Moody’s Investors Service expects the Sri Lanka-Singapore Free Trade Agreement (SLSFTA) will enhance the cross-border trade of goods and services and promote foreign direct investment (FDI) between the two countries, a credit positive for both.
Sri Lanka (B1 negative) and Singapore (Aaa stable) on January 23 signed the free trade agreement although the countries have not yet publicized the full details of the pact.
The SLSFTA will have a larger effect on Sri Lanka’s credit quality because the potential increase in current account inflows and inward investments would help reduce its elevated external vulnerability, a Moody’s News & Analysis report on credit implications of current events says.
The SLSFTA liberalizes bilateral trade in goods. Sri Lanka will eliminate tariffs on 80% of products over 15 years. Singapore’s Ministry of Trade and Industry estimates that the agreement will result in approximately SGD10 million in annual tariff savings.
Because Singapore does not impose import duties on 99% of tariff lines, the agreement’s trade benefits for Sri Lanka will materialize through the opening of access to the broader Association of Southeast Asian Nations (ASEAN) market and other large economies given Singapore’s existing preferential trade arrangements with Australia, Japan, Korea and other countries in Southeast Asia.
In 2017, Sri Lanka was Singapore’s 37th-largest trading partner, while Singapore was Sri Lanka’s eighth-largest trading partner; total bilateral trade amounted to about 0.5% of Singapore’s GDP and 2.5% of Sri Lanka’s GDP. Moody’s expect that the SLSFTA will support growth in bilateral trade.
The extent to which the SLSFTA reduces Sri Lanka’s external vulnerability will depend on its effectiveness at bolstering services and investment flows.
Sri Lanka’s current account has a structural deficit because a large merchandise trade deficit more than offsets a surplus in services and remittance inflows.
Moreover, FDI inflows only partially finance the current account shortfall, resulting in a persistent basic balance (FDI inflows plus current account balance) deficit.
The SLSFTA is likely to boost Sri Lanka’s services receipts, particularly in tourism. Using travel and passenger transport by air as a proxy, tourism accounts for about three-quarters of the services surplus. Although Singapore comprised less than 1% of Sri Lanka’s total tourist arrivals in 2017, the SLSFTA may allow Sri Lanka to leverage Singapore’s transportation hub to attract more tourists. Additionally, there are provisions on the cross-border transfers of information by electronic means and data flows, which could aid Sri Lanka’s burgeoning IT services sector.
The agreement also will promote direct investment in Sri Lanka by Singaporean companies. According to the Sri Lankan government, FDI from Singapore totaled $ 658 million (less than 1% of GDP) during 2006-17 in sectors such as food manufacturing and real estate.
By easing regulation in the services sector, the SLSFTA will broaden the scope of investment to other areas such as infrastructure, logistics, education and healthcare.
The agreement also protects against expropriation, improves transparency through safeguards against discriminatory treatment and provides for a dispute resolution mechanism, all of which create a better investment climate to attract FDI.
The free trade agreement continues Sri Lanka’s move toward greater openness of trade and investment. In particular, as part of its International Monetary Fund Extended Fund Facility program structural reform objectives, the government is reviewing its trade regime to boost trade and private-sector development, focusing on reducing costs and bolstering competitiveness through reform of para-tariffs and other nontariff barriers that have hampered exports. As part of this effort, Sri Lanka also has started negotiations on other free trade agreements, including with China. The SLSFTA is Singapore’s 21st trade agreement with 32 trading partners, and reiterates Singapore’s commitment to free and open markets. Particularly within the region, the agreement promotes the growth of outward Singaporean investment, helps maintain its strong positive net international investment position (224% of 2016 GDP), and solidifies its strength as a hub for global trade, finance, and logistics.