US embassy cable - 03COLOMBO772

UNCLAS SECTION 01 OF 02 COLOMBO 000772 
 
SIPDIS 
 
STATE PLEASE PASS TO USTR 
 
E.O 12958:N/A 
TAGS: ETRD, ECON, CE, USTR, ECONOMICS 
SUBJECT:  INDO-LANKA FREE TRADE AGREEMENT, THREE YEARS 
ON 
 
REF: (a) 01 Colombo 00872 
     (b) 00 Colombo 00354 
 
1.  Summary:  The Indo-Lanka free trade agreement 
(ILFTA) completed three years of operation in March 
2003.  Trade between India and Sri Lanka increased 
sharply in 2002.  India now offers zero tariffs on 
4,150 items exported from Sri Lanka.  Several mid- 
sized Indian companies have set up operations in Sri 
Lanka taking advantage of the agreement.  Investors 
from other countries are also expected to take 
advantage of the ILFTA.  The free trade agreement 
offers Sri Lanka an opportunity to become a regional 
trading hub.  End Summary. 
 
Trade liberalization 
-------------------- 
 
2.  The Indo-Lanka free trade agreement is the first 
bi-lateral free trade agreement signed by Sri Lanka. 
Under the agreement, India has gradually phased out 
tariffs for imports from Sri Lanka, except on 429 
items under a negative list, and tea, garments, and 
textiles under quotas and/or preferential duties.  The 
most recent liberalization was in March 2003, when 
India removed tariffs on 2,799 items.  Consequently, 
4,150 items from Sri Lanka are duty free to India from 
March 2003.  In turn, Sri Lanka has offered 100% duty 
concessions on about 1,100 items.  The import duty on 
balance items will be phased out by 2008 except on 
1,180 items on Sri Lanka's negative list.   Since June 
2002, a joint Ministerial Committee (JMC) meeting is 
held annually to discuss further liberalization.  Many 
implementation problems were discussed at the first 
JMC meeting held last June.  Sri Lanka's key tea and 
garment sectors continue to ask for more leeway under 
the agreement as they are currently subject to quotas 
and restrictions on ports of entry.  According to the 
Department of Commerce here, the next meeting of the 
JMC is scheduled for June 2003 and is expected to 
discuss services for the first time, although no 
specific goals have been set yet. 
 
Increasing trade 
---------------- 
 
3.  During the past three years two-way trade of goods 
between India and Sri Lanka has almost doubled 
increasing to $1 billion in 2002, from about $560 
million in 1999.   Much of the increase is attributed 
to imports from India to Sri Lanka.  In 2002, imports 
from India increased by 40% to $835 million.  India is 
Sri Lanka's number one import market, with a 14% 
share; imported items include a wide variety of 
industrial goods and food items, some of which receive 
duty concessions under the ILFTA.  Significantly, the 
agreement has allowed Sri Lanka to source a 
substantial amount of its imports from India, which is 
a cheaper supplier than Sri Lanka's usual import 
markets in South East Asia. 
 
4.  On the export side, Sri Lanka's exports to India 
increased substantially to $170 million in 2002 from 
$70 million in 2001, but India still accounts for less 
than 4% of total Sri Lankan exports.  Currently, 4,150 
items from Sri Lanka are eligible for duty free entry 
to India, subject to 35% value addition in Sri Lanka. 
Main items exported from Sri Lanka under the ILFTA are 
copper and copper wire and rods, spices, clothing 
accessories, furniture and fittings, tires and tea. 
Sri Lanka's two main exports, tea and garments, have 
quota restrictions under the ILFTA.  They receive duty 
concessions ranging from 50% to 75%.  Sri Lankan 
exports to India are expected to grow further this 
year following duty concessions offered by India in 
March 2003. 
 
Investment 
---------- 
 
5.  According to the Board of Investment of Sri Lanka 
(BOI), since the implementation of the ILFTA in 2000, 
73 Indian companies, with a total investment 
commitment of Rs 36 billion ($400 million) have sought 
to invest in Sri Lanka.  According to BOI, 42 of these 
companies have signed agreements, with 20 projects 
already in commercial operation.  Other projects are 
awaiting approval.  Most of the Indian FDI has been by 
small and medium scale industrialists and has been in 
the industrial sector (metal-based projects, 
industrial chemicals, rubber products, and electrical 
wire and bulbs).  Some of the companies have found it 
more economical to serve South India from Sri Lanka 
than from other parts of India.  A few Sri Lankan 
companies have also expanded their investments in 
order to export to India.  These products include 
plastic furniture, aluminum wire, biscuits and roofing 
sheets. 
6.  Sri Lanka is also expecting to attract third 
country investment with intentions to exploit the 
Indian market via Sri Lanka.  Already a few foreign 
companies have built plants here to export to India. 
The largest is a $20 million investment by a Malaysian 
company exporting medium density fiber (MDF) board. 
Meanwhile, a high-tech US company is considering a 
proposal to assemble telecom parts in Sri Lanka for 
export to India.  This product, which carries a MFN 
duty of 35% in India, can be exported duty free from 
Sri Lanka.  BOI promotion officers told the Embassy 
that they are pursuing plans to promote Sri Lanka 
through the ILFTA to select U.S. companies. 
 
Sri Lanka as a regional hub 
--------------------------- 
 
7. Sri Lanka's strategic location in the Indian ocean 
near the shipping lanes connecting east and west, its 
close proximity to Indian subcontinent and its largely 
liberalized trade regime together make it an ideal 
location for a regional hub in South Asia.  The ILFTA 
links Sri Lanka to the large Indian market with a 
population of over one billion people.  In addition, 
Sri Lanka is negotiating a free trade agreement with 
Pakistan (population 150 million) and also plans to 
discuss a FTA with Bangladesh.  Further, the 
Government's latest economic policy document 
"Regaining Sri Lanka" states that the Government will 
seek to develop new markets through bilateral and 
regional trading agreements with additional countries. 
In addition to benefits accrued through these trade 
pacts, companies setting up in Sri Lanka can import 
raw materials duty free, obtain tax holidays and have 
access to an educated, easily trainable workforce. 
 
8.  In order to meet hub status, Sri Lanka is in the 
early stages of planning to upgrade its 
infrastructure.  Among the plans are major expansions 
to the international airport and the Colombo port.  In 
addition, there are plans to build a new port in 
Hambantota in the southern province.  Preliminary 
studies to build a land bridge between India and Sri 
Lanka have been completed. 
 
Comment 
------- 
 
9.  The ILFTA is not perfect, and far from what the US 
would consider a gold-standard FTA.  Still, it is an 
important start in a region where, with the exception 
of Sri Lanka, tariffs remain among the highest in the 
world.  As SAARC's efforts to stimulate regional trade 
remain stalled, Sri Lanka is assembling an apparatus 
of FTAs that will allow it to function as a trading 
hub for South Asia.  This island of 20 million people 
may be South Asia's best shot at increasing intra- 
regional trade flows - and the outside world's best 
shot at penetrating the largely closed South Asian 
market. 
Wills