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Chapter 8: Trade & Investment Relations between India and the Countries of South Asia

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Chapter 8 Trade & Investment Relations between India

and the Countries of South Asia

—EPAs are Effective in Facilitating Shujiro Urata

Professor, Waseda University Graduate School of Asia-Pacific Studies

Research Fellow, Japan Center for Economic Research

1. The South Asian countries are beginning to draw attention

The Indian economy continues to show healthy growth, while interest in the economies of

countries neighboring India such as Bangladesh, Pakistan and Sri Lanka is also on the rise. These

countries are commonly thought of as part of a region left behind by economic development and

stricken by serious poverty problems. However, recognition that these countries are actually

recording comparatively high levels of growth has spurred the increased interest in recent years. This

chapter will cover current trade and direct investment relations between India and other South Asian

countries, and will point out challenges for closer cooperation. The chapter will conclude by

shedding some light on how to address these challenges.

2. The economic situation in South Asian countries

2.1 South Asian economies are overwhelmed by India

The economic situation in South Asian Countries is summarized below. Here, South Asia is

defined including India, Bangladesh, Pakistan and Sri Lanka. Figure 8.1 indicates economic

indicators for these countries. India’s economy is overwhelmingly larger than the other economies,

and in terms of trade, direct investment, population, and GDP, Bangladesh, Pakistan and Sri Lanka

have a much smaller scale compared to India.

Japan Center for Economic Research “Asia Research” Report

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Table 8.1: The economic situation for South Asian countries (2010) India Bangladesh Pakistan Sri LankaPopulation (millions) 1,170.9 148.7 173.6 20.9Population growth rate (%) 1.3 1.1 1.8 0.9Population structure (ages 0-14) 30.6 31.3 35.4 24.9 (ages 15-64) 64.5 64.1 60.3 67.0 (ages 65 and up) 4.9 4.6 4.3 8.2GDP (billions of dollars) 1,729.0 100.1 174.8 49.6Per capita GDP (dollars) 1477 673 1007 2375GDP growth rate (%) 2000-2007 7.70 5.74 5.26 4.89 2007-2008 4.93 6.19 1.60 5.95 2008-2009 9.10 5.74 3.63 3.54 2009-2010 9.72 5.83 4.36 8.01Exports (billions of dollars) 162.6 15.1 17.7 7.3Imports (billions of dollars) 249.6 21.8 31.7 10.2Exports-to-GDP ratio (%) 11.8 16.9 10.9 17.5Imports-to-GDP ratio (%) 18.1 24.4 19.6 24.3Inward direct investment (flow, millions of dollars) 2000-2007 9,761.7 547.0 1,903.9 294.8 2008 42,545.7 1,086.3 5,438.0 752.2 2009 35,648.8 700.2 2,338.0 404.0 2010 24,639.9 913.3 2,016.0 477.6Inward direct investment (stock) (millions of dollars) 197,939.3 6,072.1 21,494.0 5,008.4Outward direct investment (stock) (millions of dollars) 92,406.5 100.0 1,727.0 380.2Inward direct investment (stock)-to-GDP ratio (%) 11.4 6.1 12.3 10.1Outward direct investment (stock)-to-GDP ratio (%) 5.3 0.1 1.0 0.8Note: Exports, imports, exports-to-GDP ratio, imports-to-GDP ratio are from 2009.

Source: Statistics aside from direct investment are from the World Bank, World Development Indicators on line.

Direct investment statistics are from UNCTAD, FDI Database on line.

The economies of Bangladesh, Pakistan and Sri Lanka appear small in a comparison of absolute

scale (GDP) with respect to India, however, when looking at population, for example, Pakistan has a

population of 170 million people, while Bangladesh has a population of 150 million people, making

them the 6th and 8th most populous nations in the world, respectively1. Sri Lanka has the highest GDP

per capita of the four, followed by India, Pakistan and then Bangladesh. In terms of external

economic relations, the exports-to-GDP ratio and imports-to-GDP ratio for India, Bangladesh,

Pakistan and Sri Lanka all exhibit similar tendencies.

2.2 The steadily moving South Asian economies

One point that Bangladesh, Pakistan and Sri Lanka all have in common is that their growth rates

have increased since the beginning of the 21st century (figure 8.1). Growth rates in these economies

dropped following the deceleration in the global economy caused by the 9.11 terrorist attacks in the

U.S. in 2001 and the bursting of the dot-com bubble. After that, high levels of growth continued

until declining due to the large downturn in the global economy caused by the global financial crisis,

1 The top ten most populous nations in the world excluding Bangladesh and Pakistan are: 1. China, 2. India, 3.

U.S.A., 4. Indonesia, 5. Brazil, 7. Nigeria, 9. Russia, 10. Japan


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which was triggered by the collapse of the Lehman Brothers in 2008. Since 2009, there has been a

gradual trend towards recovery.

Figure 8.1: Economic growth rates for South Asian countries

3. Trade and investment in South Asia

3.1 Trends in Recent Years

There have been years during which exports have dropped in Bangladesh, Pakistan and Sri Lanka,

but for the most part they have risen consistently since 1990 (figure 8.2). The value of exports in

nominal U.S. dollars between 1990 and 2009 increased 9.0-fold in Bangladesh, 3.1-fold for Pakistan,

and 3.8-fold for Sri Lanka. There have been larger swings in inward direct investment (flow) than

there have been in trade, and between 1990 and 2010, that of Bangladesh increased 282-fold, that of

Pakistan increased 7.2-fold, and that of Sri Lanka increased 11-fold (figure 8.3).


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Figure 8.2: South Asian exports

Figure 8.3: Domestic direct investment (flow) for South Asian countries

3.2 India as a Trade Partner

Next is an examination of the importance of India as a trade partner for Bangladesh, Pakistan and

Sri Lanka. Figure 8.4 shows the proportions of these three countries’ exports that were to India


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between 1990 and 2009. The figure indicates that Bangladesh and Pakistan each trended at modest

levels around 0.5% to 2.5%, and since the early 2000s have tended to rise, although only slightly. Sri

Lanka also hovered at around the 1% mark, similar to the other two countries, until the beginning of

the 21st century, when the proportion of exports to India shot up dramatically, marking 8.9% in 2005.

Since then, however, that number has been falling.

India is the third largest export destination country for Sri Lanka, but is not in the top ten for

Pakistan and Bangladesh 2. In terms of imports, India is the largest import partner for Sri Lanka, the

second largest for Bangladesh, and the eighth largest for Pakistan. Meanwhile, the proportions of

Indian exports headed to Bangladesh, Pakistan and Sri Lanka in 2009 were, respectively, 1.3%, 0.9%,

and 1.1%. The proportions of Indian imports from each these countries was no more than

approximately 0.1%.

Figure 8.4: Proportions of Exports to India from Three South Asian Countries

In evaluating trade relations between Bangladesh, Pakistan, and Sri Lanka in relation to India up

to this point, one aspect that has not yet been addressed is the economic scale of these countries.

Thus, export intensity, a calculation that takes economic scale into consideration, is addressed next

(figure 8.5).3 This figure reveals that while exports to India constitute a typical level for Bangladesh

and Pakistan, the importance of exports to India for Sri Lanka is quite high. On the other hand,

exports from India to Bangladesh and Sri Lanka are extremely high when taking into account the

2 See JETRO (2011) for trade partner rankings 3 Export intensity is a value from zero to infinity. When the values is larger than one, intensity is interpreted as

being at least standard.


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scale of their economies (figure 8.6). These results suggest that exports to India from these three

countries are of a much smaller scale than would be expected by their geographical proximity,

leaving room for expansion.

Figure 8.5: Export intensity for three South Asian countries relative to India

Figure 8.6: Export intensity for India in relation to three South Asian countries


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In terms of inward direct investment, India is the largest investor country (2010) in Sri Lanka, the

seventh largest investor in Bangladesh, and while India does not fall into the top ten for Pakistan, is

still a principal source of investment4. It is thought that there is still room for investment expansion

in relations between these three countries and India.

3.3 Breakdown of traded products

Measuring the correlation coefficients for the export structures between India and the three

countries puts Bangladesh at 0.15, Pakistan at 0.32, and Sri Lanka at 0.22, meaning that they are not

that similar, or in other words, not competing that much5. Meanwhile, the correlation coefficient for

the export structure of Bangladesh and Sri Lanka is 0.78, meaning that they are highly similar. The

export structure correlation coefficients for Bangladesh and Pakistan as well as for Pakistan and Sri

Lanka respectively are 0.38 and 0.28, and so their export structures are not particularly similar.

Competitive products have a strong tendency to comprise a large proportion of total exports,

making it possible to evaluate competitiveness for commodities in each country by observing the

breakdown of exported products. A refined and formulated index of this idea is the revealed

comparative advantage (RCA) index6. Table 8.2 charts the top five commodity items for each

country from among 97 exported items (HS 2-digit classification) for Bangladesh, Pakistan and Sri

Lanka. The figure illustrates that all three countries have a comparative advantage in textiles.

Table 8.2: Comparative advantage commodities in three South Asian countries HS Classification Product name RCA

Bangladesh 53 Other vegetable textile fibers; paper yarn and woven fabric of paper yarn 101.36 61 Articles of apparel and clothing accessories, knitted or crocheted 32.65 62 Articles of apparel and clothing accessories, not knitted or crocheted 28.78 65 Headgear and parts thereof 24.12 63 Other made up textile articles; sets; worn clothing and worn textile articles; rags 11.54 Pakistan 63 Other made up textile articles; sets; worn clothing and worn textile articles; rags 56.62 52 Cotton 55.32

42 Articles of leather; saddlery and harness; travel goods, handbags and similar containers; articles of animal gut (other than silkworm gut) 12.90

10 Cereals 12.20 57 Carpets and other textile floor coverings 11.97 Sri Lanka 14 Vegetable plaiting materials; vegetable products not elsewhere specified or included 81.95 9 Coffee, tea, maté and spices 47.37 53 Other vegetable textile fibers; paper yarn and woven fabric of paper yarn 25.86 62 Articles of apparel and clothing accessories, not knitted or crocheted 18.38 61 Articles of apparel and clothing accessories, knitted or crocheted 17.97

4 JETRO (2011). 5 Correlation coefficients were measured with respect to the 96 HS 2-digit products. 6 RCAij = (Xij/Xwj)/(Xi/Xw). Xij is exports of good j by country i, Xwj is exports of good j to the world (w), Xi is

overall exports by country i, and Xw is overall exports of the world. If RCAij is greater than 1, country i can be interpreted to have a comparative advantage in good j.


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Next is an examination of the bilateral trade patterns of Bangladesh, Pakistan and Sri Lanka with

India (table 8.3). One major difference in trade between these countries and India compared to their

trade with the rest of the world is that with respect to India, Pakistan and Sri Lanka have a higher

proportion of both imports and exports of animal products such as dairy products, while they have a

comparatively low proportion of textiles. A comparison of trade between Bangladesh and India

versus trade between Bangladesh and the rest of the world shows that in terms of exports to India,

the proportion of textiles is low, and the proportions of mineral products and chemical industrial

products is high.

4. South Asian trade policy: Promoting broad-region FTAs

Beginning in 1991 as a response to the economic crisis, India has furthered economic reforms,

liberalized the economy, and implemented outward-oriented policies. In Bangladesh, Pakistan and

Sri Lanka, trade and investment liberalization policies also began to be adopted when liberalization

of trade and investment was called for as a condition for receiving aid from the World Bank and the

International Monetary Fund as a response to the grave economic situation caused by increases in

external debt. Average import tariff rates (effective rate, arithmetic mean) for all commodities

dropped in Bangladesh from 106.5% (1989) to 14.5% (2007), in Pakistan from 50.1% (1995) to

14.0% (2008), and in Sri Lanka from 27.4% (1990) to 11.3% (2006) 7.

7 See the World Bank (each year’s edition)


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Table 8.3: Trade between India and Three South Asian Countries: Commodity Breakdown Comparison (2007, %)

Exports Imports Bangladesh Pakistan Sri Lanka Bangladesh Pakistan Sri Lanka Animal Products 1.5 67.4 32.3 0.9 65.0 63.8 Plant Products 2.6 16.5 14.6 20.8 21.5 17.4 Animal/Plant Oils 0.1 0.9 1.1 0.3 1.0 1.1 Food Products 0.3 3.4 8.5 9.6 3.9 9.3 Mineral Products 18.0 0.3 1.0 9.2 1.2 0.9 Chemical Engineering Products

19.4 3.6 4.4 10.3 6.3 3.0

Plastics/Rubbers 0.5 0.2 0.3 4.3 0.2 0.2 Leather/Fur Products 1.0 1.0 0.6 0.0 0.0 0.5 Wood/Timber Products 0.2 0.1 0.6 0.0 0.2 0.4 Paper Materials, Paper Products

0.1 0.9 0.2 1.1 0.1 0.2

Textile Products 47.1 0.3 35.8 18.2 0.4 2.2 Footwear, Umbrellas 0.1 0.0 0.1 0.1 0.0 0.6 Mineral Goods 0.5 0.0 0.3 0.5 0.0 0.1 Precious Stones, Rare Metals

0.0 0.0 0.0 0.1 0.0 0.0

Base Metal Products 4.2 5.4 0.2 8.2 0.0 0.1 General Machinery 1.5 0.0 0.0 6.0 0.0 0.0 Electrical Machinery 2.5 0.0 0.0 2.7 0.0 0.0 Transport Equipment 0.4 0.0 0.0 6.5 0.0 0.0 Precision Machinery 0.0 0.0 0.0 0.4 0.1 0.0 Other Manufactured Goods

0.1 0.0 0.0 0.5 0.0 0.0

Other 0.0 0.0 0.0 0.1 0.0 0.0 Total 100.0 100.0 100.0 100.0 100.0 100.0 Source: Calculated by author using COMTRADE data

That said, compared to countries in East Asia, the tariff rates of countries in South Asia are still

high. The effective rates reported by the WTO for agricultural products are 7% in Pakistan and

26.3% in Sri Lanka, while for industrial products are 13.4% and 8.2%, respectively. In addition,

tariff concessions are set much higher than the effective rates in all these countries, meaning that

there is plenty of room to legally raise effective rates.

Although South Asian countries were later in concluding Free Trade Agreements (FTAs) than

those in other regions, in recent years FTAs are now being concluded in the region (table 8.4). India

has taken the most positive stance toward FTAs of the four countries (India, Bangladesh, Pakistan,

Sri Lanka), and as of October 2011 had thirteen FTAs in effect, and an additional eight FTAs being

negotiated. Pakistan is the next country in this group in terms of the number of FTAs in effect with

six, while Sri Lanka and Bangladesh trail behind with four and two, respectively.


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Table 8.4: South Asian nations and FTAs

Proposed

Framework Agreement Signed, Under Negotiation

Under Negotiation Signed In Effect Total

India 8 4 8 0 13 33

Bangladesh 0 2 1 1 2 6

Pakistan 10 5 3 2 6 26

Sri Lanka 2 1 0 1 4 8 Source: Asian Development Bank, Asian Regional Integration Center

The South Asian Free Trade Area (SAFTA), a broad-region FTA including the South Asian nations,

came into effect in January 2006. The seven member states include India, Bangladesh, Pakistan and

Sri Lanka. India, Pakistan and Sri Lanka, the more developed countries in the region, planned to

lower the maximum tariff to 20% or below, excluding some sensitive-list items, between July 1,

2006, and the end of 2007. Following this, they planned to reduce tariffs to 0-5% during the

five-year period ending at the end of 2012 (the end of 2013 for Sri Lanka). Bangladesh, Nepal,

Bhutan and Maldives, which are the least-developed nations in the region, planned to reduce the

maximum tariff to 30% or less between July 1, 2006, and the end of 2007, after which they would

lower tariffs to 0-5% during the eight-year period ending at the end of 2016.

The limited number of harbors at which duty-free benefits can be enjoyed, and the numerous

sensitive-list items are factors hampering trade expansion in SAFTA. As of November 1, 2011, the

number of items excepted from liberalization is planned to be 993 (19%) for Bangladesh, 695 (13%)

for India, 936 (17%) for Pakistan, and 834 (16%) for Sri Lanka8. In November 2011, however,

Pakistan decided to grant India most-favored nation status, which will likely contribute to the

expansion of trade. India has given most-favored nation status to Pakistan since 1996, but for

political reasons Pakistan had not yet granted the same status in return.

By analyzing the traded commodity breakdown between Bangladesh, Pakistan, Sri Lanka and

India, it is possible to consider the advantages of establishing FTAs. Table 8.5 displays values from

the Trade Complementarity Index (TCI), measured using 2007 statistics9. The breakdown of exports

for India and the breakdown of imports for Bangladesh, Pakistan and Sri Lanka have a fair bit of

overlap, which means that we could expect a great deal of expansion in exports from India to these

countries if bilateral trade liberalization is implemented. A similar trend would also be expected for 8 The figures in parantheses are percentages of the total number of products (HS6 classification, 5224) 9 TCij = 100 – sum(|mik – xij| / 2). TCij is the trade complementarity coefficient of country i and country j, mik is the

commodity component ratio in the imports of country i, and xij is the commodity component ratio in country j. TCij takes values from zero to 100. When there is absolutely no overlap in the import/export makeup between country i and country j, TCij is zero, and when the import structure and export structure completely coincide between the two countries, it is 100.


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exports from Pakistan to Bangladesh and Sri Lanka. Contrastingly, expansion in exports from

Bangladesh to India, Pakistan and Sri Lanka is unlikely. These figures reflect analysis performed

using only actually observed trade patterns, and trade barriers (import tariff rates), which are the

most important factor for estimating the impact of an FTA, have not explicitly been taken into

account. Analyzing the impact of an FTA with an explicit focus on this important factor requires a

simulation using an economic model such as a computable general equilibrium (CGE) model.

Table 8.5: Trade Complementarity Index between South Asian Countries

Importing Country

Exporting Country India Bangladesh Pakistan Sri Lanka

India 44.4 52.3 60.5

Bangladesh 5.3 7.4 7.6

Pakistan 18.6 36.8 31.6

Sri Lanka 22.3 18.8 21.6 Source: UN ESCAP, ARTNet on line

5. Promoting Economic Growth in South Asia

The four South Asian countries of India, Bangladesh, Pakistan and Sri Lanka have all marked

steady economic growth in recent years. In order to achieve further growth, it is important to expand

between South Asian countries, and to expand economic relations with other regions of the world,

particularly with East Asian nations, which are expected to experience high levels of growth in the

future. To this end, obstacles to direct investment invitations and to trade expansion must be reduced

and eliminated. Obstacles to trade expansion include institutional barriers such as tariffs as well as

practices that are targets for trade facilitation, including customs clearance systems and procedures

that lack both efficiency and transparency. Barriers to investment expansion include not only issues

related to investment systems such as capitalization limitations and visa issuance for non-citizen

employees working at foreign corporations, but also issues such as an undeveloped infrastructure

and a shortage of capable, local human resources. Establishment of a comprehensive free trade

agreement (economic partnership agreement) that includes not only trade liberalization, but also

economic cooperation such as investment liberalization and human resource development, would be

effective in response to these issues. As the nation in a position to lead South Asia, there are high

hopes for India to promote trade liberalization within the framework of SAFTA, which is currently in

progress, to play a constructive role toward achieving the Comprehensive Economic Partnership for

East Asia (CEPEA), the members of which include India, the ten members of ASEAN, Japan, China,

South Korea, Australia, and New Zealand, and to serve as a bridge between South Asia and East

Asia.


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Reform and Trade Performance in South Asia, O. H. Chowdhury and W. van der Geest eds. The University Press, Dhaka.

Asian Development Bank. 2011. Asian Development Outlook 2011 Update: Preparing for Demographic Transition, Manila.

Chaudhary, M. A. 2004. Trade and Investment Stagnation during External Sector Reform in Pakistan. In Economic Reform and Trade Performance in South Asia, O. H. Chowdhury and W. van der Geest eds. The University Press, Dhaka.

Hayakawa, K., F. Kimura, T. Machikita. 2010. Firm-level Analysis of Globalization: A Survey of the Eight Literatures. ERIA-DP-2010-05. Jakarta:ERIA.

Japan External Trade Organization (JETRO). 2011. 2011 JETRO White Paper and JETRO Global Trade and Investment Report. http://www.jetro.go.jp/en/reports/white_paper/

Shahabuddin, Q., N. C. Nath, S. C. Zohir and D. K. Roy. 2004. Trade and Foreign Direct Investment Performance during Policy Reform in Bangladesh. In Economic Reform and Trade Performance in South Asia, O. H. Chowdhury and W. van der Geest eds. The University Press, Dhaka.

World Bank (various issues). World Development Indicators (printed version).

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