India and Pakistan should take steps to formalise their informal trade

There are significant possibilities of creative and dynamic economic engagement between these two large neighbours.

When there are compelling reasons for it, trade will occur, one way or another. The recent report The Dubai Angled Triangle by Nikita Singla and Priya Arora of BRIEF (Bureau of Research on Industry and Economic Fundamentals) provides one of the most robust quantitative estimates of informal trade between India and Pakistan.

Where is the problem, you might ask? Is it a problem if trade is informal, as long as it occurs? Should Pakistan care? Should India care?

Yes, it is a problem, because there are major costs involved. Informal trade is not ideal for consumers or for concerned governments. Consumers often pay more for circuitous trade, or in the case of illegal trade, are less assured of the quality of the product. Government revenue, to the extent trade is illegal, also suffers. Informal trade cannot be a substitute for many types of formal trade. Perhaps most important in a dynamic sense, informal trade cannot be the basis for potential value chains between India and Pakistan, examples of which include sectors such as garments and textiles, automobiles and parts and drugs and medical devices.

Assume, extrapolating backwards from the numbers in the BRIEF, that informal trade in 2015 was about $2 billion. Adding that to formal trade in 2015 gives a total trade number of $4 billion. This represents less than 11 per cent of the total potential trade of $37 billion between India and Pakistan, based on the 2015 calculations in the World Bank Report, A Glass Half full: the Promise of Regional Trade in South Asia. Informal trade can only do so much of the hard work. The rest has to come from chipping away at policy barriers. Eighty-nine per cent of trade that does not take place represents significant welfare losses for the people of India and Pakistan (since the restrictions on bilateral trade imply that it has to be substituted by less efficient alternatives), and potential loss of customs revenue for the governments.

The bottom line is that there are significant possibilities of creative and dynamic economic engagement between these two large neighbours, and even the pre-2019 policy regime barely allowed the surface of those possibilities to be scratched. I will offer a few thoughts on what a more people-centred trade policy regime might look like, whose objective should be an open trading regime with increasing degrees of integration over time between the two economies. Discussions between India and Pakistan to achieve this objective should embrace one basic principle: As the larger and relatively more advanced economy, India should allow Pakistan more time to adjust, that is, liberalisation should be asymmetric, as has indeed been the case historically.

The first step could be to resume cross-LoC trade which has always operated under restricted conditions, and is as much a mean to sustain relationships as it is to trade. Concerns around transparency have negatively impacted this trade over the last decade (BRIEF report Unilateral Decisions, Bilateral Losses). The lack of transparency needs to be addressed in the complete ecosystem which includes the standard operating procedure, invoicing, goods and services tax norms, and trader registration. This could be accompanied by an intent to start a “border haat” on, say, the Wagah-Attari border, once COVID-19 has been seen off. A border haat is a weekly market that enables low-value trading through face to face contact between communities. Operating at four locations so far on the India-Bangladesh border, these markets have enabled people-to-people contact and renewal of cross-border relationships, provided economic opportunities for vendors, porters, transporters, and buyers, and reduced smuggling. If the border haatexperience is positive, it can encourage the opening of an increasing number of haats along the India-Pakistan land border.

Along with these relatively small steps, trade officials could agree on a date to start tariff-based trade, supplanting the pre-2019 regime. On the agreed date, India could offer a full MFN (Most Favoured Nation) import regime to Pakistan. In turn, Pakistan could abolish its pre-2019 negative list for India, and put those 1,209 items on the negative list, plus the 936 items on its current SAFTA (South Asian Free Trade Area) sensitive list under a revised India-specific sensitive list, with MFN tariffs on the 936 items, and MFN or higher tariffs (with a mutually agreed maximum tariff) on the 1,209 items. This new regime, which would be fully tariff-based, would offer the starting point for further liberalisation. To save face on both sides, this agreement could be touted as a conditional opening, with annual certification by both parties, to the effect that the other party has not taken steps “prejudicial to its neighbour’s interest.”

The next step would be to dig deeper into tariffs, building on SAFTA and agreements reached between the two countries in 2012. Pakistan could offer a five-year timeline to put all its products on MFN tariffs, and an additional five years to provide SAFTA preferences on these products, with the exception of 100 tariff lines that would stay sensitive beyond the 10 year period. It would also open the Wagah border to trade in all products, and not restrict it to the 138 products that were allowed prior to 2019. In return, India would immediately offer SAFTA preferences to all products from Pakistan except for 100 sensitive products. The tariff rate on those 100 products would be the MFN rate. The maximum rate under SAFTA preferences would be 5 per cent for both countries.

These trade negotiations could, in time, enable even more ambitious discussions on transport connectivity, land transit, and investment, where the possibilities are fascinating.

The specific suggestions on tariffs and the timeline are of course indicative. I have offered what I consider to be relevant ways to move forward. The exact path can only be determined through talks and negotiations. The idea is to have a dialogue, resume trade, and use the opening of trade to catalyse further liberalisation in trade as well as other economic areas.

Initiating talks is not a sign of weakness. It is a sign that people, whose livelihoods are at stake, matter more than politics. Both sides need to appreciate this. Perhaps the negotiations can be labeled as “Trade talks for the people of India and Pakistan”.

The writer is Senior Visiting Fellow, Centre for Policy Research, New Delhi, and former Lead Economist, World Bank

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