Notes on SAFTA

This is just a summary/note of the status of South Asian Free Trade Agreement (SAFTA). It is heavily extracted from Weerakon’s chapter in this book published by the WB. I will post updated analysis and figures later. It walks through the events leading to SAFTA (from the establishment of SAARC and the passage of SAPTA). The one thing that stands out is that the role of India in stimulating trade in the SAARC region.

Most of the SAARC nations heavily depend on the Indian market for trade. Meanwhile, in terms of trade volume, India trades the least with SAARC nations. So, SAARC nations need India to liberalize its trade regime further, not the other way round! It is time for other SAARC nations to reciprocate India. I still need to get hold of a good paper that weighs the gains and losses to each SAARC nation from SAFTA.

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In 1977, Sri Lanka initiated the process of policy liberalization and other countries followed in the 1980s. A regional bloc named South Asian Association for Regional Cooperation (SAARC) was established in 1985.

India liberalized in early 1990s, leading to a wave of economic liberalization in South Asia. To be fair, without India’s initiation, no trade agreement under SAARC would be possible. SAARC countries rely heavily in the Indian market for both exports and imports. However, this is not the case with India, which trades more with ASEAN, the EU and the US.

A proposal to initiate SAPTA was agreed upon by SAARC members in December 1995. The next year, they agreed to start SAFTA by 2000 (but not later than 2005). With good progress in SAPTA by 1998, the SAARC nations proponed the initiation date of SAFTA to 2000.

Unfortunately, the initiative dealt a blow due to rising political tension between India and Pakistan. The SAFTA framework was only adopted in 2004 after political tension cooled between the two countries. To be fair, progress in the SAARC blog has been a victim of bitter animosity and untrustworthy environment between India and Pakistan.

Outstanding issues liked to rules of origin (ROO), sensitive lists and other concerns were sorted out in January 2006. Under the proposed Tariff Liberalization Program (TLP), SAFTA will become fully effective for LDCs (Nepal and Afghanistan) by 2016 and for non-LDCs by 2013.

There are legitimate concerns about the usefulness of SAFTA because of the number of goods in sensitive list, ROO conditions, and other preferential access through bilateral FTAs that will offer more generous tariff cuts and market access than SAFTA does. Moreover, there are arguments that regional integration would not be that effective because there is hardly any potential for comparative advantage-driven trade because most of the countries share similar socio-economic fundamentals such as low income, abundant labor, language in general, etc. Others echo the view that countries are better off if they liberalize trade unilaterally (this works only if India leads and it benefits other SAARC nations). Some (here and here) argue that regional trade integration will in fact yield a net welfare loss and slow unilateral liberalization. However, new studies have identified benefits not only in trade in goods but also in services and investment.

SAPTA did not move far enough because of various self-imposed trade constraints.The most limiting factor of SAPTA was the scope of goods protected under special lists. For instance, products imported from under SAPTA concessions translated to only 15 percent of total imports between SAARC nations. Intra-SAARC trade was just 5 percent of total trade with the rest of the world.

Meanwhile, SAFTA adopted a negative list and sensitive list rather than goods covered under preferential concessions. Under SAFTA, non-LDC members are required to reduce existing tariff to 20 percent within two years of implementation of the agreement. Then, in the next five years, they are required to reduce tariffs to a range of 0-5 percent. For LDCs, in the first two years, tariffs should come down to 30 percent and to 0-5 percent in the next eight years. The LDCs are in a better position in terms of reducing tariff. Note that the tariffs reduction under SAFTA still fall short of the concessions under some of the bilateral trade agreements among SAARC nations, mainly with India.

With regards to rules of origin (ROO)- which generally includes provisions to prevent trade deflection, facilitate value addition, and augment the volume of intraregional trade- SAFTA ROO is similar to that under the bilateral FTAs in the region.

Regarding sensitive list, which is used to shield sensitive industries from increased competition, there are a lot of items that do not face competition, i.e. tariffs are not brought down. In general, countries retain a negative list of 20 percent of tariff lines for non-LDC nations. Nepal maintains the highest number of items under sensitive list. There is no formal and binding provision in the framework agreement requiring that negative lists are pruned down over time. This is in contrast to other FTAs, which require explicitly that negative lists be phased out with time.

Almost 53 percent of total import trade among South Asian nations by value is excluded from the liberalization of tariffs proposed under the SAFTA treaty. India is taking an unilateral move to prune its sensitive list by removing an additional 264 items applicable to LDCs. There is also no explicit commitment to deal with nontariff barriers.

SAFTA is confined to trade in goods, leaving trade in services, investment and other areas of economic cooperation. Moreover, the required initial tariff liberalization of 20 percent threshold is not that encouraging because most of the nations have been unilaterally lowering Most Favored Nations (MFN) tariffs quite substantially over time.

More than 90 percent of regional trade for Nepal, Bangladesh, Sri Lanka is confined to a bilateral relationship with India. Basically, the process of creating SAFTA involves market access between India and other South Asian economies. India is the biggest consumer of other SAARC nations’ exports. If India gives generous concessions, then the trading partner benefits tremendously. For instance, Nepal and Sri Lanka benefit from trading with India. Nepal’s share of trade with India in total intra-SAARC trade is almost 100 percent, while in total world trade, Nepal’s trade with India is close to 70 percent.

The SAARC nations need India to open up its markets and give more concessions, not the other way round. In fact, India’s share of imports from SAARC nations is close to one percent, which is less than its imports from ASEAN+3 nations (27 percent).

Nepal’s trade with India is increasing rapidly while its trade share with ASEAN+3 is decreasing. India is becoming the most valued market for Nepali exports. The more concessions India gives, the more will be Nepal’s trade with India.

At present, most South Asian nations are restricting 55-65 percent of their imports from India under SAFTA sensitive lists.

Almost all the countries have signed either bilateral or regional (or both) trade agreements involving India.

Green industrial policy in Brazil

Tarun Khanna and Santiago Mingo argue that the green industrial policy of Brazil worked.

What did they do?

Brazil’s experience at promoting renewable fuels, beginning in the 1970’s, is directly relevant to today’s polarized views of industrial policy. A 10-year industrial policy program called Pro-álcool was crucial in the development of the industry. Today, Brazil is the world’s most competitive producer of renewable fuels, based primarily on bioethanol. Ethanol accounts for more than 50% of current light-vehicle fuel demand in the country, and Petrobras – Brazil’s energy giant and one of the largest companies in Latin America – expects this share to increase to more than 80% by 2020.

Our research shows that industrial policy was successful in promoting a competitive bioethanol industry in Brazil. A massive stimulus package, prompted by the 1970’s rise in oil prices, gave rise to an entirely new industry. But it would not have worked without the crucial role played by competition.

How did they do?

As world energy prices collapsed, Brazil fortuitously turned off its subsidy tap, whereupon a

brutal Darwinian free-for-all ensued. This competitive rationalization was the key to the policy’s success.

The Brazilian state offered low-interest loans and credit guarantees for the construction of distilleries, as well as tax incentives for the purchase of ethanol-powered vehicles. Ethanol prices were manipulated to make it an attractive alternative to gasoline. In addition, the government induced Petrobras to distribute the renewable fuel. Gas stations installed ethanol pumps. The government signed agreements with the major automobile companies to provide incentives to make vehicles that could run on 100% ethanol.

By the 1990’s, the major subsidies and policies were abolished, and the industry was deregulated. Our statistical analysis of the entry and exit patterns of entrepreneurs in the Brazilian ethanol industry shows that the more efficient acquired the less efficient. Most underperforming ethanol companies went bankrupt or were taken over by entrepreneurs who had successful track records in running efficient operations.

The government did not bail out the underperformers, allowing market forces to restructure the industry during the post-subsidy phase. Certainly, the beneficiaries of Pro-álcool’s subsidies lobbied the state to continue the protective policies even after their usefulness – inducing the development of the industry – had expired. Fortunately, the government was not persuaded.

Lessons from Brazilian IP exercise:

Brazil’s experience offers three important lessons for nations implementing renewable energy initiatives: (1) government policies must be consistent, simple, and long-lasting, providing assurance to would-be entrepreneurs that they can invest for the long haul; (2) picking winners, the familiar weakness of overenthusiastic bureaucrats, must be kept to a minimum; and (3) the state must have the discipline to dismantle subsidies when the need for them has passed.

The poverty of poverty professionals

Ravi Kanbur echoes what a lot of development professionals working on the ground in developing countries have been saying for a long time.

Each poverty professional should engage in an “exposure” to poverty (also known as “immersions”) every 12 to 18 months. I do not mean by this rural sector missions for aid agency officials, nor the running of training workshops by NGO staff. What I mean is well captured by Eyben (2004); these are exercises that “are designed for visitors to stay for a period of several days, living with their hosts as participants, as well as observers, in their daily lives. They are distinct from project monitoring or highly structured ‘red carpet’ trips when officials make brief visits to a village or an urban slum….

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What is striking about the class of poverty professionals (of whom I am one) is that the good living (granted, not at the billionaire or millionaire level, but pretty good nevertheless) is made through the very process of analyzing, writing, recommending on poverty. To me, at least, this is discomforting and disconcerting

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I recall many years ago, when I was in my twenties, telling the anthropologist Mary Douglas about how I was starting to do consulting for the World Bank on poverty issues, and how important it was to do this work. “And it’s not too bad for one’s own poverty either, is it?” came her worldly, knowing, reply. The seeds of discomfort sown by that comment have germinated and taken root, and now won’t let go.

Perception of poverty matter. What is troubling is that researchers who have never lived a life of a poor person (for simplicity, discount the opportunity cost of what Collier says "hope") brand people living in developing country as "poor" when the "poor" don't feel that s/he is really "poor".

Highlights of Mahatma Gandhi National Rural Employment Guarantee Act (NREGA)

Highlights of MGNREGA, the largest employment guarantee public works program in the world. In later posts, I will post summaries of audit reports to check if these conditions are fulfilled. Also, I will post how NREGA is doing so far. Here is a previous blog post on NREGA.

Eligibility: Any person who is above the age of 18 and resides in rural areas is entitled to apply for work.

Entitlement: Any applicant is entitled to work within 15 days, for as many as he/she has applied, subject to a limit of 100 days per household per year.

Distance: Work is to be provided within a radius of 5 kilometers of the applicant’s residence if possible, and in any case within the Block. If work is provided beyond 5 kilometers, travel allowances have to be paid.

Wages: Workers are entitled to the statutory minimum wage applicable to agricultural laborers in the state, unless and until the Central Government “notifies” a different wage rate. If the Central Government notifies, the wage rate is subject to a minimum of Rs.60 per day.

Timely payment: Workers are to be paid weekly, or in any case not later than a fortnight. Payment of wages is to be made directly to the person concerned in the presence of independent persons of the community on pre-announced dates.

Unemployment allowance: If work is not provided within 15 days, applicants are entitled to an unemployment allowance: one third of the wage rate for the first thirty days, and one half thereafter.

Worksite facilities: Laborers are entitled to various facilities at the worksite such as clean drinking water, shade for periods of rest, emergency health care, and crèche.

Employment guarantee scheme: Each State Government has to put in place an “Employment Guarantee Scheme” within six months of the Act coming into force.

Permissible works: A list of permissible works is given in Schedule I of the Act. These are concerned mainly with water conservation, minor irrigation, land development, rural roads, etc. However, the Schedule also allows “any other work which may be notified by the Central Government in consultation with the State Government.”

Program Officer: The Rural Employment Guarantee Scheme is to be coordinated at the Block level by a “Program Officer”.

Implementing agencies: Works are to be executed by “implementing agencies”. These include, first and foremost, the Gram Panchayats (they are supposed to implement half of the works), but implementing agencies may also include other Panchayati Raj Institutions, line departments such as the Public Works Department or Forest Department, and NGOs.

Contractors: Private contractors are banned.

Decentralized planning: A shelf of projects is to be maintained by the Program Officer, based on proposals from the implementing agencies. Each Gram Panchayat is also supposed to prepare a shelf of works based on the recommendations of the Gram Sabha.

Transparency and accountability: The Act includes various provisions for transparency and accountability, such as regular social audits by the Gram Sabhas, mandatory disclosure of muster rolls, public accessibility of all documents, regular updating of job cards, etc.

Participation of women: Priority is to be given to women in the allocation of work, “in such a way that at least one-third of the beneficiaries shall be women”.

Penalties: The Act states that “whoever contravenes the provisions of this Act shall on conviction be liable to a fine which may extend to one thousand rupees”.

State council: The implementation of the Act is to be monitored by a “State Employment Guarantee Council.”

Cost sharing: The Central Government has to pay for unskilled labor wages and 75% of the material and semi-skilled, skilled labor wages. State governments have to pay the 25% of the material costs and unemployment allowance, if liable.

Capital controls, the financial crisis, and the developing countries

The recent financial crisis has reignited debate on capital controls. Before the crisis, most financial institutions believed government control of the inflows of capital was bad for a nation’s economy and credit rating. During the crisis, however, several countries, including Brazil, Colombia, Thailand and Malaysia among others, imposed capital controls that helped reduce economic volatility. This has cleared the stigma that capital controls are bad for the economy, according to a distinguished panel of experts hosted by Carnegie.

Marcos Chamon, an economist at the IMF, highlighted the findings of a recent IMF Staff Position Note on controls in capital inflows and Jorge Arbache, a senior economic adviser to the president of the Brazilian Development Bank, and Boston University’s Kevin Gallagher discussed the policy space available to developing countries for imposing capital controls. Carnegie’s Eduardo Zepeda moderated.

Capital Controls and the Global Financial Crisis

Capital inflows are fundamentally positive when there is a general need for additional financing for productive investment and risk diversification, explained Chamon. However, when there are sudden and temporary surges that could potentially increase macroeconomic volatility, capital controls can be valuable tools.

During the crisis, net capital flows into emerging markets dropped by more than US$ 200 billion between the third and fourth quarters of 2008. Capital controls could help manage that kind of economic volatility:

• Changed perception: “The recent crisis has added ammunition to the already abundant stock of evidence in favor of controlling short-term capital controls in developing countries to curb vulnerability and avoid undue macro-economic imbalances,” argued Zepeda.
• Controls help economic resilience: Recent evidence from countries such as Malaysia and Thailand, who had imposed capital controls prior to the crisis, shows the strong resilience of their economies during and after the crisis, argued Chamon.

Conditions for controls: Chamon added that capital controls might be appropriate when: 

1. currency is overvalued.
2. further reserve accumulation is undesirable.
3. there are concerns about inflation or overheating of the economy.
4. there is a limited scope for fiscal tightening.
5. there is a high risk of financial fragility even after prudential reform framework.

• Not bad any more: The post-crisis economic soundness of the countries that imposed capital controls before the crisis has cleared the bad perception associated with such policy, stated Gallagher. Even credit rating agencies have stopped downgrading the rating of countries that impose capital controls.
• Weak institutions: Arbache stated that countries with weak institutions are more likely to impose greater control on capital inflows and outflows.

The Trade Regime

Policies to prevent and mitigate financial crises are forbidden in large parts of the trade regime. The panelists suggested that there should be exceptions for capital controls in trade and investment treaties between countries.

• Barriers to controls: Trade and investment treaties pose significant barriers to the effective use of capital controls, argued Gallagher.
• Lack of policy space: Most trade agreements do not leave their signatories policy space for capital control. For instance, the WTO and the U.S. Bilateral Investment Treaty and Free Trade Agreement do not allow members to adopt controls in capital inflow and outflow, Gallagher added.

The Example of Brazil

Brazil imposed several capital control measures, including taxes on capital account transactions and on fixed-income and equity inflows. Arbache argued that a more vigorous capital control is needed as a short-term policy option. The Brazilian economy is facing a number of pressing problems, which might require capital controls combined with structural policies for fiscal reform, including:

• appreciating exchange rate.
• widening current account deficit .
• decreasing export competitiveness.
• rising asset prices.
• rising inflation pressure.
• monetary policy that is losing its effectiveness.

Capital Controls as a Tool

Capital controls might be suitable for curbing sudden short term capital flows, Gallagher offered. They could be one of several tools used to stem financial market instability. In such a case, capital controls should be a coordinated effort among a majority of the central banks, concluded Gallagher.

[Source: This summary is adapted from an event on capital control organized at Carnegie Endowment. Yours truly wrote the event summary for TED program.] Click here, here and here for the speaker’s presentation.

Definite economic meltdown with indefinite bandas in Nepal

My latest piece is about the economic costs of the Maoist-imposed strike in Nepal. Yesterday, due to public and diplomatic pressure, the Maoist party ‘postponed’ the conflict (as if imposing strike is their property right!). My point is simple: if the parties continue with strikes, then the Nepali economy will collapse. Here and here are my previous costs estimate of bandas.

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Impending Economic Tsunami

Definite economic meltdown with indefinite bandas

Pretty much everything is in a standstill since May 1. The UCPN-Maoist has imposed an indefinite strike to topple the government. In a nation of over twenty-eight million people, few hundred of thousands of supporters, both willing and reluctant, are bused into cities, including Kathmandu, to show discontent over the ruling of the existing government.

This is battering the ailing economy hard. The political leaders need to understand that there will be no peace and the constitution would mean very little if there is an economic tsunami.

A dysfunctional economy will inflict more pain than the political upheavals we have been witnessing since 1996. Without urgent remedial policies for the collapsing economy, no matter who and which party runs the government, the situation will only get bad. Most of the causes of and remedies for the collapsing economy can be traced back to an unstable political climate and persistent strikes. More on this in a minute.

First, lets be clear about the deteriorating macroeconomic situation. The official inflation rate has been hovering around 12 percent and is not expected to come down anytime soon if supply-side constraints persist. For the first time in more than three decades, the balance of payments (BOP) is in deficit, reaching Rs 23.53 billion in the first eight months of this fiscal year against a surplus of Rs 32.58 billion in the same period last fiscal year. This is primarily caused by a decline in the growth of remittances and a soaring trade deficit. Bandas and political instability are two of the main factors causing soaring trade deficit.

Trade deficit reached Rs 206.07 billion, a 62.9 percent growth against 29.5 percent growth in the first eight months of last fiscal year. Exports declined by 8 percent while imports surged by 43.9 percent. Meantime, remittances reached Rs. 146.93 billion, a 9.9 percent growth as compared to 58.9 percent growth last year. The rapid rise in trade deficit is drawing down official reserves, which is sufficient to fund only 6.6 months of merchandise and service imports. We used to have reserve enough to fund nine months of imports. Worse, current account deficit (% of GDP) is expected to be in the negative territory and GDP growth rate to stagnate around 4 percent for at least until 2015, according to the IMF's estimate.

On top of this, there is liquidity crunch in the market. Recently, we experienced a severe shortage of domestic currency. The Indian rupee is gradually becoming a favored currency option due to loss of confidence in the Nepali rupee. While the housing sector is bubbling, other productive sectors are suffocating with a lack of liquidity. The central bank has already injected net liquidity of Rs 69.1 billion so far this year. The commercial banks are jacking up interest rates, making it harder for investors to withdraw money and serve interest payments. Despite high interest rate, deposit growth is lower than last year's. The inter bank lending rate increased by 8.85 percent from 6.38 percent. This means that even banks are wary of lending to each other. Most of the variables are progressively getting bad. Much worse is yet to come, if the current political instability, strikes, bandas, and economic stalemate persist.

How does this affect an ordinary citizen? Well, the worse these variables get, the precarious the situation will become because markets will lose confidence in the economy. It will result in closure of many factories. Unemployment rate, which is around 46 percent, will increase as firm will lay off workers and freeze hiring. Worse, would-be entrepreneurs will withhold investment. With a deteriorating situation, foreigners will pull out their investment from sectors ranging from consumer goods to hydropower. Importers will also lose confidence in the ability of domestic firms to supply goods in time, leading to cancellation of orders as was done by the Wal Mart and Gap Inc at the height of the last revolution. The need for social safety nets will increase and livelihood of many rural people will perish as intermediate buyers quit markets. Ultimately, the most vulnerable people will be hit by the strongest tides of the tsunami. The poor will be the ultimate losers. The politicians will be the last one to get hit, if they do.

In terms of costs to the economy, in a worst-case scenario, a back-of-the-envelope estimation of the costs of bandas shows that per banda day the economy bleeds 88 percent of the total value of goods and services produced in a day. This one shot, standalone estimation also shows that the industrial sector would suffer Rs 346 million per day. An average Nepali citizen of working age population would lose Rs 117 per banda day.

The crux of this mess lies in political instability and bandas. There is already a vicious strike-unemployment cycle in the economy. In terms of GDP per capita, we are the poorest nation in Asia. Frequent and fickle bandas will make us even poorer. In a country that has approximately 70% of the population live below $1.25 a day and has high population growth rate, income per capital will only go down and poverty will only increase.The most unfortunate situation is that even though we have money (budget surplus of Rs 4.40 billion in the first eight months of FY2009-10) to spend, we are not being able to do so due to politically-induced disruptive activities even at local level. 

The UCPN(M) should take some responsibility for the deteriorating macroeconomic situation. The economically destructive activities of YCL; incessant pressure exerted by militant labor unions on the weak industrial sector; forced donation campaign tantamount to illegal tax collection; deliberately inflicting troubles in firms operated by foreign companies; disruption of supply lines; and a threat to life and property of entrepreneurs are the infamous activities mostly associated with the largest party in the parliament.

If they are returning to power, then they will have to explain to the citizens how they are going to rescue Nepal from the impending economic tsunami. The CPN(M) have not uttered a single word about their economic policy to ward off the grave challenges confronted by our economy. 

Dahal and Bhattarai must explain, in plain terms, at least their strategy to salvage the economy; to revive the industrial sector; to return back illegally confiscated property; to provide employment to thousands of indoctrinated and duped YCL cadres who have been promised jobs and other opportunities; to provide safety nets to the laid off workers from the industrial sector; to rehabilitate its indoctrinated supporters; to address starvation in the Western region; and to reduce poverty. They need to realize that people did not join CPN-Maoist because of their belief in the failed Marxist-Leninist doctrines, but because of poverty and state apathy in instituting an inclusive society. These cannot be addressed by imposing bandas and by trying to topple the government with pernicious political strategy.

[Published in Republica, May 6, 2010, pp.7]

A brief history of economic crises

The past 180 years offer a smorgasbord of financial crises to study. They include:

• The crisis of 1825-1826 – This global contagion affected Europe and Latin America. Greece and Portugal defaulted.
• The crisis of 1890-1891 – Argentina defaulted and suffered bank runs. Baring Brothers faced failure. The U.K. and the U.S. were among the nations affected by this crisis.
• The panic of 1907 – Bank runs hit Europe, North America, Latin America and Asia.
• The Great Depression – Commodity prices cratered. Interest rates and inflation soared during this global meltdown.
• The downturn of 1981-1982 – Commodity prices plunged. U.S. interest rates reached the highest levels since the Depression. This crisis hit most emerging markets.
• The debt crisis of the 1980s – Widespread sovereign defaults, hyperinflation and currency devaluations primarily hurt developing African and Latin American nations.
• The Japanese crisis of 1991-1992 – Real estate and stock market bubbles burst in Japan and the Nordic nations, also affecting other European economies. Japanese real estate prices still hadn’t returned to prebubble levels nearly two decades later.
• The “tequila crisis” of 1994-1995 – The Mexican currency collapse ensnared emerging economies in Latin America, Europe and Africa.
• The Asian contagion of 1997-1998 – This crisis began in Southeast Asia and spread to Russia, the Ukraine, Colombia and Brazil.
• The global contraction of 2008 – The bursting of the U.S. subprime real estate bubble triggered stock market crashes, currency collapses and banking crises.

The financial crises shares the following common themes:

• Capital inflows predict financial crises – “Capital flow bonanzas,” as in the U.S. in 2005, characteristically preceded the Big Five crashes and, later, the 2008 subprime meltdown.
• A wave of financial innovation often leads to crisis – The creation of new mortgage-related mechanisms intended to reduce risk boosted the 2005-2006 housing boom.
• A housing boom often portends a financial crash – Prices can take years to recover. After the Spanish, Norwegian, Finnish and Swedish crashes, home prices took four to six years to hit bottom. In Japan, real estate prices remained low 17 years after the boom.
• Financial liberalization often precedes a crisis – Throughout the 1980s and 1990s, financial crises almost inevitably followed spates of loosened financial regulation.

Source: This time is different: Eight centuries of financial folly