The South Asian free trade area : an analysis of policy options for Sri Lanka

Abstract

South Asia was slow to take up the issues of regional economic cooperation, although SAARC was established in 1985 and the creation of the SAFTA remains a widely discussed policy issue in this region. Recently, there has been a proposal, mainly from the business community, to initiate bilateral free trade agreements among the SAARC member countries, particularly with India. In the case of Sri Lanka, for example, its support for the SAFTA was prompted largely by the desire to gain access to the Indian market, an objective which was already achieved under the ILFTA. There is also a proposal to enter into a bilateral trade agreement with Bangladesh. Hence, the benefits that Sri Lanka could gain as a member of the SAFTA is considered as a debatable policy issue. This study compares the impacts of different trade policy options on Sri Lanka using GTAP Version 6 (Database 2001) to determine the impacts on output, employment, welfare and trade. The simulation results indicated that the multilateral trade liberalization is the best trade policy outcome for the Sri Lankan economy. The South Asian Customs Union ensures the next highest welfare for Sri Lanka, followed in order by the SAFTA and the ILFTA. However, the proposed Sri Lanka-Bangladesh FTA cid not reflect significant welfare gains to both trading partners. Furthermore, it was determined that the SAFTA can be formed without having significant trade diversion effects. Moreover, from the results, it was revealed that Sri Lanka's manufacturing sector is benefiting more than the agricultural sector under all of the trade liberalization scenarios. Therefore, the study recommended among different trade policy options under the regionalistic approach that Sri Lanka should instead focus on implementing the SAFTA, as the SAFTA ensures the highest welfare to Sri Lanka among the regional trade policy options considered in the study. In addition, the ILFTA can also be continued to strengthen the SAFTA. The next stage of the SAFTA is transforming the SAFTA into South Asian Customs Union, which is already a component of the agreement. However, this trade policy option is to be negotiated. Finally, it could be appeared that the SAFTA needs still to find its linkages to the multilateral trade liberalization.