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India-Pakistan Trade Relations

A New Beginning
  • By Mohsin Khan, Senior Fellow, Rafik Hariri Center for the Middle East, Atlantic Council
January 29, 2013 |

One of the more significant recent economic developments in South Asia was the revival of trade talks between India and Pakistan in 2011. A question frequently raised is why India and Pakistan trade so little with each other despite the existence of common history, language, culture, and long borders. Economic theory and evidence from around the world would predict that trade between the two largest economies in South Asia would be far greater than its current level of around $2.5 billion. While both countries are aware of the merits of trade, a variety of political and infrastructural—physical, legal, and regulatory—impediments have virtually paralyzed bilateral trade relations between the two neighbors.[i]

It is clear to most observers that Pakistan’s economic development will depend to a large extent on normalizing relations with India to pave the way for South Asian regional economic integration. Facing diminishing marginal returns to traditionally growth-leading sectors, Pakistan is in need of larger and growing export markets to tap the potential of industrial hubs in the south and west (Baluchistan coastline and Karachi in Sindh), in the central belt (Multan, Lahore, Gujrat, Gujranwala, and Sialkot in Punjab), and in the north (Peshawar in Khyber Pakhtunkhwa). Trade with India, with its large and growing market, can be an important factor in realizing this goal. For India, trade with Pakistan is not only advantageous in itself, but would also facilitate trade with Afghanistan, China, Iran, and the Central Asian countries. Thus, for both countries, increased trade with each other would be a win-win outcome.

Even though both countries are members of the South Asia Free Trade Area (SAFTA), established in January 2006 as a successor to the South Asian Preferential Trading Arrangement (SAPTA)[ii], trade between the two countries is unnaturally small and the opportunity for gains from increased trade is correspondingly large.[iii] As can be seen in Figure 1, total trade (exports plus imports) between the two countries in 2011 amounted to a little more than $2.5 billion, up from a paltry $750 million in 2005.[iv] Still, Pakistan accounts for less than 0.5 percent of India’s trade and India accounts for a little over 3 percent of Pakistan’s trade, compared with the very large shares of bilateral trade following independence of the two countries in 1947.[v] Informal trade via third countries (such as the United Arab Emirates, specifically Dubai) is estimated at $2 billion to $3 billion per year, and this trade could obviously be undertaken bilaterally at significantly lower cost.[vi]

This paper examines key issues related to India-Pakistan trade relations from the Pakistani perspective. The paper first discusses in Section 2 the initiatives taken since early 2011 by the two countries to improve these relations. Meetings have been held between Pakistani and Indian government officials at various levels, and between business people from both sides of the border, to work out a common strategy for enhancing trade between the two countries. Inside Pakistan, there have been discussions involving the most important stakeholders—politicians, business people, and the military. These various meetings culminated in Pakistan’s announcement that it would offer India most favored nation (MFN) status by the beginning of 2013, a status that India had granted Pakistan in 1996. Essentially this meant that as of 2013, restrictions on imports from India would have to be eliminated and the same tariff rates would apply to Indian imports as are imposed by Pakistan on imports from other countries.

Section 3 estimates the potential for trade between the two countries once the process of trade liberalization is underway. A number of studies have shown that trade could be significantly higher if the policy-determined and physical barriers were reduced. More specifically, the estimations in this paper indicate that total trade (imports plus exports) could eventually expand some 20 times its current level of $2.5 billion to $50 billion under normal trade relations. A trade level of $6 billion to $10 billion in the next five years is now the consensus estimate of the government, academics, and business people in Pakistan.

Section 4 takes up the effects of Indian non-tariff barriers (NTBs) and other trade impediments on Pakistani exports. The aim is to identify the main obstacles that hamper trade in order to determine which ones are the most important and require immediate attention. It is worth noting that several such NTBs, notably related to visas, customs procedures, multiple standards, and ineffective dispute resolution, have been resolved or are near resolution. Other impediments to trade still need to be addressed, including in particular physical infrastructure such as roads, border crossings, and customs warehouses, as well as specific NTBs, including internal state taxes, subsidies, and sales taxes. 

Trade liberalization almost always results in “winners and losers,” and this issue is taken up in Sections 5 and 6 by examining the sectoral impacts in Pakistan of opening up trade with India. Two complementary approaches are taken in looking at this issue. The first (in Section 5) is a review of existing studies on the sectoral impact of trade with India, the most recent of which was undertaken by the government of Pakistan in 2011 in the context of discussions related to  the granting of MFN. The second (in Section 6) involved direct meetings with the chambers of commerce in a number of major cities in Pakistan. The basic conclusions reached from utilizing the two approaches are as follows. First, Pakistan will gain from access to advanced technology and machinery from India. Second, it is likely that the pharmaceutical and automobile industries will lose out to more competitive Indian industries. Third, the agricultural sector could benefit if it is allowed to compete on a level playing field; at present, India’s heavily subsidized agriculture makes Pakistani products uncompetitive. Fourth, certain sectors like textiles, electric fans, and tires will gain from trade with India because of its large market as well as Pakistan’s geographical proximity to certain regions of India, as compared to some of the Indian states producing these products. Finally, there will be efficiency gains for the major industry clusters in Gujrat, Gujranwala, and Sialkot, as they will be able to achieve economies of scale with a large Indian market and land routes through India to other South Asian countries where Pakistani goods already have a competitive edge.

The final section of the paper lists some of the priority areas on which the two governments, in particular Pakistan, need to focus to create an environment for sustained improvement in economic relations.

 

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[i] For a general discussion of the advantages of closer economic relations between India and Pakistan, see Kemal et al. (2002), State Bank of Pakistan (2006), Panagariya (2007), and the papers contained in Naqvi and Schuler (2007). Khan (2009) explicitly examines and lists the constraints on India-Pakistan bilateral trade.

[ii] Both SAFTA and SAPTA are part of the South Asian Association for Regional Cooperation (SAARC), formed in 1985. The original SAARC members were Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, and Sri Lanka. Afghanistan joined SAARC in 2007.

[iii] As noted by the Confederation of Indian Industry (2005), Nabi and Nasim (2001), and Taneja (2007), among others. A very useful description of Pakistan’s trade relations with its South Asian neighbors is contained in Hufbauer and Burki (2006, Appendix A).

[iv] By way of comparison, India and Sri Lanka have had a free trade agreement (FTA) since 2000, and total Indian–Sri Lankan trade is about $4 billion, even though Sri Lanka’s GDP is roughly a quarter that of Pakistan’s. Also, Indian trade with Bangladesh, which has half the size of Pakistan’s GDP, reached $3.5 billion in 2010.

[v] At that time, 70 percent of Pakistan’s trading transactions were with India, while 63 percent of Indian exports went to Pakistan.

[vi] On the extent of informal trade between India and Pakistan, see Khan et al. (2007). Anecdotal evidence suggests that such trade could be much higher, possibly even over $5 billion a year.

It appears that while there are widely heralded attempts being made to dismantle “official” trade hurdles, other barriers are being added to maintain the status quo, specifically in those sectors where Indian interests are most threatened by Pakistani exporters, such as cement and gypsum.