Leaving Pakistan–India trade barriers up ties political progress down

Author: Pravakar Sahoo, Institute of Economic Growth

The recent announcement by Pakistan’s finance minister that most favoured nation (MFN) status to India will not be considered is an additional blow to India-Pakistan relations.

A group of Indian fishermen sits on the ground after their release from a prison as they show their temporary travel documents while crossing into India through India-Pakistan Wagah border near Lahore, Pakistan, 24 August 2013. Pakistan recently announced that it would not consider conferring most favoured nation status on India. (Photo: AAP)

While improved trade relations could significantly enhance political ties between the two countries, and this announcement makes it more likely that bilateral relations will continue to languish at current low levels.

The latest figures show that India’s 2012 trade with Pakistan accounted for a mere US$2.15 billion of its total trade of US$778 billion (less than 0.3 per cent). Exports to Pakistan accounted for only 0.56 per cent of India’s exports, while imports constituted 0.11 per cent. Given the size of both countries’ economies and the complementarity of their trading baskets, the present level of trade should be higher. The denial of MFN status compounds these difficulties, and arguably neutralises the positive steps taken by both countries over the last few years.

Along with Pakistan’s denial of MFN status to India (which would give market access to Indian exporters in all products), the ad-hoc ‘positive list’ approach taken by Pakistan has contributed to low base trade by creating uncertainty among traders on both sides of the border. Though the positive list approach, which allowed for the import of 2000 items from India, was abolished in 2012 and replaced with the ‘negative list’ approach, which prohibits listed items from importation, improvement has been marginal. The negative list contains 1500 items, with 500 being untradeable items belonging to the iron, steel and automobile sectors in which India has comparative advantage. In addition there are non-tariff barriers on both sides, including: licensing and customs requirements; visa policies and restrictions on travel; high trade and transaction costs due to long waiting periods at the borders; a lack of information on tradable items; and India-Pakistan trade compliance regulations.

India’s exports to Pakistan at the industry level have witnessed negligible and fluctuating growth due to the limitations of the positive list, even in very competitive industries such as base metals and articles, and textiles. India fares better in industries where there are more items on the positive list. For example, India is doing well in chemical products in the Pakistani market, as Pakistan added 308 more items to the positive list between 2000–09, taking the total items to 568. In recent years, India has also exported more mineral products and textiles subsequent to these products being added to the positive list. The quantity of goods moving from India to Pakistan is determined by local demand at any given point in time, and MFN status would have given stability to this demand.

On the other hand, Pakistan’s exports to India are suffering from India’s lack of tariff liberalisation. India has agreed to bring down all tariffs under the South Asia Free Trade Area, other than those on the negative/sensitive list. But India’s negative list includes some of the top 10 import items from Pakistan, such as edible fruits and nuts, some cotton textiles materials, carpets and sacks.

There have, however, been a few positive developments in recent years that have helped India-Pakistan economic relations despite the denial of MFN status. In April 2012, both countries agreed to launch a new integrated check point at the Attari-Wagha border crossing to address the issue of trade and transaction costs. Further, in September 2012, both nations concluded a visa agreement that loosens the travel restrictions across the border. India has also permitted foreign direct investment from Pakistan since August 2012 through the Foreign Investment Promotion Board to ameliorate the environment of suspicion and mistrust. But because there are barely any capital flows between the two countries worth mentioning, the initiatives taken in the last couple of years to reduce non-tariff barriers could hardly be expected to boost trade without a stable framework created around MFN status.

China has a higher share of the Pakistani commodities market, where both India and China have comparative advantages in the world market. Given the similarity in export baskets of China and India to Pakistan, Chinese exports appear to be replacing Indian exports in the Pakistani market. There is direct competition between Chinese and Indian goods for some of Pakistan’s top imports, such as chemical products, textiles and textiles products, and prepared food. Of course, China does well because of its price competitiveness, as well as the open access that it has to Pakistan’s market in comparison to India. With respect to investment, India has historically missed out on the opportunity to invest in Pakistan because of political mistrust, whereas China has been investing heavily in projects such as the Gwadar Port, the Karakoram Highway, the Special Economic Zone in Pakistan, and China-Pakistan economic zones.

MFN status would not only help provide stability in trade relations between the two countries but would also assist Pakistan in technology upgrades, greater productivity gains, and increased revenues from legal trade. It is reported that India-Pakistan informal trade (trade occurring through a third country) accounts for more than formal trade (which is around US$4 billion). Further, consumers would experience lower product prices and greater variety. Despite Pakistan’s recent rejection of MFN status to India, India could unilaterally reduce all kinds of non-tariff barriers that would be capable of creating confidence among Pakistani traders. A good and stable political relationship would help trade but opposite is quite possible. A case in point is the strong economic relations between China and Japan, which help in stabilising fluctuating political relations.

Pravakar Sahoo is an associate professor at the Institute of Economic Growth (IEG), Delhi, India.