metadata: authors: 0: author: De,Prabir
1: author: Kathuria,Sanjay
2: author: Raihan,Selim
count: India,Bangladesh
docna: 0: docna: Unlocking Bangladesh-India trade : emerging
            potential and the way forward
docty: Policy Research Working Paper
theme: Regional integration,Other trade and integration,Trade facilitation and market access
majtheme: Trade and integration
subtopic: Private Sector Economics,Urban Solid Waste Management,Private Sector Development Law,International Trade and Trade Rules,Marketing,Trade Facilitation,Trade and Multilateral Issues
teratopic: Law and Development,Transport,Macroeconomics and Economic Growth,International Economics and Trade
abstracts: cdata!: The primary objective of this study is
            to analyze the impact on Bangladesh of increased market
            access in India, both within a static production structure
            and also identifying dynamic gains. The study shows that
            Bangladesh and India would both gain by opening up their
            markets to each other. Indian investments in Bangladesh will
            be very important for the latter to ramp up its exports,
            including products that would broaden trade complementarity
            and enhance intra-industry trade, and improve its trade
            standards and trade-handling capacity. A bilateral Free
            Trade Agreement would lift Bangladesh's exports to
            India by 182 percent, and nearly 300 percent if transaction
            costs were also reduced through improved connectivity. These
            numbers, based on existing trade patterns, represent a lower
            bound of the potential increase in Bangladesh's exports
            arising from a Free Trade Agreement. A Free Trade Agreement
            would also raise India's exports to Bangladesh.
            India's provision of duty-free access for all
            Bangladeshi products (already done) could increase the
            latter's exports to India by 134 percent. In helping
            Bangladesh's economy to grow, India would stimulate
            economic activity in its own eastern and north-eastern
            states. Challenges exist, however, including non-tariff
            measures/barriers in both countries, excessive bureaucracy,
            weak trade facilitation, and customs inefficiencies. Trade
            in education and health care services offers valuable
            prospects, but also suffers from market access issues. To
            enable larger gains, Bangladesh-India cooperation should go
            beyond goods trade and include investment, finance, services
            trade, trade facilitation, and technology transfer, and be
            placed within the context of regional cooperation.
geo_reg_key: 517198,517212,517191
repnme: repnme: Unlocking Bangladesh-India trade : emerging
            potential and the way forward
display_title: Unlocking Bangladesh-India trade :
            emerging potential and the way forward
listing_relative_url: /research/2012/08/16563734/unlocking-bangladesh-india-trade-emerging-potential-way-forward
topicv3: Private Sector Development m1326060 1921,Intraregional Trade m1326248 1175,Trade m1326924 698,Trade Facilitation and Logistics m1327174 772,Regional Integration m1504278 2576
publishtoextweb_dt: 2012-08-01T00:00:00Z
historic_topic: Law and Development,Transport,Macroeconomics and Economic Growth,International Economics and Trade
no_of_pages: 54
author_keys: 0: author_key: 1093517
1: author_key: 96365
2: author_key: 901153
model_extractions: WPS6155 Policy Research Working Paper 6155 Unlocking Bangladesh-India Trade Emerging Potential and the Way Forward _Prabir De Selim Raihan Sanjay Kathuria_ The World Bank South Asia Region Economic Policy and Poverty Sector August 2012
Policy Research Working Paper 6155

# **Abstract**

The primary objective of this study is to analyze the impact on Bangladesh of increased market access in India, both within a static production structure and also identifying dynamic gains. The study shows that Bangladesh and India would both gain by opening up their markets to each other. Indian investments in Bangladesh will be very important for the latter to ramp up its exports, including products that would broaden trade complementarity and enhance intra-industry trade, and improve its trade standards and trade-handling capacity. A bilateral Free Trade Agreement would lift Bangladesh’s exports to India by 182 percent, and nearly 300 percent if transaction costs were also reduced through improved connectivity. These numbers, based on existing trade patterns, represent a lower bound of the potential increase in Bangladesh’s exports arising from a Free Trade Agreement. A Free Trade Agreement would also raise India’s exports to Bangladesh. India’s provision of duty-free access for all Bangladeshi products (already done) could increase the latter’s exports to India by 134 percent. In helping Bangladesh’s economy to grow, India would stimulate economic activity in its own eastern and north-eastern states. Challenges exist, however, including non-tariff measures/barriers in both countries, excessive bureaucracy, weak trade facilitation, and customs inefficiencies. Trade in education and health care services offers valuable prospects, but also suffers from market access issues. To enable larger gains, Bangladesh-India cooperation should go beyond goods trade and include investment, finance, services trade, trade facilitation, and technology transfer, and be placed within the context of regional cooperation.

This paper is a product of theEconomic Policy and Poverty Sector, South Asia Region. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at http://econ.worldbank.org. The authors may be contacted at prabirde@hotmail.com, sraihan_duecon@yahoo.com, skathuria@worldbank.org.

_The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent._ Produced by the Research Support Team
# **Unlocking Bangladesh-India Trade: Emerging Potential and the Way Forward**

Prabir De<sup>1</sup> , Selim Raihan<sup>2</sup> , and Sanjay Kathuria<sup>3</sup>

1. Fellow, Research and Information System for Developing Countries (RIS), New Delhi, e-mail: prabirde@hotmail.com. 2. Associate Professor, Department of Economics, University of Dhaka, Dhaka and Executive Director, South Asian Network on Economic Modeling (SANEM), Dhaka, e-mail: sraihan_duecon@yahoo.com 3. Lead Country Economist, SASEP, the World Bank, Bangladesh, e-mail: Skathuria@worldbank.org.

The authors wish to thank Mia Mikic, Thomas Farole, Olivier Cadot, Md. Abul Basher and Zahid Hussain for their useful comments on earlier versions of this paper, and Poulomi Dasgupta for her research assistance. They also acknowledge the support provided by the World Bank for this study. The views expressed are the authors‘ alone, and not necessarily those of the World Bank, RIS, University of Dhaka and SANEM. The usual disclaimers apply.

[Sanjay Kathuria is affiliated to the EPOL Sector Board, and is a Lead Economist in SASEP] Key words: Bangladesh, India, FTA, Trade facilitation, Trade liberalization, CGE model JEL codes: F10, F13, F15, F17
# **Table of Contents**

|**Abstract ........................................................................................................................................... i**|
|---|
|**1. Introduction ............................................................................................................................... 1**|
|Data and Methodology ...................................................................................................................... 2|
|**2. Quantifying the Benefits of Trade Liberalization and Facilitation between India and**|
|**Bangladesh: Brief Review of the Literature ............................................................................... 2**|
|**3. Market Access for Trade in Goods and Selected Services .................................................... 5**|
|3.1. Bangladesh‘s Trade with Neighboring Countries ...................................................................... 5|
|3.2. Trade Complementarity and Intra-Industry Trade ..................................................................... 8|
|3.3.<br>Trade in Services in Education and Health Sectors between Bangladesh and India .......... 12|
|3.4. Scenario Analysis with the Global Computable General Equilibrium (CGE) Model ............. 13|
|3.4.1. Removal of India‘s Negative List and Its Impact on Bangladesh‘s Export to India ............. 15|
|3.5. Market Access Issues ............................................................................................................... 19|
|3.6. Beyond Trade in Goods ........................................................................................................... 21|
|**4. Connectivity, Trade Facilitation, and Transit ...................................................................... 21**|
|4.1. Implications .............................................................................................................................. 27|
|**5. Conclusions and Policy Implications ..................................................................................... 27**|
|**References .................................................................................................................................... 31**|

ii
# **1. Introduction**

Despite bonds of culture and a shared history, as well as neighborly proximity, economic ties between Bangladesh and India are far below potential. There is a feeling that rapid growth in both countries and increasing levels of economic sophistication in India now present opportunities for enhanced economic cooperation. Bangladesh could export far more, for example, to India‘s vast market, and Indian firms could invest in Bangladesh, benefiting from abundant and relatively inexpensive labor, and re-export to India as well as other countries. And there are plentiful opportunities for trade in services.

Current reality is different. Trade in South Asia in general––and between India and Bangladesh, in particular––faces innumerable barriers, some of which are purely economic in nature. Because of these barriers, the loss to industry and consumers in general is considerable. For example, if markets were to open up effectively, Bangladesh could increase its exports of leather and ceramic products to India, and India could increase its sugar exports to Bangladesh, where currently it is being smuggled in. Pakistan could increase its trade in fresh and dry fruits. India could buy molasses and cement from Pakistan and export machinery back, or increase its export of yarn to Sri Lanka. Since this is not the case at present, South Asian traders have to contend with a multitude of trade barriers, while the absence of proper facilitating mechanisms multiplies trade costs. For example, a surgical equipment manufacturer in Pakistan sells equipment to Indian hospitals via a third country simply because India and Pakistan do not trade in these products directly. The landed cost of _jamdani sarees_ or _hilsa_ fish from Bangladesh in the West Bengal state of India is high because the trade standards adopted by the two countries are very different. There are many other examples. Pakistan imports tea from Kenya, when neighboring India and Sri Lanka offer much better options. India exports a significant amount of cotton yarn to Bangladesh, but not to Sri Lanka or Nepal, which are deficient in cotton yarn. As a result, informal trade in South Asia has grown considerably and in many cases exceeds the formal trade volume.

Better market access, improved physical connectivity and transit, and energy trade between India and Bangladesh are important instruments for unlocking bilateral trade potential. Greater engagement in these areas would also stimulate employment and other economic and social activities, which in turn would help to reduce poverty (particularly in the border areas), enhance foreign direct investment (FDI) flows, and generate new business opportunities for the private sector. Bilateral trade and investment offer immense opportunities for accelerating growth and reducing poverty. India could become a hub for stimulating the growth of intra-industry trade and boosting FDI inflow to Bangladesh. At the same time, Bangladesh can become an additional source of trade and investment for India‘s eastern and north-eastern states. Furthermore, in view of several regional and sub-regional cooperation initiatives involving India and Bangladesh, greater bilateral economic cooperation and integration between these two economies is a critical step for an integrated South Asia. This integration will eventually provide a basic foundation for a more effective SAARC (South Asian Association for Regional Cooperation) in moving towards more free-market and trade-oriented policies. Deeper India-Bangladesh cooperation would be a part of the process towards a stronger SAARC.

The prospects of cooperation between Bangladesh and India seem brighter than ever, particularly since the governments of both countries have recently shown political interest in this regard. The Prime Ministers of the two countries met in 2010 and 2011<sup>1</sup> and agreed to cooperate in (i) broadening access to each other‘s markets, (ii) improving physical connectivity, including sub-regional transit, and (iii) electricity trade. Would deeper cooperation in these fields lead to significant economic and social benefits? A full-length study on bilateral economic cooperation between India and Bangladesh would be needed to answer that question.

> 1 Refer to the joint communiqué issued on the occasion of the visit of the Prime Minister of Bangladesh to India on January 12 2010, and the joint statement issued on the occasion of the visit of the Prime Minister of India to Bangladesh on 7 September 2011.
This study‘s primary objective is to explore the benefits for trade and economic growth that could be derived from enhanced market access for Bangladesh in India, and improved physical connectivity between the two countries. It studies the impact of market access on trade in goods, an area of particular interest to Bangladesh. It also analyzes trade facilitation and transit issues between the two countries, and examines a set of emerging challenges for the region, setting out a road map for deepening bilateral economic relations.

## **Data and Methodology**

The study is based on secondary data.<sup>2</sup> A computable general equilibrium (CGE) model was used to address market access issues and to assess the impact of, say, a free trade agreement (FTA) on potential exports. The indirect effects of even a single tariff reduction may be quite complex, and this complexity increases with the number of trade policies and markets involved. As FTAs cover multiple sectors and various trade reforms, they are often simulated using CGE modeling. The CGE model relies on standard microeconomic theory for rigor and consistency and on computer algorithms for model-solving.

An augmented gravity model was also used to assess the effect of trade facilitation and trade cost elements on bilateral trade. Estimated results from this partial equilibrium model would help to estimate the potential for trade, whereas those from the CGE model would provide directions to the way forward.

# **2. Quantifying the Benefits of Trade Liberalization and Facilitation between India and Bangladesh: Brief Literature Review**

In trade theory, welfare effects of any regional trade agreement (RTA) are analyzed using two concepts: trade creation and trade diversion.<sup>3</sup> The fundamental arguments for regionalism rest on evidence that suggests RTAs are predominantly trade-creating.<sup>4</sup> The reasoning is that most RTAs are likely to entail relatively low welfare losses resulting from trade diversion, since the countries involved are often neighbors and hence already engaged in substantial trade;<sup>5</sup> countries can ―lock in‖ reform through RTAs, which is often politically less feasible under multilateral arrangements,<sup>6</sup> and if multilateral trade talks fail or stall, trade liberalization is restricted to RTAs. It is further argued that countries can build on the progress of regionalism and ultimately move towards a freer trade regime on the whole. There are, however, some critical arguments against formation of any RTA. It is alleged that an RTA undermines the spirit of multilateralism, and that the world might be divided into protectionist blocs, and that protectionists might accept RTAs in order to oppose further multilateral liberalization. In that case RTAs might be stumbling blocks to multilateralism. Simultaneous, complicated RTA negotiations could also bring about a ―spaghetti bowl‖ effect.<sup>7</sup>

> 2 Data came mostly from national government sources of Bangladesh and India, and multilateral development organizations such as the World Bank, IMF, WTO, UNCTAD, UNESCAP, and UNCOMTRADE.

> 3 Integration is both a policy of protection and a move towards free trade. The effect of the protectionist element of integration is called _trade diversion_ , and the effect of the trade liberalization element is called _trade creation_ . The RTA‘s overall effect on the welfare for a member country is determined by comparing the tradecreation and trade-diversion effects. If trade creation dominates, the formation of a RTA will enhance welfare; if trade diversion is greater, the RTA will lead to a welfare loss for the country concerned. Note that if member countries are the low-cost producers of the traded good, there will be no trade-diversion effect and integration will unambiguously increase welfare.

> 4 See Rodríguez-Delgado (2007).

- 5 See Krugman (1991).

> 6 Whalley, (1996), for example, asserted that a desire for increased credibility of domestic reforms was a central preoccupation behind the Mexican negotiating position on the North American Free Trade Agreement (NAFTA).

- 7

> See Bhagwati and Panagariya (1996).

2
Baysan _et al._ (2006) have argued that the economic case for any regional integration in South Asia has been relatively weak. They point to three important features of the South Asian economies that they believe make a regional FTA economically unattractive. Firstly, the economies are relatively small: despite its population (one-fifth of the world), the region‘s per-capita income is low, so its economic size remains small: less than 5 percent of the world‘s GDP, and just 0.4 percent if India is discounted. Since, as Baysan _et al._ contend, it is improbable that the most efficient suppliers to the member countries are located within the region, the probability that the FTA would be largely trade diverting is quite high. Secondly, they argue that the levels of protection among all South Asian countries, with the possible exception of Sri Lanka, are too high to make a regional arrangement practical. Third, they contend that when countries in an FTA are allowed to choose sectors to exclude from tariff preferences, domestic lobbies press to protect those sectors of their country that may not withstand foreign competition. The rules of origin, too, may be misused by bureaucrats to block imports if an inefficient domestic competitor is affected.

Baysan _et al._ ‘s first argument, however, may not apply to bilateral trade between India and Bangladesh, since India has been a major source of imports for Bangladesh, suggesting that India might be the most efficient import source for many products. Secondly, study has shown that tariffs in India are often redundant because competition between Indian producers is so intense that it forces down prices domestically, even to levels below world prices.<sup>8</sup> The third argument may stand, however, because the sensitive lists of SAFTA members are long.

Empirical quantitative studies on regional integration in South Asia differ significantly in terms of the methodologies employed. Broadly, three types of models have been used: (i) gravity models; (ii) partial equilibrium models; and (iii) CGE models.

Gravity models have been widely used to predict the impact of RTAs on bilateral trade flows,<sup>9</sup> and their findings have been mixed.<sup>10</sup> Srinivasan and Canonero predicted that the impact of SAFTA on trade flows would be small for India but much larger for the smaller countries. Coulibaly found net export creation, whereas Tumbarello and Hirantha found net trade creation from the South Asian Preferential Trading Arrangement (SAPTA). On the other hand, Hassan observed net trade diversion effects from SAPTA, and Rahman (2003) found that regional integration is unlikely to generate significant trade expansion in this region. Using an augmented gravity model, Rodríguez-Delgado found that trade liberalization under SAFTA might influence regional trade flows mainly by increasing India‘s exports and both Bangladesh‘s and Nepal‘s imports.

The advantage in partial equilibrium models<sup>11</sup> is that they are generally based on disaggregated data and are also flexible, which facilitates sector-specific study. However, they ignore general equilibrium interactions and thus cannot capture inter-sectoral effects on the economy.

> 8 See Pursell (2004) and World Bank (2004).

> 9 The gravity models basically try to explain bilateral trade flows with a set of explanatory variables, which in turn try to predict the impact of the arrangement on bilateral trade flows. Typically, the exercise involves estimating a bilateral trade-flow equation with bilateral trade (imports, exports, or total trade at the aggregate or sector level) as the dependent variable and country characteristics, such as the gross domestic products, population, distance, commonality of language or cultural ties and the existence of preferential trade arrangements, as independent variables. Once estimated, the equation can then be used to predict the impact of a union between country pairs that did not have such a union during the sample period.

> 10 See Srinivasan and Canonero (1995), Hassan (2001), Coulibaly (2004), Hirantha (2004), Tumbarello (2006), Rahman (2003), and Rodríguez-Delgado (2007).

> 11 The major partial equilibrium studies on RTA in South Asia have been Govindan (1994), DeRosa and Govindan (1995), Pursell (2004), and the World Bank (2006).

3
To explore the potential of an India–Bangladesh bilateral FTA, the World Bank (2006) provided a comparative assessment between Bangladesh and India with respect to cement, light bulbs, sugar, and readymade garments (RMGs). The partial equilibrium simulation suggested that for cement, lights bulbs, and sugar the likely effects of an FTA between Bangladesh and India were an expansion of Indian exports to Bangladesh, but no exports from Bangladesh to India. This is mainly because Indian export prices for these products are substantially lower than ex-factory, before-tax prices of the same or similar products in Bangladesh. The simulations for RMGs predicted increased Bangladeshi exports to India and also increased RMG exports from India to Bangladesh. The study found that an FTA would bring large welfare gains for consumers in Bangladesh provided there is adequate expansion of infrastructure and administrative capacity at custom borders. It, however, cautioned that the benefits of such an FTA for Bangladesh could be wiped out if it had the effect of keeping out cheaper, third-country imports (mainly from East Asia), and such trade diversion costs could be large. The study suggested that the only way to minimize trade diversion costs would be through further unilateral liberalization.

Studies based on CGE models<sup>12</sup> predict the effects of the trading arrangement on all variables including production, consumption, and trade flows in all sectors of the economy as well as on welfare. These studies employed the Global Trade Analysis Project (GTAP) database and model, though they differ in technicalities and assumptions because of the evolution of the GTAP itself. Pigato _et al._ found that regional integration in South Asia would produce benefits for member nations, though unilateral trade liberalization would yield larger gains. Bandara and Yu argued that, in terms of real income, such integration would lead to gains for India and Sri Lanka, while Bangladesh would stand to lose. Raihan and Razzaque found that Bangladesh would incur a net welfare loss from SAFTA because, despite a positive trade creation effect, the negative trade diversion effect would be large enough to offset the positive gain. However, all other South Asian countries would gain from SAFTA, and as far as any individual country is concerned, India would gain the maximum.

From a trade perspective, and to forge greater regional integration in South Asia, there is a need to reduce trade costs. Despite falling tariffs, trade in South Asia has suffered because of higher trade costs. Banik and Gilbert (2008) found that for a 100 percent increase in trade costs, exports from India to neighboring Asia are expected to fall between 42 percent and 73 percent. De (2009) found that trade transport costs across South Asia are very high and vary across goods and countries. The cost of trade transport increases for landlocked countries like Nepal. Land borders in South Asia are overcrowded and need special attention to reduce time delays and transaction costs. Higher trade costs not only restrict trade but can also reduce the political will for greater regional cooperation.

Other studies show that trade facilitation reforms significantly contribute to greater regional integration in South Asia‘s intra-regional trade.<sup>13</sup> Hertel and Mirza (2009) observed that trade facilitation plays an important role in determining patterns of global trade flows, where the relative effect on bilateral trade of improving exporters‘ border logistics is larger than improving importers‘ trade facilitation. The study also revealed that proportionate increases in intra-regional trade are larger in all countries for textile and clothing, automobiles and parts, and other manufactured goods.

South Asia is notoriously weak in facilitating trade at borders.<sup>14</sup> The region suffers from excessive direct costs and time taken at border crossings, and inefficiencies in cross-border transactions. Trade in this region is also constrained by poor infrastructure, congestion, high costs, and lengthy delays. These problems are particularly severe at border crossings, many of which pose significant barriers to trade. De and Ghosh (2008) argued that transaction costs of India‘s exports to Bangladesh have increased despite

> 12 Major studies that applied the CGE model to regional integration in South Asia are Pigato _et al._ (1997), Bandara and Yu (2003), and Raihan and Razzaque (2007).

> 13 Refer, for example, Asian Development Bank (ADB)-UNCTAD (2008)

> 14 See, for example, De (2008a, 2008b), and De (2011).

4
simplification of documentation at borders. The paper concluded that the rent-seeking informal economy is deep-rooted and makes trade transaction expensive at borders. Sharma (2007) observed that removing such inefficiencies in trade transactions would increase welfare in the region by about US $116 million per annum as compared to a gain in income of US$ 418 million from a preferential removal of regional trade tariffs. However, it is worth noting that some smaller countries in the region gained much more from removal of transaction inefficiencies than from trade liberalization. This underscores the importance of implementing reforms in border infrastructure and logistics in tandem with other policy reforms to enhance regional integration.

Nahar and Siriwardana (2009) examined, in a CGE framework, the contribution of trade liberalization policies to household welfare and poverty in Bangladesh. They found that complete removal of tariffs favors export-oriented, labor-intensive sectors, such as RMGs and the knitting industry in Bangladesh in both the short and long term. They argued that in rural areas trade liberalization has a positive impact on poverty in the short run, and in urban areas it has helped raise poor people to the non-poor category in the long run, despite a negative impact in the short run.

# **3. Market Access for Trade in Goods and Selected Services**

South Asia‘s ability to integrate successfully with the global economy is drawing increasing international interest. However, bilateral trade barriers present an impediment not only to access for trade in goods between countries but integration of the region as a whole. This section discusses market access issues in bilateral trade in goods, particularly for Bangladesh. It presents the pattern of Bangladesh‘s trade with other South Asian countries and applies a global general equilibrium model to explore the effects of an FTA between Bangladesh and India.

**Table 1:** **<u>Share of Bangladesh’s Exports with Neighbouring Countries*</u>**

|**Country**|||**Y**|**ear **|||
|---|---|---|---|---|---|---|
||**1995**|**2000**|**2005**|**2007**|**2008**|**2009**|
|**Bhutan**|0.00|0.00|0.02|0.00|0.00|0.00|
|**India**|0.79|0.35|1.90|2.31|2.20|1.53|
|**Nepal**|0.03|0.00|0.01|0.01|0.01|0.01|
|**Pakistan**|1.03|0.91|0.87|0.41|0.40|0.48|
|**Sri Lanka**|0.41|0.10|0.13|0.13|0.14|0.12|
|**South Asia total**|**2.26**|**1.36**|**2.93**|**2.86**|**2.75**|**2.14**|
|**Rest of the world**|97.74|98.64|97.07|97.14|97.25|97.86|

*As percentage of total export.

_Source_ : Calculated based on UN COMTRADE.

## **3.1. Bangladesh’s Trade with Neighboring Countries**

Intra-regional trade between South Asian countries has been low for decades. Prior to 1951, its share of the region‘s total trade was in double digits. By 1967, however, as South Asia became progressively more closed to the world market and political rivalry between India and Pakistan intensified, intra-regional trade fell to just 2 percent of the total. It rose through the 1990s and by 2002 had increased to 4.4 percent (Baysan _et al_ .). It peaked at 6.21 percent in 2004 and then fell back to 4.46 percent in 2010 (Figure 1a), though this decline in intensity is attributable more to South Asia‘s increased trade with the rest of the world than to intra-regional declines.<sup>15</sup> The region‘s outward trade may look healthy, but its internal activity, compared to other regions such as NAFTA, ASEAN, and EU, is very low (Figure 1b). South

> 15 During 2004 and 2008, South Asia‘s trade with the world more than doubled (from US$245 billion in 2004 to US$600 billion in 2008) and increased faster than intra-regional trade (based on IMF DOTS).

5
<!-- Start of picture text --> 7<br>—¢—Intra-regional Trade 6.20<br>Intensity Index 6.02<br>6 —@- Intra-regional Trade Share 5.28 5.80 5.19<br>5 9.24 5.13<br>458 4.82. 4.76 4.46<br>x© 4 3.99 3.98389... 4.42 4.28 4.68 4.41 4.33<br>-5 3.64 72.383 ; 3.71 3.8 4.06 4.21<br>B33 351 84 353 3.29 2.93<br>5 3.31 3.18<br>@ (2.91<br>S 2.29 1.99<br>ra 2<br>1.91<br>1<br>0<br>PP RP BP BP BP Be BP BR BP NY NY NY KRY NY KRY NY NR NY KN KN<br>wo wo wo wo ve} wo ive} wo wo wo So So So So So lo} fo} lo) lo} fo} So<br>ive} ive} ive} wo ve} wo sve} oO se} ve} fo} oO oO oO So fo} fo} o lo} fo} Ld<br>Oo rR N w = wn a ~ co ite} Oo rR N Ww a wn a ~s co wo Oo<br><!-- End of picture text -->
**Figure 1b: SAARC Trade vs. Other Regions**

<!-- Start of picture text --> 80<br>70<br>60<br>50<br>40<br>30<br>20<br>10<br>0<br>ASEAN SAARC NAFTA EU<br>Intraregional trdae(%)<br>1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010<br><!-- End of picture text --> _Source_ : Calculations based on Direction of Trade Statistics Online Database (DOTS), IMF.

**Figure 2: Bangladesh Trade with India (1980–2010)**

<!-- Start of picture text --> 4500<br>4000<br>Imports from India<br>3500<br>3000<br>2500<br>2000<br>1500<br>1000<br>Exports to India<br>500<br>0<br>US$ million<br>1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010<br><!-- End of picture text --> _Source_ : IMF DOTS.

Bangladesh‘s trade with neighboring countries is unequally distributed, having little to do with Bhutan, Nepal, or Sri Lanka. India is Bangladesh‘s primary trading partner, followed by Pakistan. Bangladesh has a high deficit in its trade with India––having risen from US$ 44 million to US$ 2.5 billion from 19812009 (Figure 2).<sup>17</sup> The ten years from 2000-2009 have seen the fastest rise in Bangladesh‘s exports to India (42.65 percent per annum growth), while Bangladesh‘s import growth from India declined to 16.24 percent per annum (Figure 3). Nevertheless, Bangladesh exports are only 1 percent of India‘s total imports and the range of products is small, mostly fertilizers and jute products. RMGs are Bangladesh‘s major exports, but the share going to India is very small, at least so far.

> 17 From a macroeconomic point of view, the issue is whether the current account deficit is sustainable, and this has not been a concern because Bangladesh has had consistent trade surpluses with trading partners like the US and EU, and has also enjoyed surpluses on its invisibles account.

7
**Figure 3: Bangladesh: Bilateral Trade Growth Rates (%)**

<!-- Start of picture text --> 50<br>44.33<br>45 42.65<br>40<br>35<br>30<br>25<br>18.47<br>20 16.24<br>13.32<br>15<br>10<br>5<br>0.79<br>0<br>1981-1990 1991-2000 2001-2009<br>Export to India Import from India<br>(%)<br><!-- End of picture text --> _Source_ : Calculated based on IMF DOTS.

# **3.2. Trade Complementarity and Intra-Industry Trade**

The trade complementarity index (TCI) indicates whether trade is likely to grow between countries. Research indicates that trade complementarity between India and Bangladesh is relatively limited, although it has grown.<sup>18</sup> The TCI at the disaggregated level (6-digit HS) for 2002 and 2007 offers mixed results for the two countries (Table 3). Bangladesh had a higher trade complementarity than India in both years,<sup>19</sup> though Bangladesh‘s decreased and India‘s increased. The scale of trade is driving the complementarity. Hence, although India‘s TCI score is lower, the number of commonly traded products is far higher, so India fulfills a larger proportion of Bangladesh‘s import demands; similarly, Bangladesh‘s higher TCI score for fewer traded products indicates a smaller trade creation potential with the existing basket of goods. The TCI scores do indicate, however, that bilateral trade between India and Bangladesh has the potential to grow, since trade in similar product lines has grown. This will deepen production networks between the two countries.

The scope for production networks and vertical trade between the two countries can be judged by the intensity of intra-industry trade (IIT) at the disaggregated (6-digit HS) level. IIT occurs when a country simultaneously imports and exports similar types of products within an industry or sector. There are two types of IITs––horizontal and vertical.<sup>20</sup> IIT has been described also as a measure of the degree to which

> 18 In some of the literature, it is observed that the lack of complementarity and high degree of competition in export structures imply daunting prospects for expanding regional trade in South Asia. Refer, for example, Pitigala (2005).

> 19

> The TCI measures the degree to which the export pattern of one country matches the import pattern of another. A high degree of complementarity is assumed to indicate more favourable prospects for a successful trade arrangement. The index lies on the range 0–100, with 100 indicating perfect complementarity. The latest period for Bangladesh trade data in UN Comtrade and other comparable sources was 2007. Before calculating TCI, data coordinates at HS nomenclature H2 were matched for both the countries for both years. For further details on TCI, refer Mikic and Gilbert (2007, p. 72).

> 20 Greenaway _et al_ . (1995).

8
trade in a particular sector is based on scale economies and/or market structure.<sup>21</sup> By engaging in IIT, a country can reduce the number of similar goods it produces and benefit from scale economies. Higher IIT ratios suggest that these sources of gains are being exploited. The IIT index measures the degree of overlap between imports and exports in the same commodity category, with a value of 1 indicating pure intra-industry trade and a value of 0 indicating pure inter-industry trade.<sup>22</sup>

|**Tabl**<br>|**e 3: Trade Comp**<br>|**lementar**<br>|**ity Index **<br>|**(TCI) at 6-digit H**<br>|**S**<br>|
|---|---|---|---|---|---|
|**Reporter**<br>**(Exporter)**|**Partner**<br>**(Importer)**|**TCI**|**(%)**|**Number of Com**<br>**Prod**|**monly Traded**<br>**ucts**|
|||(2002)|(2007)|(2002)|(2007)|
|Bangladesh|India|42.0|39.3|1,057|1,752|
|India|Bangladesh|27.1|32.2|4,256|4,270|

_Source_ : Calculated based on UN COMTRADE.

|**Table **|**4: Intra-Industry Trade (IIT) Index* in 2007: Common Set of **|**Products at 6**|**-digit HS**|
|---|---|---|---|
|**HS Code**|**Product**|**IIT India**|**IIT Bangladesh**|
|230220|Rice bran oil|0.935|0.836|
|721550|Bars and rods other than free-cutting steel not further worked<br>than cold formed/cold finished|0.923|0.421|
|850720|Other lead-acid accumulators|0.922|0.557|
|600622|Other knitted or crocheted fabrics of cotton, dyed|0.771|0.929|
|960719|Other slide fasteners|0.770|0.719|
|610510|Men‘s/boys‘ shirts of cotton|0.758|0.819|
|621790|Parts of garments/clothing accessories|0.729|0.463|
|848390|Parts of transmission shafts, cranks, bearing housings, gears or<br>clutch|0.703|0.778|
|854419|Winding wires of other metals/substances|0.505|0.633|
|620319|Suits of other textile materials|0.486|0.704|
|521211|Other unbleached woven fabrics of cotton weighing not more<br>than 200 g/m<sup>2</sup>|0.417|0.770|

*IIT index was calculated for bilateral trade between India and Bangladesh.

_Source_ : Calculations based on UN COMTRADE.

To identify the vertical IIT, the indices at a high disaggregated level (HS 6) are compared with those at a low disaggregated level (HS 2). IIT indices that are low at HS 6 and high at HS 2 are a necessary, although not sufficient, condition for the existence of vertical trade because they suggest that the countries trade different products in the same sector.<sup>23</sup> Examination of the common set of traded goods between

> 21 Horizontal IIT refers to the simultaneous exports and imports of goods classified in the same sector and at the same stage of processing, usually based on product differentiation. Vertical IIT refers to the simultaneous exports and imports of goods classified in the same sector but at different stages of processing, usually based on the ―fragmentation‖ of the production process into different stages, each performed at different locations and taking advantage of the local conditions. See, for example, Sodersten and Reed (1994).

> 22

> 23

> Before calculating IIT, data coordinates at HS nomenclature H2 were matched for both countries. The traditional way to measure the degree of intra-industry trade is the Grubel-Lloyd Index (G-L Index). For further details, refer to Mikic and Gilbert (2007, p. 76).

> The authors are grateful to the referee for asking to carry this particular comparison. However, the usual caveat is that there might be aggregation bias. When the IIT index is observed to be low at HS6 but high at HS2, one

9
India and Bangladesh (Table 4) and the estimated IIT indices for major products for both partners (Appendix 1), brings the following to light:

||**Table 5: Vert**<br>|**ical Tra**<br>|**de Potential between India and Ban**<br>|**gladesh***<br>|||
|---|---|---|---|---|---|---|
|**Reporter**|**Partner**|**HS2**|**Commodity (HS2)**|**IIT**<br>**(HS2)**|**IIT****<br>**(HS6)**|**Potential**<br>**(HS2 ****HS6)**|
|India|Bangladesh|03|Fish, crustacean, mollusc, and<br>others|0.970|0.787|0.183|
|India|Bangladesh|09|Coffee, tea, MATN, and spices|0.801|0.560|0.241|
|Bangladesh|India|03|Fish, crustacean, mollusc, and<br>others|0.200|0.003|0.197|
|Bangladesh|India|08|Edible fruits and nuts|0.180|0.001|0.179|
|Bangladesh|India|14|Vegetable plaiting materials|0.770|0.012|0.758|
|Bangladesh|India|19|PREP. of cereal, flour, starch, and<br>milk|0.160|0.012|0.149|
|Bangladesh|India|25|Salt, sulphur, earth, stone, and<br>plastering materials|0.830|0.140|0.691|
|Bangladesh|India|31|Fertilizers|0.950|0.194|0.756|
|Bangladesh|India|33|Essential oils, resinoids,<br>perfumery, and cosmetics|0.800|0.476|0.324|
|Bangladesh|India|39|Plastics and articles thereof|0.440|0.326|0.114|
|Bangladesh|India|53|Other vegetable textile fibres|0.020|0.000|0.020|
|Bangladesh|India|54|Man-made filaments|0.330|0.019|0.311|
|Bangladesh|India|55|Man-made staple fibres|0.530|0.288|0.242|
|Bangladesh|India|56|Wadding, felt, and nonwoven<br>yarns|0.690|0.041|0.650|
|Bangladesh|India|63|Other made-up textile articles|0.310|0.235|0.075|
|Bangladesh|India|84|Nuclear reactors, boilers, parts|0.980|0.277|0.703|
|Bangladesh|India|87|Vehicles of railway, tram, roll-<br>stock|0.080|0.051|0.029|

*IIT indices are calculated for bilateral trade between India and Bangladesh at H2 nomenclature. **Average of multiple products at HS6. _Source_ : Calculations based on UN COMTRADE.

1. The IIT index levels are higher in manufactured products than in primary products, reflecting the greater role of economies of scale in the production of manufactures.

2. IIT index scores suggest there are production-sharing opportunities, in a static sense, in 11 products, with varying potential. The range of this potential varies from textile and clothing (highest concentration) to iron and steel (lowest concentration). Electrical machinery and equipment and mechanical appliances occupy the middle portion of the value chain, with midlevel concentrations. The estimated results in Table 5 support this.

3. Only two sectors for India and Bangladesh had IIT shares in the moderate range: textiles and clothing, and electrical machinery and mechanical appliances. All other sectors had low or negligible IIT shares.

How, then, to intensify vertical IIT between the two countries? Sectors with increasing shares of IIT and high economies of scale are most likely to have bilateral trade growth potential. To realize that potential, should check on a case-by-case basis whether the different products are differentiated as final products or as parts and components versus final products.

10
<!-- Start of picture text --> Before fragmentation<br>Large integrated factory<br>After fragmentation<br>SL<br>SL PB ~ SL<br>-€ SL SL o-<br>@® PB: production blocks<br>SL: service links<br><!-- End of picture text -->
# **3.3. Trade in Services in Education and Health Sectors between Bangladesh and India**

A large part of services trade between India and Bangladesh is informal. There has been a small, formal flow of trade in education and health-related services between the two countries but, generally, barriers inhibit this bilateral trade. Barriers to trade in services are not like tariffs; they are typically regulatory, rather than explicit taxes. The barriers between the two countries are complex and have been taxing such trade for years. For example, trade in higher education services––in which Bangladeshi students pursue higher education in India––has fallen at a time when the number of foreign students studying in India has increased strongly overall (Table 6).<sup>26</sup> Capacity and quality constraints in Bangladeshi institutions encourage students to pursue higher education in India and elsewhere. Generally, consumption abroad (mode 2, students moving abroad to study), is assumed to be the most frequently-used mode by which education services are traded between India and Bangladesh. However, a host of problems prevent the two countries opening up their facilities, raising standards, recognizing each other‘s standards (mutual recognition), and removing barriers to education services trade. The Bangladesh government has unilaterally allowed foreign direct investment (FDI) through joint ventures in educational services. But Indian educational institutions (except those in information technology) are yet to open branches under mode 3 (commercial presence) in Bangladesh. With the setting up of the South Asian University (SAU) in India, the flow of Bangladeshi students in higher education might rise. The flow presently is unidirectional, to India, and at least some observers believe that there is substantial informal trade in the sector.<sup>27</sup> Both countries need to remove the barriers prohibiting formal movement of students, by issuing hassle-free and long-term multiple-entry visas. The Bangladesh government could facilitate Indian universities and institutions to set up branches in major cities in Bangladesh, with free interaction between faculties of Bangladeshi and Indian universities (say, under mode 4), thereby encouraging inter-personal contact between the two countries. The prime ministerial meeting in Bangladesh in September 2011 brought about some progress in this regard. The two leaders agreed to promote trade in services under the SAARC agreement and directed early completion of work to harmonize the education curricula and mutually recognize degrees in the two countries.<sup>28</sup> Health services trade consists mainly of patients crossing borders. However, South Asian countries face a host of obstacles to opening up health services, recognizing each other‘s standards, and removing barriers to health-care trade. Bangladeshi patients visit India for treatment every year, largely because of a paucity of quality domestic health infrastructure.<sup>29</sup> At the same time, the informal trade in health services is huge and unaccounted for. Consumption abroad (mode 2) is known to be the most popular mode of trade in health services between the two countries, but the number of Bangladeshi patients travelling to India in this mode is unknown.<sup>30</sup>

> 26 Due to the absence of mode-wise trade in higher education between the two countries, in value terms, it is difficult to pinpoint the actual flow of higher education services in either direction.

> 27

> According to Rahman (2002), a considerable number of Bangladeshi students studying in India use Indian identities.

> 28

> See the joint statement issued after the visit of the Indian Prime Minister to Bangladesh on September 7, 2011.

> 29 Refer, Raychaudhuri and De (2012). Rahman (2002) states that about 57 percent of Bangladeshi patients seeking treatment abroad in 1999 went to India, and most chose India because of the unavailability of medical facilities in Bangladesh and because  the Indian medical services are better.

> 30

> Rahman (2002) estimated that about 50,000 Bangladeshi patients were treated in India in 1999, through which India earned about US$30 million.

12
Several barriers are responsible for the rise in the informal trade in health services between the two countries.<sup>31</sup> A 2010 survey of patients‘ perceptions about barriers to accessing Indian health services showed a high proportion of similar complaints, from visa issues to medical insurance limitations and high air fare costs (Table 7). To reduce the barriers: (i) the Bangladesh government could allow Indian medical institutions to set up hospitals under mode 3 (India‘s Apollo Group has set up a hospital in a joint venture at Dhaka, but it is too small to meet local demand<sup>32</sup> ); (ii) professionals in health services could be allowed to move freely (under mode 4) between the two countries; and (iii) genuine patients from Bangladesh coming to India for treatment could be granted visas on arrival at Indian land ports or airports. Although both governments have agreed to facilitate the granting of long-term, multiple-entry visas to research scholars and students, and people visiting on medical grounds, the progress on the ground has been slower than what has been targeted.

|**Table 7: Perceptions of Bangladeshi Patients* abo**<br>**Particulars**|**ut Indian Health Services**<br>**Percentage of**<br>**Patients (%)**|
|---|---|
|Complicated visa|77.90|
|Fraud of informal foreign exchange traders|40.00|
|Lack of pan-South Asia medical insurance|80.00|
|High airfare|64.70|

*Sample size: 190 patients. _Source_ : Banik _et al_ . (2010).

# **3.4. Scenario Analysis with the Global Computable General Equilibrium (CGE) Model**

The global CGE modeling framework of the GTAP uses aggregated data on regions and commodities for its objectives.<sup>33</sup> Version 7 is used here, covering 57 commodities, 113 countries/regions, and 5 factors of production––although for purposes of this study the 113 countries/regions are aggregated to 6.<sup>34</sup> Three scenarios are considered: (i) a full FTA for goods between Bangladesh and India, (ii) India‘s unilateral duty-free, quota-free (DFQF) offer to Bangladesh, and (iii) a full FTA for goods and improved connectivity (FTA plus). To capture the improvement in connectivity, a 25 percent drop in the bilateral trade-cost margin between Bangladesh and India is simulated.

An FTA-plus–improved-connectivity option clearly would have the greatest impact on world imports to both countries (Figure 5). In both FTA-only and FTA-plus scenarios, Bangladesh‘s imports would rise more than India‘s because India is Bangladesh‘s primary source and Bangladesh is an insignificant source for India. With the DFQF option, imports into Bangladesh would increase by only 0.29 percent, since Bangladesh would not liberalize its trade regime. With regard to exports (Figure 6), it is notable that Bangladesh‘s increase would be higher with the FTA-only scenario than the DFQF option. This is because the FTA would increase access to cheaper raw materials through tariff liberalization, which would not occur in the DFQF scenario. However, exports from Bangladesh would rise most in the FTA-

> 31 Rahman (2002) found that about 20 percent of the approximately 50,000 Bangladeshis that chose to go to India for treatment in 1999 went without the right visas: in most cases, patients chose touri **s** t visas to avoid the more arduous medical visa process.

> 32

> Another new Apollo Group hospital is being established in Chittagong.

> 33

> See Appendix 2 for explanation of the GTAP model. This study uses the Version 7 database, with 2004 as base. This has been adjusted with some pre-simulations to reflect the base year as close to 2010 as possible.

> 34 See Appendices 3 and 4.

13
<!-- Start of picture text --> 10 9.49<br>9 m Bangladesh<br>8 mIndia<br>7 6.45<br>6<br>5<br>4<br>3<br>2<br>! 0.5 0.76<br>0.29 0.05<br>0<br>India-Bangladesh FullFTA Bangladesh Gets DF Market — India-Bangladesh Full FTA +<br>Access in India Improvement in Connectivity<br><!-- End of picture text --> <!-- Start of picture text --> 12<br>10.96<br>10 mBangladesh<br>S@India<br>8 7.57<br>6<br>4<br>2.87<br>2<br>0.12 0.06 0.21<br>0<br>India-Bangladesh Full FTA Bangladesh Gets DF Market India-Bangladesh Full FTA<br>Access in India + Improvement in<br>Connectivity<br><!-- End of picture text -->
<!-- Start of picture text --> 12.00 @Exportto India Total= 10.96<br>10.00 BExporttoROW<br>Total =7.57<br>8.00<br>6.00<br>4.00 Total=2.87<br>2.00<br>0.00 :<br>India-Bangladesh fullFTA Bangladesh gets DF market India-Bangladesh full FTA+<br>access in India Improvement in Connectivity<br><!-- End of picture text -->
|**Table**|**8: Change in Ex**|**ports from Banglad**|**esh to India**||
|---|---|---|---|---|
||**Share in Base**<br>**Year Export to**<br>**India (percent)**|**India–Bangladesh**<br>**Full FTA (%**<br>**Change)**|**Bangladesh Gets**<br>**DFQF Market**<br>**Access in India (%**<br>**Change)**|**India–Bangladesh**<br>**Full FTA +**<br>**Improved**<br>**Connectivity (%**<br>**Change)**|
|Chemical, rubber, and plastic<br>products<br>|36.46<br>|130.49<br>|90.16<br>|228.17<br>|
|Textiles|17.27|240.01|188.84|392.37|
|Plant-based fibres|12.38|165.23|102.54|226.99|
|Fishing|8.59|32.89|21.66|56.52|
|Metalproducts|3.17|244.63|202.71|368.19|
|Leatherproducts|2.72|195.07|158.95|365.44|
|Business services nec|2.65|31.48|1.08|61.19|
|Wearingapparel|2.45|278.51|199.61|359.31|
|Public<br>admin/defence/health/education|2.11|30.78|0.9|50.71|
|Foodproducts nec|2.05|202.69|152.56|402.46|
|Ferrous metals|1.62|261.34|201.76|370.40|
|Metals nec|1.10|335.8|245.22|513.15|
|Machineryand equipment nec|0.99|307.58|213.46|494.88|
|Petroleum and coalproducts|0.93|123.92|82.47|177.26|
|Crops nec|0.74|2002.23|1746.15|3461.86|
|Sea transport|0.72|33.43|1.33|48.26|
|Woodproducts|0.61|248.35|165.63|375.78|
|Communication|0.6|25.99|0|45.97|
|Vegetables,fruits,and nuts|0.54|1659.19|1280.7|2678.03|
|Mineralproducts nec|0.31|127.95|75|169.23|
|Minerals nec|0.27|56.93|25|116.25|
|Beverages and tobaccoproducts|0.27|137.86|85.71|222.93|
|Financial services nec|0.22|29.65|4.35|51.64|
|Transport nec|0.19|28.78|0|42.96|
|Manufactures nec|0.16|295.5|205.88|510.92|
|Animalproducts nec|0.14|78.38|40|126.75|
|Vegetable oils and fats|0.10|1765.26|1580|3174.33|
|Sugar|0.10|185.08|136.36|276.26|
|Electronic equipment|0.10|309.98|220|495.62|
|Transport equipment nec|0.07|301.17|242.86|502.39|
|Recreation and other services|0.07|30.53|0|49.36|
|Paperproducts andpublishing|0.06|179.57|133.33|312.72|
|Motor vehicles andparts|0.06|3505.94|2916.67|5233.18|
|Insurance|0.06|32.27|0|52.28|
|Forestry|0.04|381.17|250|567.42|
|Construction|0.04|27.62|25|46.58|
|Air transport|0.04|30.23|0|45.13|
|Processed rice|0.01|29.65|0|51.27|
|Trade|0.01|28.49|0|42.88|
|**Total **|**100.00**|**182.17**|**133.53**|**297.04 **|

_Source_ : GTAP simulation results.

16
**<u>Table 9: Change in Exports from India to Bangladesh</u>**

||**Share in Base**<br>**Year Export**<br>**to Bangladesh**|**India–Bangladesh**<br>**Full FTA (%**<br>**Change)**|**Bangladesh Gets DF**<br>**Market Access in**<br>**India (% Change)**|**India–Bangladesh Full**<br>**FTA + Improved**<br>**Connectivity (%**|
|---|---|---|---|---|
||**(percent)**|||**Change)**|
|Textiles|14.24|259.25|0.15|353.88|
|Processed rice|12.47|60.25|0.84|84.94|
|Chemical, rubber, and plastic<br>products|11.64|106.99|0.66|141.23|
|Machineryand equipment nec|8.34|98.73|0.19|145.46|
|Vegetables,fruits,and nuts|6.77|48.38|0.85|59.01|
|Wheat|4.59|44.82|0.66|64.91|
|Vegetable oils and fats|4.58|41.17|0.34|64.26|
|Plant-based fibres|4.30|17.96|0.25|23.69|
|Ferrous metals|4.30|82.97|0.25|120.80|
|Metalproducts|3.60|202.44|0.55|285.40|
|Petroleum and coalproducts|3.36|163.84|0.16|216.27|
|Motor vehicles andparts|2.25|147.34|0.12|195.95|
|Cerealgrains nec|2.24|0.57|0.18|0.88|
|Paperproducts andpublishing|1.98|177.10|0.31|213.37|
|Transport equipment nec|1.89|388.39|0.43|518.27|
|Metals nec|1.83|89.93|0.81|111.32|
|Coal|1.54|0.13|0.13|0.20|
|Crops nec|1.49|149.30|2.08|195.45|
|Electronic equipment|1.42|223.79|0.19|344.64|
|Mineralproducts nec|1.38|191.66|0.49|230.91|
|Dairy products|1.29|316.61|0.53|422.49|
|Minerals nec|1.05|19.28|0.13|24.73|
|Apparels|1.02|352.72|0.53|555.95|
|Foodproducts nec|0.94|85.75|0.36|135.97|
|Manufactures nec|0.64|413.95|0.64|550.97|
|Sugar|0.13|278.35|0.52|370.18|
|Forestry|0.11|83.54|0.63|128.66|
|Fishing|0.09|54.62|0.77|65.80|
|Leatherproducts|0.09|169.47|0.00|226.14|
|Woodproducts|0.08|299.14|0.86|383.68|
|Business services nec|0.08|1.71|0.00|2.70|
|Beverages and tobacco<br>products|0.05|81.58|0.00|116.66|
|Cattle,sheep, goats,and horses|0.04|1.85|0.00|2.60|
|Transport nec|0.04|1.89|0.00|2.18|
|Insurance|0.04|1.61|0.00|2.37|
|Public|||||
|admin/defence/health/education|0.04|3.13|0.00|4.21|
|Paddyrice|0.02|392.00|4.00|569.44|
|Communication|0.02|3.57|0.00|6.08|
|Trade|0.01|0.0|0.00|0.00|
|Sea transport|0.01|0.0|0.00|0.00|
|Air transport|0.01|0.0|0.00|0.00|
|Financial services nec|0.01|0.0|0.00|0.00|
|Recreation and other services|0.01|0.0|0.00|0.00|
|**Total **|**100.00**|**125.64 **|**0.47**|**172.20**|

_Source_ : GTAP simulation results.

17
**Table 10: Bangladesh’s Increased Exports** **<u>to India – Three Scenarios</u>**

|||_Bangladesh has duty-_<br>_free market access in_<br>_India with no sensitive_<br>_list_|**Scenarios**<br>_Bangladesh has duty-_<br>_free market access in_<br>_India keeping India’s_<br>_sensitive list of 480_<br>_productsfor LDCs_|_Bangladesh has duty-_<br>_free market access in_<br>_India keeping India’s_<br>_sensitive list of 46_<br>_productsfor LDCs_|
|---|---|---|---|---|
|**Rise in**<br>**exports to**<br>**base (%)**|**Bangladesh**<br>**India, from**|133.53|19.12|85.09|

_Source_ : GTAP simulation results. The increase in exports is calculated with reference to the baseline.

The static export potential could be considered as an increase in exports of 134 percent (the first scenario above), i.e., with no sensitive list (Table 10). Other simulation results show that India‘s maintaining of the sensitive list of 480 products would only see an export increase of about 19 percent, much less than the first scenario. It should be noted, however, that Bangladesh‘s major export items––readymade garments (RMGs, HS codes 61 and 62)––have a very limited export base in India, so the GTAP model would always show a small rise in these product exports, even under a ―no sensitive list‖ scenario. Initially, India was wary of allowing Bangladesh‘s garments into its market. But after the September 2011 prime ministerial agreement, India has allowed Bangladesh‘s RMGs into its market under a duty-free, quotafree scenario. However, although the GTAP simulations show the removal of the 46 textile products from the negative list raises Bangladesh‘s exports to India by about 48 percentage points (difference between first and third simulations), the volume is very small in comparison to Bangladesh‘s global sales. Nonetheless, given India‘s massive market, it also suggests that Bangladesh has enormous potential to increase garment exports to India.

The projected trade outcomes imply that an FTA would stimulate Bangladesh‘s trade with India significantly; both countries would likely see a substantial increase in manufactured goods‘ exchanged under duty-free market access. Bangladesh, especially, would benefit from improved performance in its highly labor-intensive manufacturing sectors, thereby helping to reduce poverty.

For India, closer economic cooperation with Bangladesh would be an important stepping-stone to reducing the economic isolation of its eastern and north-eastern states. A bilateral FTA between the two countries could help address this isolation, and provide an impetus to resolve problems relating to nontariff barriers.

A very important caveat for policy makers is that the above analysis based on the GTAP model simulation is static in nature and is therefore not capable of capturing the dynamic impacts of bilateral trading arrangements. Also, when trade is restricted (for whatever reason), the model cannot capture ―new trade‖; if the initial base of trade in any product is very low (or even zero), there would not be any substantial increase (or no increase, in the case of zero base) in trade for that particular commodity. However, as evidence suggests, mutual tariff concessions can generate trade in new items. For instance, in the bilateral FTA between India and Sri Lanka, the latter benefited by initiating exports of _vanaspati_ oil to India, which had been almost nil before the FTA.

Thus, these simulation results represent only a part of the additional trade that will be generated—in particular, Bangladesh could gain by creating a production base in new products. Indian FDI into Bangladesh could play a key role in that process. Seen in this light, the above simulation results could be seen as a lower bound of the potential increase in Bangladesh‘s exports to India.

18
# **3.5. Market Access Issues**

While tariff concessions have been offered under SAPTA and SAFTA, there would be greater benefit in addressing non-tariff and para-tariff barriers in both countries. In this paper, while the primary concern is Bangladeshi exports to India, a few examples of non-tariff and para-tariff barriers in both countries are discussed below.<sup>38</sup> One, India requires permitted risk analysis of agricultural imports in biosecurity and sanitary & phytosanitary categories, and this has turned out to be a complex process lacking transparency. It covers about 600 items with the aim of protecting ―human, animal or plant life or health‖. Nearly all livestock, agricultural, and food imports require sanitary or phytosanitary (SPS) certificates and import permits from India‘s Ministry of Agriculture.

Two, the Indian Food Adulteration (Prevention) Act 1954 requires the shelf life of processed foods to be not less than 60 percent of the original shelf life at the time of import. While this objective is fine, the process of determining shelf life is often arbitrary and non-transparent. India‘s Prevention of Food Adulteration Rules, 1955, are complicated. Just one rule, number 32, has 30 provisions with further subprovisions. It also cross-references other rules prescribing content, size and design of labels, display-panel specifications, details of colors and flavors, trade names, and so on. No certificate from the country of origin is accepted. The results of laboratory tests cannot be challenged. Separate regulations exist for various food types.

Three, to export textile and textile products to India, exporters must obtain a pre-shipment inspection certificate from a textile testing laboratory accredited to the National Accreditation Agency of the country of origin. Non-availability of the certificate requires testing from the notified agencies in India for each and every consignment. In some cases, even certificates issued by EU-accredited labs have been rejected by Indian customs authorities and such consignments are subject to repeat tests in India. In addition, the Textile (consumer protection) Regulation of 1988 imposes strict marking requirements for yarns, fibers, and fabrics imported into India.

Four, exporters of jute products to India must have certificates from the exporting country providing it does not contain more than 3 percent, by weight, of non-homogenate hydrocarbon (jute batching oil). Jute bags/sacks require special labeling, and each bag/sack must carry machine-stitched marking of the country of origin.

Bangladesh also imposes several NTBs and supplementary duties on Indian exports. Some of them are as follows<sup>39</sup> : One, Bangladesh has imposed over 60 percent supplementary duty on import of plastics from India.

Two, Bangladesh still maintains 225 items in its sensitive list in terms of trade with India, covering machinery, pharmaceuticals, textiles, etc.

Other issues brought up by the Commerce Secretary level discussion held on 28-29 March 2012 include the cases of port restrictions in both countries. Not all Indian ports can accept cargoes from Bangladesh. There are also port restrictions imposed by Bangladesh on Indian exports. For example, port restrictions

> 38 Sourced from Raihan (2011).

> 39 Summary record of India-Bangladesh Commerce Secretary level discussions held at New Delhi on 28-29 March, 2012.  Available at http://commerce.nic.in/WhatsNew/IndiaBangladeshTalk.pdf

19
exist in Bangladesh on export of vulcanized rubber thread via Akhaura LCS. Similarly, exports of yarn, milk powder, fish, sugar, and potatoes from India (particularly from the northeastern states and West Bengal) face port restrictions in Bangladesh.

Finally, the same Commerce Secretary level discussions also note that heavy restrictions limit professional exchanges and cooperation. Moreover, Indian companies and professionals face difficulties in sending remittances back to India. Indian exporters can remit dollars converted from taka only as royalty, consultancy and "other charges", and there is a ceiling on the repatriable amount (for example, under 'royalty', only 6 percent of the sale proceeds in Bangladesh can be repatriated). This creates problems for knowledge-intensive sectors like software, IT and telecom, architecture, and so on.

Thus, non-tariff measures/barriers such as standards, certification, regulations, labeling, documentation and public procurement, licensing, countervailing measures, tariff quotas, and anti-dumping measures are all matters of contention between India and Bangladesh. Non-tariff barriers are the most difficult, and undermine the trade potential of both countries. Sanitary & Phytosanitary and Technical Barriers to Trade and related measures have been found to account for 86.3 percent of all barriers across South Asia.<sup>40</sup> Besides, other hurdles such as stringent visa regimes, inadequate physical connectivity, restrictions in opening bank branches, lack of testing facilities at the border, non-honoring of irrevocable letters of credit, etc., have been faced by exporters and importers in both countries.

There is recent empirical evidence that standards harmonization tends to increase the export variety of a partner country,<sup>41</sup> and this may well apply to Bangladesh‘s exports to India (Rahman _et al_ ., 2011). An arrangement for recognition in India of certificates issued by Bangladeshi testing laboratories for export products will help exports.<sup>42</sup> There have been misunderstandings regarding acceptance of test certificates issued by BSTI labs for products accredited by NABL (lndia). Testing laboratories could be part of customs stations, at least to cater to testing requirements of more commonly traded products. Mutual recognition of testing laboratories and test reports from accredited laboratories by customs authorities will be very useful. In this respect, the upcoming South Asian Regional Standards Organization (SARSO) in Dhaka is a very welcome step.

Greater use of information technology in customs, to expedite processes such as electronic transfer of test reports and certificates of origin would help bilateral trade as well as the global trade of the two countries. This could be addressed if Bangladesh and India implement a single window system for customs. In parallel, harmonization of HS codes at 8-digit level will reduce disputes on classification and also provide the basis for establishing a system of seamless exchange of data between the customs authorities of Bangladesh and India.

Such non-tariff measures/barriers can easily reduce the potential gains from tariff liberalization. Therefore, the next generation of trade talks between the two countries should give the highest priority for reduction of non-tariff measures/barriers.

> 40 See, for example, ADB-UNCTAD (2008) and Rahman _et al._ (2011).

> 41 See, for example, Shepherd (2007).

> 42

> Bangladesh and India agreed that the respective standards‘ bodies, BIS and BSTI, will finalise the Agreement on bilateral cooperation to enable mutual recognition for each other's standards for specified products. Refer to the Summary record of India-Bangladesh Commerce Secretary level discussions held at New Delhi on 28 -29 March, 2012.

20
## **3.6. Beyond Trade in Goods**

Bangladesh may gain significantly more, in the long run, from diversifying exports to India, and thereby also exploit increasing possibilities for intra-industry trade. As the CGE analysis has shown, there could be fewer opportunities for Bangladesh (although not small by any means) at the ―intensive margin‖ (exporting more of the same to Indian markets) compared to exports at the ―extensive margin‖ (diversifying the export basket to India‘s large and growing market).<sup>43</sup> This is where FDI becomes very important.

A bilateral FTA between Bangladesh and India should go beyond ―trade in goods‖ to deepen cooperation and improve Bangladesh‘s export capability. Without significant structural changes in its production pattern, Bangladesh will be unlikely to derive the desired benefits from a bilateral FTA. Top priority, therefore, should be given to augmenting Bangladesh‘s export supply capability. This can be encouraged through a broader, bilateral cooperation mechanism in the areas of investment, finance, services trade, trade facilitation, and technology transfer. In the context of investment flows, horizontal and vertical integration of Indian and Bangladeshi industries could help to improve scale economies, especially for Bangladesh, and help Indian firms gain from the use of inexpensive labor. Closer economic cooperation between the two countries would also promote Bangladesh's prospects for attracting larger investment from India. Such investments, whether 100 percent Indian or joint ventures, would help to improve the country's export supply capability and boost exports to both the region and the outside world.

Bilateral economic cooperation should emphasize trade in services, to enhance connectivity, trade in health and higher education, tourism, and facilitate trade and transit, and so on. Empirical studies have found that trade in services can generate substantial gains over and above those from trade in goods.<sup>44</sup> Both countries would gain from continued trade liberalization, in both goods and services, and streamlining of trade transactions through trade facilitation.

Some sectors in both countries, however, are bound to lose out due to increased import competition. In Bangladesh these could include coal, dairy products, metal products, transport equipment, petroleum and coal products, paper products, publishing, electronics equipment, and mineral products. In India, the sectors could include leather products, apparel, meat products, and vegetable oils & fats. For this reason, a possible bilateral FTA will benefit from addressing (or at least trying to address) the costs of adjustment.

# **4. Connectivity, Trade Facilitation, and Transit**

Many empirical studies have examined the effect of transport costs on trade flows. Limão and Venables (2001) found a link between the quality of infrastructure and transport costs and concluded that infrastructure investments are important for export-led economic growth. Other studies argued that differences in logistics performance are driven only in part by poor quality of physical infrastructure services such as road, rail, waterways, port services, and interfaces.<sup>45</sup> The inadequacies are often caused by (non-tariff) policy and institutional constraints, such as red tape, inadequate enforcement of contracts, poor definition and enforcement of rules of engagement, asymmetry in standards, delays in customs, ports and border crossings, pilferage in transit, corruption, and highly restrictive protocols on movement of cargo.

One of the key challenges facing South Asia is high cost of trading. For example, transaction costs at the India-Bangladesh border are estimated to be very high due mainly to infrastructure bottlenecks both at the

> 43 Based on Hummels-Klenow (products) extensive and intensive margins. Refer to De (2012).

> 44 See, for example, Ahmed and Ghani (2009), Ahmed _et al._ (2010).

> 45

> Subramanian and Arnold (2001).

21
borders as well as within the countries.<sup>46</sup> The World Bank has argued that an FTA would bring large welfare gains for consumers in Bangladesh, provided infrastructure and administrative capacity at customs borders is adequately expanded.<sup>47</sup> The conditions of land ports in Bangladesh are not satisfactory. It has also been found that ports in Bangladesh are plagued by labor problems, poor management, and lack of equipment; costs rise further with inadequate customs services, including delays in clearances and rent-seeking.

Poor trade logistics in Bangladesh affects the cost of export and import very significantly and is reflected in the Logistic Performance Index (LPI). The World Bank (2012) finds that the domestic logistics chain – including collection of products from producers, road haulage to the warehouse, containerization, haulage to the port, and customs at port- is still very underdeveloped. Bangladesh ranks 87 in the LPI, while its South Asian comparators like India and Pakistan rank 39 and 68 respectively.

The quality and performance of logistics services differ markedly between India and Bangladesh and also across their trade partners. These variations in time and cost stem from differences in the quality and cost of infrastructure services as well as differences in policies, procedures, and institutions. The quality of such services, policies, and procedures has a significant effect on trade competitiveness and market access. While there is strong anecdotal evidence that the lack of adequate trade infrastructure might have altered the bilateral trade potential due to trade costs, this study tries to assess the effect of trade facilitation/trade cost elements (e.g., transit and time) and logistics services on bilateral trade. It does so with the help of an augmented gravity model (AvW type), and then determines important trade remedies. The regressions are based on a cross-section pooled dataset for the years 2007 and 2008. A three-stage regression process is used here to understand the impact of trade facilitation, comprising several of the logistics and trade facilitation indicators and shows that this captures essentially all the explanatory power of the indicators used separately.<sup>48</sup> Definition of variables and corresponding data sources appear in Appendix 6, and the list of Bangladesh‘s trade partners in Appendix 7. The initial augmented gravity results are worth noting (Table 11):

- Specification 1 contains the initial set of models fitted before any of the trade facilitation or logistics indicators or additional variables are included. It contains regressions of bilateral trade on GDP in the exporting and importing countries. The results are qualitatively consistent with those of earlier studies, particularly de Groot _et al._ (2004). What is most interesting is that the tariff and the dummy variables for regional transit in specification 1 are statistically significant at a 1 percent level. Furthermore, trade liberalization and regional transit would lead to increased exports of Bangladesh, other things remaining equal.

> 46 De and Ghosh (2008); De and Bhattacharyay (2007a, 2007b).

> 47 Countries that have removed common barriers to trade have raised per-capita income by increasing trade. The removal of common borders between Germany and the Czech Republic and between the United States and Mexico are seen as key factors in the incomes per capita rising in the smaller countries-–-by 26 percent in the Czech Republic and 27 percent in Mexico (Redding and Venables, 2004).

> 48 The following diagnostics are carried out: (i) linearity assumption between response variable and predictors is checked; (ii) statutory hypothesis tests are carried out on the parameter estimates; (iii) Ramsey test is done to check model specification; (iv) normality of residuals is tracked through Kernel density plot; (v) all estimates are checked for heteroscedasticity through Cameron and Trivedi‘s decomposition of IM-test; (vi) multicollinearity problems are checked by looking at the variance inflation factor (VIF); (vii) models do not suffer from endogeneity as highly correlated exogenous variables are not used in the gravity equations; and (viii) it being cross-section data, the presence of serial correlation does not appear.

22
**<u>Table 11: Initial Augmented Gravity Model Estimations</u>**

|**Variable**||||**Specif**|**ication**||||
|---|---|---|---|---|---|---|---|---|
||**1**|**2**|**3**|**4**|**5**|**6**|**7**|**8**|
||0.998***|0.995***|1.002***|0.994***|0.982***|0.941***|0.997***|0.961***|
|ln_gdp_ex|(0.0762)|(0.0836)|(0.081)|(0.0864)|(0.0718)|(0.0743)|(0.0741)|(0.0792)|
||0.0163|0.0488|0.0998|0.0887|0.0886|0.163|0.00638|0.0564|
|ln_gdp_im|(0.0976)|(0.112)|(0.127)|(0.121)|(0.11)|(0.128)|(0.109)|(0.106)|
||0.844***|0.852***|0.695**|0.608**|0.758**|0.766**|0.828***|0.811***|
|ln_tariff|(0.272)|(0.282)|(0.274)|(0.264)|(0.296)|(0.312)|(0.278)|(0.269)|
||0.553|1.167|1.097|1.390*|0.525|0.521|0.565|0.381|
|contig|(0.599)|(0.719)|(0.822)|(0.823)|(0.674)|(0.73)|(0.623)|(0.577)|
||<br>0.426|<br>0.552*|<br>0.0133|<br>0.42|<br>0.492|<br>0.749|<br>0.618|<br>0.481|
|comlang_off|(0.627)|(0.285)|(0.44)|(0.368)|(0.702)|(0.783)|(0.728)|(0.606)|
||0.947|0.773|1.098*|1.192*|1.196*|1.289*|1.092|1.057|
|rta|(0.672)|(0.64)|(0.591)|(0.694)|(0.696)|(0.738)|(0.686)|(0.681)|
||0.114|0.684|0.647|1.045|0.0797|0.121|0.0472|0.0209|
|sr_transit|(0.568)|(0.73)|(0.806)|(0.803)|(0.627)|(0.664)|(0.562)|(0.534)|
||2.561***|2.223***|2.517***|2.381***|2.898***|3.272***|2.792***|2.834***|
|r_transit|(0.716)|(0.654)|(0.658)|(0.74)|(0.779)|(0.891)|(0.802)|(0.749)|
||0.0516|0.0126|0.0141|0.107|0.0456|0.0242|0.00379|0.00922|
|ln_distance|(0.251)|(0.271)|(0.247)|(0.251)|(0.262)|(0.268)|(0.253)|(0.256)|
|||0.352|||||||
|ln_cost||(0.561)|||||||
||||1.18||||||
|ln_time|||(0.72)||||||
|||||2.625***|||||
|ln_number||||(0.91)|||||
||||||1.446*||||
|ln_customs|||||(0.835)||||
|||||||2.018*|||
|ln_infrastructure||||||(1.044)|||
||||||||0.829||
|ln_shipments|||||||(1.405)||
|||||||||1.846|
|ln_timeliness||||||||(1.232)|
|Observations|210|210|210|210|210|210|210|210|
|_R_<sup>2</sup><br>|0.808|0.807|0.814|0.825|0.819|0.823|0.815|0.818|
|Adj._R_<sup>2</sup>|0.806|0.806|0.812|0.824|0.818|0.823|0.815|0.817|
|Mean VIF#|2.630|2.970|3.140|3.020|2.900|3.200|2.740|2.850|
|IM-<br>chi<sup>2</sup>|23.050|41.830|32.680|33.110|38.890|46.950|32.820|29.850|
|test<sup>$</sup><br>_p_|0.902|0.349|0.753|0.735|0.520|0.209|0.783|0.879|
|Ramsey<br> <br>_F_|3.210|3.250|3.450|2.980|1.970|1.830|1.960|2.190|
|RESET<br>|||||||||
|test<sup>$$</sup><br>_p_|0.027|0.026|0.021|0.036|0.125|0.149|0.126|0.096|

_Note_ : Dependent variable is total bilateral exports (in logs) in 2008 or latest year available. ***, **, and * indicate values significant at 1%, 5%, and 10% levels. Robust standard errors appear in parentheses. Constant terms are not shown. # Variance inflation factors (VIF) of all explanatory variables test for multicollinearity (tolerance level <10). $Cameron and Trivedi's decomposition of IM-test is to test for heteroscedasticity. $$Ramsey RESET test is to detect model specification error or test omitted variable bias.

23
**<u>Table 12: Augmented Gravity Model Estimations</u>**

|||**Specification **||
|---|---|---|---|
|**Variable**|**9**|**10**|**11**|
||0.932***|0.889***|0.866***|
|ln_gdp_ex|(0.0807)|(0.0804)|(0.0726)|
||0.243*|0.126||
|ln_gdp_im|(0.126)|(0.132)||
||0.611**|0.577**|0.532*|
|ln_tariff|(0.300)|(0.281)|(0.277)|
||1.547**|1.527**|1.382**|
|rta|(0.771)|(0.747)|(0.641)|
||0.998*|0.751|0.472|
|contig|(0.563)|(0.61)|(0.581)|
||3.409***|3.466***|3.309***|
|r_transit|(0.889)|(0.881)|(0.810)|
||0.251|0.266|0.282|
|ln_distance|(0.251)|(0.246)|(0.242)|
||3.023***|3.397***|3.343***|
|ln_number|(0.965)|(0.959)|(0.945)|
||1.572|1.796|1.815|
|ln_customs|(1.254)|(1.196)|(1.217)|
||2.950*|3.655***|3.295***|
|ln_infrastructure|(1.531)|(1.288)|(1.247)|
|||0.431*|0.489**|
|ln_cc_ex||(0.225)|(0.210)|
|||0.129|0.134|
|ln_cc_im||(1.040)|(1.073)|
|Observations<br>|210|210|210|
|_R_<sup>2</sup><br>|0.844|0.853|0.852|
|Adj._R_<sup>2</sup>|0.843|0.853|0.851|
|Mean VIF#|4.63|4.56|4.28|
|IM-test<sup>$</sup><br>chi<sup>2</sup>|57.74|75.29|61.46|
|_p_|0.3388|0.1581|0.2264|
|Ramsey<br>RESET<br><sup>$$</sup><br>_F_|0.73|0.69|0.91|
|test||||
|_p_|0.5365|0.5586|0.4407|

_Note_ : Dependent variable is total bilateral exports (in logs) in 2008 or latest year available. ***, **, and * indicate values significant at 1%, 5%, and 10% levels. Robust standard errors are given in parentheses. Constant terms are not shown.

#VIF of all explanatory variables are to test for multicollinearity (tolerance level <10). $Cameron and Trivedi‘s decomposition of IM-test is to test for heteroscedasticity. $$Ramsey RESET test is to detect model specification error or test omitted variable bias.

- Specifications 2-8 include, one at a time, the set of trade facilitation and global logistics indicators described in Appendix 6. Tariff, regional transit dummy, and exporting country GDP are statistically significant in all the specifications. The dummy variable representing RTA, including bilateral FTA, is significant in specifications 4-6 but appears with a negative sign. Among the trade facilitation or logistics indicators, it is seen that the (i) number of trade documents in the bilateral pair (ln_number), (ii) efficiency of the clearance process (speed, simplicity, and predictability of formalities) by border control agencies, including customs

24
(ln_customs), and (iii) quality of trade and transport-related infrastructure, for example, ports, railroads, roads, and information technology (ln_infrastructure) are statistically significant. Therefore, it can be concluded that most of the trade facilitation and logistics indicators have a significant effect on bilateral trade between Bangladesh and its partner countries, including India, in the expected direction.

- All the specifications in Table 11 explain over 80 percent of the variability in bilateral trade, thereby showing considerably good fit. The robust estimation is also supported by Cameron and Trivedi's decomposition of IM-test in all the cases, which suggests no presence of heteroscedasticity in residuals (always reject null hypothesis). Next, low VIF scores suggest our models do not suffer from multicollinearity (mean VIF always less than 10). However, some of the specifications (1-4) in Table 11 suffer slightly from omitted variable bias.

The above analysis indicates that bilateral trade between India and Bangladesh is very much contingent upon tariff, regional transit, and trade facilitation. We then select the set of those trade facilitation and logistics indicators shown to be significantly related to bilateral trade in Table 11 in the remaining gravity analysis. Specifications 9-11, in Table 12, include these critical trade facilitation and logistics indicators along with the standard variables described earlier. Most of the variables in these specifications have significant coefficients, with the expected sign, except for the importing country‘s GDP per capita.

On the basis of the finding by de Groot _et al_ . (2004) and as argued by Rodrik _et al_ . (2004) that institutional quality is important in explaining bilateral trade flows, a control of corruption (cc) variable is added to the model to represent institutional quality for both the exporting and importing country (Table 12, specifications 10-11). The exporting country‘s corruption coefficient has a negative sign and is also statistically significant. Moreover, when institutional quality is included, the coefficient of the GDP becomes insignificant and still has the wrong sign. Specification 11, of Table 12, gives the results: omitting GDP of the importing country reduces the adjusted _R_ -squared value only slightly, but improves the coefficients of many of the statistically significant variables. As usual, none of the specifications (9– 11) suffer from multicollinearity, heteroscedasticity, or model specification error. It follows, then, that the importing country‘s tariff, regional transit, and institutional quality of the exporting country, coupled with trade facilitation and logistics indicators, are important for enhancing Bangladesh‘s export. For the sake of simplicity, we need to derive a trade facilitation index (TFI), which can better represent the functional relation between bilateral export and aforesaid explanatory variables. Three-stage augmented gravity estimation is then selected for the remaining analysis.

The TFI for exports of Bangladesh is estimated in three stages. The first stage involves fitting a simple gravity model that includes most of the standard variables listed in Table 12. The second stage attempts to explain the residuals of the first-stage regression by using trade facilitation and logistics indicators, which represent the components of trade cost such as trade infrastructure, customs and trade documentations, and distance (a surrogate for shipping cost). The second-stage regression derives the optimal coefficients (weights) for these variables to best explain the residuals from the first stage. If the components of these variables are important determinants of bilateral trade, this second-stage regression would be expected to have statistically significant explanatory power. The third stage uses the coefficients derived in the second stage to create a single TFI in an augmented gravity model. If this single index performs reasonably well in explaining bilateral trade flows, it can then be argued that the index systematically captures the various components of the total trade cost.

Table 13 shows the results of these three stages. The second-stage adjusted _R_<sup>2</sup> is 0.229, which is significant since it is a cross-section period where first stage‘s residual was taken as dependent variable. The third-stage augmented gravity model using the single TFI together with the first-stage variables explains 83 percent of the variability in bilateral trade. This result is almost identical to the corresponding 25
one in Table 12. Therefore, the single TFI successfully replaces several separate trade facilitation and logistics indicators.

|**Table 13: Three-S**|**tage Augmented G**<br>|**ravity Estima**<br>|**tions**<br>|
|---|---|---|---|
|**Variable**|**First**<br>**Stage**|**Second**<br>**Stage**|**Third**<br>**Stage**|
||0.990***||0.893***|
|ln_gdp_ex|(0.0724)||(0.0725)|
||0.0894||0.0494|
|ln_gdp_im|(0.11)||(0.128)|
||0.829***||0.737***|
|ln_tariff|(0.244)||(0.245)|
||0.936||1.198*|
|rta|(0.614)||(0.609)|
||0.182||0.222|
|contig|(0.432)||(0.548)|
||2.478***||3.094***|
|r_transit|(0.669)||(0.742)|
||0.161||0.357|
|ln_cc_ex|(0.189)||(0.227)|
||0.023||0.043|
|ln_cc_im|(0.102)||(0.154)|
|||0.217||
|ln_distance||(0.167)||
|||2.666***||
|ln_number||(0.937)||
|||1.424*||
|ln_customs||(1.294)||
|||0.849*||
|ln_infrastructure||(1.185)||
||||3.645***|
|ln_tfi|||(1.263)|
|Observations|210|210|210|
|_R_<sup>2</sup><br>|0.809|0.231|0.831|
|Adj._R_<sup>2</sup>|0.809|0.229|0.830|
|Mean VIF#|2.58|4.84|3.19|
|chi<sup>2</sup>|28.1|18.45|51.95|
|IM-test<sup>$</sup><br>_p_|0.6159|0.4928|0.0653|
|Ramsey<br>_F_|3.49|1.39|1.95|
|<br> <sup>$$</sup><br>||||
|RESET test<br>_p_|0.0191|0.2515|0.1277|

_Notes_ : Dependent variable for first and third stages is total bilateral exports (in logs) in 2008 or latest year available. Dependent variable for the second stage is first-stage residuals. ***, **, and * indicate values significant at 1%, 5%, and 10% levels. Robust standard errors are in parentheses. Constant terms are not shown. #Variance inflation factors (VIF) of all explanatory variables test for multicollinearity (tolerance level <10). $Cameron and Trivedi‘s decomposition of IM-test is to test for heteroscedasticity.<sup>$$</sup> Ramsey RESET test is to detect model specification error or test omitted variable bias.

26
## **4.1. Implications**

The implications of the gravity analysis in the context of India–Bangladesh bilateral trade are shown in Appendix 8, and suggest that bilateral trade is highly responsive to improvements in transaction efficiencies. The gravity estimates suggest that a 10 percent reduction in the trade-related documentation could result in a 7.31 percent increase in bilateral trade. Similarly, a 10 percent improvement in the efficiency of clearance processes by border control agencies, including customs, might lead to a 3.91 percent increase in bilateral trade. In the case of trade infrastructure, a 10 percent improvement in the quality of trade and transport-related infrastructure could lead to a 2.33 percent increase in bilateral trade. Besides, Table 13 (third stage) shows that further trade liberalization (10 percent cut in tariff) would lead to rise in bilateral trade (7.37 percent). The table also shows that regional transit in South Asia is extremely important, and would help increase Bangladesh‘s exports to South Asia substantially.<sup>49</sup> Improved trade facilitation (as defined by the TFI) will have the strongest effect on Bangladesh‘s bilateral trade; a 1 percent improvement in trade facilitation would result in an almost 4 percent increase in Bangladesh‘s exports. These results also show that the gravity model with the TFI could also be used to evaluate the effectiveness of initiatives to improve logistics.

It would be very important to place the objectives of reducing transaction costs of trading between India and Bangladesh within the larger context of regional transit in South Asia. And to gain the full benefits of regional transit, integration of transportation networks should be a priority objective of South Asian cooperation.<sup>50</sup> Two other elements that would help bilateral trade between India and Bangladesh are foreign direct investment and trade in energy––elements that might require further study. Foreign investment would help increase Bangladesh exports in the medium to long run. Inflow of foreign capital would stimulate exports and imports, transfer of technology, and generate employment. The energy sector, too, offers enormous investment and trade opportunities for both countries, particularly in a sub-regional context that includes Bhutan and Nepal.

# **5. Conclusions and Policy Implications**

Contiguous countries like Bangladesh and India can benefit greatly from opportunities for trade and economic cooperation. The scope for trade expansion between the two countries depends partly on their trade complementarity, which is relatively limited but growing, partly on account of their economic imbalance. The other driver of bilateral trade is intra-industry trade between India and Bangladesh. This has the potential to grow significantly, since trade in similar product lines has been growing, and that could deepen production networks between the two countries.

What are the prospects for production networks and vertical trade between the two countries? This study shows that the intra-industry trade (IIT) index levels are higher in manufactured than in primary products, reflecting the greater role of economies of scale in the production of those products. Moreover, the IIT index scores suggest that there are production-sharing possibilities in a static sense in 11 products. These range from textiles and clothing (the highest concentration) to iron and steel (lowest concentration), with electrical machinery & equipment and mechanical appliances occupying the middle (medium concentration) of the value chain.

> 49      Estimated coefficient of regional transit dummy is found to be statistically significant.

> 50 Owing to the importance of transportation integration, connectivity has been the central focus of SAARC. ―South Asia has flourished most when connected to itself and the rest of the world‖ (from Indian Prime Minister Manmohan Singh‘s speech at the 14th SAARC Summit in 2007, available at <u>http://pib.nic.in/newsite/erelease.aspx?relid=26591.)</u>

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How can vertical IIT between the two countries be intensified? This analysis indicates that a number of product categories and sectors exhibit an increasing share of IIT, and these are the sectors with the potential for increasing bilateral trade through IIT, at least to begin with, based on the static analysis. In order to realize this potential, both countries would have to further liberalize trade, for instance by reducing tariffs (in the case of Bangladesh) and reducing non-tariff barriers (both countries), and reducing trade costs by improving trade facilitation both at borders and within the borders.

Judging complementarity is only a start in analyzing the potential for a bilateral trade relationship. The analysis on IIT summarized in the previous section is based on actual trade patterns. The next question would be to understand the impact of liberalizing market access by one or both countries to each other‘s exports.

Market access offers have considerable potential to enhance trade. This study considered three scenarios with regard to market access for trade in goods (first, full FTA in goods; second, a one way offer by India to Bangladesh for duty and quota free access in goods (which has already happened); and third, a full FTA for goods along with improved connectivity between Bangladesh and India). A global CGE model shows that in all three scenarios, Bangladesh‘s exports to India increase very significantly. It was observed that under the first scenario, exports to India would increase by over 182 percent, in the second by 134 percent, and in the third by 297 percent. India also gains significantly in the FTA and FTA plus scenarios. In the first scenario, India‘s exports to Bangladesh would increase by about 126 percent, in the second scenario, hardly at all, and in the third scenario, by 172 percent. Reducing transaction costs in trade lead to significantly higher exports, as seen through a comparison of the first and third scenario results. The GTAP simulations also suggest that India‘s removal of 46 products from its negative list (which has already been done) could increase Bangladesh‘s exports to India by about 48 percentage points from the base level.

The projected trade outcomes imply that an FTA would provide a significant stimulus for Bangladesh to increase its presence in the Indian market. It is also likely that both countries would see a substantial increase in manufactured exports to each other as duty-free market access opened up with the FTA. However, for Bangladesh to benefit fully from such market access and expand its exports to India, it would need an adequate expansion of its inland and international infrastructure and administrative capacity for handling bilateral trade.

The above analysis is still limited by existing patterns of trade, and so does not consider the dynamic potential for trade to grow and expand into new areas that the models are not able to capture. It could be said that the CGE projections represent a lower bound for trade expansion as a result of a possible FTA agreement. For Bangladesh, whose export basked is still very concentrated, foreign investment from India as well as other countries would be critical to improve technology and skills and enhance production capabilities in goods as well as trade-related infrastructure.

Thus, a bilateral FTA between Bangladesh and India should go beyond any treaty based on ―trade in goods‖, and should include cooperation in the areas of investment, finance, services trade, trade facilitation, and technology transfer. Despite the fact that there are some risks of welfare loss for Bangladesh through trade diversion in a bilateral FTA (such risks are low since India is already a dominant competitive supplier), the gains from extended economic cooperation in investment and services trade could be much larger. And both countries would gain from continued trade liberalization and streamlining of border transactions through trade facilitation and improved physical connectivity.

The study briefly considered services trade between the two countries, a large part of which is informal. There has been a formal flow of services trade to a small extent, for example in education and healthrelated services. Barriers to trade in services (e.g., mutual recognition) are not like tariffs; typically these 28
are regulatory barriers, rather than explicit taxes; they are complex in nature and impose high costs, at least on the formal component of bilateral trade in services. Mutual recognition of degrees, easier access to visas, and Bangladesh‘s encouragement of Indian FDI in health and education services would help improve trade in such services.

Going beyond an analysis of market access, the study considered the issue of trading costs in some depth. Cumbersome and complex cross-border trading procedures raise the already-high transaction costs of the trading systems of India and Bangladesh. A comprehensive measure of trade costs is derived from a gravity model of international trade. The analysis reveals that improved trade facilitation coupled with regional transit would help increase trade between the two countries. At the same time, there is strong evidence that improving the efficiency of customs and administrative procedures and simplifying traderelated documentation would also facilitate their trade. For example, as this study shows, a 10 percent reduction in trade-related documentation could result in a 7.31 percent increase in bilateral trade; a 10 percent improvement in the efficiency of clearance processes by border control agencies, including customs, might lead to a 3.91 percent increase in bilateral trade; a 10 percent improvement in the quality of trade and transport-related infrastructure could lead to a 2.33 percent increase in bilateral trade.

Not only will there be large payoffs to addressing the major bilateral barriers to reducing trading costs, there will be additional major gains in keeping the regional picture in mind. For India and Bangladesh, the system should aim to greatly reduce current physical and soft barriers to transportation and transit by means of physical infrastructure (such as multimodal corridors and terminals) and soft infrastructure (reformed policies and procedures, regulations, and incentives for efficient transportation and transit). Simplification of processes and procedures in trade transactions would certainly increase the bilateral trade between the two countries even in very short run. Reduction of NTBs should get utmost priority in this context. To derive larger gains, India and Bangladesh, along with other South Asian partners, should develop a regional (or sub-regional) transportation and transit system that offers efficient transportation options and low transaction costs that are competitive with those found elsewhere.

India can help deepen bilateral economic relations with Bangladesh through infrastructure investment. One option would be to invest in inland and border infrastructure to reduce the bottlenecks resulting from the expansion of the domestic private sector. This would mean a strategy of infrastructure development following private investment. Another option would entail both governments using infrastructure development as an engine for bilateral and regional growth. This would require a strategy where infrastructure development leads and crowds in private investment––for example, if both governments were to jointly build adjacent special economic zones (SEZs) at the India-Bangladesh border. India‘s latest US$ 1 billion credit to Bangladesh for the development of country‘s infrastructure is an example of the latter approach.

Increased trade between Bangladesh and India will require measures going beyond tariffs. This would mean India following up the significant changes on the tariff front (India now offers a free trade regime to Bangladesh for all except 25 products) with reduction in non-tariff measures/barriers. In addition, FDI by Indian and other foreign firms would help enhance product complementarities and production networks. Finally, Bangladesh would also gain from reducing its tariffs and para-tariffs as well as non-tariff measures/barriers in its trade with India, since this will help expand its overall production capability and help it to exploit dynamic gains from trade.

India-Bangladesh cooperation offers a ―win-win‖ prospect for both countries and the South Asia region as a whole. For India, closer economic cooperation would help to reduce the economic isolation of its northeastern states. A bilateral FTA between the two countries could create scope for resolving some of these critical issues while reducing non-tariff barriers.

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Finally, the next generation of economic cooperation talks between the two countries should address nontariff measures/barriers, services trade, technology transfer, logistics and infrastructure, finance and investments.

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