Working Paper
Indo-Sri Lanka Economic Cooperation

A substantially higher rate of growth of exports is crucial to ensure success of the major outward-oriented, 'market friendly' economic reforms being pursued in India and Sri Lanka. The international economic and trade environment, however, is far less conducive than before to achieve that objective. While efforts have to be made to increase the pace of exports to traditional markets, the two countries also need to look at the possibilities for development of new markets including the trade potential of the regional market. In this regard, Sri Lanka should focus to a much greater extent than before on ways to increase exports to India as the current economic reform process in India unfolds.The expansion of Indo-Sri Lanka trade is constrained by significant barriers to trade. These have been falling in both countries and have been reflected so far in a large increase in exports from India to Sri Lanka but not the other way. Barriers remain high in India, by far the largest economy in the region and the pivot around which a regional market could develop. Further declines in barriers to imports into India on a nondiscriminatory basis can be expected but will take time before they have a significant effect on exports from Sri Lanka to India. The growth of Indo-Sri Lanka trade could best be stimulated by a 'fast track' dismantling of barriers to trade with each other, but not necessarily with third countries, while pursuing the process of more general liberalization of trade on a non-discriminatory basis. Making trade freer between the two countries on a preferential basis could pave the way for the rest of the countries of the region to follow in developing a regional market, and obtaining benefits in terms of trade and economic growth.A reciprocal preferential scheme should be designed so as to have a substantial trade effect, and at the same time be consistent with the outward-oriented policies being pursued in the two countries. Bearing in mind these objectives, the following principles are suggested as a basis for intergovernmental consideration of a preferential arrangement between India and Sri Lanka:1. All trade should be included except for a small exclusion list of sensitive items.2. Non-tariff barriers such as prohibitions, quantitative restrictions and licensing should be abolished for trade with each other except for items on the exclusion list.3. Tariffs should be reduced across-the-board for all items.4. Tariff reduction should be based on the principle of equivalence of tariffs across the- board for all items except for those on the exclusion list. The level of tariffs should be the lower rate prevailing for each item in either country.5. Each country should give the other a minimum 30% preference for each product over third countries except where the non-discriminatory rate is zero.6. Deeper reductions in tariffs, over and above the rates derived on the basis of the equivalence principle and the preferential margin, should be permitted for selected items such as products of joint ventures, including specific consumer durables.7. Rules of origin for preferences to be granted on imports from each other should be liberal. A relatively low - 35% to 40% - cumulative value added test should apply for products to qualify for preferential treatment.8. The provisions of the reciprocal preferential scheme should be phased in automatically over a two to three year period.9. A dispute settlement mechanism should be established.10. The substantial Indian market should be perceived as the 'motor' to speed up the process of economic growth and expansion in the framework of the bilateral preferentia1 scheme.The success of a reciprocal preferential scheme for Sri Lanka will depend to a substantial extent on the flow of investment from India and third countries to Sri Lanka, to take advantage of the market openings in India following the adoption of the scheme. The scheme should be complemented by the removal of the restrictions in India to the flow of investment to Sri Lanka. Investment in joint ventures in Sri Lanka would be facilitated if a revolving fund, subscribed to by the two countries, and by third countries interested in promoting South Asian regional cooperation and integration in a practical manner, is established. The objective would be to facilitate sourcing within the two countries of a generous proportion of the capital goods requirements for joint ventures, and thereby promote regional trade and investment.