Role of observer countries in regional trade agreement matters for intra-regional trade: The case of SAARC

This study analyzes the effect of observer countries in the Regional Trade Agreement on intra-regional trade in the South Asian Association for Regional Cooperation (SAARC). The intra-regional trade in SAARC by members is accounted for only seven percent of total trade, while the share of observers’ trade is about 50 percent of the total trade. Foreign direct investment (FDI) and official development assistance (ODA) by SAARC observers to its members have increased every year. This implies that the role of observers’ trade and ODA in SAARC may influence the development of its member economies. First, this paper investigates the effects of trade by observer nations on the intra-regional trade by SAARC members using Poisson pseudo-maximum likelihood (PPML) gravity models with unbalanced panel over the period of 2008-2014.  Second, the paper also analyzes the effects of FDI and ODA provided by observers to SAARC members on the intra-regional trade. Eight SAARC members and eight observer countries including the European Union are analyzed in capturing the trade effect of observer economies on intra-regional trade in SAARC. This paper provides an empirical measure of observers’ trade, FDI and ODA with SAARC if the export and import of observers to/from SAARC have positive or negative signs to the intra-regional export and import. If the coefficients of export and import have positive (or negative) signs, then observers play a complementary (or adverse) role in increasing intra-regional export and import in the regional trade agreement. FDI has a complementary (or substitute) relationship with intra-regional trade if it has a positive (or negative) sign. The coefficient of ODA also identifies how to affect the development of the member economies. Insights into some academic and political implications on how to improve the relationships between member economies and observer members in a regional trade agreement are provided.

Keywords; intra-regional trade, the role of observers, regional trade agreement, SAARC, trade

JEL Category Selection: F15, F14