POLICYINSIGHTS27 NOVEMBER 2015

INSTITUTE OF POLICY STUDIES OF SRI LANKA

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to garnering maximum benefits ofexisting FTAs.

• Institutional Support: The absence ofan established body, to addressproblems arising when trading under theagreement, is an impediment to the useof FTAs. When problems arise regardinga shipment, there needs to be a formalbody of authority to take up complaintsand address them quickly.

• Consultation: Experience with theISFTA, and attempts to extend theagreement into a ComprehensiveEconomic Partnership Agreement(CEPA), highlights the need for greaterprivate-public dialogue in Sri Lanka ontrade agreements.

China's Approach toFTAsChina has been activelypursuing FTAs with variouscountries over the past twodecades. China has concluded FTAs, orentered into negotiations, with almost everymajor region in the world. By June 2014,China was a party to 11 bilateral tradeagreements and one regional tradeagreement - ASEAN , Hong Kong , Macao ,Chile , Pakistan , New Zealand , Singapore ,Peru , Costa Rica , Taiwan , Switzerland andIceland.

• Gradual Approach: China has adopteda gradual approach in negotiating withtrading partners - first, striking anagreement in trade in goods, thenservices and investment agreements.However, recent agreements were morecomprehensive in scope at the time ofsigning.

• Coverage of Tariffs and Goods: Formost of China's FTAs partners, theagreements have eliminated tariffs andallowed preferential market access toChina, to a great extent. For example, inits agreements with Chile, Peru and NewZealand, China committed to eliminate

China and Sri Lanka have commencednegotiations on a Free Trade Agreement(FTA), which hopes to open up the vastChinese market to Sri Lankan products. TheAgreement is expected not only to boostbilateral trade but also help reduce SriLanka's dependence on traditional marketsin Europe and USA. With the commence-ment of initial round of negotiations, it isnecessary to consider how best theAgreement could be drawn to ensure SriLanka maximises benefits whilst minimisesassociated costs from a FTA.

This Policy Insights highlight the mainfindings from the IPS study on 'China-SriLanka Free Trade Agreement’. Theobjectives of the study were: 1) to drawlessons from Sri Lanka's existing FTAs toidentify key stumbling blocks to tradeliberalisation; 2) to describe key features ofChina's FTAs; and 3) to identify productswith export potential to China, whichshould be included in the negotiations withChina.

Lessons from SriLanka's Existing TradeAgreementsSri Lanka participates in tworegional agreements, the South Asian FreeTrade Agreement (SAFTA) and the Asia-Pacific Trade Agreement (APTA), and twobilateral agreements, the Indo-Sri LankaFree Trade Agreement (ISFTA), and thePakistan-Sri Lanka Free Trade Agreement(PSFTA). There are a number of lessonsfrom the existing agreements that must beborne in mind when negotiating a trade dealwith China.

• Special and Differential Treatment(S&D): Given the asymmetry ofeconomic size, Sri Lanka received S&Dtreatment under each of the existingtrade deals. For instance, Sri Lanka as asmall economy was allowed a longertariff phase-out period, a longernegative list, immediate duty free access

for products, and more favourable rulesof origin under SAFTA, ISFTA andPSFTA.

• Rules of Origin (ROO): These criteria,which are used to determine the countryof origin under a FTA, have variedbetween agreements. SAFTA and ISFTArequire a change of tariff classification(CTH) at 4-digit level, which has beendifficult to meet given the substantialtransformation required for a product.PSFTA adopted less restrictive criteria(CTH at HS 6-digit level).

• Negative Lists (NLs): This list containssensitive products which are exemptedfrom tariff liberalisation. NLs should beprepared by weighing revenueconsiderations as well as implicationsfor local industries and livelihoods.However, it is important to keep the NLsto a minimum to ensure that asubstantial proportion of tariff lines andproducts are covered under theagreement.

• Non-tariff Measures (NTMs): Whentariffs are brought down throughnegotiations, NTMs can reduce the useof agreements. NTMs should beidentified at the onset and bindingcommitments made for their reductions/eliminations.

• Tariff-rate Quotas: Although tariffschedules have been liberalized to acertain extent under ISFTA and PSFTA,Sri Lanka's trade expansion with Indiaand Pakistan has been impeded byimposition of tariff-rate quotas.

• Mutual Recognition of Agreements(MRAs): Lack of MRAs for standardsbetween Sri Lanka and its FTA partnershave resulted in various additionalchecks/certifications on the goods at thepoint of imports, impeding the freemovement of goods.

• Awareness: Lack of knowledge andawareness among traders of theconcessions have been a key obstacle

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27 NOVEMBER 2015 POLICYINSIGHTS

duties on 95% to 97% of the tariff lines,which corresponded to 88 - 99% of itsbilateral imports. The only exception tothis is the China-Pakistan FTA.

• China's Negative Lists (NLs): China'sFTAs take into account the sensitive-ness of both countries and contain NLs.A number of vegetable products, animaland vegetable fats and oils, preparedfood, chemicals, wood products, pulpand paper, and textile categories areprotected by China. In almost all of theagreements, China has placed pulp andpaper in its NLs.

• Rules of Origin (ROO): They tend to varyacross agreements and product groups,which add to the complexity of China'simport regime. ROO criteria of China'sFTAs with ASEAN, Chile, Pakistan, andSingapore are Local Value Addition(40% of total content) and RegionalValue Content (60% of the value of theproduct). The criteria for agreementswith Peru, New Zealand and Costa-Ricaare Change of Tariff Classification (HS2-4 digit level) and Regional ValueContent (40-60% of the value of theproduct).

• Services Liberalisation: While theAgreements on Trade in Goods havetaken a Negative List approach, China'sServices Agreements have adopted aPositive List approach. In China's FTAswith ASEAN, Chile, and Pakistan, theAgreement on Services is a separatedocument and follows the Agreementon Goods, while in the case of others,the Agreements were more compre-hensive in coverage and included bothtrade in goods and services.

• Cooperation beyond Tariffs: Due totheir focus on liberalizing markets andfacilitating trade, agreements betweenChina and developing countries aimedat reducing tariffs and NTMs to trade.However, China has shown somewillingness to broaden its focus andinclude other issues (environmentprotection, competition policy, andlabour standards) over time.Nonetheless, China has been cautious,choosing to include them as stand-aloneagreements or MOUs.

Sri Lanka's Existingand Potential Exportsto China underProposed FTATrade between Sri Lanka and China hasgrown steadily over the years, with totaltrade almost tripling between 2009 and2013. While Sri Lanka's exports to Chinahave steadily grown over the years, imports

from China have grown at a faster rate.Consequently, Sri Lanka has beenexperiencing an expanding trade deficit withChina. In 2013, Sri Lanka had a trade deficitof USD 2.8bn.

As an export market, China is not animportant destination. It ranks at 16th placeand accounts for about 1.2% of Sri Lanka’stotal exports. However, China's importanceas an export destination seems to be on therise given that exports to China have beengrowing at a faster rate than Sri Lanka'sexports to the rest of the world during thelast 5 years.

In 2013, Sri Lanka exported USD 122mn ofgoods to China, of which textiles andclothing accounted for almost 40% ofexports, followed by vegetables, plasticsand rubber, food products and minerals.These four categories accounted for over80% of Sri Lanka's exports to China. Whilesome products already receive preferentialrates under APTA, China has extended dutyfree access for these products to othercompeting countries (i.e., ASEAN). Forexample, ASEAN already enjoys zero dutiesfor almost all of Sri Lanka's top ten exportsin China.Therefore, in negotiating anagreement with China, Sri Lanka shouldseek immediate duty access for theseproducts.

Sri Lanka has a comparative advantage vis-a-vis the world in 566 products (at HS 6-digit level), out of which Sri Lanka currentlyexports 243 items to China (Figure 1). Thereare additional 299 products with tradepotential to China, which are not exportedby Sri Lanka to China but are imported byChina from the rest of the world, presentingnew market opportunities for Sri Lankanexporters. In fact, Sri Lanka has the potentialto increase exports to China across allproduct categories, especially textiles,vegetable products, plastics/rubber(Table 1).

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Recommendations• Trade negotiations with

China should not onlycover products in whichSri Lanka currentlyexports but also has a potential to exportto China.

• Negotiations should seek concessionswhich are higher/at least equivalent totariff reductions granted to competingcountries under China’s FTAs.

• Rather than agreeing on general ROO,the negotiations should focus onachievable product-specific ROO, as therequirements across products.

• Though China's existing FTAs are basedon the principle of reciprocity, Sri Lankashould seek S&D treatment given theasymmetrical economic relation.

• Potential benefits of allowingpreferential market access to Sri Lankamust be carefully assessed taking intoaccount domestic interests andsensitivities. This would require closerconsultations with stakeholdersincluding the private sector.

• There should be binding commitmentsnot to resort to the use of NTMs as ameans of circumventing tariffreductions.

• To achieve a more comprehensivebilateral cooperation between the twocountries, the FTA should graduallymove beyond trade in goods tocooperation in other areas such asinvestment, services and tradefacilitation to build confidence in anegotiated trade agreement.

Table 1: Existing & Potential Number ofExports to China, Sector-wise

This brief is based on findings from a study on'China-Sri Lanka Free Trade Agreement' carriedout by Janaka Wijayasiri, DharshaniPremaratne, Suwendrani Jayaratne and NipuniPerera. Contact janaka@ips.lk or dharshani@ips.lk for more information.

Animal & Animal Products 24Vegetable Products 63Foodstuffs 28Mineral Products 9Chemicals & Allied Industries 17Plastics / Rubbers 30Raw Hides, Skins, Leather, & Furs 6Wood & Wood Products 28Textiles 240Footwear / Headgear 14Stone / Glass 18Metals 18Machinery / Electrical 21Transportation 7Miscellaneous 18

No. of products to worldNo. of existing products to CHNo. of potential new products to CH

Figure 1: Products with ComparativeAdvantage vis-a-vis World and

China (CH), HS 6 Level