Sri Lanka & Bangladesh look east

Earlier this month, a senior government official in Sri Lanka stated that their application for membership to the RCEP (Regional Comprehensive Economic Partnership) was awaiting approval and that they were in discussion with the RCEP members as they evolved an accession mechanism for new members. Sri Lanka had formally conveyed its intent to join the 15-member mega-regional trade agreement in 2023. In addition, Sri Lanka signed a free-trade agreement (FTA) with Thailand in February this year. Clearly, the island economy is working on a growth strategy that emphasises outward orientation and integration with the East Asian regional/global value chain (RVC/GVC) hub.
 

This is a commendable policy response from an economy that is yet in the midst of economic recovery. It is also simultaneously revealing of a realisation, by Sri Lanka, of the imperatives for export diversification, given that their recent external debt crisis was partly due to the foreign exchange reserves being constrained by an extremely narrow range of exports in goods and services. These include apparel and textiles, primary commodities like tea and rubber, and in services, mainly tourism. In addition, Sri Lanka has been plagued by decreasing labour productivity, an ageing labour force, and increased out-migration of its declining young, working-age population. Backward integration with RVCs, which is invariably labour-intensive and promotes manufacturing specialisation and competitiveness, would therefore imply positive outcomes for both the labour force and industrial development in the country.
 

Another noteworthy aspect is Sri Lanka’s willingness to participate in deeper FTAs. While the RCEP includes World Trade Organization plus regulatory provisions in many areas, the coverage in the bilateral FTA with Thailand also extends to customs procedures, investment, and intellectual property rights in addition to substantial tariff liberalisation for both countries over a period of 15 years. These provisions, through their “lock-in” effect, will help push structural and regulatory policy reforms in Sri Lanka, thereby making it more attractive for investment by multinationals. The RCEP, in addition, offers common and cumulative rules of origin that are facilitative of GVC integration and will help Sri Lanka attract export-oriented foreign investment.  

 

In addition, Thailand brings to Sri Lanka the advantage of linkages with the Eastern Economic Corridor (EEC). The EEC, which is a Special Economic Zone (SEZ), is aimed at developing Thailand’s manufacturing capabilities in the high-tech sector and enabling an extension of trade and investment opportunities through RVCs and connectivity projects to the neighbouring Association of Southeast Asian Nations (Asean) and Asian economies. Linkages between Port City Colombo, also an SEZ, and the EEC to establish trade and logistics routes are already being explored. In this context, it is worth noting that Thailand, over the past couple of years, has been among the largest recipients in Asean of Chinese and Japanese investment, with the former particularly focused on the electric vehicle segment. Other Asean economies, like Malaysia, have also expressed a keen interest in facilitating their large corporations’ investment in Sri Lanka as well as offered support to Sri Lanka’s application to the RCEP. The FTA policy can, therefore, potentially help Sri Lanka consolidate its as yet fragile economic recovery.
 

Beyond potential benefits, Sri Lanka’s participation in the RCEP signals an important shift in the trade landscape in South Asia. Bangladesh too has indicated its interest in becoming a member of the mega-regional trade agreement. Smaller, regional economies are thus actively looking for alternative trade agreements and arrangements beyond South Asia. While it is well established that “persistent” and “anticipated” conflict has constrained both the South Asian Preferential Trade Arrangement (SAPTA) and the South Asian Free Trade Area (SAFTA) in promoting intra-regional trade in the region, thus far the bilateral trade treaties and agreements with India have provided positive alternatives in the smaller economies’ export strategy. These include the India-Sri Lanka FTA as also the long-standing, historical trade treaties with Bhutan and Nepal that have functioned like de facto FTAs. In addition, in 2008, India unilaterally offered the least developed countries (LDCs), including in South Asia, a Duty-Free and Tariff Preference scheme covering over 90 per cent of their total exports. Together these arrangements have given all South Asian economies, except Pakistan, preferential access to the Indian market.
 

However, after the pandemic and following the Ukraine crisis, smaller economies are realising that mere LDC preferential market access may not anymore be sufficient to secure for them manufacturing diversification and, hence, a long-term growth path for their economies. Bangladesh, which has also faced external sector vulnerabilities during this period, is scheduled to graduate out of its LDC status in 2026. They, therefore, recognise the necessity for infusing dynamism into their comparative advantage beyond the single sector focus, which has thus far been the source of their exports and economic growth. Furthermore, their traditional export markets, predominantly the European Union and United States, registered a slowdown in the recent past and are expected to recover at a slow to modest rate. East Asia, in contrast, has maintained its economic dynamism and is projected to continue to contribute strongly to global trade growth in the immediate and near future. 
 

The other potentially significant implication of smaller South Asian economies looking eastward through bilateral and mega-regional trade agreements is the likely perpetuation of an evolving trend, that is, an increasing share of China in their global trade. Accounting for almost a quarter of their imports from the world, China already has a significantly higher share in the imports of both Bangladesh and Sri Lanka than India does. China’s share in Sri Lanka’s imports has increased by almost four times over the last decade while India’s has been almost stagnant. In the case of Bangladesh, even though India’s share in its imports increased in the last decade, it remains significantly lower than that of China (see table). As for exports, though India’s share is higher than China’s for both Bangladesh and Sri Lanka, their integration with the East Asian RVCs may well alter this trend in favour of China.
 

Hence, the shifting sands of the South Asian trade landscape may be worthy of some serious reflection for India’s regional trade strategy.

The writer is senior fellow, CSEP, professor, SIS, JNU (on leave) and author of India’s Trade Policy in the 21st Century, Routledge: London, 2022 and Regional Economic Integration in South Asia: trapped in Conflict?, Routledge: London, 2013. The views are personal