With a population of 1.3bn and an economy growing 7%-plus each year, India is a good neighbour for Sri Lanka to have. Trade volumes between the countries have soared in recent years thanks to a beneficial free trade agreement (FTA). Talks have been ongoing about how to deepen this relationship while taking into account political and economic sensitivities.
India ranked third in Sri Lanka’s export destinations in 2016, with outflows totalling $554m – down from $643m in 2015 due to falling earnings from products including tea, agricultural produce, spices and transport equipment. India ranked second in the sources of Sri Lanka imports, accounting for 19.7% of the total. Volumes dropped 10.6% as the oil price fell, and as imports of vehicles such as motor cars and auto-trishaws dipped. “India is our closest neighbour, hungry for products, with a growing middle class and a fast-growing economy – we should be able to capitalise,” Aswin De Silva, chairman of National Savings Bank, told OBG. “Meanwhile, imports from India are good for the cost of living in Sri Lanka. And there are a lot more opportunities, from tourism to research.”
Trade between Sri Lanka and India has burgeoned over the past 15 years, thanks partly to the India-Sri Lanka FTA (ISFTA), which came into force in 2000. The deal allows Sri Lanka to export more than 4000 types of goods to India duty-free. The FTA includes a negative list of goods that are subject to duties, a balance that is favourable to Sri Lanka. Some 1180 items listed attract duty when imported from India while India has 429 goods on the list. Garments and tea – major exports for Sri Lanka – are on India’s negative list, but can still be exported to India under a quota system.
The ISFTA has proven particularly beneficial for Sri Lanka – exports to its neighbour used to be surprisingly meagre, averaging $39m a year in the run-up to the FTA’s introduction in 2000. That first year, just 16% of the island’s $55.6m exports to India were under the FTA. The figure increased to 65% of the $500m exports by 2013, according to Sri Lankan financial journalist Devan Daniel. In the same period, India’s exports to Sri Lanka under the agreement rose from 9% to just 13%. Sri Lanka’s total exports under the ISFTA grew by 877% between 2000 and 2013, while imports from India under the agreement rose by 415%.
“The trade imbalance between India and Sri Lanka was 8:1 in the 1980s, 1990s and early 2000s, and now it’s 5:1,” Kapila Sri Chandrasekera, head of transaction and telecoms advisory at M Power Capital, a corporate finance advisory and private equity business, told OBG. “The ISFTA has benefitted Sri Lankan exporters. There are Sri Lankan companies that earn most of their revenues from exporting to India.”
The total value of Sri Lanka’s imports from India can fluctuate notably with the price of oil, one of India’s main exports to the island. In contrast, Sri Lanka has leveraged the FTA to boost the diversification of its exports to its larger neighbour. Partly due to this, Sri Lanka’s trade deficit in goods covered by the FTA has shrunk from 6.2 times to 1.1 times.
Nonetheless, Sri Lankan exporters are unhappy with non-tariff barriers that face them in India. “The port bureaucracy in India remains, and suggest a desire among some to discourage imports,” Chrisso De Mel, vice chairman of the Sri Lanka Shippers’ Council, told OBG. “While the central government is helpful, individual states don’t always do the same, and problems are repeatedly raised – for example over testing and certification of Sri Lankan chocolate.”
Discussions on upgrading the ISFTA began as early as 2003, with a proposed comprehensive economic partnership agreement drawn up that would deepen cooperation and increase the scope for free trade in services in particular. The agreement was due to be signed in 2008, but the Rajapaksa government backed out of the agreement under pressure from professional associations and manufacturers, who feared competition from low-cost and larger-scale Indian counterparts. Supporters of the agreement pointed out that the deal might have been an excellent opportunity to improve the position of Sri Lankan businesses vis-à-vis India by removing the non-tarriff barriers that many say they face.
With a new administration in Colombo, momentum behind deeper cooperation with India is building again. In April 2017 Sri Lanka and India inked a memorandum of understanding (MoU) regarding cooperation on economic projects during a visit from Sri Lankan Prime Minister Ranil Wickremesinghe to his Indian counterpart Narendra Modi in Delhi.
The MoU focuses on the energy sector, with projects including a 500-MW liquefied natural gas (LNG) power plant with linked terminal and floating storage re-gasification unit in Kerawalapitiya, and establishing a piped natural gas distribution system in Colombo and suburban areas. Indian investment would also help establish a network of retail outlets to supply compressed natural gas (CNG) to the Sri Lankan transportation industry and convert some existing power plants to LNG fuel. The Sri Lankan partner for these developments is state-owned Ceylon Petroleum Corporation (CPC). Indian investors are also set to invest in a solar power plant in Sampur, with an initial 50-MW capacity scaleable to 100 MW.
Another proposed deal would form a joint venture between India’s state-owned Indian Oil Corporation subsidiary Lanka IOC and its Sri Lankan counterpart CPC for the management of 84 oil tanks in Trincomalee, a port on Sri Lanka’s east coast. Lanka IOC already operates 15 tanks at an adjacent tank farm and the new deal would extend this to other units.
The MoU further encompassed several important infrastructure projects in Sri Lanka. These include Indian development of the Dambulla-Trincomalee road into an expressway, which could potentially lead to the upgrading of the Mannar-Jaffna and Mannar-Trincomalee highways as well. The deal envisages Indian support for the development of railways in Sri Lanka, including track improvements and new rolling stock. Sri Lanka also hopes to attract Indian investment to develop a container terminal at Colombo Port’s Eastern Terminal. This would be a sound strategic fit, given that around 70% of the port’s business is trans-shipment for India.
The MoU was received not without controversy. On the day before Wickemesinghe’s departure for India, petroleum sector workers went on strike over the planned deal, specifically over the proposed joint venture for the Trincomalee oil tanks. Although the strike was called off after a day following negotiations, the opposition in parliament also opposed the MoU and supported the strike, which briefly hit oil supplies.
The Indian government issued reassurances that the agreement would be a partnership, rather than a sale of a strategically important asset to India at a below-market price, as some in Sri Lanka viewed it. The Sri Lankan government also pointed out that many of the oil tanks have not been used for years, and that renting them out to a foreign investor makes commercial sense. Still, the Colombo government has said that it will have further consultations before any final deal, and in a competitive political environment, opposition to the project may slow development further.
The sensitivity of political relations with India, even with the successful FTA, presents problems for the otherwise-promising proposed economic and technology cooperation agreement (ETCA). This agreement would provide for deeper cooperation for trade in services, investment, and science and research.
The potential agreement is strongly supported by many in Sri Lanka’s private sector, including the Ceylon Chamber of Commerce, which asserts that the deal would allow Sri Lankan companies to grow outside their relatively small domestic market, and extend the services that they can offer to Indian partners and clients. The Colombo government has said that the deal would allow more Indian companies to set up branches in Sri Lanka to export and provide services to countries with which Sri Lanka has better trade relations than India – for example, Pakistan and China. The government intended to sign a deal by the end of 2016, but work was still ongoing in early 2017.
Nonetheless, opposition to the deal comes from those who are concerned that it will open the Sri Lankan labour market to Indian workers, as well as trade and professional associations who fear that competition from Indian rivals will drive them out of business.
Many businesspeople in the country see Sri Lanka’s future as a service and logistics centre between South Asia and the world, with exports of high-value agricultural and manufactured goods remaining an important part of the trade mix.
The country’s relationship with India is central to this strategy. Goods that are traded with its neighbour have grown substantially over the past 15 years, with the next step to open up the exchange of services and encourage bilateral investments. Sri Lankan businesses look set to gain from further cooperation.