Usman Khan: The balancing act in India-Pakistan Trade

Usman Khan Usman Khan
Adjunct Faculty, Department of Economics, Lahore University of Management Sciences
Policy Expert, DEVNEX (Pvt.) Limited

Even though both India and Pakistan are members of the South Asia Free Trade Area (SAFTA), established in January 2006, trade between them is strikingly small. Total trade (exports plus imports) between the two countries in 2011-12 averaged only a little over $2.5 billion. Currently, Pakistan accounts for less than 0.5 percent of India’s trade and India in turn represents a little over 3 percent of Pakistan’s total foreign trade, as compared with the very large shares of bilateral trade that existed following the independence of the two countries in 1947. At that time, 70 percent of Pakistan’s foreign trade was with India, while 63 percent of Indian exports went to Pakistan. There are a variety of reasons cited for the current low levels of trade between the two countries, with political differences, particularly following the 1965 and 1971 wars, being the main one. The granting of MFN status by India to Pakistan in 1996 did not improve the state of trading relations as Pakistan chose not to reciprocate the Indian overture. As such, trade between the two countries in 1996 was a mere $180 million. Finally, some fifteen years later, on November 2, 2011, the Pakistan government announced it was ready to grant MFN status to India. The Cabinet’s decision was a turning point in trade relations between the two countries and fulfilled Pakistan’s obligations as a member of the WTO. On February 29, 2012 the Pakistan government further announced that MFN with India would become effective in 2013. However, this deadline was missed, largely due to the opposition of important Pakistani stakeholders, in particular agriculturalists. The government of the Pakistan People’s Party (PPP) decided to postpone implementation of MFN until after the 2013 elections and let the new government take the final decision. While currently this decision is still awaited, there is general optimism that despite the reservations of some important stakeholders—farmers and the automotive and pharmaceutical industries—that MFN with India will come into effect. There are three main factors that have led to the change in Pakistan’s position on trade with India. First, the main political parties are generally supportive of a friendly and peaceful relations with India and favor stronger economic and commercial ties with its larger neighbor. This is certainly the position of the current government of the Pakistan Muslim League—Nawaz (PML-N). The steady slide of the Pakistani economy since 2008 has led to a general recognition that Pakistan’s long-term economic development and future prosperity are closely linked to its South Asian neighbors, and most importantly to India. This recognition emboldened both the PPP and then PML-N to revive talks on trade that had been broken off in the wake of the Mumbai terrorist attack in 2008. Second, the business community in Pakistan has been a strong lobby group for normalizing trade relations with India. This group includes traders, who are traditionally more supportive of freer trade, as well as medium and large industries where protectionist interests have historically been stronger. The Pakistan Business Council (PBC) has been leading this effort for a number of years and has played a key role in organizing meetings between Indian and Pakistani businessmen to discuss how trade could be increased and in which particular sectors and products. These meetings also led to the establishment in March 2013 of the Pakistan-India Joint Business Forum (PIJBF), consisting of 15 members of the business community from each of the two countries. The PIJBF principal task is the promotion of bilateral trade between India and Pakistan. Third, the Pakistan military’s views on increased economic integration of the two countries is obviously key to developing and improving trade ties. Ultimately, normalizing trade relations will depend on how the military is able to balance economic and security objectives. Until recently, there was a widespread perception that the Pakistan military was firmly opposed to trade with India on security grounds. But there have been recent signals from the military to both political and business leaders that the subject of trade with India is open for discussion. It appears that the military feels that all avenues to improving the economy should be explored, including expanding trade with India and thus supports the granting of MFN to India if it will help the Pakistan economy. At present majority of the trade over the land border is happening in the agriculture sector. The section below summarizes the joys and fears of Pakistani stakeholders in the agriculture sector.
Agricultural Trade Agriculture is a very important component in the economies of both India and Pakistan. The sector contributes a significant amount to GDP and employment of both countries. In terms of size, India’s agricultural production is more than five times that of Pakistan, yet Pakistan’s per capita production across major crops is substantially higher than in India. Although there are similarities in the structure of agricultural production across geographically contiguous regions of the two countries, there are major differences as well. While Pakistan has grown substantially in livestock production over the past few years, Indian agriculture has been dominated by the rise of cotton production that trebled in the last 10 years since its adoption of bio-genetic varieties. Moreover, the geographical and climatic diversity across the two countries is a major factor behind differences in variety and pattern of agriculture produce, creating considerable opportunities for trade. But perhaps the most important difference between the agriculture sectors of the two countries is their contrasting policy regime. Since 1947 India, driven primarily by the objective of achieving food security for its population, adopted and maintained an interventionist regime in agriculture. The state continues to subsidize agricultural inputs, provides price support for 24 crops and maintains high average applied tariff rates on agriculture. In contrast, Pakistan over the years has liberalized its agriculture sector which now has minimal state intervention. Market liberalization reforms have meant a gradual phasing out of subsidies and price supports and a reduction in agricultural tariff rates. The only crop procured by the government at a fixed pre-announced price is wheat; the rest are freely traded at market prices. From the standpoint of the agricultural sector of Pakistan this difference in policy regime creates an uneven playing field —Indian subsidies reduce costs of cultivation, distort prices and affect the direction and volume of trade. The other contentious issue is that of market access. High average tariffs on agriculture goods and non-tariff barriers (NTBs) on the Indian side, such as health and quality standards (SPS and quarantine standards), are cited as the major reasons for the relatively low Pakistani agriculture exports, despite India granting MFN to Pakistan in 1996. The non-issuance of visas for Indian Punjab is also highlighted as a major obstacle to trade in agricultural goods. Altogether, according to the World Bank, the Overall Trade Restrictiveness Index (OTRI) in agriculture in India was 69.5% compared to 5.8% for Pakistan. Despite the fact that Pakistan has not extended MFN and maintains a negative list on imports from India, both the overall and agricultural trade balance is still heavily tilted in India’s favor. The major agriculture imports from India have been cotton, refined sugar and more recently, fresh vegetables. On the other hand, the main agricultural export of Pakistan to India over the past two years has been dried dates (US$ 47.2 million in 2011). Exports of onions, shallots, shrimps and apricots have recently picked up but are still very small in terms of volume and value. Interestingly, trade in the major crops (wheat and rice) between the two countries is non-existent, largely because of the relatively high applied tariffs. An analysis of relative competiveness in agricultural products indicates that Pakistan has considerable potential in exporting to India. Various studies which have carried out Revealed Comparative Advantage (RCA) calculations show that Pakistan is competitive in citrus fruit, mangoes, apricots, peaches, olives, fish and fish products. These products have the potential to attract significant demand in Indian markets. Furthermore, India with its huge population ( of more than 300 million people belonging to the middle-class) offers a lot of opportunities for export of value-added agricultural processed fresh and preserved food, dairy products, juices and vegetable food supplements. Also, niche export market opportunities exist for vegetarian, halal, kosher and organic products. For the agricultural sector of Pakistan to realise the potential of trade with India, it is essential that the issue of market access be addressed in the bilateral trade negotiations between the two countries. The WTO compliant agricultural subsidies and price support given by the Indian government to its farmers is a domestic issue. Given the political economy of subsidy provision in India, it is highly unlikely that India would reduce these in the near future. Therefore, in the short term, what Pakistan needs to negotiate for is Indian reductions in both its applied MFN tariffs on agriculture goods and the specific agriculture-related NTBs that hinder Pakistan’s potential exports. Opening of the Indian market to Pakistan in these ways would go a long way in pacifying the agriculture lobby. Over the medium- to long-run, there is considerable opportunity of cross-border investments in agriculture and processed food, given the fact that there have been significant efforts to liberalize the investment regime in both the countries. Likewise, there is tremendous scope in trade and joint ventures/investments in inputs such as seeds and agricultural appliances. Moreover, with increased water scarcity and changing weather patterns, there is an urgent need for the two countries to resolve their outstanding water issues and treat water as a common resource. Finally both India and Pakistan should institutionalize research linkages to facilitate transfers of technology for more sustainable agricultural practices in the region.
In conclusion, there is now a wide consensus in Pakistan that opening up trade with India would on balance prove to be positive for the economy. Improved trade relations would allow producers in Pakistan access to a very large market that has been growing at over twice the rate experienced by Pakistan over the past few years. Pakistani consumers would benefit through positive trade creation and trade diversion effects, including lower prices for consumer goods and the availability of a greater variety of products. The government would earn more tax revenues as the trade going through legal channels increases. The agricultural sector would gain from better technology, access to higher quality seeds, and the availability of cheaper mechanized inputs. While historically protected firms, particularly in the automotive and pharmaceutical sectors, may lose out, there losses would be offset by the expansion of other smaller, modern and more competitive firms. Also, through use of India’s cheaper land routes, such firms could access the markets of other South Asian countries more easily and with lower transportation costs.