the case
of the financial industry.
• Entry by large service TNCs involves competition policy
considerations, and many host countries may not feel
ready to deal with the technical and legal issues
involved.
• Further, it is difficult to assess the impact of liberalization
of a particular service sector, especially if it employs a
large number of unskilled people.
• Finally, it is frequently difficult to put in place domestic
regulations
Need to address these issues within the region.
Benefits from Liberalisation of Services
(Mode 3) under SAFTA
• Economies of scale if firms are able to set up
base in one country and provide services to
other countries in the region.
• For example, in higher education services,
intra-regional cooperation in movement of
students and professionals can attract renowned
universities and professional colleges to open
campuses in any one country in South Asia.
• India can be a hub for higher education and IT
services
• Lowers risk as compared to opening Mode 3
multilaterally.
Benefits from Liberalisation of Services
(Mode 3) under SAFTA
• This can provide an important learning to these countries
in terms of binding their commitments in GATS. For
example, opening up to the region i.e., in a limited way
initially, may help these countries to adjust their domestic
regulations in a way that assures better quality of
services provided at competent prices.
• Given the similar levels of structural development,
geographical proximity and cultural ties, it will be easier
for South Asian countries to negotiate MRAs in services
• The impact on the economy in terms of employment and
prices can also be examined before any commitment is
undertaken in GATS.
Benefits from Liberalisation of
services under SAFTA
• Finally, regional cooperation in services can lead to
“flying geese” phenomenon in South Asia where
countries specialize in different stage of value-chain and
in the process exports of all concerned countries rise
along with the specialization of the region.
• Such a value chain can be formed in information and
technology enabled services (ITES) like BPO and
outsourcing with countries like Bangladesh, Sri Lanka,
Pakistan and India specializing in different ends of the
value-chain.
• Land-locked countries like Nepal and Bhutan, can also
be tapped in future to include them in this process.
Domestic Regulations needed
• It may also lead to higher prices of services that were
earlier available at a subsidized rate under public-private
ownership.
• These rises in prices may translate into higher
inflationary pressures reducing the overall welfare of the
economies.
• To circumvent such spirals it is important for the region
to have appropriate domestic regulations in place, which
will assure better quality of services at affordable prices.
• Clear domestic regulations will also increase the
transparency in the system and encourage foreign direct
investments.
• Over-regulations need to be avoided in sectors where
FDI is required, i.e., where domestic service-providers
do not have the capability and capacity to fulfill excess
demand,
Role of India in Regional
Integration
• Experience so far highlights the dominant
role played by India in the region in terms
of both trade and investments.
• India is the largest investor in the region
and has the largest share in intra-regional
exports.
• It receives the largest inflow under Mode 4
within the region
• India’s dominant role has led to increased
resilience of the region towards external
shocks, e.g., global economic crisis.
• In 2009, FDI inflows to the region did not decline (till
March 2009); mainly because of India. FDI rose in 2008
as compared to 2007 in –Pakistan, Bangladesh and Sri
Lanka.
• Large potential of forming supply chains in
Textiles and Textile Products, Auto
components and Leather products within
the region.
India’s role in Regional Integration in
Services
• Such a value chain can be formed in
information and technology enabled
services (ITES) like BPO and outsourcing
with countries like Bangladesh, Sri Lanka,
Pakistan and India specializing in different
ends of the value-chain.
• Land-locked countries like Nepal and
Bhutan, can also be tapped in future to
include them in this process.
But can India act as the “Flying
Geese” of the region given the
political situation is a ?
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