The case for connecting South Asia and Southeast Asia

A new opportunity for South Asia–Southeast Asia integration

The time is ripe for enhancing economic integration between South Asia and Southeast Asia. The new “normal” era of slow growth in advanced industrial economies following the global financial crisis suggests that Asian economies will need to rely more on domestic and regional demand to secure inclusive growth. The recent slowdown in growth in the People’s Republic of China suggests further grounds for tapping growth opportunities between South Asia and Southeast Asia. The move toward an Association of Southeast Asian Nations (ASEAN) Economic Community (AEC) in 2015 and beyond will provide for a large and more integrated market with notable purchasing power and scale economies. This will facilitate the deepening of foreign direct investment-driven production networks and strengthen the role of ASEAN as a conductor of Asian regional integration. A new pro-business Indian government signals impetus for advancing India’s new Act East Policy, enhancing cross-border infrastructure investments and deepening domestic economic reforms. Negotiations are underway for the mega-regional Trans-Pacific Partnership (TPP) and the Regional Comprehensive Economic Partnership (RCEP) but most South Asian and Southeast Asian economies are excluded at this point. Recent political and economic reforms in Myanmar—a key land bridge between the two subregions—has made possible closer economic ties and connectivity that were not feasible a few years ago. Yet, there is still little research on the role of hard and soft connectivity in deepening economic ties between South Asia and Southeast Asia.

Accordingly, the Asian Development Bank (ADB) and the Asian Development Bank Institute (ADBI) conducted a comprehensive study of how improved physical connectivity and associated soft infrastructure can foster closer economic ties between the two subregions¹. Physical connectivity here relates to transport and energy, while associated soft infrastructure includes the critical areas of financing of infrastructure, trade facilitation, reforms, and institutions for coordination. The study concludes that relatively modest investments in physical connectivity can significantly enhance regional integration between South Asia and Southeast Asia. Furthermore, the benefits of such physical connectivity-led integration are likely to far outweigh the costs. Some noteworthy findings from the ADB/ADBI study are discussed below.

Assessing economic ties and cross-border connectivity

First, economic ties between these two subregions, while making progress, have been limited, hindered by bottlenecks in infrastructure, financial markets, trade facilitation, trade barriers, and limited regional cooperation. South Asia and Southeast Asia cross-subregional trade increased 23 times from $4 billion to $90 billion over 1990–2013. But Southeast Asia’s share of South Asian trade rose from 6% to only 10%, while South Asia’s share of Southeast Asian trade just doubled from about 2% to only 4%. The same story applies to cross-subregional investment and cross-subregional financial flows. This suggests that there is significant potential for growth of economic ties between the two subregions. In particular, foreign direct investment-driven production networks and parts and components trade, which are a key drivers of trade expansion in Southeast Asia, have yet to take firm root in South Asia.

Second, improving transport and energy connectivity is a crucial building block for greater economic integration between the two subregions. Key land barriers to cross-subregional transport are located mainly in Myanmar while other gaps are identified in Bangladesh, Cambodia, India, the Lao People’s Democratic Republic, Thailand, and Viet Nam. Although road connections exist, many segments need to be upgraded, especially in Bangladesh, India, and Myanmar. In contrast, there are no existing railway links between the Greater Mekong Subregion (GMS) countries and South Asia, or between the GMS countries themselves, with the exception of a connection between the People’s Republic of China and Viet Nam. Moreover, the incompatibility of railway gauges (track widths) between the regional border countries of India, Bangladesh, Thailand, and Myanmar and other technical differences mean that transshipment will be required even after through rail links are developed.

The bulk of cross-subregional trade still moves by ship. However, important seaports for South Asia–Southeast Asia trade—notably Kolkata Port in India, Chittagong Port in Bangladesh, and Yangon Port in Myanmar—suffer from problems relating to limited accessibility for large ships, gaps in facilities, variable operational efficiency, and gaps in connectivity between seaports and rail and road networks.

Energy trade between South Asia and Southeast Asia, except for conventional shipments of coal, gas, and other fuels, does not occur, yet there is much unexploited potential to be tapped. The main opportunities for cross-subregional energy trade lie in electric (mainly hydro) power and gas pipelines, plus pooling and interconnection of electric power grids. Myanmar has an important potential role to play in energy trading, given its substantial capacity for hydropower and reserves of natural gas, plus its critical position as a gas pipeline location.

Costing and financing cross-border connectivity projects

Third, the total investment costs for projects to enhance cross-subregional connectivity (in highways, railroads, ports, and energy trading) are estimated at $73 billion. This figure includes $18 billion for roads, $34 billion for railways, $11 billion for port projects, and $11 billion for energy trading projects². The total costs for priority investment projects in transport are estimated at $8 billion (including $1 billion for roads, $5 billion for railroads, and $2 billion for ports).

Road corridor options to connect South Asia to Southeast Asia have been evaluated and the best option is the 4,430 kilometer Kolkata–Ho Chi Minh City Corridor. Rail connectivity comes as a second priority after road connectivity due to much higher costs, more extensive gaps, and incompatibilities between national networks. Priority seaport projects include the construction of new deepwater ports or floating container transshipment terminals at Chittagong and Kolkata, and improvement of the road infrastructure linking Thilawa Port with Yangon. The promotion of more frequent visits by large-scale container ships is the key to lowering transport costs and supporting development of supply chain networks.

Fourth, financing cross-subregional infrastructure projects remains challenging. Traditional sources of infrastructure financing, including public finance and bank loans, are becoming more constrained. The development of Asian financial markets and related initiatives is needed to strengthen access to infrastructure finance. Bond markets can play a greater role in channeling Asian savings toward infrastructure projects. Guarantees for project bonds may help foster demand for these products by long-term institutional investors. Infrastructure funds, both domestic and international, are valuable, especially if the ASEAN Infrastructure Fund is extended to a Pan-Asian infrastructure fund covering South Asia as well. Measures to integrate regional financial markets and ease restrictions on international capital flows can also contribute. Future collaboration, including co-financing infrastructure projects between development banks—ADB, the emerging Asian Infrastructure Investment Bank, and the World Bank—would contribute to increasing the supply of infrastructure finance in Asia.

Public–private partnerships (PPPs) provide an important top-up for infrastructure funding, but are not a panacea. Improving the transparency, regulatory framework, and governance of PPP projects, together with the addition of political risk guarantees, can increase the attractiveness of this asset class. Furthermore, support from multilateral development banks and international coordination for cross-border projects can help ensure success in PPPs.

Trade facilitation and coordination

Fifth, improving trade and transport facilitation would make trading between the two subregions easier and more stable, with lower transaction costs. Businesses complain about excessive documentation requirements for customs clearance and there has been limited adherence in the subregions to international best practices for customs modernization. The ASEAN Single Window Initiative is presently being implemented and will eventually provide for a notable reduction in trade costs. There is a need to consider development of a regional single window initiative covering South Asia as well. The lack of cross-border transit agreements in the two subregions is another major obstacle that needs to be addressed.

Sixth, closing coordination gaps in South Asian and Southeast Asian cooperation and integration may require retooling existing institutions and creating new institutions to facilitate economic links. The current institutional landscape for regional connectivity is populated by several—at times overlapping—institutions under ASEAN, South Asian Subregional Economic Cooperation (SASEC), South Asia Subregional Economic Cooperation (SAARC), GMS, or Bay of Bengal Initiative for Multi-Sectoral Technical and Economic Cooperation (BIMSTEC) arrangements. It may be productive to explore linking SASEC with the GMS through officials participating in each other’s meetings as observers and then focusing on specific regional connectivity projects. Improving capacity building for land infrastructure connectivity in economies such as Myanmar, Bangladesh, and India is also important.

Estimating gains from closer integration

The potential gains from connectivity-led closer South Asian–Southeast Asian integration are potentially large. The ADB/ADBI study used a modern computable general equilibrium model to explore the potential economic effects of alternative integration schemes involving South Asian and Southeast Asian economies. The policy scenarios are conservative and are likely to reflect lower-bound estimates of what true results can be expected. The best-case deep integration scenario involves (i) removal of all tariffs associated with South Asian and Southeast Asian trade, (ii) a 50% reduction in inter-regional non-tariff barriers, and (iii) a 15% reduction in trade costs reflecting improved trade facilitation and investment in infrastructure. The model results show that this scenario would raise welfare by $375 billion (8.9% of gross domestic product) in South Asia and $193 billion in Southeast Asia (6.4% of gross domestic product). Most participating countries show large gains, especially the smaller countries in South Asia.

Certainly, the process of closer intra-regional economic integration generates potential benefits but may entail some additional costs that need serious review and mitigation measures. For instance, some sectors will lose due to greater competition, and there may be increases in regional inequalities. Also, closer intra-regional economic ties and faster growth may entail pollution, environmental degradation, and migration issues. Regional economic integration may also hasten the spread of disease and crime. In addition, the process may exacerbate fears of migration, ethnic tensions, and other security-related issues. However, our analysis suggests that the overall benefits substantially outweigh the costs, so it should be feasible to develop compensating mechanisms to address these costs. As cross-regional integration progresses, countries and regional institutions will need to conduct research on the economic implications of these challenges and formulate appropriate policy remedies.
_____

¹ The ADB/ADBI (2015) study Connecting South Asia and Southeast Asia can be downloaded here.
² The figures only cover projects directly related to connectivity between South Asia and Southeast Asia. Projects related primarily to intra-subregional connectivity or connectivity with other subregions are not included.