Big Idea – Openness – Dealing With The Dragon

A possible Sri Lanka China FTA can deal with a lot more than merely boosting trade

By Shamindra Kulamannage.

Published on October 29, 2015 with No Comments

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The Sinhalese capital’s fourteenth century defensive shift to the West coast offered only a brief respite. It had been intermittently warring the expansionist northern Tamil kingdom that sought the riches of cinnamon, the island’s then main export. However by the early fifteenth century, geopolitics took a major shift and the threat to the Southern kingdom came not from its pesky Northern enemy but from distant China, which under early Ming emperors sailed great fleets of junks to Indian Ocean ports demanding tribute and obedience to the emperor.

Chinese admiral Zheng He was after the dalada, the tooth relic of the Buddha, to take back as a tribute in his first visit to the island in 1405. Failure to seize the relic and the treatment he received aggrieved the admiral who on his return five years later seized and took back to China the Sinhalese king, Vira Alakesvara, his queen and some of the kingdom’s notables as prisoners.

China’s ascent –now as in the fifteenth century – can leave kingdoms and nations that cross its path intimidated or worse. Now, Chinese expectations of tribute and obedience are subtle though still central to its economic aims for its vast population. A trade boosting $40 billion Maritime Silk Road to link ports, raw material supply chains and economic zones in Asia and Africa with China was announced in 2013. Sri Lanka’s Hambantota port built with Chinese aid – located by the main East-West shipping route and a Chinese owned container terminal at Colombo’s hub port –are key links of this silk route.

Sri Lanka is now a point on the Chinese maritime Silk Road that brings raw material and commodities to China from Africa, the Middle East and the West. For China – the world’s factory – the route is the way out for manufactured goods to the world.

chChina’s asserting itself in the world isn’t as brusque as in the fifteenth century and presents an opportunity for Sri Lanka’s economic advancement. In September 2014 – before the government change – Sri Lanka signed an MOU, launching technical level negotiations for a Sri Lanka – China Free Trade Agreement. For Sri Lanka which is an economy 150th the size of China, freer trade should be particularly attractive. There are a number of reasons for this.

Firstly and immediately China offers Sri Lanka’s export industries – particularly tea and readymade clothes – a significant new market. Sri Lanka exports $22 million in tea (1.5% of tea exports) and an equal value in readymade clothes (0.5% of readymade clothes exports) to China. Tea and readymade clothes are taxed at 15% to 17% by China.

Not only are the two economies dissimilar in size but their relative importance to each other as trade partners is also glaring. For Sri Lanka, which in 2013 imported $3 billion in Chinese goods, it’s an important trade partner. However for China the small island is insignificant, absorbing just 0.15% of its over two trillion dollars of annual exports. China won’t worry about being swamped by Sri Lankan products. Sri Lankan consumers seem to already prefer the value for money of Chinese imports. Sri Lanka’s only concern will be that import tariff revenue will decline if Chinese imports yielded less revenue.

The evidence of small economies that have FTAs with China is encouraging. Pakistan and New Zealand increased by four times exports to China as a percentage of total exports, in less than eight years after signing an FTA. Imports from China as a percentage of total imports also increased but by far less. Sri Lanka should also be able to replicate their success.

A free trade deal between unequal partners can work because small nations tend to complement rather than compete with large economies.

China also offers for Sri Lanka a far bigger opportunity than the short term gains of exporting more readymade clothes and tea under an FTA. It is these other, bigger opportunities that must motivate Sri Lanka.

Rising labour costs and skills shortages, are hampering the ascendency of Chinese firms up the value chain and this is the second opportunity. This has resulted in Chinese companies’ relocating some part of their supply chains to lower cost locations and countries with higher skilled workforces, creating beneficial terms of trade all-round. Parts made in various countries are combined – often in China – as final products for export. Electronics, textiles (for readymade clothes) and ICT sectors have some of the widest supply chains in the Asian region. Bilateral trade deals drive specialization, and Sri Lanka may suddenly now find that it can build an electronics and high-tech related industry here after all.

For the most part in Asia, trade barriers (import tariffs) are relatively low. The enthusiasm in Asia for bilateral trade deals is not driven by the motivation to reduce these further but by the opportunity to integrate with world-class supply chains that already exist in the region. It would be narrow-minded to negotiate an FTA with China because Sri Lanka can export more clothes and tea there.

Thirdly China is slated to join two regional trade deals – the Regional Comprehensive Economic Partnership, covering Asian countries and Free Trade Area of Asia and Pacific which would also include the US, Russia and most of South East Asia’s most dynamic economies. In addition, the Trans Pacific Partnership (TPP) dominated by the US and Japan and excluding China is also taking shape fast.

The only regional trade block Sri Lanka is part of is the pathetic one covering South Asia that hasn’t boosted any regional trading activity. Bilateral deals – like the proposed FTA with China –will allow Sri Lanka a leg in to benefit from the increased trade volumes due to these deals. Policymakers here claim they want to make a case for Sri Lanka to negotiate with the nations planning the Trans Pacific Partnership (TPP) of which China is not part. Being a member of dynamic bilateral and multilateral deals can be game changing for Sri Lanka.

The world’s second largest economy is asserting itself as an investor, lender and trading partner. Sri Lanka’s strategic position, at the crossroads of international trade, has aligned Sri Lanka to Chinese interest despite its unappealing size as a trading partner. This is the fourth opportunity that can be cemented with deeper trade ties. Already China is the second largest source of tourists to Sri Lanka accounting for over 10 percent of arrivals. It is also the fastest growing with arrivals to July 2015 up 77% over the same period last year. Chinese (including Hong Kong) foreign direct investment in to Sri Lanka in 2013 touched $400 million, but still only accounted for a mere 0.2% of Chinese outflows that year. Many Chinese projects have broken ground and if Sri Lanka wins the confidence of private firms there could be a massive boost to FDI flows here. In 2013 China accounted for seven percent of global FDI.

ch2Also by 2013 the Chinese government had emerged as one of the largest lenders to build infrastructure in Sri Lanka. The tourism, foreign investment and infrastructure finance all boost economic growth here. It ties in with a free trade deal because Sri Lanka can solidify these partnerships with higher trade volumes. Every sixth person on earth is Chinese. So it should not be surprising if closer ties lead to more Chinese tourists, FDI and foreign aid.

But trade relationships aren’t governed by commercial interest alone; geopolitics matter. This is the fifth reason why China would care about Sri Lanka. China has in play with Sri Lanka a political relationship – as one of its close allies in South Asia – and economic priorities – because the island is a key point in its string of pearls maritime route.

Sri Lankan industries aren’t competitive against Chinese ones and an FTA will worry some industries fearing Chinese market dominance here. However Sri Lanka has a remarkable opportunity to craft a firm economic model. Engagement with China will also improve the competitiveness of the economy and the private sector.

Regime change in Colombo has stalled the proposed FTA for now. Getting it back on the agenda soon makes both economic and political sense; forces which have driven the engagement between the two nations for over half a millennium.

Apart from political and religious objectives Zheng He’s expeditions had commercial aims too. That reflects the importance attached by the Chinese to Sri Lanka as a central place for inter-Asian and international trade.

Vira Alakesvara was eventually released and returned to the island but there was never any serious hope of his recovering the throne after the humiliation of foreign captivity. In 1414 the captives returned to the island – including a nominee of the Chinese emperor to the Sinhalese throne. But they came back to a more settled and tranquil political atmosphere here. In 1415 Parakramabahu VI began what was to be a very long reign of 55 years, having speedily eliminated the protégé of the Chinese emperor and founded what came to be called the Kotte kingdom.

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