Kath Noble

What India really wants

Posted in The Island by kathnoble on August 15, 2012

Assessing the resurrection of the Comprehensive Economic Partnership Agreement

While Tamil Nadu is fixated with the politics of India’s relationship with Sri Lanka, as was amply demonstrated by the hullabaloo over the conference of the Tamil Eelam Supporters’ Organisation in Chennai on August 12th, the rest of the country has been focusing on rather different issues.

The August 2nd to 5th visit to Colombo of Union Commerce Minister Anand Sharma brought with it announcements of several major developments on the economic front. He spoke of doubling bilateral trade to $10 billion per year by 2015, plus a considerable increase in investment and the resumption of negotiations on the much-postponed CEPA. Meanwhile, a 20-member delegation of India’s top business leaders were holding talks with their Sri Lankan counterparts, and more than 100 companies were showing off their wares at the India Show organised by the Confederation of Indian Industry at BMICH.

Of course, economics is not apolitical. Indeed, making the Sri Lankan economy more dependent on India has often been suggested by Indian analysts as a means by which New Delhi can acquire greater leverage over the Government.

However, Sri Lanka is already economically vulnerable, with around 60% of its exports going to the West. We have seen the follies of such dependence in the last few years as demand from Western countries has fallen with the Global Financial Crisis and subsequent recession. And during the war, we saw the potential political impact when trade preferences under their GSP schemes came up for renewal – both the European Union and the United States attempted to use the opportunity to push for their preferred policies, never mind what the Sri Lankan public wanted. A more balanced export profile would reduce these problems. Anyway, only 15% of Sri Lankan exports go to Asia, and with the region likely to continue growing faster than Western nations for decades to come, Sri Lanka really ought to be thinking about where it wants its markets to be.

India’s desire to increase Sri Lanka’s dependence on its economy may be motivated by other concerns, but that doesn’t mean increased Indian involvement is a bad thing. The Government just has to be careful.

To that end, let us look at a few concerns with the Indian proposals.

First and foremost, the CEPA is being sold to the Sri Lankan public using exactly the same rhetoric as was employed for the FTA. It is described as a wonderful opportunity for Sri Lanka to access the huge Indian market, with absolutely no danger of huge Indian companies swamping their Sri Lankan counterparts since India is not asking for reciprocity.

Who do they think they are kidding? The FTA was driven not by any desire on the part of India to help its neighbour but by the interests of the Indian business class, who had precisely two objectives – exporting more of their goods to Sri Lanka without paying tax and thus increasing their profits and increasing their profits by avoiding tax on their imports to India by diverting them through Sri Lanka.

Officials present the considerable increase in trade between the two countries since the entry into force of the FTA as undeniable proof of its success. However, this is far too simplistic. For a start, while Indian exports to Sri Lanka have been increasing steadily throughout, Sri Lankan exports have followed a rather different trajectory – going up rapidly at first, then from 2005/6 gradually falling back. More crucially, the increase in Sri Lankan exports was largely in goods in which Sri Lanka is not competitive globally, and the trade proved unsustainable.

In 2005/6, more than 50% of Sri Lankan exports to India were of just two items – copper products and animal and vegetable oils – which is rather surprising, given that Sri Lanka doesn’t produce the necessary raw materials.

In fact, the raw materials come from ASEAN, and they were heavily taxed by India at the time of the signing of the FTA. Sri Lanka, on the other hand, applied low tariffs, due to its earlier and deeper liberalisation – starting in 1977 rather than 1991 in India – and the fact that it offers incentives to foreign investors enabling them to import inputs for goods to be manufactured for export without paying tax at all, plus tax holidays for operations in Free Trade Zones. Indian businessmen promptly invested in a number of processing units in Sri Lanka. However, in the end this led to trade disputes, following which Sri Lanka had to introduce various limits on its exports to India, and finally in 2010 an FTA between India and ASEAN came into effect. The tariff difference disappeared, and Sri Lankan exports of copper products and animal and vegetable oils fell almost to zero.

We cannot say this trade was definitively a bad thing, since India’s exports to Sri Lanka would have grown even without the FTA – more than 50% are either petroleum products, vehicles or iron and steel, which are all excluded from the agreement. The trade reduced Sri Lanka’s problem with its balance of payments.

However, it is silly to suggest that it proves how good liberalisation was and will be for evermore, as officials do. After all, the trade didn’t go on for long – the few Sri Lankans who found jobs in Indian-owned factories lost them after a while, and the factories themselves are now unused and indeed useless.

The question for Sri Lanka is what to replace it with.

As usual, India seems to have the answer. This is the second major concern.

The CEPA is another of India’s babies. The expansion of the FTA to include not just trade in goods but also trade in services and investment is its much-cherished and long-awaited next step in its bilateral relationship with Sri Lanka. India is Sri Lanka’s number one investor. Also, services are its fastest growing export. The Indian business class wants more security for its investments in Sri Lanka and more opportunities to sell not just its goods but also its services – energy and education (hence the Government’s mysterious determination to push forward with the Private Universities Bill?) have been mentioned as priorities.

The major stumbling block has been Sri Lankan business, a section of which has been vigorously opposing the CEPA ever since it was first proposed, coincidentally or otherwise in 2005/6.

However, last week it was reported that the Chairman of Laugfs Holdings, who was one of the businessmen professing to be so worried about Sri Lanka being swamped by huge Indian companies if the CEPA were signed, is now quite keen on the idea. What changed? India has promised to bring Sri Lankan businessmen into joint ventures in services and also into the Indian manufacturing production chain. There are plans to set up Special Economic Zones, one in Trincomalee to make parts for vehicles and other engineering goods, and another somewhere yet to be decided to produce pharmaceuticals – a delegation to discuss the modalities was expected in Colombo on August 14th.

This could well be good for Sri Lanka. At least, it will add to capacity in both manufacturing and services and hopefully support exports, including to India, improving the ever-worrisome balance of payments. There will also be employment.

India has claimed that it is not seeking tax holidays in the Special Economic Zones (the Government may still give them, willing as it always seems to be to forego revenue!), arguing that the provision of land is incentive enough. They are quite right. The biggest problem the Indian business class faces at home is finding a place to set up their operations – there are regular and very serious agitations by farmers and tribal communities over land acquisition, with particularly intense conflict over Special Economic Zones.

Will the Sri Lankan public be overall winners or losers if this really is a quid pro quo for the CEPA? That is anybody’s guess.

Economics and politics are difficult to assess without information, and negotiations between the two countries are kept secret. Even documents that commit Sri Lanka to a particular course of action for generations to come are not shared before they are signed – sometimes they aren’t shared afterwards either. This means that vital details are often only discovered when it is too late. For example, while a phrase like investment protection seems quite harmless, in some cases protecting investments from expropriation has been interpreted by courts to mean that companies have to be compensated for any action that reduces their profits, even a general increase in the tax rate. A lot depends on the wording.

Indians have much more experience in this area, so it might be a good idea for Sri Lanka to spend a bit more time studying and a bit less time burning effigies of Karunanidhi.

This article was published in the Midweek Review on 15th August 2012. The internet version can be accessed here.

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