India and Pakistan are the two largest economies in South Asia region in terms of economic size and population. In the immediate aftermath of independence trade and commercial ties between both these countries were quite strong. However, political challenges to the India-Pakistan bilateral relationship led to worsening trade relations to the extent that today these two neighboring countries have very little bilateral trade between them when put in the relative perspective size and potential of their economies.
Attempts to improve trade ties bilaterally and through the regional forum of South Asia Free Trade Agreement (SAFTA) has not made much progress as several tariff and non-tariff barriers to bilateral remains in place. Moreover, the transaction costs of trading between the countries remain high due to a variety of reasons related to logistical impediments, procedural inefficiencies, and lack of business to business relationships. The business communities of both countries have also not been able to leverage each other's financial, technological, and managerial resources and expertise given the several barriers to investment that are currently in place. Such lack of investment-led relationships has impeded the development of meaningful cross-border supply-chains and has not allowed the development of large-scale infrastructure and energy projects of mutual benefit to both countries.
However, there is a thriving informal trade relationship between the two countries which is several times the official trade figures. The prime reason for emergence of informal trade is of high costs associated with formal trade which leads to diversion from formal to informal channels. Moreover, the existence of this informal trade is in itself proof of the potential for trade and existence of demand for each other's goods and services in both countries.
If India and Pakistan work together on allowing greater bilateral trade and investment it would benefit the entire South Asia region and create economic opportunities in a region that have significantly high levels of poverty. Such bilateral cooperation will also open the door for greater cooperation on other critical areas like development of energy corridors linking South and Central Asia and development of a Pan-South Asian transport and logistics infrastructure.
This working paper provides a brief insight into these issues and is divided into four sections. First section reviews the current status of bilateral trade. The second section presents the status of informal trade. The third section proposes some of key areas for cooperation which should be tapped for deriving maximum gain out of India-Pakistan bilateral trade. The last section provides set of suggested action points for furthering the India-Pakistan economic cooperation agenda.