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Contents

Executive Summary

2

1.

Introduction

3

2.

Rationale of Bilateral FTA between Bangladesh and India

5

Methodology

9

3.

3.1 The GTAP Model and Database

9

3.2 Scenarios to be modeled

11

3.3 Data and Aggregation

14

Analysis of the Simulation Results

4

14

4.1 Welfare and Macroeconomic Effects

14

4.2 Impacts on Sectoral Level

18

4.3 Product Level Export Potential of Bangladesh to Indian

19

Market Analyzing Trade Flows between Bangladesh and India

5

21

using Gravity Model 5.1

Data Sources for Gravity Modelling

5.2 Econometric Issues

25 25

6

Bangladesh Trade Potential - Estimated Results

26

7

Northeast India: A Window of Opportunities for

29

%DQJODGHVK¶V([SRUW 7.1

Border area of Bangladesh with Northeast India

29

7.2

Informal Trade with North East India

32

7.3 %DQJODGHVK¶V7UDGHZLWK1RUWK(DVW,QGLD

32

7.4 Products trade with the different borders to NEI

34

7.5 The Barriers and Remedies to Boost Trade between

35

Bangladesh and NEI 7.6 Inadequate infrastructural facilities 7.7 Remedies to Boost Trade between Bangladesh and NEI 8

35 36

Conclusions

37

Bibliography

39

Annexes

43

1

Executive Summary The main objective of this study is to investigate the potential economic impacts of the proposed Bangladesh-India free trade agreement (FTA). We have used the computable general equilibrium (CGE) analysis using Global Trade Analysis Project (GTAP) database. The analysis highlights the possible costs and benefits based on three different scenarios. Under the Scenario-I all bilateral import tariffs between Bangladesh and India are removed; Scenario-II represents the setting where Bangladesh cuts its all types of tariffs by 75 per cent while Scenario-III is set against the hypothesis that Bangladesh cuts all its tariff rates by 50 per cent. It is considered that India cuts all their tariffs by 100 per cent in all the three scenarios. Our findings indicate that India may gain more in terms of welfare and real GDP via the improved terms of trade, while Bangladesh has to undergo welfare loss under full FTA, but if Bangladesh is able to make a preferential free trade agreement like the Scenario-III with India, its welfare, real GDP and exports will be increased substantially. The second section of this paper attempWV WR HVWLPDWH %DQJODGHVK¶V WUDGH SRWHQWLDO with her major trading partners by using a dynamic gravity model. The coefficient of GDP is positive and highly significant as expected, which implies Bangladesh tends to trade more with larger economies. The dummies such as Adjacency, Language and RTA are found with expected sign and statistically significant. Those explain that common boarder, common language as well as regional trade agreement have the positive impact on trade flows among the nations. One of the major findings of the paper is that a large part of Bangladesh's trade has remained unrealized and the trade transaction cost is one of the major trading barriers that prohibiting the growth of Bangladesh's trade. In the final section, we have tried to explore export potentials in the Northeast India (NEI). This region is landlocked and distantly connected with the rest of India only through a narrow Siliguri corridor of around 16 km stretch. In fact, all the state capitals are at a distance varying from 1080 km to 1680 km from Kolkata. On the other hand most important cities of Bangladesh, including Chittagong, Sylhet and Comilla, are within 15 km of the northeast borders and towns; Bangladesh is also at the bridgehead point of SAARC and ASEAN. In this context connectivity and the behind the border issues are the key concerns for trade and investment between the two neighbors. Key Words: Bangladesh; India; FTA; GTAP; CGE: Gravity Modelling. 2

1. Introduction Trade theory argues that trade liberalization by reducing tariff and non-tariff barriers promotes efficiency, scale economies and trade flows, thereby, promoting economic growth (Barro and Sala-i-Martin, 1995 and Wacziarg, 1997). In spite of liberal economic reforms for trade liberalization in many countries, scholars have identified a variety of country-specific barriers OLNHGRPHVWLFV¶UHJXODWLRQVVXSSO\VLGHFDSDFLW\ trade facilitation, tariff and non-tariff barriers etc, which impede the growth of world trade. In this backdrop, besides multilateral efforts, regional and bilateral efforts facilitate countries to address some of these issues. Given the slow progress of the Doha Round of the WTO trade negotiation, both developed and developing countries have moved towards regionalism in a rigorous way to cater to their developmental needs. In recent years, the number of regional trading agreements (RTAs) has proliferated in a progressive way. Up to February 2010, 462 RTAs have been notified to the WTO; 345 RTAs were notified under the Article XXIV of the GATT; 31 under the Enabling Clause; and 86 under the Article V of the GATS (WTO, 2010).

The trading relationship between India and Bangladesh is of enormous importance for both the countries for a number of reasons. Firstly, there are longstanding concerns in Bangladesh for large bilateral trade deficit with India, and the large volume of informal imports from India across the land border which avoids Bangladesh import duties. Secondly, even though trading relationship between the two countries is less significant for India compared to Bangladesh, closer economic integration with Bangladesh is nevertheless seen by India as a very important way of reducing the economic and political isolation of the seven Indian eastern and north-eastern states from the rest of the country. Finally, both the countries have long shared common objectives for closer economic integration within the South Asia region, and this has been re-emphasized by signing on to South Asian Free Trade Agreement (SAFTA), which took effect from July 2006. Under the SAFTA, the preferential tariffs agreed in the various rounds of the South Asian Preferential Trade Agreement (SAPTA) have so far been largely ineffective in generating much intra-regional trade (World Bank, 2008).

3

2. Rationale of Bilateral FTA between Bangladesh and India ,QGLD LV %DQJODGHVK¶V IRXUWK LPSRUWDQW WUDGLQJ SDUWQHU QH[W WR (8 86 DQG &KLQD DFFRXQWLQJ IRU  SHU FHQW RI %DQJODGHVK¶V JOREDO WUDGH LQ  1, and the second largest single source of its imports, accounting for about 16 per cent of the total import, which ranks just after China. But, Indian trade with Bangladesh is a very small part of its total trading--just about 3 per cent of its total exports and a miniscule share (0.01per cent) of its total imports (DOTS-IMF, 2011). Over the last five years, %DQJODGHVK¶VH[SRUWWR ,QGLDKDV LQFUHDVHGIRXUIROGZKLOVW export to the rest of the world had only been doubled. Despite this progress, there still exists a huge trade deficit between Bangladesh and India which has increased from US$ 1.7 billion in 2004 to US$ 2.9 billion in 2010. Figure 1 GLVSOD\V %DQJODGHVK¶V trade with India from 2004 to 2010. Over this particular period, Indian exports to Bangladesh have grown significantly, while imports from Bangladesh stayed fairly low. This trend has resulted in an unprecedented trade surplus for India and has created pressure for Bangladesh to develop new strategies to cope with this undesirable trade outcome. Figure: 1%DQJODGHVK¶V7UDGHZLWK,QGLD-2010 4000 3000

US $ million

2000 1000 0 2004

2005

2006

2007

2008

2009

2010

-1000 -2000 -3000 -4000

Export

Import

Trade Balance

Source: DOTS-IMF, 2011

1 The European Union (EU) taken as one entity was the largest trading partner of Bangladesh in 2010 with trade value of about US$ 9.5 billion; EU was followed by the United States (US) with trade value of US$ 5.3 billion, and China with trade value of US$ 3.9 billion for this particular year.

5

Table 2 shows Bangladesh¶V main exporting items to India market. It shows the most important products, sacks and bags which covers around 60 per cent RI%DQJODGHVK¶V exports to India in 2010. Traditionally, Bangladesh exports chemical fertilizer, raw jute and jute manufactures, frozen fish, and RMG to India. Recently, textile fabrics, plastic goods, cement, furnace oil, battery, cut flower, pharmaceutical products, copper wire, and melamine have also been included in the basket which indicates a potential export boom to India in futuUH%DQJODGHVK¶VLPSRUWRIIRRGDQGEHYHUDJHV industrial supplies, fuels and lubricants, capital goods, transport equipment and consumer goods from India are also increasing over time (Bangladesh Bank 2012). 6LPLODUO\%DQJODGHVK¶VH[SRUWWR,QGLDLVLQFUeasing day by day, particularly in recent years, this has shown quite an accelerated rate. Table 2: Top Ten Export (HS 8 digit) Items of Bangladesh to India in 2010

(US$Million) Bangladesh Exports to India in 2010 63051000: Sacks And Bags, Used For Packing Goods, 53031010: Raw or Retted Long Jute 03026910: Hamoor fish, excluding (livers, roes, fish fillets & other fish meat of heading 03.04), fresh or chilled. 4 74040000: Copper waste & scrap. 5 53071010: Sin.Yarn Of Jute Or Of Other Textile Bast 6 41079900: Other, including sides other than full grains, unsplite or grain splits leather further prepared after tanning or crusting of bovine (including buffalo) or equine animals, without hair on, other than leather of heading 41.14. 7 53101010: Unbleached Woven Fabrics Of Jute 8 73269020: Tree climbing irons 9 31021000: Nitrogenous fertilizer, urea, whether or not in aqueous solution, excluding tablets or similar forms or in packages of a gross weight not exceeding 10 kg. 10 25171000: Pebbles, gravel, broken or crushed stone, of a kind commonly used for concrete aggregates, for road metalling or for railway or other ballast, shingle & flint, whether or not heattreated. Source: EPB, 2011 1 2 3

304.63 59.75 31.76 16.43 16.22 15.68 9.03

8.15 7.43 6.97

5.82

Reduction of trade deficit by increasing exports of Bangladesh to India and effective free trade agreement might offer a solution for reducing trade deficit and unlock the trade potential between two nations. FTA should provide for a true market access for Bangladeshi products, free of all tariff, non-tariff and para-tariff barriers, and open up 6

opportunities for investment in Bangladesh as India has offered by expressing its intention to sign an FTA with Bangladesh. Table 3 depicts the sectoral bilateral import tariffs of the two countries which have been extracted from GTAP version 7 database. Crops, food items, vegetables, textiles, etc. are the main products which were faced comparatively higher tariff rates by both the countries. Table 3: Sectoral Bilateral Import Tariffs (per cent Ad Valorem)

1. paddy rice 2. wheat 3. cereal grains 4. oil seeds 5. sugarcane 6. crops nec 7. animal products 8. cattle 9. raw milk 10. wool silk 11. forestry 12. fishing 13. coal 14. oil 15.gas 16. mineral nec 17. meat product 18. veg_oil_fats 19. dairy product 20. processes rice 21. sugar 22. food prod nec 23. textiles 24. wearing apparel 25. private _serv 26. construction 27. leather 28. wood products 29. paper pub 30. beverage tobacco 31. Vegs _Fruit 32. petroleum_ coal 33. chemical

Bangladesh Tariffs on Import from India (%) 19.6 7.5 0.3 11.8 0 8.8 16.9 0.8 0 0 13.8 32.4 14.8 0 0 13.3 17.6 6.5 32.4 22.5 29.5 19.7 21.1 32.2 0 0 14.2 24.8 22 32.3 19.3 29 14.2

7

Indian Tariffs on Import from Bangladesh (%) 0 0 0 0 0 16.9 12.5 0 0 0 27.5 0.3 0 0 0 14 0 53.4 30 0 15 25.1 14.5 15 0 0 11.3 15 15 30 99.6 15 9.4

34. mineral prod 23.3 35. metals nec 16.3 36. motor parts 22.8 37. transport 23.1 38. electronics 16.1 39. machinery equip 10 40. manufacture nec 27.9 41. Util_Cons 0 42. Trans _Comm 0 43. Other Services 0 Source: Derived from Version 7 GTAP database

9.2 16.4 84.4 14.4 13.5 14.6 15 0 0 0

India has several FTAs with other South Asian countries, including Sri Lanka and Nepal. However, the experience of Indo±Lanka free trade agreement suggests that Sri Lanka, despite being the smaller partner, has gained substantially from the treaty. There has been a substantial growth in bilateral trade between the two countries and this has narrowed down 6UL/DQND¶VWUDGHGHILFLWZLWK ,QGLD (Siriwardana and Yang, 2007). The asymmetry in trade between India and Sri Lanka was an issue during the negotiations of Indo-Sri Lanka FTA, but it was addressed by allowing Sri Lanka to adopt a longer negative list together with a longer time period to achieve zero level of tariff. This experience can prove a motivation for Bangladesh to enter into an FTA with India.

A bilateral FTA with India would consider that Bangladeshi firms would be given immediate duty-free access to the Indian market for all goods, including readymade garments (RMG). On the other hand, Indian goods would be given duty-free access to the Bangladeshi market over a period of time, possibly few years since Bangladesh has a Least Developed Country (LDC) status. As we also know a huge amount of Indian goods are smuggled into Bangladesh every year, in addition to the 3.2 billion dollar worth of goods every year that enter the country legally (Bangladesh Bank 2012). Bangladesh market is already flooded with Indian goods, many of which enter the country on a duty-free basis, since they are smuggled across the border. The bilateral FTA would give Bangladesh the opportunity to gain something in return.

8

3. Methodology 3.1. The GTAP Model and Database2 The most common modeling technique for estimating the economic impacts of a trade agreement with economy-wide effects involves computable general equilibrium (CGE) modeling framework of the Global Trade Analysis Project (GTAP). This applied general equilibrium model is thoroughly documented in Hertel (1997) and in the GTAP database documentation (Dimaranan, 2006). It is a comparative static multi-regional CGE model.

The basic structure of the GTAP database includes: industrial sectors, households, governments, and global sectors across countries. Countries and regions in the world economy are linked together through trade. Prices and quantities are simultaneously determined in both factor markets and commodity markets. The main factors of production are ± skilled and unskilled labor, capital, natural resources and land. Producers operate under constant returns to scale, where the technology is described by the Leontief and CES functions. Two broad categories of inputs are identified: intermediate inputs and primary factors of productions. In the model firms minimize costs of inputs given their level of output and fixed technology. First, producers use composite units of intermediate inputs and primary factors in fixed proportions following a Leontief production function. At the second level of the production nest, intermediate input composites are obtained combining imported bundles and domestic goods of the same input output group. The trade policy can affect the price of traded goods relative to domestically produced goods. As a result, a key relationship for model analysis is the degree of substitution between imported and domestic goods. This key relationship is commonly identified as the Armington elasticity 3 . It is assumed that domestically produced goods and imports are imperfectly substituted. This is modeled using the Armington structure.

2

Hertel, T.W. (1997), Global Trade Analysis: Modeling and Applications and the GTAP website at https://www. gtap.agecon.purdue.edu for a full introduction to the database.

3

The constant elasticity of substitution (CES) specification for the trade substitution elasticity is derived from Armington (1969).

9

+RXVHKROGV¶ behavior in the model is determined from an aggregate utility function. The aggregate utility is modeled using a Cobb-Douglas production function with constant expenditure shares. This utility function includes private consumption, government consumption and savings. Current government expenditure goes into the regional household utility function as a proxy for government provision of public goods and services. Private KRXVHKROGV¶ consumption is explained by a constant difference elasticity expenditure function.

Domestic support and trade policy (tariff barriers) are modeled as ad valorem equivalent. These policies have a direct impact on the production and consumption sectors in the model. In equilibrium, all firms have zero real profit, all households are on their budget constraint, and global investment is equal to global savings. Changing WKHPRGHO¶VSDUDPHWHUV allows one to estimate the impact from a countries¶/region¶V original equilibrium position to a new equilibrium position.

The GTAP framework has strength because of theoretical regards, its ability to represent direct and indirect interactions among all sectors of an economy and precise detailed quantitative results. The strength of the multi country CGE model is that it elegantly incorporates the features of neo-classical general equilibrium and real international trade models in an empirical framework (Thierfelder, et al., 2007).

However, tKHPRGHO¶VUHVXOWVPD\EHYHU\VHQVLWLYHWRWKHDVVXPSWLRQVDQGGDWDXVHG almost all CGE exercises include a sensitivity analysis to obtain a range of results based on different assumptions or data. A second problem with CGE analysis is the lack of a time dimension. A CGE analysis of an FTA will not provide results on how long it will take for economies to adjust and reach the new equilibrium. Recent work in CGE modeling has attempted to include some dynamic effects via financial markets, but it is a long way from capturing the dynamic features that are most relevant to FTAs.

10

3.2 Scenarios to be Modeled The GTAP model and database have been using a common global database for the CGE analysis. The GTAP is a comparative static model, and is based on neo-classical theories. The model assumes perfect competition in all markets, constant returns to scale in all production and trade activities, and profit and utility maximizing behavior of firms and households, respectively (Hertel, 2007).

However, the analysis reported in this paper is based on the comparative static version 7 of the GTAP database. Thus, it contrasts a scenario representing a hypothetical policy change to actual conditions in a given base year. Both the base year and the SROLF\VFHQDULRDUHUHSUHVHQWHGDVVWDWLFµVQDSVKRWV¶7KHUHLVQRSURYLVLRQIRUJUDGXDO adjustment or change over time. The changes in the model induced by reciprocal tariff cuts represent a shift from one equilibrium to another; here factors of production remain fully utilized. Consumers re-allocate their expenditure to take advantage of the change in relative prices of goods and services resulting from trade liberalization. Such reallocation of resources leads to income gains. These income gains are referred WRDVµVWDWLF¶JDLQVTrade issues, by their nature, require an analytical framework that allows a comprehensive view of world economies. This is not only because of interlinkages sectors in one economy to the rest of the world. These national, regional and global linkages may occur either in input or product market or, as are usually the case, in both. Therefore, in order to avoid ignoring these linkages, a general equilibrium methodology such as GTAP database is one of the most effective analytical instruments to be used in this study. As Table 4 presents, numerous studies based on CGE models use variations of the GTAP database. This brief literature reviews shows the current practices of FTA impact analysis using GTAP database. There is only one available study (Siriwardana and Yang, 2007) on Bangladesh-India FTA using GTAP version 6 database with limited sectoral aggregation. In this backdrop, this study could be latest version of FTA analysis between Bangladesh and India that may show the real impacts of a possible FTA between these two countries. In this study we have simulated three different scenarios where India eliminates all tariffs and Bangladesh successively cuts tariffs by 100 per cent, 75 per cent and 50 per cent, respectively.

11

Park (2006)

The Tripartite Free Trade Agreement

Hans Grinsted and Ron Saudrey (2011) Shahid Ahmed (2010) Raihan S. (2009) Anna Strutt (2008) Siriwardana & Yang (2007 and 2008) Kawai and Wignaraja (2007)

1. AFTA 2. ASEAN+3 with/without Hong Kong 3. China-Japan-Korea RTA 4. ASEAN+1 RTAs (ASEAN-China, ASEAN-Japan, and ASEAN-Korea RTA)

BIMSTEC-Japan FTA: A CGE Analysis (1) India- Bangladesh FTA, (2) Australia-China FTA 1. ASEAN+China FTA 2. ASEAN+Korea FTA 3. SEAN+Japan FTA 4. ASEAN+3 5. ASEAN+6

1. India-Korea CEPA, 2. India-Japan FTA EU-India Bilateral FTA

FTAs in analysis

Countries/regions: 25 sectors: 7

- GTAP 6inGAMS model, a modified version of the GTAP model version 6 developed for generalized algebraic modeling system (GAMS) users

12

Countries/regions: 36 sectors: na

Regions 4 and sectors 14 Regions 23and sectors 43 Regions 2 and sectors: na Regions 11 and sectors 20

Aggregation of regions and sectors Regions 112 and sectors 57

-GTAP model (same as the model used in Francois and Wignaraja (2007)) GTAP Version 6

GTAP Version 6

GTAP version 7

GTAP Version 7

GTAP Version 7

Model/database used for analysis Version 8 (pre released)

intermediate linkages between sectors are Included - trade is allowed to affect capital stocks through investment -static model Cobb-Douglas preferences are assumed (the GTAP model is based on constant different elasticity (CDE) demand system)

GTAPDynamic Static model

Static model

Static model

Structure of model Static model

-16 East Asian RTA scenarios: one currently effective RTA, five expansionary RTAs, three pairs of duplicate RTAs, and seven cases of overlapping RTAs estimating the impact of elimination

-estimating the impact of regional tariff elimination for goods, liberalization of services trade, and trade facilitation including improved trade-related infrastructure

Method and characteristic of simulation COMESA, EAC and SADC tripartite FTA and develop a baseline projection 2020 Different impact scenario of the two FTAs EU±India FTA: Impact on low-income economies develop a baseline scenario to 2020 using GTAP-Dyn, Potential impact of the FTAs

Table 4: Literature Survey of recent CGE studies on FTA: The Model Structure and Simulation Method

Papers

-Michigan Model-GTAP Version4 database (data as of 1995)

1.APEC FTA -

Brown, Deardorff and Stern (2003)

Countries/regions: 21Sectors:18

Countries/regions: 19 sectors: 14

-static model incorporating firm heterogeneity and fixed cost of exporting into the model Dixit-Stiglitz preference is assumed for the demand side - static model modeled under assumption of perfect competition in agriculture sector and monopolistic competition in other sector static model with effect of productivity by trade liberalization i) APEC trade liberalization impact ii) ASEAN+3 FTA estimating under assumption that barriers be eliminated in agriculture, manufacture and service sectors among ASEAN countries

-four scenarios of hub-andspoke configurations in Asia-estimating the impact of elimination of both import tariffs and export taxes to merchandise trade between hub and spokes

Kawasaki(2003)

1. ASEAN - Japan 2. ASEAN - China 3. ASEAN - China ± Japan

13

-GTAP model - GTAP Version5 database (data as of 1997)

Countries/regions: 23sectors: 16

- estimating effect of tariff reduction of each FTA combination, based upon calculation of tariffs of countries/regions, industrial sectors, respectively, by GTAP database Source: Derived from the commerce ministry website of different countries and APTIAD- UNESCAP www.unescap.org/tid/aptiad

2.ASEAN᧧3 FTA

-built on LINKAGE model developed at the WB by van der Mensbrugghe (2005) GTAP Version6 database

1. China-hub bilateral FTAs (with other Asian countries) 2. Japan-hub bilateral FTAs (with other Asian countries)

Zhai (2006)

3.4 Data and Aggregation The study uses the Version 7 of the GTAP database, as mentioned, which has 2004 as the base year. The GTAP database is updated in 2008 by incorporating different changes in global trade scenarios that occurred between 2004 and 2008. Data on regions and commodities are also aggregated to meet the objectives of this study. The version 7 of GTAP database covers 57 commodities, 113 regions/countries and 5 factors of production. For the sake of convenience the 113 regions have been aggregated to 20 regions and the 57 commodities have been aggregated into 43 as shown in Annex 1. The regions selected consist of 17 individual countries and 3 other regions which are important trading partner of Bangladesh and India. 4. Analysis of the Simulation Results The trade policy options examined in this paper focus on the impacts of Bangladesh-India free trade agreement (BIFTA) in which existing import taxes are eliminated by both parties under three different scenarios. Therefore, the results from the three scenarios reflect the impacts of a full free trade and partial free trade treaty between the two countries. Based on the model simulations, this section reports the results that show the likely impacts of a BIFTA on important macro-economic variables, economic welfare, industry outputs, and exports. 4.1 Welfare and Macroeconomic Effects The effects of a free trade agreement can be assessed at both macro-economic and sectoral levels of analysis. The welfare and other macroeconomic effects of the simulations for the countries/regions concerned are presented in Table 5. There are three different scenarios we have analyzed. Under Scenario I all bilateral import tariffs between Bangladesh and India are removed, under Scenario II Bangladesh cuts all tariffs by 75 per cent while under Scenario III Bangladesh cuts all tariffs by 50 per cent. India cuts it¶s all tariffs by 100 per cent in all the three different scenarios considered here. Under the Scenario I, there are positive welfare gains for India in terms of absolute value (US$ 444.5 million), while Bangladesh is going to have a welfare loss equal to US $ 196.8 million. The other SAARC member countries like Pakistan, Sri Lanka and the 14

rest of South Asia are affected mildly and a similar impact is observable within the East Asian trading partners like China, Japan and South Korea. Table 5: Scenario I--India and Bangladesh both cut their tariffs by 100 per cent Welfare Effect % Change of % Change % Change Country ToT (US$ million) Real GDP of Export of Import Bangladesh

-196.81

-0.13

-0.97

-0.92

0.05

India

444.46

0.01

0.29

0.29

-0.01

Italy

-12.69

0

0

-0.01

0

France

-8.72

0

0

-0.01

-0.01

Sweden

-4.49

0

0

-0.01

0

ANZ

-6.36

0

0

-0.01

0

REA

-36.15

0

-0.01

-0.01

0

RSA

-2.64

0

-0.04

-0.01

0.03

Denmark

-2.74

0

0

-0.01

0

UK

-9.57

0

0

0

0

Germany

-16.55

0

0

-0.01

-0.01

EU

-26.31

0

0

0

0

Canada

-5.37

0

0

-0.01

-0.01

USA

-14.27

0

0

-0.01

0

Japan

-31.86

0

0

-0.01

0

China

-55.77

0

-0.01

-0.01

0

Korea

-16.35

0

0

-0.01

0

Pakistan

-8.97

0

-0.03

-0.03

0

Sri Lanka

-4.72

0

-0.04

-0.02

0.03

0

0

Rest of -63.14 0 0 World Source: AuthoU¶VVLPXODWLRQRI*7$3YHUVLRQGDWDEDVH

There is no noticeable effect on the other regions/countries. In terms of real GDP, India benefits more as its economy expands by 0.1 per cent whereas Bangladesh appears to have a 0.13 per cent negative growth. It seems that Bangladesh would experience a fall in real GDP by 0.13 per cent if Bangladesh signs a full free trade agreement with India. This is due to the larger increase in imports compared to its exports to the Indian market. %DQJODGHVK¶V LPSRUWV ZRXOG rise by 0.5 per cent compared to a fall in exports by 0.92 per cent. On the other hand, India would experience a rise in its real GDP by 0.01 per cent and its exports would rise by 0.29 per cent. This suggests that the Bangladesh-India FTA would result in JUHDWHU PDUNHW DFFHVV IRU ,QGLD LQ %DQJODGHVK FRPSDUHG WR %DQJODGHVK¶V PDUNHW

15

access in India. The increase in GDP and the expansion of trade for India can be partly

attributed to the movements of the terms of trade in response to the removal of tariffs. India has improved its terms of trade whereas Bangladesh appears to have experienced deterioration. Table 6. Scenario II: India cuts 100 per cent and Bangladesh cuts all tariffs by 75 per cent Welfare Effect % Change of % Change % Change Country ToT (US$ million) Real GDP of Export of Import Bangladesh

-68.45

0

-0.53

4.61

4.08

India

281.4

0.01

0.19

0.17

0.37

Italy

-7.98

0

0

0

0

France

-6.01

0

0

0

0

Sweden

-3

0

0

0

0

ANZ

-4.97

0

0

0

0

REA

-23.68

0

0

0

-0.01 -0.04

RSA

-2.02

0

-0.03

0.01

Denmark

-1.86

0

0

0

0

UK

-6.74

0

0

0

0

Germany

-11.37

0

0

0

0

EU

-17.26

0

0

0

0

Canada

-3.83

0

0

0

0

USA

-12.87

0

0

0

0

Japan

-20.64

0

0

0

0 -0.01

China

-34.68

0

0

0

Korea

-10.63

0

0

0

0

Pakistan

-5.67

0

-0.02

0

-0.03

Sri Lanka

-3.03

0

-0.03

0.01

-0.04

0

-0.01

Rest of the -42.8 0 0 World Source$XWKRU¶VVLPXODWLRQRI*7$3YHUVLRQGDWDEDVH

In Scenario II, if Bangladesh cuts all tariff rates by 75 per cent, there are also positive welfare gains for India in terms of absolute value, while Bangladesh is still going to have a welfare loss. In terms of real GDP, India benefits more as its economy expands by 0.01 per cent, whereas Bangladesh appears to have no change in real GDP. As India would experience a rise in real GDP and its exports would also rise by 0.17 per cent but exports by Bangladesh would rise by 4.61 per cent compared to its import by 4.08 per cent, this suggests

16

that the Bangladesh-India FTA would result in greater market access for both India and Bangladesh. Bangladesh imports still are very high from India due to high demand and lack of supply capacity to produce domestically. But, an important compositional change in the

structure of exports has also been observed in the recent years: the share of traditional commodities in total export to India has come down significantly to 68.8 per cent in 2010 from 90.5 per cent in 2004, whilst the non-traditional items posting an impressive rise to 31.2 per cent in 2010 compared to 9.5 per cent in 2004. This shows that an effective FTA could increase Bangladesh¶V non-traditional exports to Indian market. Although in case of both the scenario India would have improved its terms of trade, Bangladesh appears to experience deterioration in its terms of trade (ToT). Table 7. Scenario III: India cuts all tariff rates by 100 per cent and Bangladesh by 50 per cent Welfare Effect % Change of % Change % Change of Country ToT (US$ million) Real GDP of Export Import Bangladesh 0.48 0.05 -0.22 2.57 2.4 India

156.81

0

0.1

0.12

Italy

-4.46

0

0

0

0.23 0

France

-3.82

0

0

0

0

Sweden

-1.82

0

0

0

0

ANZ

-3.49

0

0

0

0

REA

-13.82

0

0

0

0

RSA

-1.52

0

-0.03

0

-0.03

Denmark

-1.14

0

0

0

0

UK

-4.35

0

0

0

0

Germany

-7.15

0

0

0

0

EU

-10.18

0

0

0

0

Canada

-2.45

0

0

0

0

USA

-10.57

0

0

0

0

Japan

-11.95

0

0

0

0

China

-19.01

0

0

0

0

Korea

-6.1

0

0

0

0

Pakistan

-3.19

0

-0.01

0

-0.02

Sri Lanka

-1.76

0

-0.02

0.01

-0.02

0

0

Rest of -26.01 0 0 World Source$XWKRU¶V6LPXODWLRQRI*7$3YHUVLRQGDWDEDVH

17

Under the Scenario III of the simulation, where Bangladesh cuts all tariff rates by 50 per cent while India cuts its tariffs by 100 per cent, both the countries are expected to have positive welfare impacts but the anticipated welfare gain for Bangladesh is perceived to be very smaller (US$ 0.48 million). Under this scenario, the real GDP change for Bangladesh is expected to rise by 0.05 per cent, while Indian real GDP seems to be unchanged. Apparently, Bangladesh appears to increase its export and import volumes more significantly than India. Even though India is reported to experience some growth in trade, its performance is not as impressive as that of Bangladesh. But India may improve its terms of trade, whereas Bangladesh appears to experience deterioration continuously. Thus, %DQJODGHVK¶V LPSUHVVLYH SHUIRUPDQFH LQ H[SRUWV is affected by the negative change in its terms of trade.

4.2 Impacts on Sectoral Level The macro-economic and trade performance results analyzed in the previous section do not fully disclose the structural adjustments that may occur in the economies. In particular, the macro-economic results do not show the impacts of an FTA on different sectors¶ in partner countries. Policy makers need to know these details to establish how different sectors respond to trade liberalization measures under such preferential treaties. Some sectors may be adversely affected and require government compensation.

Annex 2 shows the implications of industry outputs for India and Bangladesh due to implementation of a possible Bangladesh India FTA under three different scenarios. Conventional economic theory suggests that moving to free trade under an FTA generates considerable relative price shifts that stem largely from lower import prices. These shifts can have significant impacts on sectoral outputs. As seen from GTAP projections in Annex 2, both Bangladesh and India are painting a very mixed picture. The most significant gainers in Bangladesh are leather, wearing apparel, textiles, crops nec and cereal grains. It is apparent that nearly half of the sectors will lose outputs in response to any tariff elimination.

18

The sectoral export responses to the FTA within three different scenarios are reported in Annex 3. These projections indicate how individual sectors perform in terms of exports at bilateral level with the abolition of import duties. For both India and Bangladesh, the magnitudes of change in export volumes bring similar outcomes within the three different scenarios. Under an FTA, both countries can expect increased exports in agricultural and manufactured goods to each other with Bangladesh showing potentially better prospects to gain from market access to India. For both the countries, there are substantial prospects IRU H[SRUWLQJ JRRGV VXFK DV µ7H[WLOH DQG OHDWKHU¶ µ3HWUROHXP DQG RWKHU PLQHUDOV¶ DQG µWUDQVSRUW DQG HOectronics products' to each other. All in all, it is the manufacturing exports that seem to thrive under a possible Bangladesh- India FTA for both the partners.

4.3 Product Level Export Potential of Bangladesh to Indian Market The study has identified 23 export items (at the HS 6 digit level) of Bangladesh which have export opportunities in the Indian market. These commodities include, among others, apparel products (men/ boys wear made of cotton fabrics) and accessories, fabrics, cements, jute and jute products, footwear, bicycles parts, electrical equipments, etc. (Table 8). It indicates that Bangladesh has clear price advantage in few major export items including jute (HS 530510), cements (HS 232510), plants and parts of plants (HS 121191), bicycle parts (871499), dyed plain cotton weave (520931) flat rolled products (HS 721041). Per unit export price of the above items of Bangladesh is somewhat lower compared to India. It may however be argued that these products could have market opportunities in NEI market because of the geographical proximity, lower carrying cost and shorter lead time. The above brief analysis indicates that preferential market access under SAFTA, BIMSTEC and APTA could enhance the opportunities in this context.

19

Table 8. Export Potential of Bangladesh to Indian Market

Product

232510 300420 490700 520839 520931 520942 530510 540752 590390 640299

640319 640590 640620 842290 871499

Product Name Cements, portland, aluminous, slag, supersulfate Medicaments of other antibiotics, New stamps; stampimpressed paper; Dyed woven cotton fabrics, with >=8 Dyed plain cotton weave, with >=85percent Denim, with >=85 percent cotton, >200g/m2 Jute & oth. textile bast fibres, raw/retted Dyed woven fabrics of synthetic Textile fabrics impregnated Footwear, nes

Bangladesh 's Export to World (Million US$)

India's Import from World Market (Million US$)

Banglade sh's Export Price ($/Unit)

India's Import Price ($/Unit)

8.5

78.45

35.15

44.15

31.72

3.077

11.46

10.1

95.6

2.10

46.812

367.568

38.32

297.51

8.4

3.234

12.572

3.55

13.97

7.5

6.045

23.938

3.96

9.74

15.78

2.304

28.355

3.08

5.07

7.46

144.98

37.98

84.45

95.78

150.45

6.699

40.916

5.73

7.93

10.75

5.44 10.213

67.861 13.028

6.31 7.64

9.83 4.62

1.01 3.8

47.626

11.342

7.03

4.96

4.79

5.265

18.743

8.39

2.15

1.11

9.542

23.102

3.83

4.37

2.41

5.359 5.446

33.097 88.815

8.09 1.9

46.54 6.58

5.10 4.78

Sports footwear, with rubber, plastic Footwear, not elsewhere specified (nes) Outer soles and heels of rubber or Pts of dish washing, cleaning or dry Bicycle parts nes

RCA

Source: COMTRADE data, Author¶V calculation

RCA estimates have been widely used in the relevant literature in an attempt to understand competitive strength of particular items in an importing market. To ascertain %DQJODGHVK¶s competitive edge in the Indian market an exercise was undertaken to compute the RCAs of a select set of exportable to the Indian market. To compute average RCAs of those products, export data at HS 6 digit level were accessed from the UN COMTRADE database for the year 2007, 2008 and 2009 and then calculated their average RCA. RCAs were estimated both for a select group of broad product groups that 20

are exported from Bangladesh and also for items of export at disaggregated level. 4 As would be expected, in terms of the value of RCA index, raw jute ranks at the top in the Indian market. As is seen from Table 4, other important items with RCA>1 include jute, chemical fertilizer, cement, RMG, leather, battery, textile fabrics, bicycles, medicines etc.

5. Analyzing Trade Flows between Bangladesh and India using Gravity Model The gravity model has been used in international economics as a popular methodology to measure potential trade between countries. It was inspired by the Newtonian model of gravitational forces i.e. the force of attraction between two bodies is proportional to the product of their masses and inversely proportional to the square of the distance between their centers of gravity. In the simplest gravity model, bilateral trade flows between two countries are assumed to be proportional to the product of their economic sizes (represented by gross domestic products (GDP)) and inversely proportional to a measure of the distance between the countries (Bergstrand, 1985). Before discussing a brief review of literature, would like to make couple of remarks on gravity modeling simulations. First, it is well-known that one cannot infer the welfare impacts on a country or on the trade members as a whole and on non-members of membership from its trade diverting/ trade creating features alone. This has to be kept in mind in interpreting the results. Second, imports and exports of any country cannot be negative by definition. This means that a conventional regression model for explaining trade flows, which does not take into account the fact that trade flows cannot be negative is inappropriate. In the Newtonian model, a forces of attraction and repulsion could be very small but never zero, whereas bilateral trade flows could be (and often are) zero. Zeros may also be the result of the rounding errors if trade did not reach a minimum value. These zero observations in the dependent variable, bilateral trade flows creates a problem for the use of log-linear form of the gravity equation. Several methods, some 4

The following formula was used to calculate bilateral RCA index (Balassa 1965) %DQJODGHVK VH[SRUWRIFRPPRGLW\MWR,QGLD  %DQJODGHVK¶VWRWDOH[SRUWto India) RCA = (Total exports of jth commodity by world to India) / (Total exports of world to India) $FRPSDUDWLYHDGYDQWDJHLV³UHYHDOHG´LI5&$!LQZKLFKFDVHWKHRULJLQFRXQWU\ %DQJODGHVK  has a revealed comparative advantage to export that particular product in the destination country (India).

21

purely empirical and others theoretically founded, have been developed to deal with this problem for example see Melitz et al (2003), and Silva and Tenreyro (2006). The gravity model originally stems from the Newtonian physics, but in international trade it first appeared in 1960s, when Tinbergen (1962) provided some initial foundations for gravitation of trade flows. Tinbergen (1962) and Poyhonen (1963) explained bilateral trade flows by trading partners GDP and geographic distance between countries that has established as a common approach to modeling bilateral trade flows. Anderson (1979) provided first micro- foundations based on constant elasticity of substitution preferences and goods that differentiated by country of origin. Later, Bergstrand (1985) tried to justify the use of gravity idea using models of monopolistic competition. Helpman and Krugman (1985) showed that the basic gravity equation could be derived from the differentiated products trade. Deardorff (1998) proved that the gravity model is also consistent with Hecksher-Ohlin international trade theory, but at the same time accepted that even a simple form of gravity equation can justify any trade model. Its popularity in HPSLULFV LQFUHDVHG UDSLGO\ ZLWK WKH LQWURGXFWLRQ RI ³WKHRUHWLFDO´ JUDYLW\ E\ $QGerson and Van Wincoop (2003 and 2004), which has become the de facto standard in empirical work.

Besides GDP and distance, other factors relevant for explaining bilateral trade include tariff, trade agreements, language, trade facilitation and non-tariff barriers, etc. There are numerous studies on gravity model, which have examined different types of trade costs, tariffs and non-tariff barriers, and their impacts on trade flows, regional integration agreements, currency unions, time delays at export/import, governance, corruption, and contract enforcement, etc. such as common currencies (Rose, 2000), trade costs (Harrigan, 2001, Wilson and others, 2005; Djankov and others, 2006; Baier and Bergstrand, 2007; Jacks and others, 2008;), international borders (Anderson and Wincoop, 2003; Gorodnichenko and Tesar, 2009), and methodological issues (Egger, 2002; Baldwin and Taglioni 2006, 2007; Silva and Tenreyro, 2006; Helpman and others,  0RVWRIWKHUHVHDUFKHVKDYHIRFXVHGRQ³SROLF\´EDUULHUVVXFKDVWDULffs and nontariff barriers, regional integration agreements, currency unions, and the General Agreement on Tariffs and Trade, time delays in export/import and trade facilitation, governance, and anti-corruption and contract enforcement. On the other hand, very few 22

DSSOLFDWLRQVKDYHGHDOWZLWK³QRQ-SROLF\´EDUULHUVVXFKDVWUDQVSRUWFRVWVLQIUDVWUXFWXUH barriers, etc. explicitly in the gravity model, the exceptions being Duval and Utoktham (2009), Francois and others (2009), De (2007, 2009), Hoekman and Nicita (2008), Francois and Manchin (2006). While the gravity model has been increasingly used in international trade to estimate trade potential, only Mofizur (2005) attempted to estimate the determining the factors of Bangladesh trade flows, without a mention about %DQJODGHVK¶VJOREDOWUDGHSRWHQWLDO A baseline gravity model can be written as equation (1) Xij = Į Yiȕ YjȖDijį

(1)

:KHUH Įȕ įDQGȖDUHFRHIILFLHQWV WR EHGHWHUPLQHGHPSLULFDOO\; ij is the exports of country i to country j. Yi and Yj are the national gross domestic products of countries i and j respectively; Dij is distance between countries i and j. Taking log, the baseline equation (1) can be conveniently represented in log-linear form as equation (2). lnXij ĮȕOQ chi 2 0.000 a

b

Notes: Fixed effect. Random effect. (Selection of random effect over fixed effect was based on the Hausman test.) Robust t-statistics in parentheses for OLS and z- statistics for GLS ** p