Top economist explains strong rationale behind FTAs | Sunday Observer

Top economist explains strong rationale behind FTAs

As Sri Lanka’s current model of relying on debt-creating foreign inflows to fund investment is unsustainable, there is a definite need to engage in comprehensive Free Trade Agreements (FTAs) in the region in order to tap into new sources of export growth and attract investments, opines a top economist.

Addressing a panel discussion on the impact of FTAs on the Sri Lankan economy on Friday, Economist and Adviser to the Ministry of Finance, Deshal de Mel said that unilateral trade liberalisation plays a major role in reducing costs to consumers and improving competitiveness of the economy while enabling Sri Lanka to gain access to regional value chains to kick start export growth.

Non-tradable large sectors

“If you look at Sri Lanka’s economy in the last few decades, our economy has been largely driven by four or five domestic-oriented and non-tradable large sectors, like banking and finance, domestic transportation and domestic retail. However, a lot of the funding or investment sources for these sectors have come from external sources,” said de Mel.

He noted that although the country has been able to comfortably rely on concessional foreign borrowings to fund domestic investments in the last few decades, this phenomenon has considerably changed from 2007 as the island crossed the US$ 2,000 per capita GDP limit.

“If you look back, more than 80% of our loans were from agencies like the Asian Development Bank and World Bank whose annual repayments were easy to manage as the tenure was about 30 years and interest rates were very low, around 1 or 2 %. However, in the last decade or so we had to rely on sovereign bonds and syndicated loans to finance our development activities,” de Mel pointed out.

A different strategy

Therefore, Sri Lanka’s growth was somewhat stifled in the last decade because while the country’s debt servicing increased significantly (due to growth being driven by the domestic economy), Sri Lanka also did not simultaneously witness a significant increase in exports, Foreign Direct Investments (FDI) and other sources of foreign inflows. Hence, it is clear that Sri Lanka needs to have a different strategy in terms of driving exports, FDIs and tourism, he said.

“If you look at the way Sri Lanka’s exports basket is structured, it is pretty much exactly the same today as it was three decades ago. At present 45% of our exports are from apparel and about 15% from tea comprising of about 60% from two products similar to the 1990s.

“On the other hand, today around 60% of our exports go in combination to the United States and the European Union. Again, it is exactly the same like in the 1990s. So, we have a problem of a limited diversification of our export basket and limited diversification of our export market,” the Economist who was previously attached to Hayleys Group PLC said.

He highlighted that while Sri Lanka was dependent on the Western economies for exports, economic growth in the economies of Europe and the United States during the last decade, have however been significantly less than the rest of the world.

Dynamism in economy from Asia

“The real dynamism in the economy has been coming out of Asia. So it is clear that we need re-align our strategy to greater exposure to other regions such as Association of Southeast Asian Nations (ASEAN) and East Asia in particular while expanding our export product basket to those with higher value and technology,” de Mel, who obtained his secondary education at the London School of Economics and the University of Oxford, said.

Pointing out that global trade has emerged in the last couple of decades in a way where people no longer trade in finished products the majority of global trade today, is driven by trading in intermediate products, he said.

“The phenomenon of the pre-1990s, where people do the entire manufacturing value chain domestically and export the end product, has dramatically changed. But Sri Lanka has been completely outside of this as we still have been producing finished goods like apparel and tea and exporting them,” he said. On the other hand, neighboring economies like in the ASEAN has expanded through both trade and investment. Citing the example of Japan, he said that in the 1980s, Japan faced a lot of outward investments, the yen was appreciating and wages were going up and the country was then not a competitive economy. In the midst of this, he said that companies like Toyota set up their manufacturing plants in different ASEAN regions depending on the comparative advantages.

For example, to manufacture vehicles, they would make the tyres in one country where they had access to latex and make the electronic components in the country where they had access to technology. Later, they would assemble all this in a different country and export the end product from there.

“So, this kind of component-based intermediate trade really took off in that region because of the low barriers to trade in the ASEAN. Unfortunately, in the South Asian region, like for Sri Lanka, the South Asian Free Trade Area (SAFTA) has not happened at all. Due to political manifestations in the SAARC region, the entire trade liberalization agenda has taken a backfoot and the barriers to trade are very high,” he said.

A predictable trading environment

Therefore, he noted that FTAs are crucial because they bring in a very predictable trading environment and low barriers to trade. Given the multiple cross border movements of components it is necessary for there to be low barriers to trade – tariff and non-tariff measures.

“So, what investors and traders want is to have long term certainty in the trading environment and the investment climate and ideally embedded in a transparent, predictable, rules based agreement. This is exactly what the FTAs deliver,”

More than the liberalisation of trade, de Mel said the FTAs give that binding commitment to a particular regime, which becomes really important for investment efficiency.

“So, for Sri Lanka’s future, if we want to move into new products, new kinds of exports and technology, it is essential that we move away from our current model of end-product structure to dynamic value chain based trading structures. That is where FTAs can play a very important role,” he concluded.

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