Regional economic integration a distant prospect
South Asia will remain one of the fastest-growing regions in the world for the foreseeable future, thanks to rapidly rising consumer spending and an improving investment outlook. However, growth in the region is below potential owing to a key weakness. Relatively low levels of intra-regional trade and a failure to integrate in many global value chains have long held back investment, both domestic and foreign, as well as employment growth. Unless connectivity improves and governments within the region pursue closer integration, intraregional trade is set to remain low, which will weigh on its economic prospects.
Policymakers in South Asia have long envied the economies of East and South-east Asia, where close intra-regional trade has helped to improve access to global value chains and provided the backdrop for investment and employment growth. By contrast, despite common historical and cultural bonds, efforts at forging closer trade and economic ties at regional level have reaped only small dividends—such as in trade facilitation and policy harmonisation—in recent years in South Asia. This is mainly owing to relatively poor infrastructure, a weak security environment in some parts of the region and mutual distrust between the major regional actors. These factors have historically constrained and will continue to temper the speed at which integration will occur.
The South Asian economies (encompassing India, Pakistan, Afghanistan, Bangladesh, Sri Lanka, Bhutan and Nepal in this context) represent a market of more than 1.7bn people. It has been foecast that the region will achieve rapid growth over the coming years but that its potential will still be held back by policies, which often continue to favour inward-looking growth strategies and protectionist regulation. This has often left South Asian economies not only isolated from global value chains (with notable exceptions such as textiles), but is also behind low levels of intra-regional trade. According to the Asian Development Bank, intraregional trade accounts for a mere 5 of total trade in South Asia.
Previous attempts to a build a regional economic bloc and enhance commercial opportunities have been frustrated by bitter tensions between the largest states (such as India and Pakistan) and security concerns (particularly with regard to Pakistan and Afghanistan). The South Asian Association for Regional Co-operation (SAARC), an effort to forge closer relations, held its first summit in 1985, but it has so far made relatively little progress. Although formal tariff rates came down as a result of negotiations under the South Asian Free-Trade Area (SAFTA), tariff barriers remain high owing to SAFTA’s inclusion of “sensitive” lists, which encompass hundreds of products on which the tariff concessions are not applied. There has been little effort to remove these impediments to trade among the SAFTA/SAARC members over the years and prospects for liberalization look dim at present.
Even where zero-tariff rates apply, intra-regional trade is crippled by all-pervasive non-tariff barriers. These include time and resource-intensive border protocols and documentation, underdeveloped port and road infrastructure and highly restrictive visa and investment regimes. Vertical integration of industries (such as in South-east Asia) could provide a boon for regional trade. In South-east Asia, international companies were able to leverage country-specific strengths (such as lower energy or labour costs) and consequently expanded production networks that integrated the economies closer over time. However, in South Asia this will continue to be held back by policy fragmentation, inadequate regional transport networks (undermining the predictability of delivery and adding to inventory costs) as well as high tariff levels.
Frustrated by the lack of movement on internal trade and investment, South Asian countries such as India are increasingly looking beyond the region for opportunities (particularly towards South-east Asia, North Asia and the Gulf). This makes particular sense in the case of India, which, owing to the large size of its economy (and its ambitions to move up in global value chains), will be increasingly dependent on markets in developed countries rather than the smaller South Asian economies. Landlocked Nepal has historically been reliant on close trade ties with India but, amid a recent deterioration in bilateral ties, may seek to rebalance towards China. Similarly, China’s growing engagement in Pakistan may reduce the incentive to co-operate more closely with India (whose economy is currently around seven times larger than Pakistan’s in US-dollar terms). For its part, Bangladesh is looking to China to address its economic development goals, such as upgrading infrastructure. Overall, although governments across South Asia accept that greater regional economic integration will be important to bolstering growth, political and logistical obstacles loom large. As a result, efforts to liberalize trade and investment are likely to make only slow progress.