Indo-Asia Connectivity for Shared Prosperity
Base paper on Trade and investment
Surupa Gupta, University of Mary Washington

There is wide agreement that during the last decade, liberalization of trade and investment policies, increased volume of trade, foreign direct investment (FDI), expansion of regional production networks and other factors have spurred growth in South and Southeast Asian countries. At the same time, policymakers and scholars agree that there is much room for improvement through further integration at all levels. This section discusses the progress made thus far and the potential for further growth through removal of existing barriers. Within the broader context of the two regions, this section focuses specifically on the countries that make up the Bay of Bengal Initiative for Multisectoral Technical and Economic Cooperation (BIMSTEC) comprising Bangladesh, Bhutan, India, Myanmar, Nepal, Sri Lanka and Thailand. It goes on to identify some barriers that stand in the way of regulatory and physical connectivity and presents key recommendations for reforms.

Trade and investment between South and Southeast Asia have grown substantially over the last couple of decades. Trade between the two regions has grown nearly 22 times: from a low base of $4 billion in 1990, it grew to $90 billion in 2013. However, despite this growth, the share of each region in the other’s total trade and investment remains low. Southeast Asia accounted for 10% of South Asia’s trade in 2013, up from 6% in 1990, while South Asia accounted for 4% of Southeast Asian trade in 2013, up from 2% in 1990. During 2009-2013, 9% of Southeast Asian foreign direct investment flowed into South Asia while 15% of South Asian investments went to Southeast Asia. Both regions have made progress in adopting outward-oriented reforms andin increasing integration with the rest of the world. Applied manufacturing tariffs have fallen in both regions during the past couple of decades. However, intra-regional trade, particularly in South Asia, remains low at under 6%. Cross-border supply chains in South Asia remain unsophisticated. Given the low level of integration within South Asia, it is not surprising that cross-regional trade between the two regions is higher than intra-regional trade in South Asia – this emphasizes the need to build trade both within and between the regions.In sum, these suggest that there is plenty of room for further growth.

The case for greater integration and connectivity

A strong case can be made for greater integration and better connectivity between the two regions. Besides enabling expansion of markets for goods and services, further economic integration would lead to greater specialization, leading to higher efficiency in allocation of resources in the regions. Both regions and particularly South Asia can see this as an opportunity for insertion into regional supply chains. Both regions will also further benefit from increasing their attractiveness for foreign direct investors not only from these regions but also from the United States. Trade costs will likely go down as rules and procedures are simplified and made more transparent. Several studies estimate that increasing connectivity will lead to significant GDP gains for many of the countries involved. Regional economic integration is particularly beneficial for Northeast India, Bangladesh and Nepal. As a newly democratic country, Myanmar is also expected to benefit substantially from such integration.

Although South Asian economies more generally and the Indian economy particularly grew at a fast pace during the early 2000s, that growth was not accompanied by high rates of investment. Economists argue that an increase in the level of regional integration will have a positive effect on the climate for investment in the region and likely encourage more cross-border investment. Faster growth in the manufacturing sector will also increase opportunity for employment as the latter in agriculture shrinks. Studies have shown that reducing tariff and non-tariff barriers to trade will increase trade and welfare in South Asia and will lead to trade creation, with India serving as the anchor for growth.Trade and investment barriers that need to come down include tariff and non-tariff barriers to trade as well as beyond the border barriers to investment.Clearly, bringing down some of these barriers will involve domestic economic reforms that pose political challenges.

Enhanced trade and investment will require greater connectivity – both physical as well as regulatory. There are several reasons for focusing on connectivity between these two regions. First, increase in demand from a growing Asian middle class is likely to be a driver for growth in the future. Asian economies are better off relying on domestic and regional demand in order to sustain their growth and prosperity. Better connectivity will go far in expanding access to markets and increasing regional competitiveness. Second, it will help the expansion of regional production networks, bringing in countries that have remained largely isolated from them. Third, improved connectivity will likely attract more FDI into both the regions. This, in turn, will enhance access to technology and markets and increase productivity. Fourth, financial integration is expected to reduce the costs of funding. This is important given that the region requires huge investments in infrastructure and other sectors. Fifth, better connectivity will help the regions achieve inclusive growth and reduce poverty. Finally, recent political and economic reforms in Myanmar provide an opportunity for integration. Myanmar’s location as a land bridge between the two region gives it a central strategic role in enhancing connectivity, as does its coastline and proximity to major shipping lanes.

The case for further integration and connectivity needs to be placed within the broader discussion on the future of trade and regional integration. During the last year, trade volumes have fallen globally. Particularly in the United States and in the European Union, public opinion is apparently turning anti-trade. However, the continued importance of trade and cross-border investment as a vehicle for economic development is not lost on countries in South and Southeast Asia. There is, therefore, a need to work multilaterally as well as regionally towards greater liberalization in trade and investment. Negotiations at the World Trade Organization, the main platform for trade liberalization at the multilateral level, clearly need time to refocus in a post-Doha world. As long as the United States continued to back the Trans Pacific Partnership (TPP), scholars and analysts expected the TPP to put pressure for trade liberalization on non-TPP Asian countries. With the TPP’s future uncertain after the 2016 presidential election in the US, countries in Asia will need to push for regional integration without any external pressure. China has renewed calls for building a Free Trade Area of the Asia-Pacific (FTAAP). In that context, the role of the Regional Comprehensive Economic Partnership (RCEP), a sixteen country attempt at negotiating a megaregional trade agreement, assumes renewed importance. Except for India, none of the South Asian BIMSTEC members are part of the RCEP negotiations. Both for India’s future connection with the rest of RCEP and for the other South Asian BIMSTEC countries, building connections to Southeast Asia remains urgent. At the same time, this buys South Asian countries some time to liberalize, given that the RCEP’s standards for liberalization are, by and large, lower than those proposed under the TPP. The standards that the TPP sought to impose were way beyond what South Asian countries were ready for. Finally, it is important to remember that while the US is unlikely to move on the TPP for a while, the standards the TPP represented remain important to US interests.

Integration and connectivity within BIMSTEC

Focusing on BIMSTEC member countries is a crucial piece in the effort to enhance further connectivity and integration between South and Southeast Asia. BIMSTEC, an intergovernmental group, was formed in 1997 as a means for enhancing cooperation between South and Southeast Asia and more particularly, among the states around the Bay of Bengal region. BIMSTEC is home to 1.8 billion people and constitutes a $2.5 trillion economy. As a region, its growth rate in recent years has been faster than the global average of 6.05%. Trade and investment were identified as key pillars of cooperation in BIMSTEC. Policymakers expected that as barriers to trade and investment fell, countries within the group would be able to create supply chains and that this would lead to wider cooperation. The region’s attractiveness arises from the fact that it offers one of the highest returns to capital investment. Improving physical connectivity between these regions would likely attract and enable such investment growth. Recognizing this, China and Japan are already working toward greater cooperation in these regions.While trade within the region has grown in recent years, trade among BIMSTEC members remains low at seven per cent of their total trade. There is evidence of complementarity among goods produced in these countries, suggesting a high potential for growth in trade – in fact, fourteen priority areas have been identified where such complementarities exist. Trade potential also emerges from opportunities for increased trade in services, particularly services such as finance and transportation, in air, over land and water, which potentially facilitate further trade in goods as well as trade in other services such as tourism, health that will likely have a strong impact on job creation and development in all BIMSTEC members.

Although total FDI flows into the BIMSTEC countries have increased from $8 billion in 2000 to $46 billion in 2013, after reaching a peak of $58 billion in 2008, intra-BIMSTEC investment remains low. Lack of connectivity, which may be a central factor in this outcome, also discourages investment by investors from outside the region.

Greater connectivity – both physical and regulatory – is likely to enhance both trade and investment flows within the BIMSTEC countries as well as between them and non-BIMSTEC countries. Physical connectivity involves roads, railways, air-links and maritime links while regulatory issues focus on non-trade barriers, trade facilitation issues, capital controls etc. It is clear that relative lack of both types of connectivity stand in the way of greater trade and investment flows in the region.

Trade in goods and services

Given the present low level of intra-region and cross-region trade, reduction in tariffs within and between the regions will lead to welfare gains and growth. Besides enhancing the volume of trade in goods that already cross borders in the region, the creation of regional supply chains for both regional and global markets can potentially add to growth in trade volumes. Studies indicate that value chains in agriculture, textiles and apparel as well as in services such as tourism and medical services/tourism are the likeliest to come up in the region. However, trade in goods face both regulatory and physical connectivity challenges. While tariffs have come down in almost all BIMSTEC countries, several challenges remain. Between 2001 and 2013, the average applied most favoured nation tariffs in South Asia declined from 17% to 13.9%. Southeast Asia’s averages fell from 8.7% to 7.1% during the same period. The effective applied tariffs on cross-regional trade has also fallen sharply during that time. It is important to note that while this trend is largely observable in all the BIMSTEC countries, average tariff levels in India, Thailand and other countries in BIMSTEC increased in the aftermath of the 2008 crisis.

Even as tariffs have fallen, non-tariff barriers of various types have emerged as the primary barrier to trade in goods. These include but are not limited to quotas, import licenses, sanitary regulations, prohibitions, among others. Bothat-the-border and beyond-the-border country-specific regulations as well as lengthy administrative procedures, excessive requirement for documentation stand in the way of seamless trade. As measures that are less transparent than tariffs and therefore, harder to track, NTBs pose a somewhat bigger challenge to trade. Overall, as with tariffs, non-tariff barriers have also been falling in these regions. However, the ADB estimates that 75%-80% of measures that discriminate against foreign producers and traders remain in the books. Equally worrisome is the observation that as in the case of tariffs,governmentsresort to imposition of non-tariff barriers during economic crises. During 2009-2013, in response to the most recent one, governments in the regions added hundreds of non-tariff barriers that discriminated against foreign producers. India, the largest economy in the regions under consideration, imposed 260 discriminatory NTBs. Here we try to identify several types and suggest ways to deal with them.

While nontariff barriers are more difficult to track than tariffs, the World Bank’s ease of doing business indicators provide a set of yardsticks for comparing how these countries measure up in some of these categories. These countries display a wide variation in the “Doing Business” ranking:Thailand at 46th, Bhutan at 73rd, Nepal at 107th, Sri Lanka at 110th, India at 130th, Myanmar at 170thand Bangladesh at 176th. The rankings clearly allow room for substantial improvement. Particularly problematic are indicators such as the time taken and the cost to import and export and the paperwork involved. Bangladesh, for example, requires import licenses on various goods, in addition to requiring letters of authorization. Private and public sector importers have different burdens, with the latter facing multiple requirements for registration. Thailand, which enjoys the highest rank among the BIMSTEC members in the Ease of Doing Business rankings, requires import licenses for 16 categories of products and has import prohibitions on several products. Sri Lanka imposes import licenses on 400 items and imposes fees on those licenses, among other things. Additionally, there are multiple taxes and levies that discriminate against foreign producers.

Technical barriers to trade (TBTs) constitute a second category of barriers to trade with and within the region. India, for example, imposes a ban on animal tested cosmetics. The larger problem in case of TBTsoften is that the government does not provide guidelines that tell producers how they can comply. In some cases, new rules are not notified to the WTO. Exporters run into problems with food that is made with genetically engineered products. The approval process in case of such foods is uncertain and slow. A further problem is the absence of clear jurisdiction as to which ministry within the government is responsible for approval. Exporters to India also face TBTs vis-à-vis telecommunications equipment and electronics information technology equipment.Additionally, Thailand, Sri Lanka, India and others have sanitary and phytosanitary barriers on genetically engineered commodities, poultry and meat products. While WTO rules allow countries to impose TBTs and SPSs, lack of clear guidelines and timelines for implementation place burden on exporters.

In addition to barriers to trade in goods, significant barriers to trade in services exist in the region. Foreign firms face barriers to entry in several sectors. These barriers include outright ban on participation in specific sectors to restricting ownership through equity caps to requirement of licenses. Barriers take other forms as well – states impose discriminatory taxes and levies and put limits on products firms can offer, all of which restrict their access to markets in these countries. Although foreign corporations are allowed to provide services in Bangladesh, the government controls the entry of telecommunications, banking, insurance and financial firms into the market. Firms need licenses and the process through which these are awarded is not transparent. Sri Lanka discriminates against foreign insurance companies and poses restrictions and transactions costs on several sectors including e-commerce, telecommunications and commodities. While it has used its 2011 nationalization law sparingly, such laws increase investor uncertainty regarding property rights. Public sector corruption, weak and inconsistent enforcement of anti-corruption laws and concern for corruption in large projects are common features of all BIMSTEC economies.In India, the largest economy in the region, the government has ownership of large parts of the banking and insurance industries and limits on foreign equity for other sectors such as retail and financial services. In addition, sectors such as legal, education, audio-visual, accounting, telecommunications, e-commerce face restrictions of various kinds. Thailand poses barriers to investments in telecommunications, accounting, legal, financial and legal services as well.

Physical connectivity

Physical connectivity among and within the countries pose a particularly serious challenge to trade in goods and services. The challenges and opportunities associated with maritime and riverine connectivity is addressed in a separate section. Here we highlight the challenges associated with road and air connectivity. Lack of highways both within and between these countries pose the biggest challenge to movement of goods and people. Air connectivity is weak as well and if improved, can provide connectivity to the inland regions of BIMSTEC. Airline services using smaller aircrafts can be operated connecting Guwahati, Yangon, New Delhi, Dhaka, Imphal, Mandalay, Bangkok, Colombo and so on.

The primary focus on roadways should include working on the following:

Motor Vehicles Agreement
Trilateral Highway linking Moreh (India) with MaeSot (Thailand).

The MVA among BBIN countries is receiving close attention even if some challenges remain. However, once this is adopted, working towards an MVA among BIMSTEC countries seems the logical next step. While the route for the Trilateral Highway has been identified, the success of building it depends on cooperation from Myanmar and Thailand as well as on finding development assistance on parts of the road. This huge project includes building new roads, upgrading existing roads, building approach roads as well as rebuilding distressed bridges. Besides financing, these projects require a legal infrastructure and agreements among member countries for maintenance of these facilities.

Foreign investment as a tool for development including infrastructure financing

Besides trade, inward foreign direct investments offer a significant avenue for growth in the BIMSTEC region by filling the gap between much-needed investment and domestically available funds. FDI can also fill the gap in technology, infrastructure funding as well as in solving distribution problems associated with economies that are yet to integrate substantial sections of their economy to that of the rest of the world. FDI policies of countries in the region have also seen significant liberalization in the last two decades. In India, for example, FDI policy has adopted a negative list approach – this means that any sector that is not covered in the list is fully open to FDI. For other sectors, the government has relaxed equity limits for foreign ownership.

As in case of trade, improvements in the Doing Business indicators have had a positive effect on the investment climate in the region as well. Governments in the region still need to address a long list of economic reforms. Updating and reforming land acquisition laws for industrial activity would be a necessary first step for many countries in the region. Finally, building and upgrading infrastructure and improving connectivity will go far in enhancing economic integration in the region. This task is challenging for many reasons not least of which is the challenge of financing.

All countries in the region suffer from weak public finances and a limited capacity for raising resources domestically. The governments’ goals for physical connectivity require funds that would have to come both from domestic savings as well as foreign sources. International concessional financing from institutions such as the World Bank and Asian Development Bank Relying on foreign non-concessional borrowing poses challenges – the volume needed for infrastructure building is unsustainable in most cases. There is a need to attract private foreign direct investment, build a robust public-private partnership model for infrastructure funding and building if the countries in the region are to achieve greater connectivity and thus move in the direction of enhanced trade and investment. Total infrastructure financing needs of these countries were projected to be $2565.1 billion in 2011. However, securing this money will require significant steps on the part of the governments in the region. Robust financial management is one of them. India has led the way in financial management with a flexible exchange rate. India embarked on a cautious path to capital account liberalization. Many of the countries in the region allow convertibility on the current account. But other than Thailand, none of the BIMSTEC member countries have embraced full capital account liberalization. Given the experience of the Asian Financial Crisis as well as the level of economic development in most countries, it is not entirely unreasonable for them to approach this issue cautiously.

Institutional support

The WTO membership negotiated a Trade Facilitation Agreement in Bali in 2013. The agreement was put together with the objective of expediting the movement, release and clearance of goods. The agreement also seeks to encourage cooperation between customs and other relevant agencies on trade facilitation and customs compliance. Although the agreement is yet to enter into force, all BIMSTEC members except Nepal have ratified it. The TFA should begin to dismantle some of the barriers mentioned above and make it easier to conduct trade in these countries. Increase in trade on account of improved trade facilitation is projected to increase the per capita gross domestic product. Based on World Bank data on how efficiently trade moves, Thailand scores the highest among BIMSTEC countries. Implementing trade facilitation measures should be one of the top priorities.

Several regional arrangements that are already in place can be used as frameworks for further cooperation. Besides BIMSTEC, countries in the region are part of several bilateral and regional trade and investment groupings such as BBIN, Bangladesh’s Special Economic Zones for Indian investment, India-Sri Lanka Economic and Technology Cooperation Agreement.