Paul Danahar: There has been much speculation over the signing of the deal

The agreement, which will come into effect in March next year, was signed in Delhi by the Sri Lankan President Chandrika Kumaratunga and the Indian Prime Minister Atal Behari Vajpayee.

This is the first free trade deal to be signed in South Asia and is expected to end tariffs between India and Sri Lanka within three years. Sri Lanka also hopes that the agreement will reduce a huge trade deficit in trade between the two countries.

This year's Saarc summit in Sri Lanka - dominated by nuclear tests

Indian exports to Sri Lanka totalled $560m in the fiscal year ending March, while imports came to just $42m.

The BBC Correspondent in Delhi, Paul Danahar, says that the idea of free trade areas is embraced by all South Asian countries, but progress on the issue has been slow.

He says that the annual Saarc summit between the South Asian states is often dominated by hostility between India and Pakistan, which makes moves on region-wide economic policy difficult.

Differences

According to newspaper reports, officials of the Indian Ministry of Commerce raised eleventh-hour objections to some aspects of the agreement. While the Indian foreign ministry was reportedly keen on the deal, the commerce department feared that smaller Indian entrepreneurs, particularly in the garment sector, would be hit by relaxing trade barriers.

Officials said that full details of the agreement would be released later.

Our correspondent says the free trade agreement will be welcomed by the BJP-led Indian government, which has been accused of making a mess of the economy after international sanctions were imposed in the wake of this year's nuclear tests.

It will mean Mr Vajpayee's administration can at least start the new year with one economic success under its belt.

The Sri Lankan delegation will meet Indian business leaders early on Tuesday before returning home later in the day.