Implications of SAFTA for Indian Economy: Trade, Compatibility and Welfare Effects

Date01 November 2019
Published date01 November 2019
AuthorHansa Jain
Subject MatterArticles
04_FTR874218.indd Article
Implications of SAFTA
Foreign Trade Review
54(4) 355–374, 2019
for Indian Economy:
© 2019 Indian Institute of
Foreign Trade
Trade, Compatibility
Reprints and permissions:
and Welfare Effects
DOI: 10.1177/0015732519874218
Hansa Jain1
Among the members of South Asian Free Trade Area (SAFTA), India dominates
in terms of its geographical location, land area, population size and economic
share. However, SAFTA is treated as a weak agreement as India is highly out-
ward oriented for trade. This raises a question about India’s trade compatibility
with South Asian countries. Also since SAFTA is now fully implemented, there is
a need to determine its welfare effects for India as well as for the region.
The study focuses on (a) trends and patterns of India’s intra-regional trade with
South Asian countries, (b) trade compatibility and (c) welfare effects of SAFTA
for the Indian economy. India’s trade intensity, trade share and trade compatibil-
ity with the other regional members is calculated. GTAP simulations are used to
determine welfare effects. The study is based upon the secondary data.
The study finds that with the implementation of SAFTA, India’s trade intensity
and trade share with its regional members has slightly improved. Trade compati-
bility though low, is gradually improving. The study considers SAFTA as a positive
sum game for India. India is likely to have favourable allocative efficiency effect,
terms of trade effect and investment-savings effect if trade facilitation measures
are adopted.
JEL Codes: F150, F10, F140, C150
SAFTA, trade intensity, trade share, trade compatibility, GTAP simulations
1 Sardar Patel Institute of Economic and Social Research, Ahmedabad, Gujarat, India.
Corresponding author:
Hansa Jain, Sardar Patel Institute of Economic and Social Research, Thaltej Road, Near Doordarshan
Kendra, Ahmedabad, Gujarat 380054, India.

Foreign Trade Review 54(4)
Over the past two and half decades, the world economy has seen the emergence of
many strong regional trading blocs in different parts of the world. Prominent
among them are European Union (EU), North American Free Trade Agreement
(NAFTA), Commonwealth of Independent States (CIS), Latin American Integration
Association (LAIA), Association of Southeast Asian Nations (ASEAN) and
Organisation of Economic Co-operation and Development (OECD). Since the
1990s, number of these agreements has more than quadrupled crossing 240.
Currently, each country is a member of one or the other regional trade agreement
(RTA), though there is considerable variation among regions and levels of devel-
opment. The collapse of WTO negotiations in late July 20061 has also increased
interest in regional trading arrangements.
Regional economic integration refers to grouping of countries with the objec-
tive of reducing barriers to trade on a reciprocal and preferential basis for the
member nations. This helps the countries to mobilize their resources to strengthen
their competitiveness in the world market. Due to geographical proximity, social
and cultural ties and historical linkages, it is widely accepted that RTAs have the
capacity for rapid economic growth of the region as well as expansion of world’s
output. It also protects the nation’s economy from volatile exchange rates and
other types of external shocks.
Regional integration in 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 liberalization commitments
to the South Asian countries. SAFTA has come into force since 1 July 2006 with
the aim of boosting intra-regional trade among the seven SAARC members.
Currently, there are eight member nations in SAFTA group, namely India,
Pakistan, Bangladesh, Bhutan, Nepal, Sri Lanka, the Maldives and Afghanistan.2
Tariff reductions under SAFTA occurred in a phased manner. Among the non-
least developed countries (NLDC), India and Pakistan were required to eliminate
their tariffs by December 2012 and Sri Lanka by December 2013. All the less
developed countries (LDC), namely Bangladesh, Nepal, Bhutan and the Maldives
were required to eliminate their tariffs by December 2015. It was expected that
the SAFTA mechanism, when fully implemented, will provide the member
nations’ improved access in the region, help boost their exports to the region
and improve the intra-regional trade.
Among the SAFTA nations, India dominates in terms of its location, land area,
population size, economic share and so no. Out of the total trade among the South
Asian countries, India alone shares 40 per cent of the trade. This implies that the
remaining 60 per cent of the trade is distributed among rest of the seven South
Asian countries. Therefore, the success of SAFTA highly depends upon India’s
integration with other regional members. In this context, several studies have sug-
gested the importance of India for strengthening intra-regional trade relations in

Jain 357
the SAFTA bloc. According to Wilson and Ostuki (2007), India is the important
medium to increase their gains through intra-regional trade among SAFTA mem-
bers. Rodriguez-Delgado (2007) by using gravity model simulation suggested
that SAFTA TLP would influence regional trade flows mainly by increasing India’s
exports and imports from Bangladesh and Nepal. Raihan and Razzaque (2007)
suggested that Bangladesh and other LDCs in South Asia will have to raise their
export share into the Indian market substantially in order to increase welfare
through positive terms of trade effect. He emphasized on reducing tariffs by South
Asian LDCs on the import of (at least) raw materials from India. Weerakoon
(2001) estimated approximately similar results for Sri Lanka. Bhuyan (2001)
have suggested India to take initiative to encourage the smaller economies in the
region to enhance and diversify their production and export capacity. Baysan,
Panagariya, and Pitigala (2006) hoped that the member countries will be able to
gain significantly by having greater access to India. Wilson and Ostuki (2007),
Rodriguez-Delgado (2007) and others have advocated the welfare effects of
SAFTA in the long run subject to effective participation of India. However, India
shares only 3 per cent of its trade with the SAFTA nations. With 24 per cent of the
world’s population, intra-regional trade among the SAFTA members is only 6 per
cent of the world trade (Direction of Trade Statistics, IMF DATA, 2015). The
greater outward orientation of India raises a question about compatibility of
India’s trade with its regional members.
Besides, the welfare effect of SAFTA has been criticized in the existing litera-
ture on the grounds of several geopolitical, bureaucratic and institutional hurdles
(Alam, Amin, Farooqui, & Akram, 2011; Batra, 2004) along with poor infrastruc-
ture and inefficient technology (Bandara & Yu, 2003; Baysan et al., 2006; Rahman
& Dutta, 2012; Razzaque, 2010; Sinha, 2010; Taneja & Sawhney, 2007 among
others). Baysan et al. (2006) pointed out three points that undermine the potential
gains from the SAFTA. First, there are limited complementarities in the region.
Therefore, even under the free trade mechanism, the expansion of intra-regional
trade would not be very substantial. Second, these countries trade very little
among themselves and major trading partners of the individual South Asian coun-
tries are located in the west. Third, it is alleged that SAFTA may lead to substan-
tial trade diversion than trade creation for some of the member countries.
With this backdrop, the present study is endeavoured to determine trade impli-
cations of SAFTA for the Indian economy. The study focuses on the following
three issues:
1. Trends and patterns of India’s intra-regional trade with South Asian
2. Trade compatibility between India and South Asian members and
3. Welfare effects of SAFTA for the Indian economy.
Though the study focuses on a single country, India, but in its true vein, it reflects
the whole intra-regional trade implications for SAFTA. Improvement in trade
relations with SAFTA members itself reflects the strengthening of bloc.

Foreign Trade Review 54(4)
Database and Methodology
The study is based upon the secondary source of data.3 Trade relation between
two countries is better gauzed from the trade intensity index and trade share.
Trade intensity index is the ratio of trade share of a country/region to the share of
world trade with a partner. Mathematically, TII = (t / T ) / (t / T ). Here t is
the monetary value of total trade of country/region i with country/region j, T is
the monetary value of the total trade of country/region i with the world, t is the
monetary value of world trade with country/region j, and T is the monetary
value of world trade. An index of more than one indicates that trade flow between
countries/region is larger than expected given their importance in world trade.
Trade share...

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