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LITERATURE REVIEW AND RATIONALE FOR SAFTA 27<br />
The lack of trade complementarity in bilateral trade<br />
flow and the similarity of the pattern of comparative<br />
advantage in the region have been identified as some<br />
of the main constraints for the growth of intra-regional<br />
trade (Kemal et al. 2000).<br />
Daniel (2007) evaluates the SAFTA within the<br />
global structure of overlapping RTAs using modified<br />
gravity equation. First, it examines the effects of the<br />
Trade Liberalisation Program (TLP) which started in<br />
2006. SAFTA would have a minor effect on regional<br />
trade flows and the impact on custom duties would be<br />
a manageable fiscal shock for most members.<br />
However, there exist studies that argue in favour<br />
of SAFTA. Raihan and Razzaque (2007) using CGE<br />
modeling estimate the trade creation and trade diversion<br />
effects of SAFTA. They show that a full implementation<br />
of SAFTA will lead to welfare gains for India, Sri Lanka<br />
and rest of South Asian countries, though Bangladesh<br />
suffers from welfare loss. Bangladesh’s welfare loss is<br />
mainly driven by the negative trade diversion effect.<br />
Simulation results also suggest that the negative trade<br />
diversion effect can be undermined by some associated<br />
unilateral trade liberalisation measure. It is also<br />
important to note that trade diversion for Bangladesh<br />
and possibly for other LDCs under SAFTA is inevitable.<br />
Bangladesh and other LDCs in South Asia will have to<br />
raise their export share into the Indian market<br />
substantially in order to increase welfare through positive<br />
terms of trade effect. Export diversification in this<br />
regard is very important.<br />
World Bank Study (1997) analyses the static welfare<br />
consequences of preferential liberalisation. Using an<br />
integrated general equilibrium model of the world<br />
economy (Global Trade Analysis Project, GTAP) it<br />
shows that regional trade liberalisation would increase<br />
the welfare between 0.5% of GDP for India and one<br />
percent for the rest of South Asia. The welfare gains<br />
from regional liberalisation are the sum of trade<br />
creation effects (increased trade between countries in<br />
the region) from lower barriers minus trade diversion<br />
losses caused by replacing non-South Asian imports<br />
with now preferred South Asian goods plus the terms<br />
of trade gains associated with increased access to each<br />
other’s still protected markets. The benefits to the rest<br />
of South Asia are larger than to India because the former<br />
gains free access to many highly protected markets of<br />
latter which results in a significant improvement in<br />
terms of trade. The study does not, however, estimates<br />
individual country impacts except for India<br />
RIS (2004) reports the result of studies conducted<br />
in the framework of gravity model. It suggests that<br />
complete elimination of tariffs under SAFTA may<br />
increase the intra-regional trade 1.6 times. It further<br />
suggests that in the dynamic framework the gains from<br />
liberalisation are at least 25% higher than the static<br />
gains.<br />
Kumar and Saini (2007) estimate different scenarios<br />
for SAFTA and its implications welfare on each country.<br />
They find that a South Asian Free Trade Area, as<br />
envisaged under the SAFTA scenario, does not result<br />
in welfare gains for all the member countries. SAFTA<br />
results in small welfare gains for all the South Asian<br />
countries except Bangladesh. Rest of South Asia (RSA)<br />
gains most by about half a billion dollars, while India<br />
gains by about US $204 millions and Sri Lanka by just<br />
US$89 millions only. Bangladesh on the other hand<br />
suffers welfare loss of about US$225 millions. The gains<br />
in welfare for RSA, India and Sri Lanka are basically<br />
due to gains in terms of trade, and to a lesser extent<br />
from improvements in allocative efficiency in the case<br />
of RSA and Sri Lanka. Bangladesh loses out both in<br />
terms of allocation efficiency and terms of trade by<br />
US$104 and US$106 millions, respectively.<br />
In sum, there exists a debate in the literature on<br />
the possible gains of SAFTA. Studies using different<br />
methodologies arrive at different results. Most of the<br />
studies have examined the impact of lowering tariffs<br />
to zero under SAFTA though few studies have also<br />
examined the impacts under alternative scenarios. The<br />
main objective of this study is to give a holistic picture<br />
of the effects of SAFTA on trade, inward investments<br />
and welfare aspects. More importantly, the study has<br />
focused on the potential of trade in services in the region<br />
and explored the ways of harmonising the regulations<br />
existing in different modes of trade in the identified<br />
services sectors. Possibilities of arriving at MRAs in<br />
different services sectors are delved on.<br />
In arriving at the conclusions on impacts of SAFTA,<br />
the study adds to the existing literature in three<br />
important ways. First, it estimates the change in the<br />
extent of complementarity and competitiveness at SITC<br />
five-digit level of the South Asian region for the years<br />
1991 and 2004 to assess the change in the composition<br />
of competitiveness basket as well as their complementarities.<br />
The change in the complementarity and competitive<br />
baskets overtime to a large extent is able to resolve<br />
the differences arrived at by the studies estimating the<br />
impact of SAFTA using pre and post 2000 trade data.<br />
The impact on each country’s trade and welfare is<br />
analysed using CGE modeling which is followed by<br />
the estimates of trade creation and trade diversion<br />
following SAFTA using the gravity model. The study