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South Asia was slow to adopt regional economic cooperation. The South Asian Association for Regional Cooperation (SAARC), established in 1985, and the creation of the South Asian Free Trade Area (SAFTA) remain a widely discussed policy issue in this region. This study compares the impacts of different trade policy options on Sri Lanka using the Global Trading Analysis Project (GTAP) Model. The simulation results indicate that multilateral trade liberalisation is the best trade policy outcome for the Sri Lankan economy. The South Asian Customs Union ranks the next highest in terms of welfare for Sri Lanka, followed in order by the SAFTA and the Indo Lanka Free Trade Agreement (ILFTA). However, the proposed Sri Lanka-Bangladesh FTA did not suggest significant welfare gains to both trading partners. Furthermore, it was determined that the SAFTA can be formed without having significant trade diversion effects. Therefore, of the regional trade policy options considered in the study, Sri Lanka should focus on implementing the SAFTA. In addition, the ILFTA can continue to strengthen the SAFTA. The next stage of the SAFTA is transforming the SAFTA into the South Asian Customs Union, which is already a component of the agreement. However, this trade policy option is to be negotiated. Finally, it appears that the SAFTA still needs to find its linkages to multilateral trade liberalisation.

The South Asian Free Trade Area: an Analysis of Policy Options for Sri Lanka