INDO-LANKA FREE TRADE AGREEMENT, THREE YEARS

UNCLAS SECTION 01 OF 02 COLOMBO 000772 SIPDIS STATE PLEASE PASS TO USTR E.O 12958:N/A TAGS: ETRD ECON CE USTR ECONOMICS SUBJECT: INDO-LANKA FREE TRADE AGREEMENT, THREE YEARS ON REF: (a) 01 Colombo 00872 (b) 00 Colombo 00354 ¶1. Summary: The Indo-Lanka free trade agreement (ILFTA) completed three years of operation in March ¶2003. Trade between India and Sri Lanka increased sharply in 2002. India now offers zero tariffs on 4,150 items exported from Sri Lanka. Several mid- sized Indian companies have set up operations in Sri Lanka taking advantage of the agreement. Investors from other countries are also expected to take advantage of the ILFTA. The free trade agreement offers Sri Lanka an opportunity to become a regional trading hub. End Summary. Trade liberalization -------------- ¶2. The Indo-Lanka free trade agreement is the first bi-lateral free trade agreement signed by Sri Lanka. Under the agreement, India has gradually phased out tariffs for imports from Sri Lanka, except on 429 items under a negative list, and tea, garments, and textiles under quotas and/or preferential duties. The most recent liberalization was in March 2003, when India removed tariffs on 2,799 items. Consequently, 4,150 items from Sri Lanka are duty free to India from March 2003. In turn, Sri Lanka has offered 100% duty concessions on about 1,100 items. The import duty on balance items will be phased out by 2008 except on 1,180 items on Sri Lanka's negative list. Since June 2002, a joint Ministerial Committee (JMC) meeting is held annually to discuss further liberalization. Many implementation problems were discussed at the first JMC meeting held last June. Sri Lanka's key tea and garment sectors continue to ask for more leeway under the agreement as they are currently subject to quotas and restrictions on ports of entry. According to the Department of Commerce here, the next meeting of the JMC is scheduled for June 2003 and is expected to discuss services for the first time, although no specific goals have been set yet. Increasing trade -------------- ¶3. During the past three years two-way trade of goods between India and Sri Lanka has almost doubled increasing to $1 billion in 2002, from about $560 million in 1999. Much of the increase is attributed to imports from India to Sri Lanka. In 2002, imports from India increased by 40% to $835 million. India is Sri Lanka's number one import market, with a 14% share; imported items include a wide variety of industrial goods and food items, some of which receive duty concessions under the ILFTA. Significantly, the agreement has allowed Sri Lanka to source a substantial amount of its imports from India, which is a cheaper supplier than Sri Lanka's usual import markets in South East Asia. ¶4. On the export side, Sri Lanka's exports to India increased substantially to $170 million in 2002 from $70 million in 2001, but India still accounts for less than 4% of total Sri Lankan exports. Currently, 4,150 items from Sri Lanka are eligible for duty free entry to India, subject to 35% value addition in Sri Lanka. Main items exported from Sri Lanka under the ILFTA are copper and copper wire and rods, spices, clothing accessories, furniture and fittings, tires and tea. Sri Lanka's two main exports, tea and garments, have quota restrictions under the ILFTA. They receive duty concessions ranging from 50% to 75%. Sri Lankan exports to India are expected to grow further this year following duty concessions offered by India in March 2003. Investment -------------- ¶5. According to the Board of Investment of Sri Lanka (BOI),since the implementation of the ILFTA in 2000, 73 Indian companies, with a total investment commitment of Rs 36 billion ($400 million) have sought to invest in Sri Lanka. According to BOI, 42 of these companies have signed agreements, with 20 projects already in commercial operation. Other projects are awaiting approval. Most of the Indian FDI has been by small and medium scale industrialists and has been in the industrial sector (metal-based projects, industrial chemicals, rubber products, and electrical wire and bulbs). Some of the companies have found it more economical to serve South India from Sri Lanka than from other parts of India. A few Sri Lankan companies have also expanded their investments in order to export to India. These products include plastic furniture, aluminum wire, biscuits and roofing sheets. ¶6. Sri Lanka is also expecting to attract third country investment with intentions to exploit the Indian market via Sri Lanka. Already a few foreign companies have built plants here to export to India. The largest is a $20 million investment by a Malaysian company exporting medium density fiber (MDF) board. Meanwhile, a high-tech US company is considering a proposal to assemble telecom parts in Sri Lanka for export to India. This product, which carries a MFN duty of 35% in India, can be exported duty free from Sri Lanka. BOI promotion officers told the Embassy that they are pursuing plans to promote Sri Lanka through the ILFTA to select U.S. companies. Sri Lanka as a regional hub -------------- ¶7. Sri Lanka's strategic location in the Indian ocean near the shipping lanes connecting east and west, its close proximity to Indian subcontinent and its largely liberalized trade regime together make it an ideal location for a regional hub in South Asia. The ILFTA links Sri Lanka to the large Indian market with a population of over one billion people. In addition, Sri Lanka is negotiating a free trade agreement with Pakistan (population 150 million) and also plans to discuss a FTA with Bangladesh. Further, the Government's latest economic policy document "Regaining Sri Lanka" states that the Government will seek to develop new markets through bilateral and regional trading agreements with additional countries. In addition to benefits accrued through these trade pacts, companies setting up in Sri Lanka can import raw materials duty free, obtain tax holidays and have access to an educated, easily trainable workforce. ¶8. In order to meet hub status, Sri Lanka is in the early stages of planning to upgrade its infrastructure. Among the plans are major expansions to the international airport and the Colombo port. In addition, there are plans to build a new port in Hambantota in the southern province. Preliminary studies to build a land bridge between India and Sri Lanka have been completed. Comment -------------- ¶9. The ILFTA is not perfect, and far from what the US would consider a gold-standard FTA. Still, it is an important start in a region where, with the exception of Sri Lanka, tariffs remain among the highest in the world. As SAARC's efforts to stimulate regional trade remain stalled, Sri Lanka is assembling an apparatus of FTAs that will allow it to function as a trading hub for South Asia. This island of 20 million people may be South Asia's best shot at increasing intra- regional trade flows - and the outside world's best shot at penetrating the largely closed South Asian market. Wills