SAFTAandtheBangladeshEconomy: AssessmentsofPotentialImplications

SelimRaihan*

AssistantProfessorofEconomics,attheUniversityofDhaka,Bangladesh.Email: sraihan_duecon@yahoo.com

This paper is written under a research grant from the Commonwealth Secretarial, London to CUTS International,Jaipur.Viewsexpressedinthispaperarethoseoftheauthorandnotnecessarilyreflectthoseof theirinstitutionsandoftheCommonwealthSecretariatandCUTSInternational.

TableofContent
AcronymsandAbbreviations ............................................................................................... iv 1.Introduction....................................................................................................................... 1 2.BangladeshsTradewithNeighbouringCountries:PatternsandTrend .............................. 1 3.SAFTAandtheLDCsinSouthAsia:ImplicationsforBangladesh.................................... 5 4.PotentialImplicationsofSAFTAonBangladeshsEconomy: AReviewofQualitativeandQuantitativeStudies............................................................. 9 4.1.WelfareEffectsofSAFTA:SomeQualitativeAssessmentsof PotentialImplicationsforBangladesh........................................................................ 9 4.2.EmpiricalStudiesonWelfareEffectsofSAFTA: SomeQuantitativeAssessmentsofPotentialImplicationsforBangladesh ............... 12 4.2.1.TheGravityModels ........................................................................................... 12 4.2.2.PartialEquilibriumModels ................................................................................ 13 4.2.3.TheCGEModels ............................................................................................... 14 4.2.4.SAFTAandtheExpansionofBangladeshsExportsintoIndianMarket:A SimulationExerciseusingthePartialEquilibriumWITS/SMARTModel ......... 17 4.2.5.SomeFinalObservationsonthePartialEquilibriumand GeneralEquilibriumSimulationResults............................................................ 19 5.FeedbackfromthePolicyMakersandBusinessPeopleinBangladesh ............................ 19 6.TheProspectofMultilateralismwithRegionalismforBangladesh .................................. 21 7.ChallengesandpolicyoptionsformakingSAFTAaneffectivevehicleof radeledgrowthforBangladesh:TheCallforaSAFTAPlusAgreement ..................... 22 8.Conclusion ...................................................................................................................... 23 References .......................................................................................................................... 24

ii

ListofTables
Table1:ShareofBangladeshsExportswithNeighbouringCountries inherTotalExports ..............................................................................................4 Table2:ShareofBangladeshsImportswithNeighbouring CountriesinherTotalImports................................................................................4 Table3:Exportsrisefortop30products(HS6digit)from BangladeshtoIndia(000US$)underSAFTA ....................................................18 Table4:NontariffandParatariffBarriersFacedbyBangladeshiExportersinIndia ........20

ListofBoxes
Box1:LDCsHaveLongerTimespanforTariffReduction ComparedtoNonLDCs ...........................................................................................6 Box2:SensitiveListsAmongtheSAFTAMembers............................................................7 Box3:TradeCreationandTradeDiversionEffectsofFTA .................................................9 Box4:TheGTAPModel ...................................................................................................15 Box5:TradeCreationandTradeDiversionEffectsofSAFTASimulations .......................16 Box6:ChangesinImportstoBangladeshfromDifferent CountriesunderSAFTA1(inUS$mn) ....................................................................17

ListofFigures
Figure1:CountrywiseShare(%)inIntraSAARCImportsin2003 ....................................2 Figure2:CountrywiseShare(%)inIntraSAARCExportsin2003 ....................................2 Figure3:BangladeshsTradewithNeighbouringCountries(millionUS$) ..........................3

iii

AcronymsandAbbreviations
ASEAN BIMSTEC AssociationofSoutheastAsianNations BayofBengalInitiativeforMultiSectoralTechnicaland EconomicCooperation CGE CU DFQF EU GDP GTAP EU FTA LDCs NAFTA NTBs RMGs RoO RTA QRs SAARC SAFTA SAPTA S&DT TLP WTO ComputableGeneralEquilibrium CustomUnion DutyFreeQuotaFree EuropeanUnion GrossDomesticProduct GlobalTradeAnalysisProject EuropeanUnion FreeTradeArea LeaseDevelopedCountries NorthAmericanFreeTradeArea NonTariffBarriers ReadymadeGarments RulesofOrigin RegionalTradeAgreement QuantitativeRestrictions SouthAsianAssociationofRegionalCooperation SouthAsianFreeTradeArea SouthAsianPreferentialTradeAgreement SpecialandDifferentialTreatment TradeLiberalisationProgramme WorldTradeOrganisation

iv

1.Introduction In recent years, there has been increased interest in regional economic integration in South Asia.WiththestalemateoftheWorldTradeOrganisation(WTO)negotiations,itisexpected thattheinterestinregionaltradingarrangementswillincreasefurther.Regionalintegrationin South Asia got the momentum in 1995 when the South Asian Association for Regional Cooperation (SAARC) Preferential Trading Arrangement (SAPTA) was signed. In early 2004, the SAARC member countries agreed to form a South Asian Free Trade Area (SAFTA), which has become a parallel initiative to the multilateral trade liberalisation commitmentsofthesouthAsiancountries.SAFTAhascomeintoforcesinceJuly01,2006, withtheaimofboostingintraregionaltradeamongtheseven SAARCmembers. TherehavebeensomestrongargumentsfortheregionaleconomicintegrationinSouthAsia, asthisintegrationisbelievedtogeneratesignificantintraregionaltradeandwelfaregainsfor theSouthAsiancountries.Therearealsoaspirationsamongthepolicymakersandbusiness communityinBangladeshaboutthepositiveimpactsSAFTAmighthaveontheBangladesh economy.ItisexpectedthattheSAFTA mechanism,when fully implemented,willprovide Bangladesh improved market access, help boost its exports to the region, and improve the country'sintraregionaltradebalance.SAFTAisexpectedtogeneratesubstantialnewtrade thesocalledstaticgains.Thedynamicgainscouldbeevenhigherthanthestaticgainsdueto the possible expansion in the scale of operation by getting access to the markets of the relativelylargermembercountries. However,critics havepointedoutanumberof factorswhichcouldunderminethepotential benefits from the SAFTA. For example, it is argued out that there are limited complementarities in the region. Therefore, even under the free trade mechanism the expansion of intraregional trade would not be very substantial. Secondly, these countries tradeverylittleamongthemselvesandmajortradingpartnersoftheindividualSouthAsian countriesare located inthe West.Thirdly, it isallegedthatSAFTA may leadtosubstantial trade diversion than trade creation for some of the member countries. And, finally, it may workasastumbling bloctomultilateraltrade liberalisation.Theseconcerns havealsobeen endorsed by some studies while examining the potential impacts of SAFTA on the Bangladesheconomy. Againstthebackdropoftheaforementionedargumentsandcounterargumentsthepurposeof this paper is to examine the implications of SAFTA for Bangladesh. The structure of the paper is as follow: Section 2 provides an evolution of Bangladeshs trade with its neighbouringcountriesSection3depictsthecurrentstatusofSAFTAwithspecialreference toanyfavourabletreatmentgiventoleastdevelopedcountries(LDCs)Section4undertakes areviewofthestudiesonpotentialimplicationsofSAFTASection5reviewsthefeedback from the key policymakers and representatives of other stakeholders in Bangladesh on SAFTASection6assessestheprospectofmultilateralismwithregionalismforBangladesh Section 7identifiesthechallengesandpolicyoptionsformakingSAFTAaneffectivevehicle oftradeledgrowthforBangladeshandfinallySection 8presentstheconclusion. 2.BangladeshsTradewithNeighbouringCountries:PatternsandTrend While examining Bangladeshs trade with her neighbouring countries it should be kept in mindthattheintraregionaltradeamongtheSouth Asiancountries isvery low.Until1951, totalintraregionaltradeinSouthAsiaasapercentageoftheregionstotaltradewasinthe

double digits. However, as South Asia became progressively more closed relative to the worldmarketandalsothepoliticalrivalrybetweenIndiaandPakistanintensifiedovertime, by 1967 intraregional trade fell to just two percent of the regions total trade. The share began torecover during the 1990s and by 2002 itrose to 4.4 percent (Baysan et al, 2006). Figure 1 suggests that even with a low intraregional trade Bangladesh is the single largest importerinSouthAsia.In2003,Bangladeshaccountedfor36.4percentoftotalintraregional import. In contrast, Figure 2 indicates that in 2003, Bangladeshs exports to the region accountedfor only2.3percentofthetotalregionalexports.
Figure1:CountrywiseShare(%)inIntraSAARCImportsin2003

SriLanka 26.6%

Bangladesh 36.4%

Pakistan 7.1% Nepal 14.5% Maldives 2.6% India 12.8%

Data Source:UNCOMTRADE

Figure2:CountrywiseShare(%)inIntraSAARCExportsin2003

SriLanka Maldives Bangladesh 7.5% 0.3% Pakistan 2.3% 7.3% Nepal 5.4%

India 77.2%

Data Source:UNCOMTRADE

Bangladeshs trade with her neighbouring countries is also highly unequally distributed. It appearsfromFigure3thatBangladeshtradeverylittlewithBhutan,NepalandSriLanka.In SouthAsia,India isthe majortradingpartnerofBangladesh followedbyPakistan.But,the tradewithIndia is largelyonesided,asthe volumeof imports fromIndiatoBangladesh is

considerablyverylarge,whereasthevolumeofexportsfromBangladeshtoIndiaisverylow. It, therefore, appears that Bangladesh has high bilateral trade deficit with India, which has 1 beenanissuefordebatewhetheritisamatterofanyconcern(RaihanandRahman,2007). Bangladeshexportsaminiscule(onepercent)shareofIndiasimports,anegligibleshare(one percent)ofitsownexports,andasmallrangeofproducts(fertiliserandjutegoodsmadeup twothirds of exports). Though readymadegarments (RMG) is the major export item for 2 Bangladesh,itsexportstoIndiaareverymuchinsignificant.

Figure3:BangladeshsTradewithNeighbouringCountries(millionUS$)
BangladeshstradewithBhutan
8 7 6

Bangladeshs tradewithIndia
1600 1400 1200

Export

Import

Export

Import

MillionUS$

MillionUS$

5 4 3 2 1 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

1000 800 600 400 200 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Year

Year

BangladeshstradewithNepal
12

BangladeshstradewithPakistan
250

Export
10

Import
200

Export

Import

MillionUS$

MillionUS$
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

150

100

50

0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Year

Year

BangladeshstradewithSriLanka

BangladeshsperenniallargebilateraltradedeficitwithIndiamightbeacauseforconcernbutithasnotledto anybalanceofpaymentsproblemforBangladeshasconsistenttradesurpluseswithsuchtradingpartnersasUS andEUcompensateforthesedeficits. 2 Itisallegedthat,oneofthemajorreasonsbehindverylowexportsofRMGproductsfromBangladeshtoIndia isIndias relativelyhighspecifictariffsonBangladeshsRMGproducts()

14

Export
12 10

Import

DataSource:UNCOMTRADE

MillionUS$

8 6 4 2 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Year

It is clearly evident from Table 1 that in terms of exports, South Asia has not been a significantexportdestinationofBangladesh.Infact,overthelast10years,therehasnotbeen any major change in this pattern. In 1995, Bangladeshs exports tothe South Asian region accounted for only 2.3 percent of her total exports, which by 2004 came down to only 2 percent. Table 2 also suggests thatover time Bangladeshs dependence on South Asia as a sourceofher importsdeclined.In1995,Bangladeshs importsfromtheSouthAsianregion accountedfor15.5percentofhertotalimports,whichby2004declinedto12.6percent.India has been one of the major sources of imports for Bangladesh, as India accounted for, on average,12percentofBangladeshstotalannualimportsinrecentyears.
Table1:ShareofBangladeshsExportswithNeighbouringCountriesinherTotalExports
1995 Bhutan India Nepal Pakistan SriLanka SouthAsiaTotal RestoftheWorld 0.00 0.79 0.03 1.03 0.41 2.26 97.74 1996 0.00 0.91 0.25 1.05 0.11 2.31 97.69 1997 0.00 0.59 0.13 0.85 0.12 1.69 98.31 1998 0.00 0.20 0.00 0.65 0.03 0.88 99.12 1999 0.00 0.31 0.00 0.79 0.07 1.17 98.83 2000 0.00 0.35 0.00 0.91 0.10 1.36 98.64 2001 0.00 0.43 0.02 0.56 0.06 1.07 98.93 2002 0.00 0.47 0.01 0.57 0.04 1.09 98.91 2003 0.03 0.64 0.01 0.56 0.09 1.33 98.67 2004 0.05 1.27 0.01 0.57 0.12 2.02 97.98

Source:ComputedusingthedatafromUNCOMTRADE

Table2:ShareofBangladeshsImportswithNeighbouringCountriesinherTotalImports
1995 Bhutan India 0.13 1996 0.07 1997 0.08 1998 0.04 1999 0.03 12.37 0.07 1.24 0.12 13.83 86.17 2000 0.03 6.66 0.01 1.40 0.13 8.22 91.78 2001 0.03 10.88 0.00 1.28 0.12 12.31 87.69 2002 0.02 13.40 0.02 1.24 0.01 14.70 85.30 2003 0.01 14.16 0.02 1.22 0.09 15.51 84.49 2004 0.01 11.24 0.00 1.25 0.08 12.59 87.41

11.31 17.38 19.69 14.82 0.01 0.11 0.15 0.16 3.95 1.82 0.96 1.11 0.11 0.15 0.20 0.12 SouthAsiaTotal 15.52 19.52 21.08 16.24 RestoftheWorld 84.48 80.48 78.92 83.76 Source:ComputedusingthedatafromUNCOMTRADE Nepal Pakistan SriLanka

OneimportantaspectofBangladeshstradewithIndiaisthatBangladeshsinformalborder importsfromIndiahavealwaysbeenthoughttobeveryhigh.Thoughtherehasnotbeenany comprehensive quantitative assessment on the informal border trade between India and Bangladesh, it is pointed out by a few studies that the informal and illegal trade between India and Bangladesh could be as high as three quarters of recorded trade (World Bank, 2006). However, such informal trade is mostly one way from India to Bangladesh. Therefore,ifsuchinformalimportsfromIndiaweretakenintoconsideration,Indiassharein Bangladeshstotalimportswouldriseconsiderably. Theupshotoftheaforementionedanalysispointsustothefactthat,apartfromthe imports fromIndia,SouthAsiancountrieshavenotbeenthemajortradingpartnersofBangladesh.As farasexportdestinationsareconcerned,BangladeshsmajortradingpartnersaretheEUand US. On the other hand, apart from India, other major import sources for Bangladesh are China, Singapore and Japan. Any evaluation of the prospects of SAFTA should, therefore, takenoteofthesefacts. 3.SAFTAandtheLDCsinSouthAsia:ImplicationsforBangladesh Four LDCs in South Asia, namely Bangladesh, Bhutan, the Maldives and Nepal have been providedsome special anddifferentialtreatments(S&DTs)withintheSAFTATreatyText. These special provisions may have important implications for Bangladesh. This section critically analyses these special provisions and the stakes Bangladesh might have in these provisions. TheS&DTsintheSAFTATreatyTextarecontainedin:(i)threesubparagraphsinArticle3 (Objectives and Principles) (ii) four paragraphs in Article 7 (Trade Liberalisation Programme) (iii) entire Article 11 (Special and Differential Treatment for the Least DevelopedContractingStates)and(iv)oneparagraphinArticle16(SafeguardsMeasures). AdiscussionontheseS&DTsfor theLDCsandtherelatedconcernsincludethefollowings: (a) TheTreatyText allows longertimeframestoreduceoreliminatetariffs ofthe LDC members.Also, theTreatyasksforarapidtariffreductionoreliminationbynonLDC partners on products originating from LDCs (see Box 1). This provision has been arguedtobefavourabletotheLDCmembers.However,concernshavebeenraisedon twogrounds:firstly,thefirststageoftariffreductionseemstoberedundantforallthe SouthAsiancountries,ascurrently inthese membercountries, becauseofunilateral tariffliberalisation,tariffratesonmostoftheirproductsarelessthan20percentorso. Therefore,LDCmembersareunlikelytohaveanysignificantgainduringthefirsttwo yearsoftheTariffReductionProgramme.Secondly,therearealsoconcernsaboutthe secondstage,asthe3yeargap betweenLDCandnonLDC membersappearstobe low. Also the presence of negative lists by the nonLDC members restricts significantlythepotentialsof market accessoftheproductstotheLDC members in thenonLDCs.

Box1:LDCs Have Longer TimespanforTariffReduction Comparedto NonLDCs LDCswilltakeeightyearsthereafter,insteadofsixyearsbySriLankaandfiveyears by others, to reach the free trade level of 05 percent duties. The nonLDCs will reduce their duties for the products of the LDCs within three years compared with fiveyearsforreducingdutiesoneachother'sproducts.
CountryCategory LDCs FirstStage Fromexisting tariffto30% over2years Fromexisting tariffto20% over2years SecondStage From30%or belowto05% over8years From20%or belowto05% over5years Targetyearfor FTA 2016 (05%foritems outsidenegativelist) 2013 (05%foritems outside negativelist)

NonLDCs

(b)The Treaty asks for special provisions when considering the application of antidumping and countervailing measures to LDCs. In order to protect domestic industryfrompossibleinjuryduetoincreasedpreferentialimport,theTreaty provides scopeforpartialorfullwithdrawalofpreferencegrantedunderSAFTAforaperiod ofmaximumthreeyears.However,safeguardmeasurescannotbeappliedagainstthe product of LDCs ifthe share of imports from an LDC of the product concerned in totalimportsof importingcountry is lessthanfivepercent.But,theseprovisionsdo not go far enough to ensure that the LDCs will be able to derive equitable benefits from SAFTA. At the penultimate stage of the negotiations, the Trreatygot held up becauseBangladeshwantedittogofurthertowardssecuringS&DTtotheLDCs.At thefinalstageofthenegotiations,acompromisewasreachedthatonlypartiallymeets thedemandsofthe LDCs. Forexample, insteadofthe LDCsdemandthatthenon LDCs should refrain from imposing antidumping and countervailing measures against them during the period of negotiation, the Treaty contains the vague formulationthatspecialregardshall bepaidtothesituationofthesecountrieswhile consideringtheapplicationofsuchmeasures. (c) The Treaty provides for greater flexibility for LDCs in the number of products containedintheirsensitivelists(seeBox2).However,amajorflawoftheTreatyis thatitdoesnotsubscribecategoricallytophasingoutthenegativelistoreliminating nontariff barriers (NTBs), let alone prescribing time limits for doing so. It only providesthatthenegativelistshallbereviewedaftereveryfouryearswithaviewto 3 reducing the number of items. It is also a matter of grave concern for Bangladesh withregardtothesizeofthenegativelistmaintainedespeciallybyIndia,asthemajor export items of Bangladeshs interest (i.e. RMGs and chemicals) are included in Indiasnegativelist,whichinhibitthepotentialsofexportexpansionoftheseproducts fromBangladeshtoIndia.

Therearealsoconcernsaboutthesizeofthenegativelists,astheyappeartobe toolong.Thiswilldetractfrom theprovisionofArticleXXIVofGATTwhichlaysdown thatafreetradeareashouldcoversubstantiallyall trade.

Box2:SensitiveListsAmongtheSAFTAMembers TheTreaty providesscopeformaintainingofsensitivelists,whicharenotsubjectto tariffreductionprogramme.Althoughit maintainsthatsensitivelistshallbedifferent forLDCsandnonLDCs,onlythreecountriesnamelyBangladesh,IndiaandNepal maintain different sensitive lists for LDCs and nonLDCs. Besides, the LDCs maintainlongersensitiveliststhanthe nonLDCs.
Totalnumberof SensitiveList ForNonLDCs ForLDCs 1,254 1,249 157 865 671 1,335 1,191 1,079 157 744 671 1,299 1,191 1,079 CoverageofSensitiveList as%ofTotalHSLines ForNonLDCs ForLDCs 24.0 23.9 3.0 16.6 12.8 25.6 22.8 20.7 3.0 14.2 12.8 24.9 22.8 20.7

Country Bangladesh Bhutan India Maldives Nepal Pakistan SriLanka

(d)With respect to the elimination of quantitative restrictions (QRs) the Agreement allowsgreaterflexibilities fortheLDC members,asthesecountriesarepermittedto continuequantitativeorotherrestrictionsprovisionallyandwithoutdiscriminationin critical circumstances on imports from other member countries. As far as the NTBs areconcerned,theTreaty,however,callsfortheeliminationofallQRsinthemember countriesinrespectofproductsincludedintheTradeLiberalisationProgramme.This meansthatQRswillgoassoonasa05percenttarifflevelisreached.Thisisinline with the ASEAN Free Trade Area provisions. Moreover, this appears to facilitate greater market access of Bangladeshs export products in India and other member countries.However,sincetheTreatydoesnotprescribe,letalonesetthedatelinefor, theeliminationofothernontariffandparatariffrestrictions(whicharereportedtobe 4 prominentinmostofthemembercountries ),theprospectofeffectivemarketaccess forBangladeshsexportproducts,evenafterthereductionoftariffsandsomeQRsin 5 othermembercountries,appearstobedoubtful. (e) The Treaty also includes provisions for direct measures taken by the nonLDC memberstoenhancesustainableexportsfromLDCmembers.Suchmeasuresinclude long and mediumterm contracts containing import and supply commitments in respect of specific products, buyback arrangements, state trading operations, and governmentandpublicprocurement.Thereareprovisionsfortechnicalassistancefor LDCs at their request to assist them in expanding their trade with other member countriesintakingadvantageofthepotentialbenefitsofSAFTA.AreasofTechnical Assistance as agreed upon include: (i) capacity building (trade related) (ii) developmentandimprovementoftaxpolicyandinstruments (iii)customsprocedures related measures (iv) legislative and policy related measures, assistance for improvement of national capacity and (v) studies on trade related physical infrastructure development, improvement of banking sector, development of export
4 5

SeeWorldBank(2004)foradiscussiononsuchnontariffandparatariffbarriersinSouthAsiancountries. Intheabsenceofaclearcuttimelimitandthesequenceforthephasingoutofthenegativelistandnontariff barriersotherthanQRs,itisdoubtfulwhethertheAgreement,whenitcomesunderscrutinyin WTO,willbe adjudged as being consistent with Article XXIV of GATT which prescribes the inclusion of a time and a scheduleforreachingthefreetradestage.

financing. However, there has not been any progress yet with respect to the developmentofmodalitiesfortheseassistances. (f) Amechanismhasbeenestablishedtocompensatetherevenuelosstobeincurredby theLDCsduetoreductionoftariffs.TheCompensationwill be incashandpartial: maximum five percent of the customs duty collected from SAARC import in 2005. Compensationwillbeavailableforfouryearsonly(forMaldivesitwillbeavailable forsixyears). (g)SAFTAallowsdifferentialrulesoforigin(RoO)fortheLDCandnonLDCmembers. The RoO agreed under SAFTA are general in nature (i.e. one criterion for all products)barring1991productsforwhichproductspecificrulesareapplied.SAFTA RoO requires that in order to enjoy the preference under SAFTA a product must undergosufficientprocessingforchangingthetariffheadingfromthenonoriginating inputs and for having value of at least 40 percent value addition measures as percentage of fob value. However, value addition requirements are lower for Sri Lanka and LDCs, whichare 35 percent and 30 percent respectively. Given the fact thatvalueadditionsofmostofBangladeshsexportproductsareverylow,evena30 percent valueaddition requirement would act as a significant barrier for her export expansion in South Asia. Therefore, the problem of RoO will need to be resolved, keeping an eye on the manufacturing/processing capability of the LDCs. The RoO underSAFTAshouldalsobemadeconsistentwiththosethatarecurrentlyinforcein thevariousbilateraltradeagreementswithintheSAARCregion,whichhappentobe moreliberalthantheprevailingSAFTArules.Inaddition,SAFTAshouldinitiatethe CumulativeRulesofOrigin,asinthecaseofIndiaSriLankaFTA,whichhasbeen 6 claimedtobebeneficialforSriLanka. ForthesuccessofSAFTA,asharpreduction and gradual convergence of the member countriesexternal tariffs will be essential. Notethatafreetradearea(FTA)needsastrictsystemofproofoforigin mainly for preventing trade deflection. Since trade deflections can occur only when there are wide differences in the members external tariffs, due importance should be given bothtoreducetheabsolutelevelsofthemembersexternaltariffsandtonarrowdown theintercountrydifferencesintariffrates.Widedifferencesinthemembersexternal tariffswillmaketheRoOdifficulttoimplement. It appears from the aforementioned analysis that there are some special and differential provisionsfortheLDCmembersintheSAFTAAgreement.BangladeshandotherLDCsare likelytosecuresomegains fromtheseprovisions.However,acriticalexaminationofthese provisionsrevealsthatmostoftheseprovisionsarerathervagueinnatureandthusrequire substantial clarification and revision so that Bangladesh and other LDC members can effectivelytakeadvantageoftheseprovisions.

IntheIndiaSriLankaFTAAgreementitisstatedthatinrespectofaproduct,whichcomplieswiththeorigin requirementsprovidedinrule5(b)andisexportedbyanyContractingPartyandwhichhasusedmaterial,parts orproductsoriginatingintheterritoryoftheotherContractingParty,thevalueadditionintheterritoryofthe exporting Contracting Party shall be not less than 25 percent of the f.o.b. value of the product under export subjecttotheconditionthattheaggregatevalueadditionintheterritoriesoftheContractingPartiesisnotless than35percentofthe f.o.b.valueoftheproductunderexport.

4.PotentialImplicationsofSAFTAonBangladeshsEconomy:AReviewofQualitative andQuantitativeStudies SAFTA has been able to generate significant interests among the policy makers, business communityandresearchersinBangladesh.TherearedebatesonwhetherBangladeshstands togainorlosefromSAFTA.Findingsofanumberofqualitativeandquantitativestudiesin this regard have been inconclusive, which have intensified this debate. The results of these studieshavehoweverbeeninfluencedbythedifferencesinthemethodologiesusedinthese studies. 4.1.WelfareEffectsofSAFTA:SomeQualitativeAssessmentsofPotentialImplications forBangladesh ThediscourseonthequalitativeassessmentofSAFTAfallsprimarilyonthetheoretical analysisofregionaltradingarrangements(RTA). Tradetheoryandevidencessuggestthat 7 thereareseveralformsofRTAs ,whichinclude:(i)PreferentialTradeArea(PTA),where tariffsareloweredamongthemembersbutmaintainedagainsttheoutsideworld(i.e., SAPTA)(ii)FTA,wheretariffsareremovedamongmembersbutmaintainedagainstthe outsideworld(i.e.SAFTA,NAFTA)(iii)CustomsUnion.wherealltariffsamongstthe membersareeliminated,whileexternaltariffsareadjustedtoacommonlevel(iv)Common Market,whichaCustomsUnion plusfreemovementoffactorsofproduction amongthe membercountriesandfinally(v)EconomicUnion whichisaCustomsUnionpluscommon economiclawsforthemembercountries(i.e.EU). Intradetheory,welfareeffectsofany RTAareanalysedusingtwoconcepts:tradecreation and trade diversion (see Box 3). The overall welfare effects of economic integration are ambiguousandrequirecasebycasejudgment.Thereasonisthatintegrationisbothapolicy of protection and a move towards free trade. The effect of the protectionist element of integrationiscalledtradediversion,andtheeffectofthetradeliberalisationelementiscalled tradecreation.TheRTAsoveralleffectonwelfareforamembercountryisdeterminedby comparing the tradecreation and tradediversion effects. If trade creation dominates, the formationofaRTAwillenhancewelfare.Onthecontrary,iftradediversioneffectisgreater than the trade creation effect, the RTA will lead to a welfare loss for the country under consideration.8
Box3:TradeCreationandTradeDiversionEffectsofFTA
CountryA (thehomecountry) 50 CountryB (theFTAmembercountry) 40 CountryC (restoftheworld) 30

Supplyprice

Case a :IfAimposesatariffof100percentonbothBandC,onlyAsownproducerswillbeintheAs domesticmarket. Case b :IfAimposesatariffof50percentonbothBandC,onlyCwillbethesupplyingcountryinAs market. Case g :IfAformsaFTAwithB,butretainsthe50percentdutyonC,Bwillbethesupplyingcountry inA. If

a wastheinitialcondition,movingto g willbeconsideredastradecreation,welfareenhancingforA.

If b wastheinitialcondition,movingto g isanexampleoftradediversionwithadverseconsequenceson welfareofA.

7 8

ForageneralsurveyofthetheoryofpreferentialtradingarrangementsseePanagariya(2000). Notethatifmembercountriesarethelowcostproducersofthetradedgood,therewillbenotradediversion effectandintegrationwillunambiguouslyincreasewelfare.

ThefundamentalargumentsforregionalismrestontheevidenceswhichsuggestRTAstobe predominantlytradecreating(RodriguezDelgado,2007).Krugman(1991)arguedthatmost RTAs are likely to entail relatively low welfare losses resulting from trade diversion, since the countries involved are often geographical neighbours and hence already engage in a sizableamountoftrade.ItisalsoarguedthatthroughRTAscountriescanlockinreform, which is often politically not feasible under multilateralism. Whalley (1996), for example, assertsthatadesireforincreasedcredibilityofdomesticreformswasacentralpreoccupation behind the Mexican negotiating position on NAFTA. Also, failure or stalemate of the multilateral trade talks means trade liberalisation can only take place through RTAs. It is highlightedthatcountriescanbuildontheprogressofregionalismandcanultimatelymove towardafreertraderegimeonthewhole. Thereare,however,somecriticalargumentsagainstformationofanyRTA.Itisallegedthat throughRTAthespiritofmultilateralismisundermined.Itisarguedthattheworldmightbe dividedintoafewprotectionistblocsandprotectionistsmightacceptRTAstoopposefurther multilateral liberalisation. Therefore, RTAs might work as stumbling block rather than building blocs for multilateralism. Also, the spaghetti bowl effect can emerge because of 9 manycomplicatedsimultaneousRTAnegotiations. RTAsalsodiscriminateagainstthenon membercountries,andevenLDCscouldseriouslybediscriminatedagainstduetotheRTAs amongthedevelopedanddevelopingcountries. NAFTA isagoodexample inthisregards, and it is argued that because of NAFTA, LDC like Bangladesh has been discriminated against while Mexico has been favoured in the US market (Razzaque, 2005). Furthermore, RTAsdistortresourceallocation, favouringregionalproducerstothepotentialdetrimentof local consumers(RodriguezDelgado,2007).RecentresearchonRTAsalsoemphasisesthe globalconsequencesofmultipleandoverlappingRTAsintermsof thetransactioncoststhey impose(Feridhanusetyawan,2005).Itisfurtherputforwardthatresourcesintradeministries are limited. Therefore, too much involvement in RTA negotiations may distract attention frommultilateralliberalisation. There are also concerns that through RTA (reducing tariffs for the member countries) the pricesofgoodsimportedfromthemembercountriesinthedomesticmarketmaynotfallas the member countries may see the home countrys market as a captive market for their exporters. Forexample,itisoftenallegedbythecriticsofSAFTAthatthroughthisregional trading arrangement, Indian exporters may find a captive market for their exporters in Bangladesh(WorldBank,2006).Asaresult,eventhoughBangladeshreducesthetariffsfor Indian products, the prices of those products may not fall in Bangladesh as the Indian exporterswill havethefreedomtoraiseprices uptothe level atwhichtheproductsfrom therestoftheworldaresoldinBangladesh(withhighertariffs). In general, there are some agreements among the economists about the preconditions for homecountrywelfareexpansionfromaRTA.Forexample,thehomecountrycouldgain if there are: (i) high level of the home countrys tariffs prior tothe agreement (ii) high tariff levelofthecontemplatedpartner(iii) higheconomicsizeofthepartner(iv) high shareof thepartnerinprovidingthehomecountrysimports(v)lowratioofimportsfromtherestof the world to the home countrys aggregate economic activity (vi) relative prices in the partnerseconomyclosetothoseoftherestoftheworldand(vii)similarities in economic activitiesofthepartnerwith therestoftheworld.
9

See Bhagawati andPanagariya(1996).

10

Baysanetal(2006)arguethattheeconomiccaseforSAFTAisrelativelyweak.Theauthors point outthree important features of the South Asian economies that make an FTA among them economically unattractive. First, the economies are relatively small in relation to the worldbothintermsoftheGDPandtradeflows.Thoughintermsofpopulation,theregionis substantial (one fifth of the world) the current percapita incomes are tiny so that the economic sizeoftheregionremains small: lessthanonetwentiethoftheworld intermsof theGDP.AndifIndiaistaken outofthepicture,thisproportiondropsto0.4percent.Bayson et al (2006) further argue that the probability that most efficient suppliers of the member countriesarewithintheregionisslim.Therefore,theprobabilitythattheFTAislikelytobe largelytradedivertingisquitehigh. The second reason relates to the relatively high levels of protection among the SAARC economies.Ifthecountryparticipating inaregionalarrangementwere itselfopen, itwould notsuffer fromtradediversioneven if itweretiny.It is, however,evidentthatthe levelof protection within the SAARC region remains high in all countries except, arguably, Sri Lanka.Thesimpleaverageoftheapplieddutiesinnonagriculturalgoodsrangesfrom10.7 percent inSriLankato25.4percentin Bangladesh.InIndia,thistariff isapproximately20 percent.Inagriculture,thelevelofprotectionisevenhigherandrangesfrom19.6percentin Pakistan to 40 percent in India. And Bangladesh, through the use of severalparatariffs on top of the customs duties, has recently raised nominal protection levels for many import substitutingindustriestoveryhighlevels. AccordingtoBayson etal(2006),thethirdandfinalreasonthatmakestheeconomiccasefor SAFTAweakconcernsthepoliticaleconomyoftheselectionofexcludedsectorsandRoO. Whencountriesareallowedtochoosesectorsthatcanbeexcludedfromtariffpreferencesin an FTA, domestic lobbies make sure that the sectors in which they may not withstand competitionfromtheunionpartneraretheonesthatgetexcluded.Inaddition,theRoOcan alsobesubjecttoabusebythebureaucratadministeringthem.Incaseswhereimportsfrom the partner may be threatening an inefficient domestic competitor, bureaucratic discretion maybeemployedtoblockentryoftheimports. Baysonetalsfirstargument,however,maynotbevalidinsomecaseswhileconsideringthe tradebetweenBangladeshandIndia.AshasbeenmentionedinSectionII,Indiahasbeenone of the major sources of imports for Bangladesh. Therefore, there is a possibility that for a goodnumberofproductsIndiamightbethemostefficientimportsourceforBangladesh(for example, most agricultural products, sarees, other textile items, cotton, yarn, sugar, and pulses). The second argument on high tariffs in South Asia also needs to be carefully examined. Pursell has shown that tariffs in India are often redundant. In the World Bank study,itwasalsohighlightedthatincertainindustries,theprotectionprovidebyIndiatoits domesticproducerswasredundantascompetitionamongstIndianproducerswasso intense thatithelpedthemreducepricesinthedomesticmarkets(evenlowerthanworldprices).The thirdargument,however,seemstobequitereasonablegiventhefactthattheSensitiveLists oftheMembercountriesintheSAFTAarequitelong. In contrast to the arguments put forward by Bayson et al (2006) policy makers and many business people in South Asia and especially in Bangladesh are rather optimistic about SAFTA. They see SAFTA has significant potentials to expand trade among the member countries.ItisalsohopedthatBangladeshwillbeabletogainsignificantlybyhavinggreater marketaccess inotherSouth Asiancountries,andespecially inIndia.Thosewhoargue for

11

SAFTA state that despite the little volume through formal channel, substantial trade is already taking place in South Asia with informal trade amounting to a large proportion of formaltrade.Takingintoaccounttheinformaltradetherealintraregionaltradewouldbe anywhere between 810 percent. Although studies have shown that there are limited complementarities intheSAARCregion, it isarguedthatthiswasalsothecase in ASEAN duringthemid1970s,andthatdormantcomplementaritiesintheregioncouldbeinvigorated 10 by intraregional investment and FDI. They also argue the cost of noncooperation to be quitehigh(RIS,2004and1999GEP,1998CUTS,1996).Thedebateis,therefore,farfrom settled.Irrespectiveofthedebate,thereisageneralbeliefthatregionalcooperationinSouth Asia should not be viewed only from the trade perspective, and that there are many gains fromregionalisminotherareas. 4.2.EmpiricalStudiesonWelfareEffectsofSAFTA:SomeQuantitativeAssessmentsof PotentialImplicationsforBangladesh EmpiricalstudiesonthequantitativeassessmentsonSAFTA(andonSAPTAaswell)differ significantly in terms of the methodologies employed. In broad, three types of techniques havebeenemployedtoexaminethepotentialimplicationsofSAPTA/SAFTA(Baysanetal, 2006). These are: (i) gravity model, (ii) partial equilibrium model and (iii) computable generalequilibriummodel. 4.2.1.TheGravityModels The gravity models basically try to explain bilateral trade flows with a set of explanatory 11 variablesthattrytopredicttheimpactofthearrangementonbilateraltradeflows .Gravity models, for the analysis of any RTA, have been used widely to predict the impact of the agreements on the bilateral trade flows. The studies that employ the gravity model include Srinivasan and Canonero (1995), Sengupta and Banik (1997), Hassan (2001), Coulibaly (2004), Hirantha (2004), Tumbarello (2006), Rahman (2003), Rahman et al (2006) and RodriguezDelgado (2007). The findings of these studies have been mixed. For example, studies by Srinivasan and Canonero (1995), Sengupta and Banik (1997) predicted that the impactofaSouthAsianFTAontradeflowswouldbesmallforIndiabutmuchlargeronthe smallercountries.SenguptaandBanik(1997)predicteda30percentincreaseintheofficial intraSAARCtradeandasmuchas60percentifillegaltradebecameapartofofficialtrade. Coulibaly (2004) found net export creation, and Tumbarello (2006) and Hirantha (2004) found net trade creation from SAPTA. On the other hand, Hassan (2001) found net trade diversion effect from SAPTA, while Rahman (2003) found the dummy variable for South Asia to be insignificant, indicating that a regional integration is unlikely to generate significanttradeexpansioninthisregion. Rahmanet al (2006) used an augmented gravity model to identify trade creation and trade diversioneffectsoriginatingfromSAPTA.Itwasfoundthattherewassignificantintrabloc
10

IntraregionaltradeinASEANwascloseto6percentinthemid1970s,butnowhasincreasedtoaround23 percent.ASEANtoowascharacterisedbylimitedcomplementaritiesatthebeginningbutthesituationchanged withpreferentialtrading,FDIandintraregionalinvestment(SACEPS,2002a). 11 Typically, the exercise involves estimating a bilateral tradeflow equation with bilateral trade (imports, exportsortotaltradeattheaggregateorsectorlevel)asthedependentvariableandcountrycharacteristicssuch asthegrossdomesticproducts,population,landarea,distance,thecommonalityoflanguageorculturaltiesand theexistenceofpreferentialtradearrangementsasindependentvariables.Onceestimated,theequationcanthen beusedtopredicttheimpactofaunionbetweencountrypairsthatdidnothavesuchaunionduringthesample period.

12

export creation in SAPTA however, at the same time there was evidence of net export diversioninSAPTA.ItwasalsoappearedthatBangladesh,IndiaandPakistanwereexpected togainfromjoiningtheRTA,whileNepal,MaldivesandSriLankawerenegativelyaffected. RodrguezDelgado(2007)evaluatedtheSAFTAwithintheglobal structureofoverlapping regional trade agreements using a modified gravity equation. It examined the effects of the Trade Liberalisation Programme (TLP) which started in 2006. The study predicted that SAFTA would have a minor effect on regional trade flows. The gravity model simulation suggeststhatSAFTATLPwouldinfluenceregionaltradeflowsmainlybyincreasingIndias exports, and imports from Bangladesh and Nepal. Of every US$100 of new trade flows (exports+imports),lessthanUS$20wouldoriginatewithintheotherfourmembers(Bhutan, Maldives, Sri Lanka, and Pakistan). For trade flows generated by SAFTA as a share of individual countrys GDP, only the smallest countries obtain significant increases: Bhutan andMaldivesexperienceincreasesintradeflowsequivalenttotwoandonepercentofGDP, respectivelyandIndia,Bangladesh,PakistanandSriLankaseetradeflowsincreasesofless than 0.25percentofGDP. It should, however, be pointed out that studies based on the gravity model to estimate the welfare gains from regional trading arrangements (RTAs) are methodologically flawed. Firstly,the left hand sideofthegravity equationisthe bilateraltrade,notthewelfare.But, the concepts of trade creation and trade diversion directly relate to the welfare of the country in question. Also, the impact of the RTA is captured by introducing the dummy variablesintheequationwhichisaveryweakmethodology. Furthermore,gravitymodelsarepartialequilibriumanalysistherefore,theyfailtotakeinto considerationthe intersectoral and interregional linkage effects.Therefore,gravity models can not actually estimate the welfare effects of any RTA, and therefore not capable of estimatingthetradecreationandtradediversionimpactsofRTAs.Alsothetheoreticalbasis ofthegravity modelshasalwaysbeenquestioned. 4.2.2.PartialEquilibriumModels ThemajorpartialequilibriumstudiesonRTAinSouthAsiaarebyGovindan(1994),DeRosa and Govindan (1995), Pursell (2004) and World Bank (2006). The advantage with these models isthattheyaregenerally basedondisaggregateddata,and arealso flexibleenough whichfacilitatessectorspecificstudy.However,themajorproblemwiththesemodelsisthat theyignoregeneralequilibriuminteractions,andthuscantcapturetheintersectoraleffects ontheeconomy. A partial equilibrium model for food sector, used byGovindan (1994), shows the effect of preferentialliberalisationwithintheregiononintraregionaltradeinfood. Thestudy findsthat suchpreferentialliberalisationwouldgeneratewelfaregainsthroughincreasedtradeinfood within the region. The analysis byDeRosa and Govindan (1995), however, shows that the welfaregainsaremuchhigherwhenthemembercountriesalsogoforunilateralliberalisation on a nondiscriminatory basis. A partial equilibrium analysis on the cement industry by Pursell (2004) suggests thatthe preferential liberalisation of cement industry between India and Bangladesh would lead to substantial gains through increased competition within the regionalmarket.

13

With a view to exploring the potentials of IndiaBangladesh bilateral FTA, World Bank (2006) provides a comparative assessment between Bangladesh and India with respectto a fewindustrieslikecement,lightbulbs,sugar,andRMGs.Thepartialequilibriumsimulation resultssuggestthatinthecaseofcement,lightsbulbsandsugarthelikelyeffectsofanFTA betweenBangladeshandIndiaseemtobeanexpansionofIndianexportstoBangladesh,but noexports fromBangladeshtoIndia.This is mainly becauseIndianexportprices forthese products are substantially lower than exfactory beforetax prices of the same or similar productsinBangladesh. The simulations for RMGs predicted increased Bangladeshi exports to India, but also increased RMG exports from India to Bangladesh. The study finds that a FTA will bring large welfare gain for consumers in Bangladesh provided there is adequate expansion of infrastructureandadministrativecapacityatcustomborders.Thestudyhowevercautionsthat thebenefitsofsuchaFTAtoBangladeshcouldbewipedoutifithastheeffectofkeeping outcheaperthirdcountryimports,i.e.,fromEastAsia,andsuchtradediversioncostscanbe huge.Thestudysuggeststhattheonlywaytominimisethetradediversioncostsisthrough furtherunilateralliberalisation. One very interesting implication emerges from the World Bank (2006) studythat suggests IndiashavingcomparativeadvantageinRMGoverBangladesh,butstillIndiahasbeenvery reluctant in allowing Bangladesh to export RMG in its own market. In recent time, India, however, has allowed Bangladesh, under tariffratequota, to export one million pieces of RMGtoits marketwithoutpayinganyduties.But,sucha volumeofexportsappearstobe verysmallwhileconsideringBangladeshstotalRMGexportstotheworldmarket. 4.2.3.TheCGEModels Thestudiesbasedoncomputablegeneralequilibrium(CGE)modelspredicttheeffectsofthe trading arrangement on all variables including production, consumption, trade flows in all sectorsoftheeconomyasalsoonwelfare.ThestudiesthatapplytheCGEmodeltoSAFTA analysisarePigatoetal.(1997),BandaraandYu(2003),andRaihanandRazzaque(2007). All these three studies employed the Global Trade Analysis Project (GTAP) database and model, though they differ in details due to the evolution of the GTAP itself (see Box 4). Pigato et al (1997) find that SAFTA would produce benefits for member nations though unilateraltradeliberalisation wouldyieldlargergains. ThestudybyBandaraandYu(2003)findsthat,intermsofrealincome,SAFTAwouldlead to a 0.21 percent and 0.03 percent gains for India and Sri Lanka respectively, while Bangladesh would lose by 0.10 percent. However, the rest of South Asia (comprising Pakistan, Nepal, Bhutan and Maldives) would gain by 0.08. The authors also endorse the view that South Asian countries might gain much more from unilateral trade liberalisation andmultilateralliberalisationthanfromSAFTA.

14

Box4:TheGTAPModel TheGTAPModeltheglobalcomputablegeneralequilibrium(CGE)modellingframework oftheGlobalTradeAnalysisProject(GTAP)(Hertel,1997)isthebestpossiblewayforthe ex ante analysis of economic and trade consequences of comprehensive multilateral or bilateral trade agreements. The GTAP model is a comparative static, global computable general equilibrium model, and is based on neoclassical theories. Full documentation of the GTAP model and the database can be found in Hertel (1997) and also in Dimaranan and McDougall (2002). The GTAP model is a linearised model, and uses a common global databasefortheCGEanalysis.Themodelassumesperfectcompetitioninallmarkets,constant returns to scale in all production and trade activities, and profit and utility maximising behaviour of firmsandhouseholds respectively. The version6 of GTAP database covers 57 commodities,87regions/countries,and5factorsofproduction.

RaihanandRazzaque(2007)alsousetheglobalgeneralequilibriummodel(GTAPmodel)in explainingthewelfareeffectsofanyregionaltradingarrangements.Themaincontributionof theirpaperwastodecomposethewelfare effectsofSAFTA(ascalculated fromtheGTAP simulationresults) intotradecreationandtradediversioneffectsforindividualSouthAsian 12 countries. The authors ran two simulations for two scenarios: SAFTA1 and SAFTA2. UnderSAFTA1scenario,allmembercountrieseliminatetheirintraregionaltariffsandkeep theirtariffswiththerestoftheworldunaffected. In the scenario SAFTA2, in addition to SAFTA1, Bangladesh eliminates her tariffs for the restof the world by 50 percent. Box5 provides the results of this exercise. It appears that Bangladesh would incur a net welfare loss from the SAFTA1 scenario. Though, for Bangladesh there was a positive trade creation effect, the negative trade diversion effect wouldbelargeenoughtooffsetthepositivegain.However,allotherSouthAsiancountries wouldgain fromSAFTA1.Thegain forIndiawould bethe largestas farasany individual country is concerned. In contrast to SAFTA1 under SAFTA2, the negative trade diversion effect of SAFTA1 for Bangladesh would be eliminated to a large extent, and the trade creationeffect would be large enoughtooffsetthetradediversioneffect.As aresult,there wouldbeanetwelfaregainforBangladesh.

12

It should, however, be noted that the original GTAP framework does not provide any estimates of trade creationandtradediversionaspectsofthetotalwelfareeffects.Inordertoestimatethesetwoeffectstheauthors madesomeadjustmentsintheGTAPmodel.TheGTAPmodelprovidesanetwelfareestimateoftheSAFTA simulation whichisasumofthetradecreationandtradediversion effects.Withaviewtoisolatingthetrade creationeffectfromthetotalwelfareeffectaseparatesimulation wasrun wherenecessaryadjustmentsinthe GTAPclosureweremadesothattheimportstoalltheSouthAsiancountriesfromallovertheworld(except fromtheSouthAsiancountries)wereheldfixed.Thewelfareeffects fromthisscenariowerenothingbutthe tradecreationeffectsforindividualSouthAsiancountries.Thistradecreationeffectwasthendeductedfromthe total welfareeffectintheoriginalsimulationtogettheestimateofthetradediversioneffect.

15

Box5:TradeCreationandTradeDiversionEffectsofSAFTASimulations SAFTA1Scenario SAFTA2Scenario

RestofSouth176.3 Asia
97.1

425.2 601.5

RestofSouth Asia

446.5 167.4 613.9

92.8

SriLanka

19.1 116.2 312.6

SriLanka

20.6 113.4 325.9

India
184.1 204.5

46.7 359.3

India

49.3 375.2 84.1

Bangladesh

20.4
200 100 0 100 200 MillionUS$ 300 400 500 600 700

Bangladesh
300 200

56.8 140.9
100 0 100 200 MillionUS$ 300 400 500 600 700

300

TradeCreation

TradeDiversion

Total

TradeCreation

TradeDiversion

Total

SAFTA1Scenario=FullTariffremovalbythemembercountries SAFTA2Scenario=SAFTA1+ BangladeshreducesherMFNtariffby50% Source:RaihanandRazzaque(2007)

Raihan and Razzaque (2007) also explore the possible reasons for the large trade diversion effects for Bangladesh. From the GTAP simulation results it appears that under SAFTA1, importsfromChinaandotherlowcostsources(allovertheworld)woulddeclinewhilethat from India would increase significantly, which indicates, as far as the imports into Bangladesh are concerned, a replacement of low lost cost import sources by a high cost source (see Box 6). However, two caveats should be kept in mind while qualifying these GTAPsimulationresults:firstly,theGTAPdatabasedoesnotallowenoughdisaggregation ofcommodities,andsecondly,sincethemodelisacomparativestaticmodel,potentialnew trade(ormorepreciselythedynamiceffects)cannotbecaptured.

16

Box6:ChangesinImportstoBangladeshfrom Different CountriesunderSAFTA1(inUS$mn) ThehighnegativetradediversioneffectforBangladeshunderSAFTA1isexplainedbythefact thatimportsfromIndia(arelativelyhighcostimportsource)increasessubstantiallyandimports fromallovertheworld(relativelylowcostimportsource)alsodeclinessignificantly

SriLanka Restof theWorld 243.3 111.6 6.3 0.9 48.5 31.8 162.9 2.1 607.2

Restof South Asia

Korea

Japan

China

India

USA

AgriculturalProducts Textile WearingApparels Leather Chemicals Machineries OtherManufacturing Service Total

426.3 279.9 13.8 5.0 133.0 114.4 517.1 0.1 1489.4

14.9 3.7 1.7 0.0 3.4 2.2 8.5 0.1 34.3

5.7 291.2 8.7 1.4 11.0 6.0 22.6 0.2 346.3

12.1 96.5 0.8 0.2 11.6 17.6 28.8 0.1 167.8

3.6 5.2 0.8 0.0 4.3 16.6 60.8 0.1 91.4

1.7 38.8 0.8 2.0 12.9 6.9 59.5 0.1 122.7

16.6 2.9 1.4 0.0 8.0 6.6 16.0 1.2 52.8

17.1 4.3 3.6 0.3 19.4 32.1 53.1 1.8 131.6

Source:RaihanandRazzaque(2007)

It appears from the analysis of the studies based on CGE models on SAFTA that most of thesestudiespredictawelfarelossforBangladesh,whichisprimarilydrivenbyalargetrade diversion effect that dominates over the trade creation effect. The insights, which can be derivedfromtheseCGEmodels,havebeenveryusefulsincethesemodelstakeintoaccount theintersectoralandinterregionaleffectsofanyregionaltradingarrangementlikeSAFTA. However,themajordisadvantagewiththeGTAPmodelisthatthedatabase,ithas,ismuch aggregated in nature. Therefore, it is difficult to identify, at the disaggregated level, the products and the extent to which SAFTA would lead to expansion of exports from BangladeshtootherSouthAsiancountriesingeneralandtoIndiainparticular.Inaddition, beingveryaggregativeinnature,thesemodels,ingeneral,arenotcapableofcapturingRoO aspectsinthesimulationexercises. 4.2.4. SAFTA and the Expansion of Bangladeshs Exports into Indian Market: A SimulationExerciseusingthePartialEquilibriumWITS/SMARTModel FromtheBangladeshperspective,oneofthemajorquestionsrelatedtoSAFTAiswhetherit would generate substantial exports from Bangladesh toIndia. In this subsection, we try to answerthisquestion. The limitation of the GTAP model in handling disaggregated data has already been mentioned.Incontrast,apartialequilibriummodel,namelytheWITS/SMARTmodel,allows analysisatamuchdisaggregatedproductlevel,despiteitsweaknessofignoringsectoraland regionalfeedbackswhentradepolicyinstrumentsarechangedeitherinagivensectororall sectorsinagivencountry.However,givenitscapacitytoallowanalysisathighlevelofdis aggregation, the partial equilibrium models become indispensable especially where there is interestinestablishingsensitivesectorseitherwithregardstoindustrial orfiscalpolicies.One specialadvantageoftheWITS/SMARTmodelisthatitallowstheanalysistobeundertaken atthe6digitlevel. 17

EU

UsingtheWITS/SMARTmodelwesimulatetheSAFTAscenario(removeallintraregional tariff for all countries), and our interest is to see what happens to Bangladeshs exports to India.ThismodellingexercisehelpsusidentifythesectorsinwhichBangladeshsexportsare likelytoexpandintheIndianmarketunderSAFTA.Thesimulationresultsarepresentedin Table3.ItappearsthatunderSAFTA,BangladeshsexportstoIndianmarketwouldriseby 13 anamountofUS$78mn .However,thetop30products(atthe6digitHScode),together, accountfor83percentoftheincreaseinexportearnings(US$64.9mn).Ifproductsincluded intheIndiansensitivelistsareexcludedfromtariffreduction,exportsincreasebyUS$64mn.
Table3:Exportsrisefortop30products(HS6digit)fromBangladeshtoIndia(000US$) underSAFTA
HSTariff 080290 150790 151620 220290 251710 252329 281410 310420 340111 392690 410419 410449 410719 520299 530310 530710 530720 531010 560710 630492 630510 720421 740400 740811 740819 790111 850680 850690 850710 850720 Description Othernutsfreshordried Soybeanoilandfractions Vegetablefatsandoils Mineralwater Pebbles,gravelorcrushedstones Cement Anhydrousammonia Fertiliser(potassiumchloride) Toiletsoap Plasticarticles Othertannedorcrusthidesandskinsofbovine Tannedorcrusthidesandskinsofbovine Leatherfurtherpreparedaftertanningorcrusting Cottonwaste Jutetextile YarnofJute Multipleyarnofjuteorothertextile Unbleachedwovenfabricsofjute Juteropes Othermadeupoftextile(notknittedorcrochetedofcotton) Jutebags FerrouswasteofStainlesssteel Copperwasteandscrap Copperwire OtherCopperwire Unwroughtzinc(containingbyweight99.99%zincormore Otherprimarycellsandprimarybatteries Partsofotherprimarycellsandprimarybatteries Leadacidelectrics Leadacidelectrics Totalfortop30products Totalforallproducts TotalexcludingtheproductsintheIndianSensitivelist IncreaseinExports 5012.20 1878.05 2539.79 908.30 504.48 463.48 17039.55 566.87 814.10 3880.31 576.55 930.40 555.76 1234.79 3314.02 2742.05 923.35 1500.70 2670.10 568.22 7506.17 1121.73 704.16 1296.94 1112.54 765.19 499.31 488.07 1306.81 1487.20 64911.11 78130.83 64006.38

Source:WITS/SMARTsimulationresults Note:ProductsintheshadedrowsareincludedintheIndianSensitiveListforLDCs

13

It should be noted here that originally the WITS/SMART model simulation results indicate an increase in exports from Bangladesh to India by only US$24mn. However, the GTAP simulation results for a similar scenariosuggestanincreaseinsuchexportsbyUS$78mn.InthecurrentexercisewehaveconsideredtheGTAP simulationresult,andtheincreaseinexportsbyUS$78mnhasbeendistributedamongdifferentsectorsinthe WITS/SMART model as per their shares in the rise in exports by US$24mn (the result of the original WITS/SMARTmodel).

18

AnanalysisofTable3suggeststhatunderSAFTA,Bangladesh may notbeabletoexpand herexportstoIndianmarketsubstantially.Thepresenceofsensitivelistswillfurtheractsas hindrance for export expansion. The WITS/SMART simulation results also suggest that exports of other made up of textiles (HS code 630492) from Bangladesh to India would increaseonly modestlyunderSAFTA,thoughBangladeshiexportersconsiderIndiatobea good market for Bangladeshs RMG. A critical question thus arises whether the model simulationresultsarecorrectortheexportersinBangladeshhavesomewrongnotionsabout theircomparativeadvantageonRMGexportsasfarastheIndianmarketisconcerned. 4.2.5. Some Final Observations on the Partial Equilibrium and General Equilibrium SimulationResults Despite their limitations both the partial equilibrium and general equilibrium models are useful inassessingthe impactsofany RTAonthe membercountries.Ifcarefullydesigned, simulationresultsfromthesemodelsprovideusefulinsightsinanalysingthestaticgainsfrom suchPTAs.However,sincemostofthesemodelsarestaticinnature,theyarenotcapableof capturing the dynamic impacts of such trading arrangements. Also, whentrade is restricted (whatever may be the reasons) both partial equilibrium and general equilibrium models cannotcapturethenewtrade.Because,iftheinitialbaseoftradeinanyproductisverylow (orevenzero),therewouldnotbeanysubstantialincrease(ornoincreaseinthecaseofzero base) in trade for that particular commodity as far as these model simulation results are concerned.However,asevidencessuggest,mutualtariffconcessionscanleadtotradeinnew items. In the case of bilateral FTA betweenIndia and Sri Lanka, Sri Lanka benefited from exportingVanashpatioil toIndia(whichwasalmostnilbeforetheFTA)bytakingadvantage ofthispreferentialtradingarrangement.. Theaforementionedarguments in noway,however,underminetheusefulnessofthepartial equilibrium andgeneralequilibrium modellingexerciseswithrespecttoRTAanalysis.The static gains/losses of any RTA are rather obvious compared to any dynamic gains/losses whichareuncertain,andarealsodependantonmanyotheruncertainfactors. 5.FeedbackfromthePolicyMakersandBusinessPeopleinBangladesh Wesharedtheresultsoftheaforementionedreviewandsimulationexerciseswithafewkey 14 policymakersandrepresentativesofotherstakeholderstogathertheirperceptiononthem. It appearsthatthepolicymakersandthebusinesspeopleareawareoftheseissues,andthey,to some extent, agree with many of the concerns raised by a number of empirical studies on SAFTA.However,theyhavedifferentopinionstoo. DiscussionswiththepolicymakersandbusinesspeopleinBangladeshsuggestthatthebenefit that Bangladesh foresees through SAFTA is her substantial market access in India. It has alreadybeenmentionedthattogetherwiththetradethroughinformalchannel,Indiaisbyfar thebiggestsourceofimportsforBangladesh.However,despitegrowinghugeandsustained trade deficits, India has not yet provided any meaningful trade concessions to Bangladesh. While some insignificant tariff concessions have been offered so far under SAPTA and SAFTA,nontariffandparatariffbarriersfaroutweighthebenefitsoftariffconcessions.
14

The people interviewed include, among others, a high official in the Tariff Commission, Ministry of CommerceinBangladeshandthePresidentofaleadingChamberofBusinessandIndustriesinBangladesh.

19

Discussionswiththepolicymakersandbusinesspeoplealsoindicatethatthereareanumber of products which have significant export potentials in the Indian market under SAFTA. These are plastic and melamine products, chemical products, toiletries, copper wire, betel nuts,rawjute,juteproductsandfertiliser.However,anumberofsuchproducts,i.e.,plastic products,toiletries,betelnuts(includedinothernuts:HS080290)areincludedintheIndian SAFTAsensitivelist,whichmakestheexpansionofexportsoftheseproductsintheIndian marketalmostimpossible.Bangladeshiexportersalsofacea numberofnontariffandpara tariff barriers in the Indian market. A list of nontariff and paratariff barriers faced by BangladeshiexportersinIndianmarketispresentedinTable4.
Table4:NontariffandParatariffBarriersFacedbyBangladeshiExportersinIndia
NTBs ClassificationofGoods Description CustomsauthoritiesinIndia,inmanycases,donotagreewiththeHS classificationdeclaredbyexporters.Thereisatendencyofreclassifyingthe productsinsuchamannersothathigherdutiescanbeimposed. IndiancustomsauthorityoftendoesnotacceptthevaluedeclaredbyBangladeshi exporters.Arbitraryvaluationbyofgoodsmakestheproductsuncompetitive. OfteneachconsignmentoffoodproductsissubjectedtocertificatefromthePort HealthOfficer.Samplesaresenttotestinglaboratorieswhicharefarfromthe customsstations.Suchchemicaltestsareapplicabletoleatherandleathergoods, plastic,andmelamineproducts.Forleathergoods,NOCfromWildlife Departmentisalsorequired. Allprepackagedproductsaretocarrysuchinformationas:nameandaddressof theimporters,genericcommonnameoftheproduct,net quantityinstandardunit ofweightsandmeasures,monthandyearofpacking,maximumretailsalesprice includingalltaxes,freight,transportcharges,commissionpayabletodealers. Everyjutebagcarry,bagmadeinwhichmustbemachinestitched.

CustomsValuation TestingRequirements

MandatoryRequirement forLabellingandMarking

SpecialLabellingforJute Bags MandatoryStandards Requirement

SinceAugust2003mandatorymarkingformBureauofIndianStandards(BIS)is requiredforimportof159commodities.Theseproductsinclude,amongstothers, cement,steeltubes,stoves,electricalandelectronicitems,steelproducts,leather products,helmets,gascylinder,batteries,andmineralwater.Foreign manufacturesintendingtoexporttheseproductswillhavetosetupanofficein India,withthepermissionoftheReserveBankofIndia. SanitaryandPhytosanitary Allprimaryagriculturalproductsaresubjecttobiosecurityandsanitaryand Measures phytosanitaryimportpermits.Determinationofeligibilityproceduresuffersfrom lackof transparency. TechnicalRegulations (1)Importconsignmentcontainingtextileandtextileproductsshallhaveto accompanyapreshipmentcertificatefromatextiletestinglaboratoryaccredited totheNationalAccreditedAgencyofthecountryoforigin.Ifsuchacertificateis notavailableconsignmentwillbeclearedonlyaftertestingthesamefromthe notifiedagencies. (2)AllpharmaceuticalproductsmustberegisteredbytheCentralDrugsStandard ControlOrganisationheadedbytheDrugsControllerofIndia. (3)Forjuteproductsacertificateisrequiredfromanationaltestingagency confirmingthatthecontentofnonhalogenatedhydrocarbon(jutebatchingoil)in thejutebagsforpackagingpurposesshallnotexceedthreepercent byweight. QuarantineRequirement Allimportsofplants,fruits,andseedshavetoobtainanimportpermitatleast onemonthinadvanceandallimportsshallbesubjecttoinspectionbyofficerin chargeofplantquarantinestation.Juteandjuteproductsareoftensubjecttosuch requirementeventhoughtheyarenotlivingorganisms. TariffValue ImportofC.I.sheetissubjecttoatariffvalueofUS$590/600,whilethepriceof suchproductfromBangladeshisnotaboveUS$450. CountervailingDuty Countervailingdutyatarateof16percent isimposedonagroproducts,toiletries andcosmeticitems. Source:BasedontheinformationcompiledbytheMinistryofCommerce.

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The policy makers and business people in Bangladesh are also concerned because it is not clear in the Treaty whether other NTBs will be removed with QRs. The existing Treaty provision is for elimination of only QRs on products included in the trade liberalisation programme(TLP).TheTreaty is, however,silentontheremovalofparatariffsand NTBs. Unlessthesebarrierstotradeareremovedsimultaneouslywiththereductionoftariffs,itwill bedifficulttoexploitthefullgainsfromvariousphasesoftariffreduction,andtheobjective ofpreferentialtariffswillbedefeated.Amoreseriousconcernisthat intheSAFTATreaty thereisnoformatforphasingoutthenegativelistovertheyears.Thecriteriafordesigning RoOarenotcleareither. It also appears that the Treaty is silent about how SAFTA will integrate the bilateral and multilateral trade arrangements that currently exist between some SAARC countries and betweenSAARCcountrieswithoutsidetheregion.Thereareconcernsthat if, forexample, thepaceoftariff reductionisnotaccelerated,SAFTAmaybecomeirrelevantinlightofother agreements.Also,withrespecttoRoO,therearediscrepancieswhilecomparingtheSAFTA treaty with the IndiaSri Lanka bilateral FTA agreement and also with the BIMSTEC agreement. A number of suggestions have emerged from the discussions. To minimise its potential adverse effects and maximise its beneficial effects there should be: (i) minimisation ofthe sectoral/product exceptions, (ii) have RoO that are very liberal, simple, transparent, and remain the same for all productsand (iii) have clear rules against tariffrate quotas. There should also be regional cooperation in trade facilitation, harmonisation of standards and policies, and infrastructural developments. There could be a Regional Fund for the developmentofinfrastructure,humanresources,andimprovementofexportsupplycapacity ofLDCs. 6.TheProspectofMultilateralismwithRegionalismforBangladesh As has been mentioned before, the regional market in South Asia has not yet been an important destination for Bangladeshs export products. More than 90 percent of BangladeshsexportproductsaredestinedtotheNorthAmericanandEUmarkets.Therefore, Bangladeshhasavitalinterestinimprovinghermarketaccesstoglobalmarkets.Whilethe importance of the larger integrated market of the South Asian countries can hardly be ignored, Bangladesh is also putting serious efforts at the multilateral trade negotiations. BangladeshshassomeoffensiveinterestsattheWTOnegotiationsandtheseincludegaining dutyfreequotafree(DFQF)marketaccessofLDCsproductsinthedevelopedaswellasin theadvanceddevelopingcountries,andtemporary movementof herunskilled labour inthe developed countries under GATSs mode IV negotiations. Studies have indicated that BangladeshislikelytogainsignificantlyifDFQFmarketaccessisensuredforherexportsin 15 the developed and advanced developing countries. Also, there are importance gains from themigrationofunskilledlabourastheremittancessentbythemigrantscontributemuchto theeradicationofpovertyinBangladesh(RaihanandKhondker,2007 Annabi etal,2006).

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Raihan et al (2007) explored, usingthe GTAPmodel, different dutyfreequotafree (DFQF) marketaccess scenariosfortheproductsfrom Bangladesh(aswellas fromotherLDCs)intheeconomiesofdevelopedand advanced developing countries. The simulationresults suggested significant gains for Bangladesh interms of welfareandexportrise.ThepapercalledforseriousnegotiatingeffortsfromBangladeshattheWTOinorderto securesuchDFQFmarketaccess.

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Bangladesh should also try to expand its export outlets outside the region, such as the BIMSTC,D8,andtheIORARC,ofwhichBangladeshisamember.Bangladeshmayalso seektoimproveitstradingrelationswiththeASEAN.Attemptsmayalsobemadetoobtain an association status with the ASEAN, which would open enormous opportunities for expandingexporttoASEANcountriesandalsoattractingFDIfromthatregion.

7.ChallengesandpolicyoptionsformakingSAFTAaneffectivevehicleoftradeled growthforBangladesh:TheCallforaSAFTAPlusAgreement The existing SAFTA Treaty is predominantly centred on trade in goods. Though the strategies suggested in the foregoing sections would be expected to stimulate intraregional tradeinSouthAsia,itispresumedthatBangladeshcannothopefortoomuchgainfromthe existing Treaty to enhance its growth opportunities merely by promoting exports to the regional market. Bangladesh's exports to the South Asian region are very small, and a doubling, trebling, or even a quadrupling of its intraregional exports will not lead to any significant expansionofits total exports. Therefore, in addition tothe promotion of trade a numberofareasneedtobeaddressedformakingtheregionaleconomiccooperationinSouth AsiaaneffectivevehicleforpromotingeconomicgrowthintheMembercountriesingeneral andinBangladeshinparticular.Forthatpurpose,SAFTATreatyshouldgobeyondthemere Agreementintradeingoods,andthereisaneedforsomekindofSAFTAPlusagreement which will include regional cooperation mechanism in the areas of investment, finance, servicestrade,tradefacilitation andtechnologytransfer.. TheproposedSAFTAPlusagreement shouldcall forcreatinganenablingenvironmentto promote intraregional investment. The creation of a SAARC Investment Area through an intraSAARCinvestmentagreementcouldcreatesuchanenvironment(SACEPS,2002RIS, 2002).Asanexample,thetradeinvestmentnexushascomeintoeffectiveoperationinIndia SriLanka bilateral FTAandthe largetradedeficits betweenthese twocountries have been compensatedbythecapitalaccountthroughsignificantinvestmentflows(RIS,2004).Inthe context of investment flows, horizontal and vertical integration of industries of South Asia becomes important to face the global competitive pressures. Even though a multitude of literature is available on these crucial issues, the existing agreement has completely overlookedtheseareasandsolelyfocusedontradefacilitatingmeasuresinArticle8. The SAFTAPlus Agreement will also enhance Bangladesh's prospects for getting larger investment inflows from the more developed partner countries in the region. These investments, whether 100 percentownership by regional investorsor joint ventures, should helpimprovethecountry'sexportsupplycapabilityandboostexportsbothtotheregionand totheoutsideworld.Itisobviousthatwithoutsignificantstructuralchangesinherproduction pattern Bangladesh is unlikely to be able to derive the desired benefits from SAFTA. Top priority,therefore, shouldbegiventoaugmentingBangladeshsexportsupplycapability. AmajorlimitationoftheexistingTreatyisthatitleavesouttradeinservices.Anumberof empirical literatures have shown that thetrade in services can generate substantial gains as againstthegainsfromtradeingoods.Consideringthesensitivityofthisissue,theGEPreport (1998) did not recommend the liberalisation of trade in services. But it suggested regularisation of the informal labour movement on the basis of regional norms and mechanisms and evolving rules and procedures to make things easier for the service

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providersandconsumersinthesocialsector,particularlyhealthandeducation.TheSAFTA PlusAgreementshouldassignmuchimportanceonpromotingservicestradeintheregion. 8.Conclusion This paper has examined the implications of SAFTA for the economy of Bangladesh. In doing so it has reviewed Bangladeshs bilateral trade with her neighbouring countries. The paperhasalsoexaminedtheS&DTprovisionforLDCsunderSAFTA.Thepaperrevieweda numberof studieswhich conductedqualitativeandquantitativeassessmentsofSAFTAand its implicationsontheBangladesheconomy.Itappearsthatthereareconflictingarguments on the success of SAFTA as well as on whether Bangladesh would stand to gain from SAFTA.Thedebateappearstobefarfromconclusive.However,rigorouseconomicanalysis suggeststhatBangladesh may notbeabletogainmuchwithintheexisting tradeingoods based agreement. The possibility of a large trade diversion for Bangladesh under the full implementationofexistingSAFTAAgreement,ishigh. However, it is also important to note that trade diversion for Bangladesh and possibly for otherLDCsunderSAFTA is inevitable.Bangladeshwill havetoraisetheexportshare into the regional market substantially in order to gain through positive terms of trade effect. Exportdiversificationinthisregardisveryimportant.TechnicalassistancetoBangladeshto diversifyherexportbasketcanbeavitalagenda.ItshouldalsobenotedthattheS&DTfor theLDCsunderSAFTAarenotsufficient,especiallymaintainingthesensitivelistforsome of the critical products produced by India will not help Bangladesh to increase her export share.ThepaperalsocallsforaSAFTAPlusAgreementbyhighlightingtheimportanceof someadditionalmeasuresliketheagreementsinintraregionalinvestment,finance,andtrade inservices.

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