India and Pakistan are the two most populous countries in South Asia with enormous potential for trade and commerce; despite sharing more than 3300 km of land, they have a complex trading relationship marked by ups and downs primarily due to political tensions between the two countries.

The purpose of this article is to analyze the evolving trade dynamics between India and Pakistan, focusing on direct trade and indirect trade conducted through third-party countries. This Article aims to explore the impact, and challenges associated with India Pakistan trade and how it can improve the living standard of people across the border.

India Pakistan Bilateral Trade

Since independence, India and Pakistan have maintained trade relations, but significant achievement was made in the late 1990s. India unilaterally conferred Most Favored Nation (MFN) status upon Pakistan in 1996, it helped in the steady increase in trade volumes throughout the early 2000s. A further shift toward trade rationalization occurred in March 2012 when Pakistan moved from a restricted positive list to a more flexible negative list regime of trade with India. This paved the way for a progressive move towards greater economic and trade integration with both neighbours.^[1]

Bilateral trade (in millions US$)

Source: Ministry of Commerce and Industry, GOI^[2]

India and Pakistan have three channels of trade, namely, direct trade, Cross-LoC trade in Jammu and Kashmir (J&K) and indirect trade.

a) Direct Trade between the two countries flourished before 2019, but political tensions arose in 2019, and both countries imposed high taxes and duties on each other’s imports and exports, limiting the volume and scale of trade. The table below clearly indicates the decline in direct trade^[3]:

In 2018-19, total trade was $2,561.50 million, which declined to $647.21 million in 2022-23. India’s exports decline from $2,066.63 million to $627.1 million, while imports from Pakistan drastically declined from $494.87 million to $20.11 million. Main reasons behind this decline include India revoking Pakistan’s Most Favoured Nation (MFN) status, Pakistan suspending bilateral trade, and the imposition of high tariffs. Both countries have since turned to alternative trade routes. The economic impact has been particularly severe for Pakistan, affecting industries like cement and textiles, while India has diversified its imports. Future trade revival depends on improved diplomatic relations and reduced trade barriers.

b) Cross-LoC Trade was a Confidence Building Measure (CBM) between India and Pakistan. It started in the October, 2008. Cross-LoC Trade was also a mechanism for trade between two parts of J&K at various points along the Line of Control (LoC) in Jammu and Kashmir. The Cross – LoC trade between India and Pakistan was suspended by the Indian government. The decision was taken due to differences over issues like terror funding, misuses, narcotics and smuggling, etc. It is now suspended since April18, 2019.^[4]

However, due to restrictions and excessive import and export duties, Indirect Trade through third countries such as the United Arab Emirates (UAE), Singapore, Afghanistan, etc., is flourishing. Indirect Trade not only involves a third country but also a chain of middlemen and extra transportation and logistics costs. This increases the final prices of the goods and thereby creates an additional burden on the citizens of both countries.

c) India-Pakistan Trade through Third Countries

c – I) Trade Routes: Due to restrictions on the direct trade between India and Pakistan, the traders use following third countries to route their imports and exports:

1. United Arab Emirates (UAE): The UAE is a very important intermediary for imports and exports of goods between India and Pakistan. To avoid excessive tariffs and restrictions, Indian products are often exported to the UAE and then re-exported to Pakistan and vice versa. In this process, the cost of goods exported and imported increases without any substantial value addition in the goods. End-users receive the same product at a higher cost. India is software and Information Technology (IT) services power house and major exporter of software and IT services globally, Indian software and IT exports are more than USD 300 Million annually^[5] but due to indirect channel services based exports are also gets expensive to Pakistan.
2. Singapore: Another popular hub for indirect trade. This route is used for electronics and high-tech goods.
3. Afghanistan: Some trade happens indirectly via Afghanistan, although security and logistical challenges exist.
4. China: Goods manufactured in India may reach Pakistan through China or Chinese-controlled supply chains.

Goods Traded between India and Pakistan: Export and import potential is very high, however it is not exploited to its full potential. Following are the main imports and exports between India and Pakistan:

1. Indian exports to Pakistan: Indian exports to Pakistan mainly but not limited to include textiles, Pharmaceuticals, machinery, and food items.
2. Pakistani exports to India: Pakistani exports to India mainly include but are not limited to textiles, cement, fresh fruits, salt and dry fruits.

Negative impact on Indirect Trade

There is a significant cost escalation due to third party involvement. Indirect trade increases costs due to additional shipping, customs duties, and handling fees. Goods are often more expensive for end consumers in both countries because of this circuitous route and additional intermediaries in third countries in the entire process.

Third countries benefit from acting as mediators in this trade, creating economic opportunities for themselves at the cost of India and Pakistan. Such trade also highlights the dependency on international markets to meet domestic demands.

Apart from restrictions on Direct Trade, complex documentation issues and compliance requirements that often discourage smaller traders.

According to the World Bank estimates, India and Pakistan could significantly increase bilateral trade if direct barriers were eased. The trade potential is estimated to be around $37 billion annually.^[6]

Co-operation between India and Pakistan

Despite political and border tension, India and Pakistan have showcased peaceful engagement and cooperation on following issues:

Indus Water Treaty: The Indus Waters Treaty is a remarkable water-sharing treaty between the upstream riparian State of India and the downstream riparian state of Pakistan regarding the Indus River system. The Indus Water Treaty was facilitated by the good offices of the World Bank. India was allotted the eastern rivers (Sutlej, Beas, Ravi), while Pakistan was given the western rivers (Chenab, Jhelum and Indus) of the Indus water basin. Out of the total water of the Indus water basin, 80% approx is allotted to Pakistan and 20% is allotted to India. The Indus Water Treaty has an inbuilt dialogue and dispute settlement system in the form of the Permanent Indus Commission, which continues to facilitate dialogue on water-sharing issues and settlement of disputes.

Kartarpur Corridor between India and Pakistan: India and Pakistan inaugurated the Kartarpur Corridor in 2019. It allowed Indian citizens visa-free access to the Kartarpur Sahib Gurdwara in Kartarpur, Pakistan. This initiative highlights the potential for cooperation between the countries. It also promoted religious tourism and people-to-people contact. There is also the possibility of many other similar initiatives between the countries.

Ceasefire Agreement on the Line of Control (LoC): In February 2021, India and Pakistan renew the 2003 ceasefire agreement along the Line of Control (LoC) in Jammu and Kashmir. This initiative considerably reduced cross-border firing and ensured stability in the border regions.

These efforts highlight that meaningful cooperation is achievable despite political challenges, offering a mechanism and possibilities for improved bilateral relations between India and Pakistan.

Concluding Observation

The Regional Trade offers huge economic benefits, and it will also improve the bilateral relations between India and Pakistan.

Further, regional trade in local currency between India and Pakistan is possible. India is already engaged in local currency trade with countries like Russia. Local currency trade will reduce transaction costs associated with trade, eliminate the need to use US dollars for bilateral trade, remove exchange rate risks by delinking with foreign currency, and enhance the efficiency of bilateral trade between India and Pakistan.

Furthermore, India has developed a low-cost, path-breaking payment system for cashless payments, the Unified Payment Interface (UPI). UPI payment system is similar to RAAST Payment System in Pakistan.^[7] Indian UPI system is being extended to neighboring countries and could also be extended to Pakistan, by integrating UPI and RAAST, which would benefit both countries. The real time digital, traceable, electronic payment and low cost, like UPI and RAAST, will solve many issues like hundi payment/hawala transactions; prevent smuggling, and illegal transactions, etc.

Trade has historically acted as a confidence-building measure (CBM) between neighbours and adversaries. Resuming economic and trade relations could pave the way for dialogue on broader issues, including security and connectivity. Improved relations could lead to enhanced cooperation and co-ordination in other areas like energy, climate action, and counterterrorism, etc. Furthermore, the restarting of India-Pakistan direct trade and re-establishing the Most Favored Nation (MFN) status to each other could be game-changers for the entire region, South Asia.

^[1] High Commission of India, Islamabad, https://www.india.org.pk/pages.php?id=101

^[2] High Commission of India, Islamabad, https://www.india.org.pk/pages.php?id=101

^[3] Foreign Trade (South Asia), Ministry of Commerce, Government of India, available at  https://www.commerce.gov.in/about-us/divisions/foreign-trade-territorial-division/foreign-trade-south-asia/

^[4] https://www.dawn.com/news/1476957

^[5] https://economictimes.indiatimes.com/news/economy/foreign-trade/indias-services-exports-to-cross-usd-300-bn-target-for-this-fiscal-piyush-goyal/articleshow/97269745.cms?from=mdr

^[6]Kathuria, Sanjay, A Glass Half Full: The Promise of Regional Trade in South Asia, South Asia Development Forum, Washington, DC, 2018, available at  https://openknowledge.worldbank.org/entities/publication/3a4a1a79-a5bb-52e5-bee4-8073bbf4f80f, also see, https://www.worldbank.org/en/news/press-release/2018/12/05/pakistan-could-boost-trade-with-south-asia-eight-fold, https://www.businesstoday.in/latest/economy-politics/story/india-pakistan-trade-can-increase-from-2-dollar-billion-to-37-dollar-billion-says-world-bank-119018-2018-12-06

^[7] https://www.sbp.org.pk/dfs/Raast.html