Preferential Trading in South Asia

This paper examines the economic case for the South Asia Free Trade Area (SAFTA) Agreement signed on January 6 th, 2004 by India, Pakistan, Bangladesh, Sri Lanka, Nepal, Bhutan, and the Maldives. It starts with a detailed analysis of the preferential trading arrangements in South Asia to look at the region's experience to date and to draw lessons. Specifically, the study examines the most effective free trade area in existence, i.e., the India-Sri Lanka Free Trade Area, and evaluates the developments under the South Asian Preferential Trade Area (SAPTA). The paper concludes that, considered in isolation, the economic case for SAFTA is quite weak. When compared with the rest of the world, the region is tiny both in terms of economic size as measured by GDP (and per capita incomes) and the share in the world trade. It is argued that prima facie, these facts make it likely that trade diversion would be dominant as a result of SAFTA. This point is reinforced by the presence of high levels of protection in the region and the tendency of the member countries to establish highly restrictive 'sectoral exceptions/sensitive lists' and stringent 'rules of origin'. We argue that SAFTA makes sense only in the context of a much broader strategy of creating a larger preferential trade area in the region that specifically would encompass China and the member nations of the Association of South East Asian Nations. In turn, the case for the latter is strategic: the pursuit of regionalism in the Americas and Europe has created increasing discrimination against Asian exports to those regions, which must inevitably impact the region's terms of trade adversely. An Asian bloc could be a potential instrument of changing incentives for the trade blocs in the Americas and Europe and forcing multilateral freeing of trade. Assuming that the SAFTA Agreement is here to stay, the paper also suggests steps to ensure that the Agreement can be made more effective in promoting intra-regional trade, while minimizing the likely trade-diversion costs and maximizing the potential benefits.