The presence of a trade agreement facilitates trade, but the absence of an agreement does not necessarily restrict trade, shows a new research on informal trade between India and Pakistan
The impact of uncertainty generated by the pandemic is felt globally on supply chains, trade, businesses and consumers. As countries close borders and resort to protectionist measures, the restrictions in the trade environment between any two countries cause traders to find alternate routes to trade. This is where intermediaries or third countries become relatively more important to reach markets which are difficult to penetrate otherwise.
When analysing bilateral trade flows, the gravity model of international trade is traditionally used, that considers several factors like the economic size of the countries, geographical proximity, cultural similarity, linguistic commonalities, common currency, etc. Though the gravity model is based on the idea that geographically proximate countries tend naturally to trade more with each other, trade in real world is not frictionless. There are several factors which jointly contribute in creating an environment which leads to trade friction. In some cases, trade-friction can arise due to inconsistent trade policies, domestic protectionism, illegal trade, non-tariff barriers, lack of infrastructure and connectivity, and more commonly, lack of trust between the trading countries and political tensions.
Traders in India and Pakistan, for example, often take the heat of such friction. The bilateral trade between India and Pakistan stood at USD 2.6 billion in 2018-19, which is far below the potential trade of USD 37 billion (Sanjay Kathuria, A Glass Half Full: the Promise of Regional Trade in South Asia, World Bank Group, 2018).
An increase in restrictions in the formal channel leads to a rise in trade through informal channels. For instance, in Africa, the average share of informal trade in the year 2009 was estimated at 43 per cent of the GDP which was almost equal to the formal trade (see, for example, Informal Cross-Border Trade and Trade Facilitation Reform in Sub-Saharan Africa, OECD, 2009). An informal trade assessment study conducted for Kenya in the year 2012 estimated that informal cross border trade accounted for more than 40 per cent of Kenya’s GDP, which was equivalent to the formal trade of the country. Besides Africa’s porous borders that facilitate informal trade, some of the key factors which result in a huge share of informal trade in African countries include high level of import duty on select commodities, inadequate infrastructure, cumbersome documentation and long custom procedures, among others.
A similar scenario is seen amongst the South Asian countries where trade barriers restrict the countries to achieve the potential level of trade. Political volatilities, high tariffs and non-tariff barriers, high transportation cost, inadequate infrastructure, and lengthy procedures exist, disrupting the flow of intraregional trade between these countries. Despite these barriers, intraregional trade between South Asian countries has increased over the years, but mainly through the indirect routes or informal channels. The presence of a trade agreement facilitates trade, but the absence of an agreement does not necessarily restrict trade. This is evident as informal routes like the UAE continue to exist to reroute India’s trade with Pakistan, despite the suspension of formal trade. Informal trade is estimated at 50 per cent of formal trade in South Asia, in which India and Pakistan contribute a significant share.
Our newreport, The Dubai Angled Triangle – Changing trend of trade between India and Pakistan via the UAE, focuses on informal trade between India and Pakistan via third countries like the UAE. According to our estimates, the value of total informal trade between India and Pakistan stood at USD 2.34 billion in 2018, with USD 1.76 billion in the direction of India to Pakistan, USD 528 million from Pakistan to India and USD 52.5 million worth of trade via khepias (or informal carriers).The UAE constitutes 92 percent of the total informal trade between the two countries. These estimates could be understated as informal trade, by its nature, goes unrecorded. Yet, the estimated trade values are similar to the trade recorded through the formal channels implying that the informal trade is at least as high as the formal trade in either direction.
Results of detailed surveys carried out for this research demonstrate clearly that trade through third countries has been flourishing, resulting into triangle shipments between India and Pakistan via Dubai. This reflects a continuous inclination of the trade fraternities on both sides towards doing business with each other. Goods exported via a third country become more expensive for the importer due to the increase in cost of shipment and transportation which is ultimately passed on to the final consumer. The restrictions on trade between India and Pakistan – like the negative list of imports from India to Pakistan, restricted positive list of commodities allowed for trade via the Wagah-Attari border, sensitive lists and paratariffs that are a barrier to SAFTA's functioning, lack of adequate infrastructure and logistics support for trade between the two countries etc. – have over the years pushed the informal trade further up.
Business, like water, never stops. Even after all the restrictions and barriers, goods find their way through third country routes, creating a parallel twin account of trade.
(Nikita Singla is associate director and Priya Arora is senior research associate at Bureau of Research on Industry and Economic Fundamentals (BRIEF), New Delhi. Views expressed are personal do not necessarily reflect those of Outlook Magazine)