KARACHI: This is just a concept. South Asian Free Trade Area or Safta for short. But it may become a reality if the South Asian nations are willing to come closer to each other-without compromising on their individual political sovereignty.

Safta does offer opportunities for the South Asian nations to improve their living conditions by increasing intra-Saarc trade. But it throws up challenges that need to be addressed. Generally economists and bankers agree that Safta could be made a reality and South Asian nations can reap its benefits. But there are also voices of concern.

Let us first assess the possible implications of Safta on the quasi-liberalized financial sector of Pakistan.

Any trade agreement can impact on the financial sector in two ways: It can lead to altering of the foreign exchange policy of a country or it can have implications for its balance of payments (BoP) by changing the trade component of the current account.

The Safta draft agreement has built in safeguards against these contingencies. Article 8 of the agreement states that foreign exchange restrictions will be governed by existing multilateral agreements signed by these countries as part of GATT and the relevant articles of the IMF. As such "the countries (ratifying Safta) will not be obliged to alter their exchange rate regimes," says Dr. Asad Sayeed noted economist and a former adviser to Social Policy Development Centre.

As for the implications on BoP, article 11 and 15 guard against any possible contingency arising from ratifying Safta agreement. Article 15 states that any "contracting state facing balance of payments difficulties may suspend provisionally the concessions agreed under this agreement." This implies that in case of a BOP problem states can remove tariff concessions given to Saarc countries. "Such a provision is not present in the WTO," points out Dr. Sayeed.

Article 11 states that if a least developed country is losing a significant amount of customs revenue then "other member states will undertake to compensate for this loss." But a more important question with regard to BOP difficulties is that if Pakistan and India open up their trade regimes will it result in an absolute increase in the volume of trade or will it have more of a substitution effect?

"In my view the substitution effect will dominate...thus there is going to be no significant BOP impact," says Dr. Sayeed.

So if one assumes that the impact of Safta on both foreign exchange regime and the BOP is fairly benign "then the financial sector is also not likely to be affected substantively." He says that "Pakistan's financial sector is fairly well regulated and thus one does not foresee any adverse impact (of Safta on it)."

But another noted economist and Dean of College of Business Management Dr. Javed Akbar Ansari views Safta "as an American project for establishing Indian regional hegemony as a sub- imperial power." He fears that "free trade within the region will lead to a concentration of technology-intensive and high productivity activities" in Western and Southern provinces of India and "capital will desert Pakistan seeking higher profits."

"The Pakistani financial sector will be subordinated to Indian monetary policy and financial institutions," he warns. Dr. Ansari says that this feared Indian domination of Pakistani finance "can be reduced if Pakistan combines trade account liberalization with capital account inconvertibility" or imposition of strict controls on transfer of capital to and from India.

His worst fear is that "America will put pressure on Pakistan to gradually liberalize the capital account and accept the Indian proposal for a single currency." This will inevitably lead to Indian "dominance of the Pakistani financial system."

Now let us identify the opportunities and challenges of Safta specific to the banking business.

Increased intra-Saarc trade activities should naturally lead to higher banking business in the region. But naturally banks will have to become more competitive and invest more in human resources and technology upgrading.

President of National Bank of Pakistan Syed Ali Raza says that Safta "would not only facilitate intra-Saarc trade but would also contribute significantly to the expansion of investment and production opportunities; foreign exchange earnings as well as the development of economic and technological cooperation."

"As the trade moves through official channels it would...mean more business for the banks." The financial sector would be called upon to handle the additional "volume of trade which was earlier being smuggled or coming through illegal channels."

As article 8 of the Safta agreement calls for simplification of banking procedure for import financing.

"The banking and financial system has to be made supportive and responsive to the demand of regional trade," adds Mr. Raza. If freeing of trade in goods leads to enhanced trade especially exports from Pakistan then "additional capacity may have to be created and banks may be asked to finance this requirement." But a key point is that before moving towards free trade certain facilitation measures would need to be initiated which include easing of trade documentation and financial procedures.

"Gains of a free trading zone could be made more beneficial if the members succeed to abolish barriers to trade in services such as tourism, investment, transportation and insurance," Mr. Raza says. "Large multinationals are already operating and with the opening of intra-regional trade more are likely to step in."

"If there is movement of factors of production, labours would no longer be illegal immigrants and they would not have to go to the Hawala market "to remit back home their earnings." They could use the official channel.

To sum up Mr. Raza believes that "financial sector stands to benefit (from Safta)."

But what banks will have to do in the post-Safta regime? Mr. Shaukat Tarin who heads Pakistan Banks Association and is also chairman of Union Bank says they will have to do the following:

* They will have to identify industries in Pakistan that will benefit from Safta. Banks should take a view on these industries and aim to facilitate their success by increasing the exposure to the growth sectors.

* They will also have to identify the industries that may be at risk because of free access to our market. The banks should reevaluate their strategies on these industries vis-a-vis exposure and potential of the sector.

* There will be many opportunities to finance modernization and expansion of those industries that are to benefit from Safta.

* Banks will also have to enhance project finance capabilities.

* More importantly banks will learn from each other and share technology, product and market knowledge.

Pakistan with a successful track record of privatization and banking sector reforms can help other countries "and we can learn a few tricks from India in capital markets and consumer lending."

Mr. Tarin says with Safta coming into force the trade between Pakistan and India alone is expected to grow to US$4 billion. (The same may happen with the trade volumes in between other countries of the region). So trade flows for banks would grow.