metadata: authors: 0: author: De,Prabir
1: author: Ghani,Syed Ejaz
2: author: Raihan,Selim
count: Pakistan,India
docna: 0: docna: What does MFN trade mean for India and
            Pakistan ? can MFN be a Panacea ?
docty: Policy Research Working Paper
subtopic: Oil Refining & Gas Industry,International Trade and Trade Rules,Trade Facilitation,Transport Services
teratopic: Transport,Private Sector Development,Macroeconomics and Economic Growth,International Economics and Trade
abstracts: cdata!: India and Pakistan, the two largest
            economies in South Asia, share a common border, culture and
            history. Despite the benefits of proximity, the two
            neighbors have barely traded with each other. In 2011, trade
            with Pakistan accounted for less than half a percent of
            India's total trade, whereas Pakistan's trade with
            India was 5.4 percent of its total trade. However, the
            recent thaw in India-Pakistan trade relations could signal a
            change. Pakistan has agreed to grant most favored nation
            status to India. India has already granted most favored
            nation status to Pakistan. What will be the gains from trade
            for the two countries? Will they be inclusive? Is most
            favored nation status a panacea? Should the granting of most
            favored nation status be accompanied by improvements in
            trade facilitation, infrastructure, connectivity, and
            logistics to reap the true benefits of trade and to promote
            shared prosperity? This paper attempts to answer these
            questions. It examines alternative scenarios on the gains
            from trade and it finds that what makes most favored nation
            status work is the trade facilitation that surrounds it. The
            results of the general equilibrium simulation indicate
            Pakistan's most favored nation status to India would
            generate larger benefits if it were supported by improved
            connectivity and trade facilitation measures. In other
            words, gains from trade would be small in the absence of
            improved connectivity and trade facilitation. The idea of
            trade facilitation is simple: implement measures to reduce
            the cost of trading across borders by improving
            infrastructure, institutions, services, policies,
            procedures, and market-oriented regulatory systems. The
            returns can be huge, even with modest resources and limited
            capacity. The dividends of trade facilitation can be shared
            by all.
geo_reg_key: 517198,517212,517191
repnme: repnme: What does MFN trade mean for India and
            Pakistan ? can MFN be a Panacea ?
display_title: What does MFN trade mean for India
            and Pakistan can MFN be a Panacea
listing_relative_url: /research/2013/06/17857354/mfn-trade-mean-india-pakistan-can-mfn-panacea
topicv3: Transport m1326661 135,Trade m1326924 698,Trade Facilitation and Logistics m1327174 772,Trade Linkages, Spillovers and
            Connectivity m1504235 2601,Petroleum Industry m1583790 4710
publishtoextweb_dt: 2013-06-01T00:00:00Z
historic_topic: Transport,Private Sector Development,Macroeconomics and Economic Growth,International Economics and Trade
no_of_pages: 48
author_keys: 0: author_key: 1093517
1: author_key: 94311
2: author_key: 901153
model_extractions: WPS6483 Policy Research Working Paper 6483 What Does MFN Trade Mean for India and Pakistan?

Can MFN be a Panacea?

_Prabir De Selim Raihan Ejaz Ghani_ The World Bank Poverty Reduction and Economic Management Network Economic Policy and Debt Unit June 2013
Policy Research Working Paper 6483

# **Abstract**

India and Pakistan, the two largest economies in South Asia, share a common border, culture and history. Despite the benefits of proximity, the two neighbors have barely traded with each other. In 2011, trade with Pakistan accounted for less than half a percent of India’s total trade, whereas Pakistan’s trade with India was 5.4 percent of its total trade. However, the recent thaw in India-Pakistan trade relations could signal a change. Pakistan has agreed to grant most favored nation status to India. India has already granted most favored nation status to Pakistan. What will be the gains from trade for the two countries? Will they be inclusive? Is most favored nation status a panacea? Should the granting of most favored nation status be accompanied by improvements in trade facilitation, infrastructure, connectivity, and logistics to reap the true benefits of trade and to promote shared prosperity? This paper attempts to answer these questions. It examines alternative scenarios on the gains from trade and it finds that what makes most favored nation status work is the trade facilitation that surrounds it. The results of the general equilibrium simulation indicate Pakistan’s most favored nation status to India would generate larger benefits if it were supported by improved connectivity and trade facilitation measures. In other words, gains from trade would be small in the absence of improved connectivity and trade facilitation. The idea of trade facilitation is simple: implement measures to reduce the cost of trading across borders by improving infrastructure, institutions, services, policies, procedures, and market-oriented regulatory systems. The returns can be huge, even with modest resources and limited capacity. The dividends of trade facilitation can be shared by all.

This paper is a product of the Economic Policy and Debt Unit,, Poverty Reduction and Economic Management Network. 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 EGhani@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
# **What Does MFN Trade Mean for India and Pakistan? Can MFN be a Panacea?**

## **Prabir De, Selim Raihan, Ejaz Ghani**<sup>**1**</sup>

> 1 The authors are, respectively, Fellow, Research and Information System for Developing Countries (RIS), New Delhi (prabirde@hotmail.com), Professor, Dhaka University, Dhaka    ( <u>selim.raihan@econdu.ac.bd) and Lead</u> Economist, PREM, The World Bank (Eghani@worldbank.org). This paper was prepared and discussed in 2012. Authors are grateful to two anonymous referees, and Ulrich Bartsch, Jose R. Lopez Calix, Kalpana Kochhar, Erik Nora and Daria Taglioni for their useful comments. The authors are responsible for any remaining errors. The views expressed here are those of the authors and not necessarily The World Bank or any institution they may be associated with.
# **1. INTRODUCTION**

India and Pakistan, the two largest countries in South Asia with nearly 1.4 billion people, are close to a new dawn in history **.** The two neighbors, who had ring-fenced each other for more than six decades, are now progressing towards closer economic relations with a vision to enhancing peace and stability in the region. Both countries had overcome many significant hurdles in normalizing the trade relations in past, of which Pakistan’s recent decision to extend the most favored nation (MFN) status to India is the most significant one.

Trade between the two countries never had a smooth ride in the past. Bilateral trade always faced a series of bottlenecks, cascaded mostly by political tension and rivalry. After partition in 1947, India accounted for about 70 percent of Pakistan’s official trade. However, discordant political relations brought a halt to bilateral official trade between the two countries. During 1965 and 1973, bilateral trade flows were negligible. In 1971, India and Pakistan signed the first trade agreement, which did not last long. Pakistan introduced a first positive list in 1989 (four products originally), and then kept the number increasing almost every year. Soon after establishment of the WTO in 1995, India granted MFN status to Pakistan. From the end of 1990s until the middle of the past decade, political issues continued to affect the bilateral economic relations.

India and Pakistan revived trade talks in 2011. These trade talks with serious acts on both sides have been guiding India and Pakistan towards building closer economic ties. For example, Pakistan decided to extend MFN status to India in 2012, and replaced the restricted positive list with a negative list in February 2012. India reciprocated by allowing FDI from Pakistan. The two countries have also agreed to simplify customs procedures, and facilitate the process of goods certification and visa liberalization.<sup>2</sup> Recent results are a bit more encouraging. For example, Pakistan’s exports to India during April- December 2012 increased by 66 percent to US$ 461 million, whereas some new products of Pakistan have started getting higher market access in India (e.g. US$ 33.24 million export of Styrene<sup>3</sup> (HS code 29025000) and US$ 143.81 million export of brass scrap (HS code 74040022) to India during April to December 2012).<sup>4</sup> India’s exports to Pakistan, on the other hand, witnessed slower growth during April to December 2012. But some Indian products found new markets in Pakistan during the same period, such as skim milk (US$ 8.01 million), biscuits (US$ 3.98 million), bangles and imitation jewelry (US$ 4 million), and some existing products got higher market access such as cotton and polyester fabrics (US$ 278 million).<sup>5</sup> Greater trade with India offers an immediate and rich possibility of economic growth for Pakistan and India will also benefit as it is a positive sum game (Husain, 2013).

So what will be the gains from trade? Which industries will benefit? What needs to be done to realize the maximum benefits from the MFN? This paper presents a set of policy recommendations with a view to strengthening the economic relations between India and Pakistan. It provides estimates on the gains from MFN trade using a global computable general

> 2 Refer, Raihan and De (2013) for a detailed account of bilateral trade relations.

> 3 This is also known as vinyl benzene and phenyl ethane. 4 Sourced from Export – Import Databank, Department of Commerce, Government of India, New Delhi 5 Ibid

2
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the rising trade between India and Pakistan has also been accompanied by a sharp rise in the trade deficit between them.<sup>7</sup> Nevertheless, compared with their economic strength, trade between India and Pakistan is negligible and much below its potential.

||**Table 1: I**<br>|**ndia’s Tr**<br>|**ade with Paki**<br>|**stan **<br>|
|---|---|---|---|---|
||**Export**|**Import**|**Total Trade**|**Trade Balance**|
|||**(**|**US$ million)**||
|1990|43.49|44.86|88.35|-1.37|
|1995|70.4|37.37|107.77|33.03|
|2000|163.33|65.05|228.38|98.28|
|2005|647.19|158.42|805.61|488.77|
|2010|2252.89|310.44|2563.33|1942.45|
||||**CAGR (%)**||
|1990-1999|9.22|9.88|9.56||
|2000-2009|27.45|17.32|25.18||

Source: Calculated based on UNCOMTRADE

**<u>Table 2: Composition of India’s Top 15 Exports to Pakistan</u>**

|||**20**|**00**|**20**|**05**|**20**|**10**|
|---|---|---|---|---|---|---|---|
|**HS**<br>**Code**|**Commodity Description**|**Export**<br>**(US$**<br>**million)**|**Share***<br>**(%)**|**Export**<br>**(US$**<br>**million)**|**Share***<br>**(%)**|**Export**<br>**(US$**<br>**million)**|**Share***<br>**(%)**|
|1701|Cane or beet sugar and chemically pure sucrose,in solid form|37.11|22.65|1.09|0.18|611.65|27.36|
|5201|Cotton,not carded or combed.|**|**|33.18|5.60|300.33|13.43|
|5407|Woven fabrics of synthetic filamentyarn|0.00|0.00|0.01|0.00|299.09|13.38|
|2902|Cyclic hydrocarbons.|0.13|0.08|119.03|20.07|177.73|7.95|
|2304|Oil-cake and other solid residues|25.95|15.84|47.31|7.98|75.52|3.38|
|0713|Dried leguminous vegetables and shelled|0.19|0.12|18.86|3.18|58.40|2.61|
|4011|Newpneumatic tyres,of rubber|7.01|4.28|35.28|5.95|36.88|1.65|
|3204|Synthetic organic colouringmatter|7.16|4.37|13.49|2.27|32.37|1.45|
|2710|Petroleum oils and oils obtained from bituminous minerals|**|**|21.72|3.66|26.49|1.18|
|0904|Pepper of thegenus Piper|3.42|2.09|0.09|0.01|25.52|1.14|
|3808|Pesticides|0.05|0.03|2.63|0.44|24.88|1.11|
|0902|Tea|5.84|3.57|7.69|1.30|23.42|1.05|
|7202|Ferro-alloys|0.39|0.24|5.87|0.99|22.23|0.99|
|3902|Polymers ofpropylene or of other olefins|10.80|6.59|21.97|3.70|20.60|0.92|
|2942|Other organic compounds|6.17|3.76|45.12|7.61|20.47|0.92|
||**Total export from India to Pakistan **|**163.83**|**63.62 **|**593.06**|**63.11**|**2235.79**|**79.33**|

Note: *Share in total export ** No trade Source: Calculated based on UNCOMTRADE

> 7 The widening and surplus trade balance is in favor of India; but it should not be the major concern. Bilateral trade deficit has to be seen in the light of country’s total trade balance.

5
**<u>Table 3: Composition of Pakistan’s Top 15 Exports to India</u>**

|||**20**|**00**|**20**|**05**|**20**|**10**|
|---|---|---|---|---|---|---|---|
|||**Export**||**Export**||**Export**||
|**HS**<br>**Code**|**Commodity Description **|**(US$**<br>**million)**|**Share***<br>**(%)**|<br>**(US$**<br>**million)**|**Share***<br>**(%)**|<br>**(US$**<br>**million)**|**Share***<br>**(%)**|
|0804|Fruits,fresh or dried.|25.11|36.07|24.76|14.92|59.55|18.57|
|2523|Cement|**|**|**|**|34.38|10.72|
|2710|Petroleum oils and oils obtained from bituminous minerals,<br>other than crude|**|**|**|**|23.34|7.28|
|7801|Unwrought lead|**|**|1.43|0.86|20.93|6.53|
|2711|Petroleumgases and othergaseous hydrocarbons|**|**|**|**|16.02|5.00|
|2917|Polycarboxylic acids, their anhydrides, halides,<br>peroxides andperoxyacids|0.18|0.27|7.21|4.35|13.51|4.21|
|2903|Halogenated derivatives of hydrocarbons.|||||12.26|3.82|
|5209|Woven fabrics of cotton|0.14|0.21|9.45|5.70|12.20|3.80|
|2902|Cyclic hydrocarbons.|**|**|**|**|11.75|3.66|
|2836|Carbonates; peroxocarbonates|0.02|0.03|0.00|0.00|10.46|3.26|
|5208|Woven fabrics of cotton|0.19|0.27|10.45|6.30|10.09|3.15|
|0713|Dried leguminous vegetables, shelled, whether<br>or not skinned or split.|2.42|3.47|64.90|39.11|9.72|3.03|
|5101|Wool,not carded or combed.|0.02|0.03|1.91|1.15|8.68|2.71|
|5205|Cottonyarn(other than sewingthread)|0.36|0.52|3.43|2.07|6.31|1.97|
|3923|Articles for the conveyance orpackingofgoods,ofplastics|**|**|0.69|0.42|6.13|1.91|
||**Total export from Pakistan to India**|**69.62 **|**40.86**|**165.95**|**74.86**|**320.73**|**79.61 **|

Note: *Share in total export ** No trade Source: Calculated based on UNCOMTRADE

**The composition of exports from India to Pakistan has been primarily limited to about 15 commodities, which on average accounted for around 64 percent of the total Indian exports to Pakistan in 2000, but increased to around 80 percent by 2010** (Table 2) **.** These commodities include sugar, raw cotton, synthetic fabrics, tea, petroleum products and chemicals, reflecting India’s more diversified industrial base. Shares of both raw cotton and woven fabrics in India’s export to Pakistan increased from almost zero in 2000 to more than 13 percent in 2010, whereas the share of oil-cake and other solid residues contracted from about 16 percent to 3 percent during the same period.

**The composition of official exports from Pakistan to India has also been limited to very few commodities.** These include fruits and vegetables, wool and products, petroleum products, chemicals, lead, and more recently cement. In 2010, the sectors with the largest shares in exports from Pakistan to India were of fruits (19 percent), followed by cement (11 percent), and petroleum products (7 percent) (Table 3).

**Trade between India and Pakistan is restricted by closed trade regimes.** Pakistan and India have amongst the most restrictive trade regimes (Figure 4). Bilateral barriers to trade are very complex in nature and “thick” at the India-Pakistan land border. India and Pakistan also perform poorly with their global peers on trade logistics. Non-price barriers (e.g., costs on account of

6
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Pakistan, the major stumbling block is the presence of NTBs (Taneja et al., 2011). A list of such NTBs is provided in Annex 1. Deeper cooperation between India and Pakistan can potentially result in significant reductions of these barriers.

**Trade facilitation is not well developed.** Road network quality is low with little regional linkages, while rail networks between ports and markets are often missing, putting unnecessary burden on already inadequate road networks. Only a limited number of items are allowed to be transported via rail/road; there are specific timings for the opening of these routes and in most cases, there are no proper warehousing/storage facilities available. Information flows on trade related matters between the two countries is particularly weak, thereby generating enormous problems to exporters and importers. Both, India and Pakistan follow a restrictive visa regime. India and Pakistan do not provide overland transit to each other’s goods moving to or coming from any third country. Moreover, a mismatch exists between the Indian 8-digit HS classification sometimes used and the Pakistani 6-digit classification of items on the positive list, giving customs officials’ room to allow entry based on discretion. Most of the bilateral payments are made through the Asian Clearing Union (ACU), and businessmen in both countries have complained about the inefficiency of this procedure. Since banks are yet to open branches across the border, this leads to significant delays, especially when letters of credit need to be confirmed, and which can take up to a month. Finally, redressal mechanisms for grievances do not exist and prevent some mutually beneficial exchanges from taking place.

**India and Pakistan fare poorly with global peers on logistics.** South Asian countries in general suffer from excessive direct costs and time taken to cross the borders and form inefficiency in cross-border transactions, which ultimately affect trade negatively. Trade in the region is constrained by poor condition of infrastructure, congestions, high costs, and lengthy delays.<sup>11</sup> Inefficiencies relating to administrative procedures and operations tend to be common in South Asian countries, and that these inefficiencies are often more costly than tariff barriers to the domestic economy. These problems are particularly severe at India-Pakistan border crossings, many of which pose significant barriers to trade. Recognizing these factors, South Asian countries have realized that the potential gains from trade facilitation reforms are very high, and that the goals of the trade facilitation negotiations do not conflict with their pursuit of economic development.

# **3. WELFARE GAINS FROM MFN TRADE**

**Several studies have estimated that large gains are available from removing barriers to trade between India and Pakistan.** Annex 2 provides a list of estimates on the gains from trade, based on assessments using partial equilibrium gravity models. Some estimates suggest that there is a bilateral trade potential which is 20 times larger with a bilateral free trade agreement than it is today, while a more recent estimate indicates total trade between India and Pakistan could expand from its current level of US$ 2.5 billion to as much US$ 42 billion if the “normal”

> quotas, tariff-rate quotas, licensing regimes, price bands, and NTMs. NTMs are policy measures, other than ordinary customs tariffs, that can potentially have an economic effect on international trade in goods, changing quantities traded, or prices or both. Some of these measures may constitute non-tariff barriers.

> 11 Refer, for example, Roy and Banerjee (2010)

9
relations were to hold for the two countries (Figure A1 of Annex 2).<sup>12</sup> Our analysis using a gravity model indicates Pakistan is having large unrealized trade with India. The gravity model estimates reported in Table A1 of Annexu2 reveal that US$ 2.56 billion bilateral trade between India-Pakistan was realized in 2010 against a potential of US$ 7.03 billion. We estimate that the India-Pakistan trade (official) potential is likely to reach US$ 12.05 billion in 2015 from Pakistan’s perspective. Pakistan’s trade potential with India is roughly 2.5 times greater than actual trade today, which may expand to 4.36 times in 2015, _ceteris paribus_ (Table A1 of Annex 2). However, most of the studies argue that trade potential between the two countries would be much higher than the current level if the large informal and/or third country trade is counted. The bottom line is that with a staggering expansion potential of bilateral trade, deeper engagement through normal bilateral trade would lead to significant welfare gains between the two countries.

**We estimates that there are significant welfare gains for India and Pakistan out of MFN trade; however, the welfare gains increase dramatically with the improvement in bilateral trade facilitation.**<sup>13</sup> Welfare results from two simulations using the global general equilibrium model (namely the GTAP model<sup>14</sup> ), depicting the first scenario where Pakistan gives MFN status to India and the second scenario where Pakistan extends MFN status to India along with improvement in trade facilitation between the two countries, are presented in Table 4.<sup>15</sup> The simulations indicate that welfare effects of MFN will be very high - both for India and Pakistan, if the initiative is accompanied by improved trade facilitation measures (Table 4)<sup>16</sup> . Therefore, improvement of connectivity and trade facilitation between India and Pakistan should get the utmost priority in order to make the benefits of trade arising from new trading arrangement more inclusive. Benefits of trade facilitation to Pakistan will be more if indirect benefits are also counted. With improvement in connectivity and trade facilitation, Pakistan could narrow the welfare gap while giving MFN to India. The GTAP simulation suggests that there would be some positive welfare effects on other South Asian countries (Table 4) out of the ‘peace dividends’ generating from improved economic cooperation between India and Pakistan. There will however be some negative welfare effects for the countries outside of South Asia, since Pakistan, after giving MFN status to India, would divert the source of some of its imports from other countries to India.

> 12 Estimated by the Peterson Institute for International Economics (PIIE) based on a gravity model, as reported in Khan (2011)

> 13 Annex 3 provides an analysis on the construction of the MFN scenario. In brief, the MFN scenario incorporates the reduction in import prices for Pakistan because of increased potential of sourcing imports from India at cheaper prices. In addition, it is assumed that there would be some ‘peace dividends’ for all the South Asian countries because of this improved trade relation between India and Pakistan.

> 14 Annex 4 provides the underline assumptions and further details on the GTAP modeling exercise.

> 15 By improvement in trade facilitation, the study assumes a cut in transportation cost for bilateral trade in goods between India and Pakistan by 25 percent. In this regard, the “ams” - import-augmenting "technical change" in the Armington nest in the GTAP model (which can be used to lower the effective price of imported products) is shocked in the model.

> 16 The sensitivity analysis of these GTAP simulations and the subsequent ones are presented in Annex 5. This analysis suggests that the direction of the results remain unchanged under all the sensitivity tests, though the magnitude of the results changed depending on the values of the elasticities.

10
# **Table 4: Welfare Effects of MFN and Bilateral Trade Facilitation India and Pakistan**

(Equivalent variation in US$ million at 2007 prices)

|**Country**|**MFN**|**MFN+BTF**|
|---|---|---|
|Bangladesh|21.08|32.25|
|**India**|**160.71**|**1406.67 **|
|Nepal|18.01|32.22|
|**Pakistan **|**99.21**|**1229.08**|
|Sri Lanka|34.92|63.32|
|Rest of South Asia|15.72|21.38|
|China|-10.52|-102.62|
|USA|-18.39|-122.33|
|EU 25|-29.55|-200.94|
|Rest of the World|-66.71|-585.41|

Note: MFN = Most Favored Nation; BTF = Bilateral Trade Facilitation between India and Pakistan Source: GTAP simulation

**A number of sectors in India will benefit in terms of rises in exports to Pakistan due to the MFN status and improvement in bilateral trade facilitation** (Figure 7) **.** Such rises in exports from India would happen due to India’s unit cost advantage compared to Pakistan’s other trading partners.<sup>17</sup> Under the mere MFN scenario, the change in exports from India to Pakistan would vary from meat (348 percent) to vegetables, fruits and nuts (0.2 percent). Besides, India’s exports to Pakistan would rise for chemical, rubber and plastic, food processing, mineral fuels (petroleum, coal products), metals, machinery and equipment, textiles, leather products, dairy products, fishing, etc. However, under the MFN plus bilateral trade facilitation scenario there would be much larger rises in exports from India from these sectors.

**MFN status to India would have negligible impact on Pakistan’s sectoral exports to India** (Figure 8) **.** There would however be some rise in the exports of plant based fibers, animal products and metals from Pakistan to India. However, MFN status together with improvement in bilateral trade facilitation would result in some sectors in Pakistan to benefit in terms of increased exports to India. Such sectors include wool, wheat, textile, wearing apparels, leather products, metals, machineries, chemicals, etc.

**Mere MFN status to India would raise Pakistan’s import from India by 32 percent, whereas MFN plus enhancement of bilateral trade facilitation would lead to rise in such import by 202 percent** (Table 5). Under the MFN plus bilateral trade facilitation scenario, Pakistan’s total import would rise by 2.7 percent, which is 2.43 percentage points higher than that under the mere MFN scenario. On the other hand, **Pakistan’s exports to India would rise by a staggering 202 percent under the MFN plus bilateral trade facilitation scenario against only 0.4 percent under the MFN scenario** (Table 5) **.** Similarly, Pakistan’s total exports

> 17 From the WITS database 561 products at the 6 digit HS code are identified (which are outside of Pakistan’s positive list) where the unit costs of imports if they are sourced from India would be lower than the unit costs of imports if they are sourced from other countries. This suggests that there would be a possibility of change in import source in favor of India for these product categories when Pakistan extends MFN status to India. A discussion on these products is reported in Annex 3.

11
<!-- Start of picture text --> Total 202<br>PubAdmin/Defence’ Heath/Educat<br>Recreation and other services d 235<br>Business services nec a lB MEN-BTF<br>Financial services nec 4<br>Airtransport 34 =m MEN<br>Seatransport 92<br>Transportnec a7<br>Trade = 51<br>Construction Ey<br>Machinery Manufactures nec Ce ay<br> and equipment nec el 539<br>Transport equipment nec a 552<br>Motor vehicles and parts Se 265<br>Metal products —— 291<br>Metals nec Ey 694<br>Ferrous metals — 283<br>Mineral products nec | 318<br>Chemical,Petroleum,rubber, coalplastic products prods i | 286<br>Paper products, publishing — 362<br>Wood products El 267<br>Leather products ett 608<br>Beverages and tobacco productsTextiles ee | 357<br>Food products nec , 336<br>Meat: cattleVegetable sheep,Dairy oilsgoats, products and horse fats a <=:nig 408 74g<br>Mineralsnec BM ygl<br>Fishing 93<br>Forestry 1 128<br>Animal products nec coal<br>Cattle, sheep, goats, horses 33<br>Crops nec 230<br>Vegetables, fruit, nuts = 70<br>Cereal grains nec mm 48<br>0 200 400 600 800<br><!-- End of picture text -->
<!-- Start of picture text --> Total eer 202<br>PubAdmin/Defence/Heath/Educat [5 73 74<br>Recreation and other services 5B?<br>Business servicesnec 1p 96 3g<br>Insurance la75, 66<br>Financial servicesnec J)73 74<br>Communication 6.229<br>Airtransport S58?<br>Seatransport a<br>Transportnec {5 36 74<br>Trade J5cq 64<br>Construction 13 97 7<br>Machinery Manufactures nec rer 348<br> andequipmentnec to.93 — 365<br>Motor vehicles and parts Pests) 198<br>Metal products -4b 99 , 239<br>Metals nec = 43.<br>Ferrousmetals lo.o2 190<br>Mineral productsnec {997 | 179 m= MFN+BTF<br>Chemical, rubber, plastic prods os 243 = MEN<br>Petroleum, coal products a b2<br>Paper products, publishing is.<br>Leather products 1p 29 I 334<br>Wearing apparel lo63 = 300<br>Textiles lo o3 316<br>Beverages andtobacco products ons<br>FoodproductsnecMineralsFishingnec |3419lo 27 ‘Bp ots2889<br>Wool,Animalsilleworm productscocoons nec m3 1163<br>Cropsnec lo4ag 227<br>Plant-based fibers 192<br>Oil seeds 150<br>Vegetables, fruit, nuts 1594<br>Wheat mers 395<br>-200 200 600 1000 1400<br><!-- End of picture text -->
<!-- Start of picture text --> 0.7 5<br>06 - —e MEN<br>MENBIF<br>>3 OS<br>£ oa.<br>Fos,5<br># 02-4<br>01-<br>0:<br>anaSSSSESSSSESSSSSSEEi. i.FfFwenreas i. i. i. i... ee. rw |82<br><!-- End of picture text -->

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scenario is conducted along with the South Asian regional trade facilitation scenario<sup>20</sup> . The GTAP results suggest that SAFTA with MFN scenario would lead to higher welfare gains for Pakistan and India than a scenario of SAFTA without MFN. However, when a South Asian trade facilitation scenario is added, such gains become much larger. The SAFTA scenario (with or without MFN) would however lead to some welfare loss for Bangladesh because of larger trade diversion effect than trade creation effect (Raihan, 2012).

**The MFN scenario would lead to larger positive effects on Pakistan’s imports and exports under SAFTA** (Table 8). Without MFN status SAFTA would lead to rise in imports of Pakistan from India by 53 percent, whereas with MFN status the import from India under SAFTA would increase by 75 percent. When trade facilitation is added to the second scenario such rise in imports from India would be 256 percent. Under the first scenario, Pakistan’s exports to India would rise by 523 percent, and the SAFTA plus MFN scenario would increase such exports by 525 percent, indicating that the MFN would not have much impact on rise in exports from Pakistan to India. However, under the SAFTA with MFN plus trade facilitation scenario such exports would rise by a staggering 1112 percent. Pakistan’s total exports would rise by 11.33 percent, which would be much higher than those under the other two scenarios.

**Table 8: Impact on Pakistan’s Import and Export under SAFTA Scenarios** <u>(% change from base)</u>

||**SAFTAwi**|**thout MFN**|**SAFTAw**|**ith MFN**|**SAFTA+**|**MFN+STF**|
|---|---|---|---|---|---|---|
||**% change in**<br>**import from**|**% change in**<br>**export to**|**% change in**<br>**import from**|**% change in**<br>**export to**|**% change in**<br>**import from**|**% change in**<br>**export to**|
|Bangladesh|37.05|130.46|36.81|130.97|181.32|403.29|
|India|53.04|523.10|75.04|524.96|256.87|1111.89|
|Nepal|-8.33|18.75|-8.33|18.75|116.00|176.08|
|Sri Lanka|33.38|39.08|30.62|39.44|129.62|128.91|
|Rest of South Asia|44.98|19.39|44.28|19.57|191.50|107.54|
|China|-0.06|-7.90|-1.08|-7.40|-7.18|-17.77|
|USA|0.96|-7.04|0.52|-6.89|-1.71|-17.04|
|EU_25|0.91|-7.44|0.26|-7.27|-1.54|-17.98|
|Rest of the World|0.00|-7.73|-1.05|-7.50|-6.66|-17.96|
|**Total **|**3.09**|**3.97 **|**3.29**|**4.21**|**10.50**|**11.33**|

Note: MFN = Most Favored Nation; STF = Trade facilitation among SAFTA member states Source: GTAP simulation

> 20 One of the direct outcomes of trade facilitation is the rise in trade flows due to fall in costs and/or time of transportation. In this study under the regional trade facilitation scenario, we assume that the price of imported goods of the regional trade among the South Asian countries is reduced by 25 percent due to improvement of trade facilitation measures. In technical term, the “ams” - import-augmenting "technical change" in the Armington nest in the GTAP model (which can be used to lower the effective price of imported products) is shocked.

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therefore go beyond MFN and embrace to a second generation FTA that would open the door to other initiatives. To attain this objective, three policy options are suggested:

# **One, further trade liberalization and removal of NTBs**

**Further deepening of trade liberalization (e.g. removal of NTBs, cleaning the sensitive lists, removal of quantitative restrictions, etc.) between these two countries is needed.** Although average tariff rates have come down in both India and Pakistan, tariff dispersion remains high. High tariffs rates still persist on some major products. For example, Pakistan’s applied import tariff of 35 percent on Indian granite (contributing about 55 percent of Pakistan total import from world) or 20 percent on condensers for steam or other vapor power units (contributing about 100 percent of Pakistan’s import from world) have restricted bilateral trade. On the other hand, India’s import tariff on Pakistani dates (edible fruits & nuts) remains high. India's tariffs are also relatively high on imports of textiles and agricultural products from Pakistan.

Another important gain of granting MFN status to India would be streamlining and gaining transparency of the tariff regime in Pakistan, which dynamically can be very important for Pakistan to strengthen its industrial competitiveness since the complexity of the tariff regime in Pakistan is a major source of lack of dynamism for firms and a large trade obstacle.

Noted by Husain (2013), India’s sensitive list only grants preferential treatment to 65 percent of Pakistan’s exports, and is heavily loaded with agricultural and textile products in which Pakistan has a comparative advantage. Continuing the process of unilateral liberalization, in parallel with regional integration, could help the South Asian countries continue to diversify their still narrow export bases and potentially evolve new comparative advantages and complementarities that could facilitate the successful implementation of SAFTA.

**In addition to rationalizing import duties, policy makers could eliminate all kinds of quantitative restrictions, regulatory duties, and other para-tariffs, and several other measures that have been restricting trade in the past.** Despite the fall in average tariffs, trade restrictiveness of both India and Pakistan has been heavily triggered by the large volume of NTBs. Annex 7 presents a list of impediments to India-Pakistan trade. Deeper cooperation between India and Pakistan can potentially result in significant reductions of these barriers.

# **Two, trade facilitation and improvement of connectivity**

**Trade facilitation is aimed at ensuring the movement and clearance of goods across borders within the shortest time at the minimum cost** .<sup>21</sup> Thus, the two elements which form the crux of the issue are time and cost. Time itself has a cost besides the cost incurred in monetary terms. Therefore, trade facilitation would mean addressing these issues and attempting ways and means to minimize the cost and time taken for movement of import and export cargo.

> 21 The definition of trade facilitation in broader terms goes beyond what has been noted in the WTO. In literature, trade facilitation has been identified as the means to move trade across borders and not restricted to country’s customs authority.

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**There is a need to support trade facilitation to complement the trade liberalization (e.g. removal of the delay in payment between exporter and importer by introducing online banking, acceptance of digital signature on cross-border trade documents, etc.).** Trade facilitation landscape of the region is not impressive when one considers ‘behind the border’ issues. Among the major causes of high trade transaction costs are the number of cumbersome and complex cross-border trading practices, which also increase the possibility of corruption. Goods carried by road are subject largely to transshipment and manual checking at the border, which imposes serious impediments to trade. The situation is further compounded by lack of harmonization of technical standards. Significant reductions in transaction costs will be critical to the bilateral trade cooperation’s effectiveness. Therefore, to reduce trade-related transaction costs, governments must collaborate on a trade facilitation agenda that encompasses procedures, regulations and processes that impose costs on cross-border commercial transactions (e.g. customs, standards, movement of people, etc.). Trade facilitation reforms such as the simplification and harmonization of customs procedures or the improvement of border infrastructure and management systems would increase countries’ capacity to trade, and would assist traders in India and Pakistan to compete with or integrate into global supply chains. Such reforms would also increase customs efficiency, improve revenue collection, reduce corruption, promote foreign investment and lower the various transactions costs involved in getting goods to market.

**The CGE modeling simulations in this study show that improved trade facilitation would increase the volume of trade between India and Pakistan by reducing the transaction costs of trade, making exports more competitive and imports less expensive; however, South Asian countries are way behind their global peers in logistics and trading across border measures.** While India has successfully reduced the time taken to export, exporting a consignment in Pakistan still takes about 21days. On the positive side, Pakistan beats India and other South Asian countries with lowest cost of exports in the region. In case of export time, preparation of documents takes most of the times needed for export in South Asia except for Maldives and Nepal where time needed for customs and ports and inland transit, respectively, outweigh document preparation time. Electronic submission of trade documents would reduce the transaction time and cost drastically. Therefore, reduction of transaction time through simplification and harmonization of documentation and electronic submission should be the priority.<sup>22</sup>

**Trade between India and Pakistan is constrained by the poor condition of infrastructure, congestion, high costs, and lengthy delays, and these problems are particularly severe at the India-Pakistan border crossings** . India and Pakistan have 3,323 km of land border that demarcates the Indian states of Punjab, Rajasthan and Gujarat from the Pakistani provinces of Punjab and Sindh. However, they lack adequate trade transportation links.<sup>23</sup> In addition to the

> 22 To support the trade flows between the two countries, India’s Integrated Check Post (ICP) at Attari-Wagh border, inaugurated on 13 April 2012, is a correct step forward. In regards to physical infrastructure, the Wagah bordercontrol facilities must be greatly expanded. Specifically, sophisticated X-ray machines through which trucks can pass quickly should be a top priority, warehousing is needed at Attari, and several new train stations need to be built. On the Line of Control in Jammu and Kashmir, the government should also invest heavily in all forms of tradeenhancing infrastructure.

> 23 Annex 8 provides the existing trade links between India and Pakistan.

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Attari-Wagah border, which is the major road and rail crossing between India and Pakistan, three more land routes, namely, Khokrapar-Munabao, Muzaffrabad-Srinagar, and Poonch-Rawalakot, have been used for trade between the two countries. India and Pakistan also have only one direct sea route (Mumbai-Karachi) and two air routes (Delhi-Lahore, and Mumbai – Karachi). Restrictions imposed by the two countries on trade along border opened many indirect trade routes between the two neighbors, some of which act as major trade axis. Mumbai-DubaiKarachi and Mumbai-Dubai-Bandar Abbas-Afghanistan-Pakistan are the prominent ones. Compared to their proximity, India and Pakistan do not have much presence of trade infrastructure links between them and circumvent much of the bilateral trade through unofficial routes. Therefore, transit in South Asia would reduce the transportation distance between the trading partners, thereby reducing the transportation costs.

Restrictions in transport border crossings between India and Pakistan are a major constraint to global and intra-regional trade in South Asia. Removing these restrictions would boost trade within South Asia as well as lower cost for international trade in general as many land-locked countries and regions will benefit from access to the closest ports. Currently, the efforts at improving trade facilitation and transport networks are being done in a fragmented manner and with little cooperation even where cross-border issue are involved. Establishing corridor-based approaches for improving the trade – transport arrangement for South Asian trade would be essential for improving the efficiency of regional transport and for reducing trade costs.

**The MFN agreement holds the potential for India and Pakistan to improve their connectivity with Central Asia and beyond.** Pakistan has bilateral transit with Afghanistan, which was renewed in 2010. Pakistan has also signed an FTA with China in November 2006, and the fast-track clearance for cross-border transit between China, Pakistan, Kazakhstan and Kyrgyzstan commenced in November 2008 after 13 years of negotiations. Therefore, India’s transit with Pakistan and Afghanistan will facilitate the market for goods and energy trade (power and gas pipelines) between India and the energy rich Central Asia and Middle East, and vice versa. The advent of MFN status may help complete the implementation of the Turkmenistan-Afghanistan-Pakistan-India (TAPI) gas pipeline, as a new environment of trust and cooperation prevails. Some activities are underway including a very successful hydro-power trade between Bhutan and India in the Eastern market and an ongoing project in the Western market that will bring electricity from Tajikistan and Kyrgyzstan to Afghanistan and Pakistan<sup>24</sup> . With Pakistan being a member of ECO (Economic Cooperation Organization) and India in EAS (East Asia Summit) Group, India and Pakistan can jointly build a stronger connectivity and trade partnership among Southeast, South and Southwest Asia.

# **Three, allowing FDI to move freely**

**India and Pakistan should pursue a 21**<sup>**st**</sup> **century type of regionalism (trade in tasks) through free movement of FDI. It is imperative to make FDI move freely between the two nations.** FDI becomes relevant as economic engagement between the two countries deepens. A

> 24 For example, there is Central Asia-South Asia (CASA) energy project that seeks to sell 1000 MW of surplus power from Tajikistan and Kyrgyzstan to Afghanistan and Pakistan. The project is being developed in cooperation with a number of multi-lateral financial institutions including the World Bank.

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greater degree of bilateral investments could enhance trade, facilitate production networks and strengthen bilateral relations. Exports in sectors such as agriculture produce, chemicals, textiles, auto components could be enhanced through bilateral investment. The GTAP simulations indicate the winning sectors in terms of rise in export from India to Pakistan such as chemical, rubber and plastic, food processing, mineral fuels (petroleum, coal products), metals, machinery and equipment, textiles, leather products, sugar, etc. In other words, SAFTA with enhanced trade facilitation will help firms in India and Pakistan with the opportunity to exploit economies of scale through access to an enlarged market. In view of bigger market size, MFN status to India would attract Indian FDI into Pakistan in these sectors, thereby facilitating intra-industry trade between the two counties. For example, the export of petroleum products from India to Pakistan is one aspect of trade relations which will benefit from the new arrangement.<sup>25</sup> Undoubtedly, there would be a huge expansion in the number of new opportunities for trade and commercial enterprise in the region. At present, Pakistan is the only country from which investment is barred after India dispensed with similar clauses for Sri Lanka in 2004 and for Bangladesh in 2007. Recently, Indian investors have shown willingness to invest US$ 20 to 50 billion in Pakistan’s mining, petroleum, energy, power and infrastructure projects.<sup>26</sup> Indian private sector has also shown eagerness to export electricity to Pakistan through Wagah-Attari border. After enhancement in trade ties, opportunities for big projects like gas pipeline project between Turkmenistan, Afghanistan, Pakistan and India will further increase.

# **5. CONCLUSION**

South Asia is the least integrated region in the world. This has slowed down the promotion of shared prosperity and the pace of poverty reduction (Ahmed and Ghani, 2008). Three of the poorest South Asian countries, Afghanistan, Bhutan and Nepal, are land-locked. Several lagging regions in the larger South Asian countries of Bangladesh, India and Pakistan are located in the border areas. Of 14 states in India that have borders with neighbors, 12 have per capita income levels that are at or below the national average (Arunachal Pradesh, Assam, Meghalaya, Mizoram, Nagaland, Tripura, Manipur, West Bengal, Bihar, Uttar Pradesh, Jammu and Kashmir, and Rajasthan). In Pakistan, per capita income is lower than average in the border provinces of NWFP, Balochistan, and rural Sindh. In Bangladesh, the border districts tend to have per capita incomes lower than the national average.

Typically, these sub-regions have poor connectivity within countries and with the markets in the neighboring countries. This, in part, explains why poverty mass in South Asia is concentrated in the lagging regions while economic mass is concentrated in the leading regions. Therefore, stronger cooperation between India and Pakistan would reduce the vulnerabilities of South Asia’s poor.

South Asia’s coming demographic transition and the fact that traditional advanced country partners have entered a prolonged slowdown provides a new momentum for regional integration. Demographic dividend and large domestic market could be the catalysts that attract global

> 25 Lakshmi Mittal, an Indian steel tycoon, has set-up a new oil refinery in the border city of Bhatinda in India’s Punjab state in association with India’s Hindustan Petroleum Corporation Limited. It will eventually have the capacity to supply large amounts of petroleum products to Pakistan.

> 26 According to, Pak-India Business Council (PIBC) Chairman Noor Muhammad Kasuri.

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production centers into South Asia, as firms move in response to wage differences, and globalization benefits low-income regions and countries.

The world has changed in fundamental ways since the global financial crisis of 2008. The recent headwinds from the Euro Area crisis have caused a deceleration in exports and a reversal of portfolio capital, and lowered GDP growth in developing countries. Some of these downside risks to growth and trade can be minimized through improved trade facilitation and increased South-South trade. Reducing the cost of trading will substantially increase the trade in goods, services, ideas, capital and movement of people and thereby increase regional growth.

The potential benefits of economic cooperation are undoubtedly obvious. Global examples of successful cooperation agreements reinforce the point that possible gains for India, Pakistan and other South Asian countries from effective cooperation and partnerships can be substantial. In particular, the experience of East Asia is illustrative of the potential gains from more and better cooperation. Cross-border physical connectivity has improved tremendously through land, sea and air-based transport network, private sector-led vertical integration of production networks has spurred industrial productivity and growth, and e-commerce is flourishing.

Poor logistics deter engagement in regional production sharing. Logistics encompass an array of essential activities for trade—including transport, transit trade, warehousing, cargo consolidation, border clearance, distribution, and payment systems. Trade facilitation and competitive trade logistics are fundamental building blocks of trade and economic development. Countries with better logistics can grow faster, become more competitive, and increase their investment. Better logistics have a greater effect on trade promotion than tariff cuts. That would benefit both firms and consumers, who would receive lower prices and support diversification into higher value-added exports and better services.

The cost of trading in South Asia is much higher compared to other regions. Indeed, several South Asian countries are ranked lower than Sub-Saharan Africa on the logistics performance index by the World Bank. India and Pakistan do not extend freedom of transit to each other or to international traffic in transit. Testing laboratories for trade between India and Pakistan in agriculture, processed food, chemicals, garments, are not available at borders. Customs authorities in South Asia still insist on print copies in case of cross-border transmission of trade documents.

While examining the alternative scenarios on the gains from trade, we find that what makes a MFN work is the trade facilitation that surrounds it. The results of the general equilibrium simulation indicate Pakistan’s MFN to India would generate larger benefits if it is supported by improved connectivity and trade facilitation measures. In other words, gains from trade would be small in the absence of improved connectivity and trade facilitation.

The idea of trade facilitation is simple-- implement measures to reduce the cost of trading across borders by improving infrastructure, institutions, services, policies, procedures, and marketoriented regulatory systems. The returns can be huge, even with modest resources and limited capacity. The dividends of trade facilitation can be shared by all. This is a subject for future research.

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