prospects for a south asian free trade agreement: problems and challenges

International Business Review 8 (1999) 399–419www.elsevier.com/locate/ibusrev

Prospects for a South Asian free tradeagreement: problems and challenges

Subhash C. Jain*

University of Connecticut, Box U-41M, 368 Fairfield Road, Storrs, CT 06269-2041, USA

Abstract

South Asia is a huge area with a population of over 1.2 billion people. Yet, trade betweennations in this region is meager. A South Asian Free Trade Agreement should help in boostingtrade in the region. Such an agreement will be mutually beneficial for all the South Asiannations. Unfortunately, the chronic enmity between India and Pakistan makes the trade agree-ment difficult. In spite of this, there are hopeful signs that some sort of trade agreement inSouth Asia may occur in the beginning of the next century. This optimism is based on thefact that seven nations in the region (Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan,and Sri Lanka) have entered into a Preferential Trade Arrangement called SAPTA whichbecame operational in December 1995. SAPTA may lead to a fully-fledged trade agreementonce the nations realize the benefits of market cooperation. As a large nation in the region,India must take the lead if ever South Asian Free Trade Agreement were to become a reality. 1999 Elsevier Science Ltd. All rights reserved.

Keywords:Regional economic bloc; South Asia; Free trade agreement

Belonging to a regional economic bloc has become an important route for nationsto achieve economic growth. There is NAFTA, the North American Free TradeAgreement with the U.S., Mexico, and Canada as the members. Across the Atlantic,there is the world’s biggest and most integrated bloc, the European Union. Fast-growing Asian nations belong to ASEAN, the Association of Southeast AsianNations. And then there is ANZCERTA, the Australia New Zealand closer Economic

* Tel: 1 860-486-4134; fax:1 860-486-5497; e-mail: [email protected].

0969-5931/99/$ - see front matter 1999 Elsevier Science Ltd. All rights reserved.PII: S0969 -5931(99 )00014-1

400 S.C. Jain / International Business Review 8 (1999) 399–419

Relations Trade Agreement; CARICOM, the Caribbean Common Market; andECOWAS, the Economic Community of West African States.

MERCASOUR, a relatively new trade agreement among South American nationsof Argentina, Brazil, Uruguay, and Paraguay, is making fast headway, and maysomeday include all Latin American countries. This kind of integration is slowlyspreading to another key part of the world; i.e., South Asia. Seven nations in theregion—Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, and Sri Lanka—haveentered into a Preferential Trade Arrangement called SAPTA, which became oper-ational in December of 1995. The arrangement is an umbrella framework of rulesproviding for step-by-step liberalization of inter-regional trade. The member coun-tries to the agreement hope that this initial measure should lead to a South Asia FreeTrade Agreement by the year 2000.

The purpose of this paper is to examine if: (a) the South Asian regional tradeagreement is workable despite the long-standing enmity between India and Pakistan;(b) the regional economic cooperation makes sense among countries that are basicallyvery poor; and (c) the regional agreement can help the member nations to emergeas a competitive force in the world market. The paper is divided into four sections.Section 1 summarizes the background information on the region. Section 2 probesthe emergence of the Preferential Trade Arrangement. Section 3 focuses on the SouthAsia Free Trade Agreement (SAFTA). Finally, Section 4 examines the implicationsof SAFTA for the region, and the world at large. The paper is based on thirty personalinterviews that I conducted with nineteen Indians, eight Pakistanis, two Bangladeshisand one Nepalese. The interviewees comprised fourteen corporate executives, eightpoliticians, five academics and three bureaucrats.

1. Economic background of the region

Although there is no formal definition of which nations comprise South Asia,usually the area includes the three developing countries of India, Pakistan, and SriLanka, and four lesser developed nations, Bangladesh, Nepal, Maldives, and Bhutan.Fig. 1 provides the basic economic information on South Asia. Two conclusionsbecome obvious, First, South Asia remains one of the poorest regions in the world,accounting for one-fourth of the world’s population, but with a gross national productof only 2% of the world’s total.

Second, India is a giant in the region, with Pakistan as another substantial nation.Apparently, cooperation between these two countries is a prerequisite for anyregional agreement in the area.

1.1. Regional trade

Intra-regional trade still accounts for less than 4 percent of the total trade of theSouth Asian nations, as shown in Fig. 2. Unfortunately, this figure has shown adownward trend in the last few years. Intra-regional exports of the South Asiancountries in comparison to their global exports showed as a declining trend from

401S.C. Jain / International Business Review 8 (1999) 399–419

Fig. 1. Key economic indicators of SAARC countries.

Fig. 2. Intra-SAARC trade in relation to the world.

about 5 percent in 1980 to less than 3 percent in 1995.1 At the same time, the intra-regional imports during the same period accounted for about 3.5 percent of theregion’s global imports. Fig. 3 lists intra regional trade statistics of the South Asiannations. Except for Maldives and Nepal, the intra-regional imports and exports ofthe region’s nations have remained low. The extremely low levels of intra-regionalimports and exports of the two large economies of the region, India and Pakistan,show how little they depend on the region’s market. Trade between Indian and Pakis-tan fares worse. As shown in Fig. 4, there there has been hardly any increase intrade volume between these two nations in the last ten years. For example, in 1980–

1 SAARC Secretariat, Kathmandu.


Fig. 3. SAARC countries’ intra-regional trade (as a percentage of total trade).

Fig. 4. Pakistan’s total trade with India (in millions of Pakistani rupees).

81, 3.29 percent of Pakistan’s total exports went to India. This figure declined to aslow as 0.51 percent in 1985–86, and recovered to only 1.28 percent in 1995–96.2

Pakistan’s imports from India accounted for as little as 0.04 percent in 1980–81,going up slightly to 0.66 percent in 1995–96. Pakistan’s trade with India accountsfor less than one percent of India’s total trade in the last fifteen years, despite India’ssubstantial increase in trade with the rest of the world.3

1.2. Market opportunity

At the time of its creation in 1947, Pakistan’s foreign trade with India was substan-tial, accounting for 56 percent of its exports and 32 percent of its imports. But theformal trade between the two countries was suspended in 1965, following the Indo-

2 Pakistan Economic Survey, 1995–96.3 Economic Survey of India 1996. New Delhi, India: Ministry of Finance.


Pakistani war (Naquash, 1994). By mutual agreement, however, limited trade wasrevived in the 1980s. The composition of bilateral trade has been mainly confinedto commodities. For example, Pakistan exported fruits, rock salt, cotton, and leatherto India, importing tea, spices, iron ore, dyestuff, and vegetable oil. However, thedollar amount of trade remained low.

Officially, India and Pakistan treat each other aslast resorttrading partners, failingto exploit the opportunity for trade in many products that could be bought at lowercosts and with shorter delivery time. Irrespective of the official restrictions, on theother hand, substantial illegal trade takes place between the two nations because themarket opportunity dictates it. It has been estimated, for example, that smuggledIndian goods—textiles, spices, coffee, tea, spare parts, small engineering goods,audiovisual cassettes, and other products worth several billions—are convenientlyavailable in Pakistani markets. Similarly, edible oils, dried fruits, and textiles fromPakistan are smuggled into India (Barua, 1995). Likewise, smugglers move jute andhides from Bangladesh to India, taking back consumer goods.

Apparently, there are potential opportunities for economic cooperation among theSouth Asian nations. Especially between India and Pakistan. Recent studies haveidentified a number of industries whereby trade and/or joint ventures between thetwo nations would be mutually beneficial.

Consider iron ore. Pakistan lacks iron ore for its steel mills, and thus is forced toimport the product. India is a major producer of iron ore, accounting for almost 20percent of the world production. But Pakistan imports iron ore from far awayplaces—Australia, Canada, Brazil—ignoring the savings that would accrue in trans-portation due to geographical proximity and the shorter delivery time. Similarly,Pakistan would rather import tea from Kenya, China, Bangladesh, Indonesia, andSri Lanka, where per kilogram prices are $3.25, $3.80, $2.46, $2.98, and $2.90,respectively; while the Indian price is $2.42 per kilogram and considered better inquality.4

Although India is a major producer of cotton, its production is subject to widefluctuations, forcing her to import cotton. Pakistan, another major producer of cotton,could be an excellent cotton source for India, ensuring steady supplies at stableprices. But India would rather buy cotton elsewhere. As a matter of fact, there aredifferent product categories in the area of cotton and related fibers which the twonations can buy from each other, and thus significantly strengthen their cotton textileindustries by exploiting the complementaries and taking advantage of the cost savingsfrom transportation via land routes.

Other products that Pakistan can import from India are aluminum, transport equip-ment, and industrial machinery. For example, the price of Indian aluminum is muchlower than the international price. Pakistan imports almost $50 million worth ofaluminum from Europe and Southeast Asia (Khan, 1994). India produces a varietyof commercial vehicles, passenger cars, two- and three-wheel scooters, diesel railway

4 “Economic Cooperation in the SAARC Region: Potential Constraints and Policies.” New Delhi, India:Research and Information System for the Non-Aligned and Other Developing Countries, 1990.


locomotives, and railway equipment designed to withstand the adverse infrastructurein developing countries. Pakistan can meet most of her transport equipment needsfrom India at competitive prices. In addition, the Indian suppliers can respond to herafter-sales service and spare parts needs better than exporters located far away. Like-wise, industrial machinery is conveniently available to Pakistan at a price 30 percentlower than the European price, yet Pakistan favors the latter.

India behaves no differently than Pakistan. India needs huge quantities of pig andscrap iron. Despite the fact that globally, Pakistan is the fifth largest producer ofscrap iron, India has not taken advantage of the low transportation costs of obtainingPakistani pig and scrap iron (Azhar & Amin, 1995).

Both India and Pakistan have Suzuki car assembly lines. A division of laborbetween the two countries could increase production and offer scale economies inmanufacturing components. The automobile industries in the two countries could setup a joint task force to develop strategies to become globally competitive.

Joint ventures and technology transfers among SAARC nations could expedite theprocess of industrialization in the region. India has accumulated enormous experiencein setting up, managing, and successfully running a wide range of industrial projects,both locally and in the Middle East and Southeast Asia, using intermediate tech-nology, which is appropriate in South Asia. The similarity of language, culture,environment, and administrative structures in India and Pakistan make these twocountries natural partners to form joint ventures useful for both countries. To makethe point, using India’s expertise, joint ventures can be set up in the region forcanning, preservation and packaging fruits, vegetables, breakfast foods, dairy pro-ducts, skim milk powder, starch and glucose, malt, instant tea and tea blends. Thereis also potential for setting up joint ventures in the manufacturing of vital drugs andpharmaceuticals and for chemical fertilizer and petrochemical plants.

Working together, India and Pakistan can successfully handle energy supply prob-lems in the region. The per capita consumption of energy in the region is very low.The power shortage is likely to be a major impediment to industrial growth. Toincrease power generation for local industrial requirements, Pakistan has opened upits energy sector to attract foreign investors. India possesses the manufacturing anddesign capability for large steam turbines and generators required for power gener-ation. Indian companies have supplied and erected several power projects all overthe developing world on a turnkey basis. Indian technology has also been adaptedto coal with a high ash content, a process that is especially suitable for countries likePakistan. Briefly, cooperation among South Asian nations can be mutually rewarding.

Regional cooperation is also feasible in the area of phosphate fertilizers, in whichall SAARC countries have a deficit. In Pakistan, large deposits of rock phosphateshave been discovered that can be used to meet the regional demand. India hasdeveloped technology that can be used to exploit the Pakistani phosphates in jointventures set up in Pakistan and/or India.


2. Origin of economic cooperation in the region

The origin of cooperation in South Asia goes back to May 1980, when the thenPrime Minister of Bangladesh proposed such cooperation. Except for India and Paki-stan, all the nations in the region endorsed the idea. India feared that a regionalorganization might provide an opportunity for its small neighbors to regionalize allbilateral issues and join each other to gang up against India (Dash, 1996). Pakistanassumed that it might be an Indian strategy to organize the other South Asian coun-tries against Pakistan and ensure a regional market for Indian products, thereby con-solidating and further strengthening India’s economic dominance in the region.Despite the initial cold reception from the two important nations in the region, Bang-ladesh continued its quiet diplomacy at various levels. And, finally, all nations autho-rized Bangladesh to prepare a working paper for discussion among the region’sbureaucrats. It took almost five years before all seven nations agreed to a regionalagreement entitled South Asian Association for Regional Cooperation (SAARC) inDecember 1985. The basic purpose of SAARC is to pursue mutual interests in agric-ulture, rural development, telecommunications, meteorology, health and populationcontrol, transport, sports, arts and culture, postal services, and science and tech-nology.

SAARC continues to evolve with new programs and institutions. Unfortunately,most SAARC programs exist on paper only with little implementation. But it doesprovide a forum for the political leaders of the member states to regularly meet eachother and informally examine matters of mutual concern.

Perhaps the single most important achievement of SAARC is the trade agreementcalled the SAARC Preferential Trade Arrangement (SAPTA) which came into forcein December 1995.5 SAPTA sets a special trade zone offering preferential tariff andnon-tariff treatment to member states, giving “Most Favored Nation” status to eachother, creating a payments union, and setting up the Regional Fund for Development.In addition, it contains provisions giving special treatment to the least developedcountries in the region.

A strategic aspect of SAPTA is not stipulating any pre-conditions for reciprocityor uniformity. A member country can unilaterally reduce its tariffs on imports fromall other member countries, or it may extend tariff privileges only to selected coun-tries. The decision not to improve reciprocity helped to reduce misgivings, parti-cularly in Pakistan, that India, the largest and relatively most industrialized countryin the region, would benefit disproportionately from the reduction of trade barriers.

To start with, the seven countries exchanged lists of goods on which they willoffer tariff preferences. India had the longest list (136 items), followed by Pakistan(39), Sri Lanka (31), Bangladesh (12), Maldives (3), Nepal (2), and Bhutan (2).

The initial list of 226 products has been expanded to 1500 products for concessionswhich took effect from March 1 1997 (Khan, 1997). In spite of progress, the trade

5 Text of Agreement on SAARC Preferential Trading Arrangement (SAPTA). Kathmandu, Nepal:SAARC Secretariat, 1995.


between countries of the region amounts to less than 4 percent of their total trade,and the items covered by the deal are a small fraction of even this.

3. Prospects for a South Asian free trade agreement

The South Asian Free Trade Agreement (SAFTA) will not be feasible without thewilling cooperation of India and Pakistan, the erstwhile adversaries. But free trade,and the mutual links and dependencies emerging from it, may lay the foundationfor settling political disputes between the two nations.

A free trade agreement, compared to bilateral and multilateral trade agreements,is more conducive to trade expansion. For example, India and Pakistan are signatoriesto various multilateral preferential trade agreements, such as the GATT Protocolson Trade amongst Developing States, Commonwealth Preferential Tariff System,and the South Asian Preferential Trade Agreement. But they had little effect onincreasing their bilateral trade. At the same time, significant opportunity exists forfree trade between the two nations. In 1995, for example, the two-way trade betweenIndia and Pakistan amounted to $180 million, which, in the light of their global tradeof $88 billion, is ridiculously low.6 Economic cooperation flourishes when membercountries have diverse products and raw materials. Nations in South Asia have, moreor less, complementary economies, diverse industries, different natural resources,and varying agricultural bases. Pakistan can export pig and scrap iron, raw cotton,fruit and fruit products, rock-salt, leather goods, cotton fabrics, cotton yard, pet-roleum products, and miscellaneous manufactured products all of which India cur-rently imports from far away places. India, on the other hand, can export tea andcoffee, iron ore, aluminum, transport equipment and industrial machinery (forexample, textile machinery) to Pakistan. In the latter half of the 1980s, Pakistanhad identified 573 products, which were importable from India. Similarly, India hadannounced a list of 780 products, which could be bought from Pakistan. Recentstudies have identified additional products, which could be traded between the twocountries (Vinod, 1990). In other words, the two countries have complementary econ-omies, which augurs well for bilateral trade. On an official level, however, thesecountries are failing to exploit the full potential for trade in a range of products thatcould be bought at lower costs and with shorter delivery time. With formal tradingchannels blocked, “unofficial trade” between the two countries has flourished, run-ning into billions of U.S. dollars (Vinod, 1996). Smuggled Indian goods such astextiles, spices, coffee, tea, spare parts, small engineering goods, and audiovisualcassettes, can be bought with ease in Pakistani markets. Pakistani products such asedible oils, dried fruits, and textiles, conveniently make their way across theIndian border.

Similarly, Bangladesh can export tea, newsprint, jute goods and leather to Pakistanwhile importing textiles, cement, light engineering goods and railway rolling stock.

6 Pakistan Economic Survey, 1995–96, and the World Bank Development Report, 1997.


India will find it useful to import urea, sponge iron, semi-processed leather, andnewsprint from Bangladesh. At the same time, Bangladesh’s need for manufacturedgoods such as steel, chemicals, light engineering goods, capital goods, coal and lime-stone can be met by India.

Thus, economic complementarily is not a problem among South Asian countries.What is lacking is the political will to make the joint effort toward free trade, and,in turn, improve the economic conditions in the region.

4. Potential benefits of free trade in South Asia

As a result of free trade, a number of benefits are likely to accrue to the entireregion. These benefits will not only strengthen the economics of South Asian nations,their political clout in world affairs will increase as well.

4.1. Market efficiencies

A free trade agreement in South Asia will permit countries to obtain productioninputs from each other at lower prices and at the same time save on transportationcosts due to their geographic proximity, resulting in huge savings. As mentionedabove, Pakistan can meet its iron ore needs through imports from India much moreeconomically than buying from far away places such as Australia, Canada and Brazil.Similarly, India would benefit through procuring scrap iron from Pakistan rather thanSouth Korea. Not only are the prices lower in the neighboring country, savings intransportation from the geographic proximity and shorter delivery time would betremendous.

India’s large market offers tremendous opportunities for Pakistani consumer goodsindustries to realize economies of scale and tap the market not only in India, butcompete in other global markets as well. At the same time, Pakistan’s 130 millionconsumers offer a captive market for Indian industries. In addition, free trade willincrease competition among companies in the region, forcing weaker players to quit.The enhanced competition will enable consumers to obtain quality products andlower prices (Mukherjee, 1992).

4.2. Macro-economic impact

At the macro-economic level, productivity in the region will increase, leading tohigher economic growth and higher employment. The merchandise trade deficits,particularly that of India and Pakistan, may decline as their imports are divertedfrom costlier third sources to cheaper bilateral ones.

4.3. Global economic clout

The global trend towards regionalization of trade makes it difficult for individualnations to boost trade. By eliminating trade barriers in a trade bloc, the member


states provide each other’s exporters a competitive advantage over outside exporters.The disadvantage that the outside exporters face increases with the levels of the tradebloc’s external tariffs: the higher these levels, the more costly the products from theoutside exporters will be in relation to goods exported by the trade bloc membersto each other.

Textiles and apparel constitute the largest export item for both India and Pakistan.In the 1980s, global competition in the industry increased, with many countriesentering the market. Privileges available to members within a trade bloc put anadditional burden on India/Pakistan exporters. In addition, restrictions are imposedon their exports on pretexts such as dumping, circumvention of export quotes,infringement of copyright laws, and intellectual property rights laws and concernsover environmental issues and child labor. Such restrictions have had a significantnegative effect on textile and apparel exports from the subcontinent. Further, tradeblocs coordinate their external trade policies to ensure access to each other’s marketand thus safeguard their competitive positions. In such an environment, India andPakistan are squeezed from all sides in an industry that has been crucial to theirexport earnings. Together, they account for about 1–2 percent of global trade, andthus their economic and political clout is too marginal to allow them to individuallyor jointly seek trade concessions in global markets.7 By establishing a South Asiantrade bloc, and by concentrating efforts on progressively expanding bilateral tradeto the maximum attainable extent. South Asian nations will be able to deal withother blocs for reciprocal arrangements with built in strength.

4.4. Taking advantage of the SAPTA progress

As mentioned above, after struggling for ten years, the South Asian Associationfor Regional Cooperation (SAARC) took a concrete measure to strengthen economiesof the region through the South Asian Preferential Trade Arrangement (SAPTA).The SAARC member nations have endorsed the progression of SAPTA to the SouthAsia Free Trade Agreement by the year 2000, which can be deferred to the year2005. In other words, a foundation has already been laid to establish a South Asiafree trade area, and it would be a mistake for the nations to let the opportunity pass.As a matter of fact, leadership in the member nations should avoid making decisionsthat may discourage the free trade agreement.

As the free trade agreement is fully established, SAARC will become stronger.This will augur well for the member countries to find solutions to their difficultpolitical problems, including the dispute over Kashmir.

As the regional trade expands, particularly bilateral trade between India and Pakis-tan, the economies of South Asian nations will progressively integrate. Once thebenefits of integration become larger and more evident, the policymakers willbecome aware of the importance of sustaining and further consolidating economicand political ties. These ties should help in subsiding mutual suspicion, paving the

7 The World Bank Development Report, 1997.


way for an amicable resolution of outstanding disputes. The governments in theregion will be prompted to start channeling resources away from defense establish-ments to the grossly neglected areas of infrastructure, education, and other develop-mental spheres.

To illustrate the point, during 1996–1997, Pakistan allocated 26 percent of itsnational budget to defense, which exceeded the country’s entire development budget.If the defense spending had been invested in development projects, it would havebeen sufficient to construct 100 000 primary schools in rural areas, educating 23million children, and install over 500 000 tube wells.8 For India, higher figures wouldapply given that its defense allocations are much higher than Pakistan.

4.5. Making it attractive for MNCs to invest in the region

Foreign direct investment by MNCs has become an attractive source of capitalfor developing countries worldwide. With the liberalization programs that almostevery developing nation seems to be pursuing, MNCs have many more alternativestoday to decide where they want to invest. South Asia as a region has not fared wellin attracting MNCs when compared with China, Southeast Asian Tigers, and evenLatin America. The Free Trade Agreement will open a huge market for potentialinvestors to serve. The region offers several advantages crucial to attracting foreigninvestment, such as low inflation rates, a good industrial base, abundant rawmaterials, English-speaking skilled labor force, and modern financial systems, alongwith a growing middle class. The commitment of the governments in the region toconsolidating their macro-economic policies for liberalization and deregulation, andcooperating with each other to create a free market will make the region more attract-ive for the MNCs as they seek new investment opportunities. South Asia couldemerge as the hub to access lucrative markets of central Asia, the Middle East, andSoutheast Asia.

5. Problems and challenges

Conceptually, establishing a free trade agreement in South Asia appears attractive.However, a number of problems hinder the realization of the agreement. These prob-lems pose challenges for the political leaders to tackle. Especially, India will haveto play a lead role in building confidence among its neighbors in various ways ifthe goal of free trade agreement it to be accomplished.

5.1. Trade barriers

The two major nations in the region, India and Pakistan, impose heavy tariff andnon-tariff barriers which must be drastically reduced for the free trade area in the

8 The News. Karachi, Pakistan, September 13, 1992.


region to become a reality. Fortunately, the tariff barriers (e.g., customs duties,import surcharges and taxes, countervailing duties) have been progressively decliningin response to the import tariff rationalization programs pursued by the two govern-ments; as a part of the structural adjustment programs imposed by the World Bankand the IMF as lenders; and due to the commitments obligated under the 1995 WorldTrade Organization Accord.

For example, India’s maximum import tariffs of 300 percent in 1991 declined to55 percent in 1995 (Mukherji, 1996). Pakistan’s maximum import tariffs declinedfrom 125 percent during the same period to 65 percent. Over time, these rates areexpected to decline further since the Uruguay Round Agreement stipulates an importtariff ceiling of 35 percent.

5.2. Availability of trade-related information

Exporters and importers in the region find it difficult to seek reliable, quick, inex-pensive and timely information on trade-related matters. These include product speci-fications, technologies, prices, exportable surpluses, manufacturers and distributorsof goods, domestic production and consumption patterns, market structures, industrialtrends, tariffs and non-tariff barriers, trade regulations and procedures. In addition,stringent travel restrictions between India and Pakistan have prevented the develop-ment of contacts and hindered the exchange of information among the business com-munities in the region. Such lack of information has forced the importers to sourcethe goods from faraway nations while they could have been imported from a neighb-oring country at a much lower price.

5.3. Communication and transportation limitations

Between India and Pakistan, trade is restricted by the non use of connecting surfacecommunication links. All roads linking India and Pakistan have been closed forsecurity reasons. Trade is permitted only via rail and sea routes. Further, rail-basedtrade, confined to a single track, is hindered by a shortage of cargo wagons, irregularservice schedules, and time-consuming border customs and security clearance for-malities.

5.4. Industrial disparity between the regional giants

One of the biggest problems that discourages trade between India and Pakistan istheir industrial disparity. India has a distinct superiority over Pakistan in terms ofsize, diversity and competitiveness. To begin with, India inherited a solid industrialbase from Britain. In addition, its established banking system, substantial resourcebase, and its policy of vigorously pursuing industrialization through local efforts andthrough “Indianization” of imported technologies has enabled it to emerge as a large,diversified, and fairly sophisticated manufacturing base capable of producing a broadspectrum of goods for domestic consumption and export. On the other hand, Pakistaninherited a small, predominantly cotton-related industrial base, and virtually no bank-


ing system. Although Pakistan has come a long way since independence in the lastfifty years, its industrial prowess lags behind India. This disparity is especially evi-dent in the industrial goods sector where India has attained virtual self-sufficiencyin the production of equipment and components for power generation, construction,mining, textiles, and in manufacturing products, automobiles, consumer electronics,appliances chemicals and pharmaceuticals.

India’s superiority in the industrial sector has made it a low-cost producer of mostgoods compared to Pakistan. Since India’s industrial base is larger, Indian companiescan obtain most of their value-adding inputs from cheap domestic sources whilePakistan must import them at a much higher price. Further, labor costs, utilities(electricity, gas, telephone) and bank lending rates are comparatively lower in India.Also, the Indian government provides its industries and exporters comparativelysuperior fiscal incentives and institutional assistance (Khan, 1997). In addition, thelarge size of the India market provides its companies scale economies. Because ofthese factors, business lobbies in Pakistan express concern that free trade in theregion will lead to Indian goods flooding the Pakistani markets. Many influentialpeople in Pakistan feel that India may eventually transform Pakistan into its extendeddomestic market, leading to India’s economic domination and the political hegemon-ization of Pakistan.

It is also argued that India would be the main beneficiary of foreign direct invest-ment attracted by the unified South Asian market. India possesses distinct advantagesover Pakistan in areas often considered crucial in making foreign investmentdecisions by MNCs. The gravitation of foreign direct investment to India as a resultof the South Asian free market agreement would expand India’s industrial sectorand its trade surplus with Pakistan. India will add to its industrial base, especiallywith world-scale manufacturing units and technology-intensive industries opting tolocate in India instead of elsewhere in South Asia. Eventually, India will become atruly economically modern nation at Pakistan’s expense. This directly conflicts withPakistan’s goal of attaining economic equality with India.

5.5. Political differences

The Hindu–Moslem enmity in the sub-continent is a legacy of the centuries.As a result, the mutual distrust and suspicion between India and Pakistan is thebiggest hurdle to the expansion of trade and economic ties. The Kashmir problemlies at the core of their conflictive relationship. Pakistan is concerned about India’sconventional military superiority and its large military/industrial complex. Thescramble by India and Pakistan to acquire nuclear weapons capability has intro-duced another ominous dimension to their relationship. Finally, reactionary andchauvinistic political forces in both states and irresponsible reporting in both printand electronic media have contributed to the climate of mutual distrust and hos-tility. Against the background of deep-rooted political differences, prospects ofeconomic cooperation between India and Pakistan or for that matter in the regionare bleak.


6. Recommendations for policymakers

Examined above are the problems and challenges that must be faced before theSouth Asia Free Trade Agreement could be implemented. The crux of the matter isthat India and Pakistan must be fully willing to go along with the agreement. Thisis feasible only if measures can be taken that are responsive to their concerns. Ineconomic terms, both India and Pakistan should be net beneficiaries along with othernations in the region in a free trade area framework. In other words, for each nationthat benefits must exceed the costs. In no case should the benefits accruing to onenation be disproportionately large at the expense of other members. The recommen-dations discussed below incorporate this basic consideration.

6.1. MFN status for India

Both India and Pakistan are signatories to the Uruguay Round Agreements. Assuch, each nation should accord Most Favored Nation (MFN) status to the other.While India has done so, Pakistan, taking advantage of GATT/WTO provisionswhich permit member states to restrict or even prohibit the imports of goods fromother member states under certain circumstances, has not reciprocated. It has, how-ever, extended MFN status to other South Asian nations.

Economically speaking, assigning MFN status to India will be beneficial for Pakis-tan. Pakistani companies will be able to import industrial inputs, equipment andconsumer goods from India at substantially lower prices than they pay to their currentsources from other nations (Khan, 1996). Further, the restrictions on imports fromIndia are not effective anyway, since the Indian goods are trans-shipped to Pakistanthrough intermediaries based in Bangladesh, Hong Kong, Singapore, the United ArabEmirates, or smuggled directly into Pakistan across the long land border. The MFNstatus would preclude resorting to trans-shipments, making Indian goods cheaper forPakistani consumers. At the same time, smuggling would be cut down, ending thecustoms revenue loss to the government. Above all, Pakistan will be able to meetits obligations under the Uruguay Round in an atmosphere of friendship. Indian couldlodge a formal complaint against Pakistan to WTO’s dispute tribunal. Should thathappen, Pakistan may be forced to accord MFN status to India, failing which it mayend up facing trade sanctions by other WTO members or asked to leave the organiza-tion. Thus, Pakistan can ill afford postponing the decision on MFN status for India.

6.2. Tariff barriers

To a very large extent, the way tariff barriers are proposed to be eliminated willdetermine if the South Asia Free Trade Agreement will become a reality. Normally,the approach that nations follow in establishing a free trade agreement is to specifytime limits for the elimination of tariffs in order to minimize the risk for the weakerindustries in different nations.

SAARC should establish a working group to determine tariff reduction schedulefor various goods/industries, giving consideration to strengths and weaknesses of


each nations, and whether their industrial bases are structurally similar or dissimi-lar. At the same time, India and Pakistan should jointly establish a task force inwhich different groups, different government departments such as finance, indus-try, commerce, customers, etc., and private sector representatives from the twonations could work out a mutually acceptable free trade arrangement betweenthem. Needless to say, the people on the task force should be dedicated and haveexperienced hands committed to making the free trade agreement a reality. Thetask force should be jointly headed by the Prime Ministers of the two countries.The conclusions and recommendations of the task force on tariff barrier elimin-ation between India and Pakistan should be submitted to the SAARC workinggroup. The working group will accommodate the requirements/concerns of othernations within the India/Pakistan tariff reduction proposal to develop a South AsiaProgram for tariff reduction.

6.3. Non-tariff barriers

At the same time that a schedule for eliminating tariff barriers is determined, thenon-tariff barriers that hinder trade among South Asian nations should be examinedas well. India, in particular, imposes heavy non-tariff barriers on imports fromneighboring countries. A list of all non-tariff barriers should be compiled and allparties should agree to a timetable to phase them out over a period of two years.

6.4. Rules of origin

It is conceivable that importers, particularly in India and Pakistan, may use thefree trade agreement as a means for circumventing high import tariffs and non-tariff barriers applicable on goods imported from third states. For example, Indiancompanies may seek to route their imports from a third state through Pakistanrather than import directly into India, if India imposes higher duties than Pakistanon goods from the third country. This will result in customs revenue loss for India.This applies to other signatories to the South Asian Free Trade Agreement as well,including Pakistan. To safeguard against such deals, a system must be designedto minimize the import diversion risk. Therule of origin is an effective methodthat has been widely used by other nations to prevent import diversion. It meansthat a product must have a minimum specified percentage of local content to beeligible for duty-free entry into other countries linked by a free trade agreement.The rules of origin may have to be industry-specific and may have to be differentfor different nations, since their strengths vary due to size, industry base andavailability of raw materials.

6.5. Provision for disadvantaged industries

As indicated above, the SAARC membership includes giant India with a well-established industrial sector; Pakistan with a tolerable industrial base; Sri Lanka,small in size, but economically better off than the rest; and the remaining four coun-


ted among the least developed nations of the world. Thus, it is possible that asthe Free Market Agreement takes shape, Indian companies may gain a comparativeadvantage over companies in the other countries. For example, an Indian companyfrom a position of competitive parity may gain a comparative advantage over aPakistani company, resulting, say from an abrupt increase in the latter’s manufactur-ing cost. The Pakistani company may become non-competitive and its survival maybe threatened. In such cases, a protective mechanism needs to be devised to protectdisadvantaged companies in the transitional period.

6.6. Intergovernmental rules and regulations

Most South Asian countries impose rules, regulations and procedures for tradethat are confusing and counterproductive. Thus, each nation in the region needs tostreamline the requirements for customs clearance, quality control, pre-shipmentinspection of goods, opening of letters of credit. Each aspect of trade should besimplified and standardized. Consider arbitration, for example. Simplified proceduresshould be established to arbitrate in bilateral trade disputes. The proceedings shouldbe fast and the decision binding, and, as necessary, it should be backed up with harshsanctions against errant traders to deter them from reneging on their commitments.Similarly, time-consuming visa issuance procedures and such requirements as themandatory police reporting for visitors and their confinement to specified territoriesshould be scrapped. These procedures are especially harsh in the case of India forPakistani visitors and vice versa. Both the countries should abolish visa requirementsfor each other’s citizens.

Further, India and Pakistan should reopen their overland highways for bilateraltrade and take measures to keep the highways in good repair for enhancing vehiculartraffic capacity. Similarly, air and shipping links between the South Asian nationsshould be expanded and overhauled. In addition, charges for freight shipment, cargoclearing and storage at all ports must be eliminated or at least drastically reduced.By the same token, telecommunication (telephone, fax, telex, and electronic mail)links and postal services must be consolidated and their applicable tariffs sufficientlycut down.

Each country should provide other nations in the region the right of trade transit.For example, India should grant Pakistan the right of trade transit through its territoryto facilitate Pakistan’s trade with Bangladesh, Bhutan and Nepal. Pakistan may recip-rocate by providing India the right of trade transit to Central Asia markets.

Ongoing contacts should be encouraged between banks in each country. Forexample, the nationalized banks may be asked to open branches in neighboring coun-tries on a reciprocal basis. Further, each government through its central bank shouldgenerate sources of import/export credit at concessional rates to traders.

Also, contacts between chambers of commerce, schools of business, and trade andindustry bodies in different countries in the region should be developed. SAARCcould set aside funds to promote such contacts.

Finally, efforts should be made to establish and update the South Asian trade databank. This will become the common source of information for traders in the region.


Access to the trade data bank should be free of charge and its use should be encour-aged through training seminars and publicity.

7. Opportunities for additional economic ties

The successful conduct of SAPTA should lead to further economic cooperationin the region. For example, capital technology, know-how, labor and managerialtalent available in the region can be pooled through joint ventures to boost industry.Private companies both small and large, should be encouraged, particularly those inIndia and Pakistan, to embark on forming different kinds of joint ventures. As amatter of fact, joint ventures can also be formed among public sector companies inthe region to consolidate economic links among the members.

India, in particular, has a variety of experiences in forming joint ventures acrossnational boundaries. An Indian Chamber of Commerce and Industry study showedthat India at the end of 1994 had been engaged in 524 joint ventures in 69 countriesin such fields as light engineering, steel, chemicals and pharmaceuticals, glass,cement, paper, leather, rubber, textiles and allied products, and food processingindustries. Some of these joint ventures were highly capital intensive and technologi-cally challenging. Pakistan has also implemented a few joint ventures primarily inlight engineering, sugar, textile and apparel industries. Together, companies belong-ing to India and Pakistan can form joint ventures for their mutual benefit. But givenIndia’s much larger resource base, Indian businesses should take the initiative inpursuing the joint ventures. Indian technologies, although comparatively less sophis-ticated than those utilized by industrialized countries, are more appropriate for con-ditions in South Asia because they are much cheaper, easier to maintain, and gener-ally are more labor intensive.

Different kinds of joint ventures can be formed to increase economic activity onboth sides of the border, indeed in the entire SAARC region. One possibility is theimport-substitute ventures India can help other countries in the region to establishmanufacturing joint ventures to produce products that they currently import. Thiswill help these countries to reduce imports, conserve foreign exchange and curtailthe merchandise trade deficits. One problem with these types of joint ventures isIndia’s loss of potential export market in the neighboring countries. To take care ofthis problem, preference should be given to producing products that India mainlymanufactures for domestic consumption. Countries in the region, India and Pakistan,for example, may promote joint ventures to manufacture products for export. It isbetter if these ventures are located outside India. This will help the smaller countriesto diversify their export base. Since India’s export base is more diversified, it shouldnot pose any challenge for her. Competition with the neighbors is unlikely toadversely affect demand for Indian goods in its export markets (with the exceptionof textile goods and ready-to-wear apparel) since the products in question can betargeted to new segments. In addition, since the proceeds from the exports of thejoint-ventured products will partially accrue to Indian partners, no conflict of interestfor India should arise. Countries in the region can also form linking joint ventures


to manufacture different components of capital and consumer goods. For example,for fractional horse-power motors, motors could be produced in one country whilethe rest of the components in the other country with each country buying each other’sproducts to assemble the complete motor for the domestic market, as well as forexport. Such joint ventures will facilitate interweaving of production processes andthereby enhance the structural integration of the economies in the region. Fig. 5identifies fields where joint ventures between Indian and Pakistani companies couldbe mutually beneficial. Efforts should be made, probably at the level of SAARC, toidentify industries for forming joint ventures with other countries in the region.

For joint ventures to become a reality, the governments of India and Pakistan willhave to take the lead in establishing a congenial environment for businessmen inthe two countries to make positive responses, and to set examples for other nationsin the region to follow. The two governments should issue a joint policy declaration,backed by an assurance from their parliaments, assuring the security of investmentsand noninterference in the operations of the joint ventures. This will eradicate any

Fig. 5. Perspective India–Pakistan industrial joint ventures.


apprehensions among companies of losing their investments in the event of height-ened political tensions between India and Pakistan.

In addition, rules and procedures for joint ventures should be simplified and stan-dardized. To encourage companies in the two countries to form joint ventures, apackage of fiscal and institutional support measures should be offered. These shouldinclude: custom duties, exemptions on production inputs imported from third states,tax exemptions, elimination of restrictions on the bilateral transfer and repatriationof capital and remittances of dividends, the signing of an accord for avoidance ofdouble taxation, and more. Companies will require substantial funding to implementan extensive program of joint ventures. Initially, the commercial banks in the twocountries may be hesitant to provide funding for Indian–Pakistani joint ventures.Therefore, their central banks should establish and administer a regional joint venturepromotion fund to provide credit to perspective joint venture partners on soft termsand conditions.

Finally, an agency should be established to collect and disseminate informationon joint venture opportunities in the region, aid in the institutional and legal for-malities required to establish joint ventures, and coordinate help and assistance avail-able from different sources to implement them.

8. Conclusion and implications

A free-trade agreement among the South Asian nations will pave the way forfaster growth. This paper has identified a number of areas for trade among theSAARC countries for their mutual benefits. Similarly, industries in which joint ven-tures can be formed have been singled out. Suggestions have been made to makethe free trade agreement feasible in the region. In brief, both global economic forcesand regional facts and figures justify that countries in South Asia should enter intoa regional market agreement such as the South Asia Free Trade Agreement.

Unfortunately, in light of low level of mutual trust, spillover effects of the ethnicand religious conflicts and the magnitude of bilateral disputes in South Asia makethe free trade accord infeasible. As long as political tensions remain unresolved, anyform of regional cooperation in South Asia will remain difficult to achieve. Even ifan agreement is struck, its implementation and hence the resulting benefits will belimited. SAARC experience shows that in the midst of deep-rooted political differ-ences only a “stop-and-go” pattern of cooperation is feasible in which limited prag-matic cooperation on specific techno-economic issues is possible over a period oftime.

The only hope is that economic benefits that a trade agreement promises may forcethe leaders to keep aside the political differences and pursue economic cooperation tothe fullest extent. As the economic cooperation in the form of intra regional tradeand joint ventures bears fruit, probably political tensions can be subdued by economicprosperity all around.

Recent proceedings of the SAARC meetings offer evidence of the willingness ofSouth Asian nations to enhance regional economic cooperation. The discussion to


create SAFTA before the turn of the century is a hopeful sign. Assuming this hap-pens, the success will depend on carefully addressing the following issues. First, thegovernments in the region as well as institutions (e.g., media) will have to createconditions that enhance cooperation and understanding. For example, travel betweencountries should be made convenient. The press and other media should avoid high-lighting small confrontations. Second, given the large heterogeneity in the region inlevels of economic development, economic cooperation should be planned in sucha fashion that all nations benefit. India, the largest economy in the region, will haveto make sure that its efforts to seek global competitiveness and attract foreign invest-ment are designed to benefit the entire region. Third, the free market agreement goalsshould be realistic. Setting unrealistic intra regional trade is likely to be counterpro-ductive. It is better to pursue modest trade objectives and seek joint economic devel-opment projects of modest scale.

The first step toward liberalizing trade in the South Asian region was taken inJanuary 1999 when India and Sri Lanka signed a bilateral free trade agreement.Hopefully, this agreement will pave the way for other countries in the region tomake bilateral trade agreements with each other, which ultimately could become themodels for the entire region to finalize the proposed South Asian Free Trade Agree-ment (SAFTA) (Jayaram, 1999).

Finally, for the free trade agreement to become a reality in the region, it is neces-sary that interests of the small countries be duly protected. In other words, theregional free trade should not predominately benefit India and Pakistan at the costof other nations. This is feasible if the larger countries show willingness to be sensi-tive to the needs of their smaller neighbors. For example, Indo-Sri Lankan free tradeagreement requires India to phase out tariffs on 1000 items in three years, while SriLanka would take eight years to remove tariffs on a range of Indian imports. Suchflexibility will underwrite the concerns of smaller economies in the region.

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