Sri Lanka’s absence from Asia’s big FTA game

Article originally appeared on Sunday Times

Sri Lanka is pursuing a more proactive free trade agreement (FTA) strategy to reduce trade barriers with major Asian economies. FTA negotiations are on-going with China, India, Singapore and there is talk of FTAs with Bangladesh and Thailand. However, Sri Lanka is absent from Asia’s big FTA game – the Regional Comprehensive Economic Partnership (RCEP).

Concerns about losing sectors and unemployment have made trade agreements unfashionable in the post global financial crisis era. Unilateral trade liberalisation has slowed. The WTO Doha Round has effectively ended after years of negotiations. The US has left the ambitious Trans-Pacific Partnership (TPP), signed early last year. Brexit has made EU trade uncertain.

Yet negotiations are proceeding in Asia on its own mega trade agreement – RCEP. While there have been some contentious issues during the negotiations and afterwards, an RCEP agreement could be reached by 2019, with significant economic implications for Sri Lanka and Asia. Some of the difficult issues in the talks include tariff elimination in sensitive goods sectors, non-tariff measures, and movement of skilled professionals.

Although many are pessimistic about trade policy outcomes, RCEP offers hope for continuing preferential trade liberalisation in Asia in challenging economic times.

Background

RCEP negotiations began in late 2012 in Cambodia. The end-2015 deadline for concluding the negotiations has passed but talks are intensifying following the TPP’s apparent demise. The 20th round of RCEP negotiations are in Songdo, Korea on October 17-28.

RCEP parties aim to achieve a modern and comprehensive trade agreement, and the agenda covers trade in goods, services, investment, economic and technical cooperation, and dispute settlement. Compatibility with WTO trade rules on goods and services is also a principle for RCEP negotiations. The RCEP is likely to be less ambitious than the TPP (with high standard trade rules geared more toward advanced economies), and the prospect of development assistance for adjustment means developing countries will find it easier to join.

The RCEP seeks to reconcile two long-standing proposals into a large, region-wide trade deal: the East Asian Free Trade Agreement, which includes the Association of Southeast Asian Nations (ASEAN), China, Japan, and Korea, and the Comprehensive Economic Partnership for East Asia, which adds Australia, India, and New Zealand. The RCEP bridges the two proposals by giving ASEAN a central role in coordinating regional trade, and adopting an open accession scheme.

Value of RCEP

The RCEP can help regionalise the sophisticated global value chains that make Asia the world’s factory. It will also reduce the overlap among Asian FTAs and the risk that Asia becomes a confusing ‘noodle bowl’ of multiple trade rules. If a comprehensive agreement can be reached, trade barriers in Asia will come down and the new rules will be consistent with WTO agreements. Rules of origin could be rationalised and made more flexible, and be better administered through electronic means. In investment rules, where no WTO agreement exists, RCEP will promote easier foreign direct investment (FDI) flows and technology transfers by multinational corporations.

Since RCEP will contain three of the largest economies in the world — China, India, and Japan—it is globally important. The RCEP bloc represents 49 per cent of the world’s population and accounts for 30 per cent of global GDP. It also makes up 29 per cent of global trade and 26 per cent of global FDI inflows. Our conservative estimates, using a computable general equilibrium model, suggest that if RCEP was implemented it would bring income gains to the world economy of at least US$260 billion within a decade. Other estimates suggest an even higher figure of around $600 billion. India – the only South Asian economy in RCEP – is projected to gain from the agreement, while outsiders to RCEP like Sri Lanka and the rest of South Asia would lose from trade diversion.

Potential drawbacks

However, there are some challenges to the RCEP negotiations and their aftermath.

First, smaller ASEAN economies may find it difficult to stay in the driving seat of RCEP amidst China’s economic dominance. Second, RCEP may only achieve limited trade and investment liberalisation if parties with different levels of development and interests negotiate exclusions to protect sensitive sectors. Third, there is a risk that businesses, particularly small and medium-sized enterprises (SMEs), may underuse the RCEP tariff preferences and other rules due to a limited understanding of its legal provisions. Fourth, many countries will find it difficult to finance physical infrastructure and improve trade facilitation so goods and services can be transported smoothly across RCEP member countries.

RCEP negotiations should focus on a template with the best features of existing Asian FTAs, including ASEAN+1 FTAs and the Korea-US FTA. On difficult issues, the minus-X formula should be used to permit an RCEP member to opt out of agreed commitments until it is ready. Afterwards, significant outreach and business services are needed for SMEs to lower the costs of using RCEP. Expanding the Asian Bond Market Initiative and supporting public–private partnerships can also help increase regional infrastructure financing.

Once RCEP is eventually in force, it is envisaged that new members may join the agreement and reap economic benefits. Joining RCEP offers Sri Lanka the prize of simultaneous access to an enormous regional market and dynamic Asian FDI. It is also arguably simpler to attain, and is less draining on Sri Lanka’s scarce negotiating capacity than separately negotiating bilateral FTAs with each of the sixteen members. Through its membership of the ASEAN Regional Forum, Sri Lanka is involved in informal multilateral discussions on security issues in Asia and the Pacific but not on economic issues. Observer status of ASEAN is an important first step in Sri Lanka’s quest for RCEP membership and should be pursued through enhanced diplomatic efforts with ASEAN economies. Furthermore, think tanks in Sri Lanka should study the economic effects of RCEP on Sri Lanka.

Dr Wignaraja is the Chair of the Global Economy program at the Lakshman Kadirgamar Institute.  He spoke at Advocata recently on export-led growth.