Impact of the Indo-Sri Lanka Free Trade Agreement on the Sri Lankan Economy

The Indo-Lanka Free Trade Agreement (ILFTA), which was signed in December 1998 at the highest political level, and its subsequent implementation in March 2000 marked an important milestone in India–Sri Lanka relations, and in trade relations in particular, as it concretized and paved the way for closer economic integration. This article provides a quantitative assessment of the impact of the ILFTA on macroeconomic variables, welfare and output focusing on the Sri Lankan economy. In addition, the study investigates the impact of trade liberalization on trade structure, bilateral trade between Sri Lanka and India and trade partners of Sri Lanka. We perform simulations using the Global Trade Analysis Project (GTAP) model Version 6, to quantify the impacts of liberalized trade between Sri Lanka and India. The GTAP is a computable general equilibrium (CGE) model of the world economy.The results indicated that both Sri Lanka and India will experience welfare gains from the ILFTA. Moreover, it was evident that the Indo-Lanka full trade liberalization scenario ensures higher welfare to both the countries than the Indo-Lanka FTA with negative lists. Hence, the scenario with negative lists could be treated as a second best solution as ‘with-negative-lists’ scenario where both the countries could not reap the maximum benefits under the FTA. The simulation results demonstrate that trade diversion effects are not much significant due to trade liberalization between the two countries. The industry analysis reflected that the industries, such as metal products, paper products and publishing, electronic equipment, chemical, rubber and plastic products, machinery and equipment necessaries and other primary products will benefit due to the ILFTA. However, it could be seen that the industrial sector is benefiting more than the agricultural sector due to trade liberalization between the two countries.