Trade creation and trade diversion in India- Sri Lanka free trade agreement (ISFTA): a sector specific analysis
Student name: Ms Sonam Choudhry
Guide: Dr Poornima Varma
Year of completion: 2012
Host Organisation: Centre for WTO Studies, Indian Institute of Foreign Trade (IIFT), New Delhi
Supervisor (Host Organisation): Dr Murali Kallummal
Abstract: India’s first FTA, the India-Sri Lanka FTA (ISFTA) was signed in December 1998, and came in
to force in 2000. India and Sri Lanka account for the largest bilateral trade flow in the South
Asian Association for Regional Cooperation (SAARC) region. Given the growing importance of
this bilateral trade, the present paper attempts to analyze the impact of India - Sri Lanka Free
Trade Agreement (ISFTA) on trade creation and trade diversion. The analysis is carried out at
the sectoral level as the FTA is expected to have varying impact on sectors as well as regions in
the two countries.
The study utilizes the data obtained at the 6 digit level of Harmonized System (HS) of trade
classification data (HS 1996 classification), covering the period 1996 to 2000. Unit values of
exports and imports are taken as the proxy for import and export prices. If unit values of imports
to India from Sri-Lanka are higher than the world unit value of imports then we assume that this
indicates the possibility of trade diversion. Similarly, if unit values of imports from Sri Lanka are
lower than unit value of India’s exports to world then we assume that there is a possibility of
trade creation. This methodology along with other trade indicators has been used in identifying
the specific sectors for further analysis. The other trade indicators that have been used in the
present study are growth rates in trade flows, Vertical Intra-Industry Specialisation, Import
Dependency Index, Export Propensity Intensity Index, Relative Comparative Advantage and
Finger-Kreinin (FK) index.
Our preliminary analysis based on above exercise showed that the specific sectors that require
close scrutiny are textiles, metals and engineering equipments. Further analysis using the partial
equilibrium modeling approach (SMART model) to simulate the likely increase in trade flows
under the various tariff reduction scenarios showed that India- Sri Lanka FTA will cause trade
creation compared to trade diversion. This result is justifiable owing to the fact that both India
and Sri-Lanka play a less role in world trade scenario.
