Trade and Investments in South Asia Opportunities and

Trade and Investments in South Asia: Opportunities and Challenges Saman Kelegama Institute of Policy Studies of Sri Lanka SAFA Conference 2016, Lahore, 30 January 2016

Outline of Presentation Growing Trade, Investments and Global Integration Challenges still Remain Trade and Investments – Opportunities Trade and Investments -- Impediments Trade and Investments – Challenges Way Forward

Growing Trade, Investments and Global Integration Recent developments in South Asian countries (SACs) – the reemergence of democratic governments, new growth momentum despite the global economic downturn and greater openness – warrant a fresh look at the region’s prospects for further liberalization SA is currently the 2 nd fastest-growing region in the world – GDP in SACs has grown strongly at about 6% since the 1990 s, and almost 7% in during 2004 -2009 and around 6% in the post-2009 period This higher growth trend is directly attributable to the opening up of the economies among other factors Trade and investment reforms implemented since the 1980 s & 1990 s have increased the region’s level of global integration: trade and FDI have grown consistently since then Since opening up, trade dependence ratio of all SACs have increased and shown an increasing trend over the years, and all SACs have shown high growth of exports and imports

Substantial Challenges Still Remain While the advent of globalization has ushered in a new era of economic growth and development in SA, the region remains mired in highly uneven and polarized growth patterns Poverty remains a big challenge for the region – the incidence of poverty is still high and the absolute number of people living below the poverty line has actually increased Low intra-regional trade between SACs has been a constant concern at less than 6% of SA’s total trade with the world, compared to 52% in East Asia and the Pacific, 17% in Latin America and Caribbean and 11% in Sub-Saharan Africa (ADB 2009) Cross-border trade in services remains low and so is investment -negligible at around 1 % In the context of the current economic slowdown in industrialized countries, the case for stronger regional ties becomes all the more important

Opportunities

Trade in Goods SACs trade with the rest of the world has been growing Intra-regional trade is at US$ 20 bn and amounts to 5. 8% of South Asian global trade, but this figure may be close to US$ 45 bn if the informal trade taking place in the region (estimated at US$ 25 bn, RIS, 2015) is also taken into account South Asian informal trade has been growing at 112% between 2005 and 2012 (RIS, 2015) With a growing youth bulge and increasing middle class consumers in the SACs, the demand for intra-regional trade will be more in the coming years Agriculture and industry still paly a vital role in SACs and these two sectors can play a vital role in stimulating regional trade

Exceptional Growth of Trade in Services Trade in services and investment flows have been the key drivers of many economies in recent decades – services have become the single largest sector in many economies The 'new economy' of the 21 st century refers to a services-based economy and SACs are no exception, with over 50% of GDP in many SACs Growing contribution of services to region’s trade basket and high growth of services exports: Consistent increase in SA’s share in world services trade over the last 15 years SA trade in services during the last two decades have been growing faster than trade in goods Although SA accounts for only 3% of world services exports, its services exports have grown more rapidly than world services exports since 1993 The region’s RCA in services has risen steadily and improved over RCA in merchandise trade

Exceptional Growth of Trade in Services Growth Rate of Services and Merchandise Trade in South Asia Average Annual Growth Rate (%) 30 25 20 Services 15 Merchandise 10 5 0 1991 -2000 Source: World Bank (2008) 1991 -2006 2001 -06

Emerging Patterns of Comparative Advantage and Complementarity in Services Category of Services Sector Countries with Revealed Comparative Advantage (RCA>1) Labour and resource intensive Transport India, Pakistan Labour and resource intensive Travel Maldives, Nepal Labour intensive Construction India, Bangladesh Skill and technology intensive Communications Bangladesh, India, Nepal, Pakistan, Sri Lanka Skill and technology intensive Computer and information services India, Sri Lanka Skill and technology intensive Financial and insurance services India, Pakistan Notes: Considers average RCA (31) for the period 2000 to 2006 Source: RIS (2008)

India’s emergence as a Global ICT Outsourcing Hub India has emerged as a global hub for outsourcing of ICT software and BPO services –exports of these services totaled $ 65 bn in 2014 -15 In terms of the Global Services Location Index complied by A. T. Kearney, India has continued to occupy the 1 st rank among different countries since 2004 In 2007, Sri Lanka and Pakistan were also included for the 1 st time in recognition of their potential for location of services, and rank at 21 and 28 respectively in 2011 The emergence of India as a major hub for exports of software and BPO services generates opportunities for other SACs in expanding their exports of these services Thus, a strategy of regional economic integration and enterprise cooperation across SA may assist the other SACs to benefit from a ‘flying geese’ model from the success story of India in IT services

Complementarities in services trade between SACs While India leads the region in ‘modern’ or sophisticated services (ITES, BPO etc. ), other SACs specialize in ‘traditional’ services, such as travel and transport Trade in services within the region is thus more balanced with smaller and poorer economies generally enjoying surpluses with larger economies, thereby helping to bridge asymmetries that exist in trade in goods in the region There are other areas like maritime transport, tourism, and energy services where SA has export potential owing to factors such as geography, history, and natural resource endowments: Bangladesh has huge reserves of natural gas, with potential to export to other countries in the region through cross border supply; Paksiatn can be a conduit for a gas pipeline from Central Asia SL has potential in shipping and port services, given its geographic location India & SL have considerable scope to export travel & tourism services, given their rich cultural, natural, and historical heritage

Remittances SACs are labour abundant countries, and consequently the region is one of the most important exporters of services through the natural movement of persons – both high-skilled and low-skilled The relative significance of trade in services via Mode 4 is also evident from the large volume of inflow of remittances received by SACs – the largest global recipient of overseas remittances is India Official remittance flows to SA have been rising continuously over the past 2 decades from US$ 5. 6 bn (1. 4% of GDP) in 1990 to US$ 81. 2 bn in 2010 (8. 8% of GDP) to US$ 118 bn in 2014 (9. 3 % of GDP) Remittances are the largest source of external fund flows in SA – in 2006, they were almost as twice as large as private debt and portfolio equity, 3 times as large as FDI and 7 times as large as official development assistance – this trend continued till about 2014 Compared to other regions, remittances in SA are a far more important form of external fund flows than FDI

Investments in South Asia: Opportunities Services such as telecommunications, banking, energy, transport, and software services are among the main drivers of FDI in the region Recent years have seen a rise of FDI in SA – FDI inflows to SA have increased by nearly 8 times between 1996 and 2006 and by 4 times between 2007 and 2014 (Out of US$ 41 bn FDI to South Asia in 2014, US$ 34 bn went to India) However, despite these trends, the share of SA in world FDI remains at less than 2% of world FDI inflows Also, post-2008 has seen a decline in FDI, following the global economic downturn – highlights need for intra-regional FDI As in the case of exports, India is the most important player in driving FDI flows in services in SA Outward FDI from India increased from US $ 5 bn in 2005/06 to US $ 12. 8 bn in 2006/07 to US$ 38 in 2013/14 but less than 10% of this has gone to SACs

Investment Opportunities Cont. India’s Investment Boom Indian outward FDI has been generally directed towards developed economies, yet neighbouring SACs are increasingly looking to India as a source of FDI : In Nepal and Bhutan, India is the predominant source of FDI - over 100 Indian joint ventures currently operate in Nepal, accounting for 36 -40% of its total FDI It has also emerged as the largest investor in Sri Lanka and many Indian companies are also involved in the IT and ready-made garments sectors in Bangladesh Indian companies are also involved in cross-border FDI e. g. Tata purchasing Tetly, Tata Motors purchasing Jaguar/Land Rover, Tata Steel purchasing Corus, Hindalco-Novelis India has invested in hydro projects in Bhutan and buys back the electricity, and has played an important role in infrastructure development in Nepal

Impediments

Persistent Barriers to Trade Despite reductions in tariff rates, nontariff barriers (NTBs) are still significant, and are currently increasing their shares in total trade costs in the region Trade facilitation has become the leading NTB that reduces intraregional trade in SA: Airports and maritime ports in SA are less advanced than those in China and other countries in East Asia Weak land networks across national borders also pose a formidable barrier to trade in SA, particularly for the landlocked countries poor roads lengthen transportation time and reduce the longevity of vehicles, imposing higher per unit costs for cargo According to a World Bank study the costs of trading across borders in SA are among the highest in the world SA is also characterized by inefficient and complicated administrative procedures and lack of transparency in inspection and documentation requirements

Constraints from Domestic Regulation Domestic regulation is a critical issue for developing countries – SA has historically been plagued by over-regulation Numerous external & domestic regulatory barriers to SA’s services exports exist in Mode 4 and Mode 3 immigration and labour market regulations and recognition requirements lack of uniformity in training and standards within the countries leading to deficiencies and considerable divergence in the quality of service providers policies towards foreign commercial presence or presence of foreign service suppliers remain restrictive However, regulation is important, particularly in the services sector where the “good” cannot be inspected prior to consumption Thus what is required for liberalization is an effective but uncumbersome regulatory regime

Barriers to Investment in South Asia SA’s share in world FDI continues to be low mainly owing to: The relatively small size of individual country markets The relative failure of regional integration efforts in unifying these markets by removing border and behind-the-border impediments and weaknesses Studies have shown that a country’s business environment and institutional quality are equally, if not more, important for FDI than low wages or concessions for investments - however, the regional investment climate is far from satisfactory: SACs are considered among the least competitive in the world – The GCI (2011 -12) ranks these countries, except two countries, near the bottom in the set of 142 countries that were considered SA remains relatively more difficult to conduct business compared to other regions in the world – according to Doing Business Indicators (WB 2011), SA is the 2 nd hardest region to do business

Infrastructure and Manpower Constraints In order for trade and investments to develop, countries need an appropriate infrastructure, including education, telecommunication, aviation & connectivity Significant in the context of outsourcing (Mode 1 exports): Physical infrastructure constraints – underdeveloped telecommunications infrastructure, slow network connectivity, insufficient bandwidth, high connectivity costs, and erratic power supply Human resource constraints – lack of adequately trained & quality manpower, low levels of computer literacy, high turnover rates, absence of required language abilities & other specialized skills Infrastructure development also important in creating supply capacities in relatively lesser developed members, leading to more balanced regional development

Facing the Challenge

Slow Progress in SAFTA has proved to be a slow process vulnerable to regional politics The imbalance of power among member states has resulted in India being perceived as a risk to security and a source of possible economic domination These regional dynamics have stunted trade and cooperation by making the progress of regional cooperation dependent upon the status of relations among member states, rather than on economic opportunities Further progress in integration and expanding trade will thus be contingent upon erasing the “trust deficit” that exists and creating improved relations among member states Also, SAARC decisions are not properly implemented and a majority of the South Asian people is yet to feel the impact of SAARC cooperation Less binding commitments, thus commitments are most often not implemented With Global Value Chains increasingly determining trade, reducing tariffs in the region has become vital for SACs integration process both to the world and in the region

Slow Progress of SATIS Although SATIS came into operation in 2010, the submission of “offer” and “request” list for preferential liberalization is very slow Even in some of the “offers” they are not GATS-Plus Afghanistan and Bhutan not being members of the WTO are take considerable time for submission Some countries are reluctant to open up services until fixing the regulatory framework ASEAN has made many advances in services liberalization With increasing “servicification’ of the manufacturing sector (services value added accounts for 26% of manufacturing in developing countries), services liberalization is important for SAC competitiveness

Investment Challenge Efficiency-seeking industrial restructuring in the region is at a very low level and this is seen from IIT indices estimated in various studies Joint ventures with buy-back arrangements and subcontracting activities at a low level in the region Verticle and horizontal integration of industries is important for investment to drive trade and the tradeinvestment nexus to drive intra-regional trade ASEAN Investment Area, ASEAN Industrial Cooperation, etc. , are partly based on this ideas and SAARC Investment Area yet to come into operation SAARC Investment Protection and Promotion Agreement has not been signed due to minor points

Way Forward Moving forward as a region calls for making the best use of opportunities to overcome challenges For SA, this can be best realized by exploiting the immense potential for regional integration – and its subsequent trade, investment, and growth opportunities – which to date remains untapped Promoting greater regionalism is crucial in addressing challenges, as this creates opportunities to harness the spillover benefits of India’s growth success Regional trade agreements are more viable as economies are on a levelplaying field and are more likely to have economic complementarity – already evident in SA especially in services trade Given its economic power, India will have to take on a disproportionately larger responsibility for promoting regional cooperation in SA Yet, regional integration will not be achieved by India’s unilateral actions alone – other SACs will have to respond positively to Indian initiatives for successful regional integration

Thank you