Further, over this period, the balance of trade has remained consistently in India's favour -in some years five times as high. So, even the lower guesstimate (0.5 billion dollars) illustrates the trade potential and the scope for generating foreign exchange and revenue for the government.
Clearly, these aspects have important policy implications and highlight the need for getting an accurate fix on the value of illegal trade.
Contextualising this need are recent trade liberalisation initiatives at several levels - global, regional and bilateral. The global WTO mandate has steadily driven down quota restrictions and tariffs between the two countries.
Bilaterally, the South Asian Preferential Trade Agreement (SAPTA), signed in April 1993, allows reciprocal, bilateral tariff reductions on mutually agreed tradable items.
So far, four rounds of trade negotiations have been concluded under SAPTA covering over 5,000 commodities. Each round contributed to an incremental trend in the product coverage and the deepening of tariff concessions over previous rounds.
SAPTA was both a precursor and provided a spur to the South Asian Free Trade Agreement (SAFTA). SAFTA calls for multilateral tariff reductions, eventually leading to free trade.
It is likely to open up significant opportunities for intra-SAARC trade and enhance the historically lackluster economic exchange between South Asian countries.
Concurrently, SAARC members, particularly India, have entered into free trade agreements (FTAs) with neighbours, such as Nepal and Sri Lanka. Such bilateral initiatives are likely to boost movement on SAFTA, which is expected to come into force in January 2006.
The perception that illegal trade is of a considerable magnitude, and the multi-level initiatives to improve trade relations between Pakistan and India suggest that it would be possible to direct this trade into formal channels. This could have potentially important foreign exchange, revenue and industry impacts.
The World Bank commissioned the Sustainable Development Policy Institute to assess these impacts.
THE STUDY, WHICH IS NOW COMPLETE, HAD A THREE-PRONGED PURPOSE:
-- To estimate the value of informal trade and to assess whether such trade would be re-routed through official channels if trade barriers between India and Pakistan were removed under two alternative trade regimes;
-- Most Favoured Nation (MFN) status
-- Free trade as envisioned under SAFTA
-- To estimate the potential revenue impact of switching from informal to formal trade
-- To assess the impact on local industries
BARRIERS TO TRADE: The scope for diverting illegal trade to formal channels is a function of the trade barriers both countries have erected against each other. The barriers are both formal and informal. Formal trade barriers comprise tariff and non-tariff barriers.
The latter consist of quota restrictions, trade bans, such as the denial of MFN status and social, environmental and quality standards. Informal barriers are defined as transaction costs, and they fall into three categories: transport costs, procedural costs and rent seeking - a euphemism for bribes.
In terms of their global trade, India and Pakistan have abolished quota restrictions and reduced tariff rates steadily in conformity with the WTO mandate. Bilaterally, tariffs in India remain much higher on average than in Pakistan.
Similarly, Pakistan has not given India reciprocal MFN status. It maintains a positive list of over 800 importable items from India.
One would expect the one-sided arrangement to lead to a positive trade balance for Pakistan. But relatively higher tariffs in India, and an array of hidden barriers, leave little wriggle room for Pakistani exports to India. By and large, moves to facilitate trade by India have remained cosmetic.
The perception is that, despite the MFN concession, official tariff rates and transaction costs (especially hidden) remain higher in India.
The existence of high transaction costs has forced much of the trade, even in commodities legally tradable, to flow through illegal channels. These costs are a key swing factor.
In other words, if formal sector transaction costs in importing exceed those in illegal trading, and this difference is greater than the tariff rate, a switch from illegal to legal trade is not likely to occur.
Entrenched practices and institutional factors have a bearing on informal transaction costs. Finally, normative considerations, such as livelihood and employment, should also temper trade policy aimed at reaping economic benefits. These aspects are addressed in some detail.
Data for the study was acquired through secondary and primary sources. Primary data was collected through surveys and personal interviews with stakeholders and public officials. The respondents consisted of formal and informal importers, members of the chambers of commerce and industry, customs officials, forwarding agents, rangers, security officials, wholesalers, and transporters.
The transport modalities are diverse and include ships, aircraft, trucks, buses, cars, motorcycles, bicycles and pack animals. Human carriers are known variously as gandamars and laghris and include women carriers and paraplegics.
The truck and bus drivers also act as agents for retailers and wholesalers in the Punjab. They both order and transport goods.
ILLEGAL TRADE ROUTES: The study identified six major and five minor informal trade routes. The major routes are:
-- Dubai-Bandar Abbas-Kabul--Jalalabad-Bara
-- Dubai-Bandar Abbas-Kandahar--Wesh-Chaman
-- Dubai-Bandar Abbas--Kandarhar-Noshki-Quetta
-- Dubai-Bandar Abbas-Kandahar-Gulistan-Qila Abdullah
-- India-Karachi-Peshawar-Jalalabad-Bara: Afghan Transit Trade (ATT)
-- Sindh Cross-border
-- India-Dubai-Karachi.
Trade through the first three channels is containerised; the containers are shipped to Bandar Abbas, transported overland by truck to Jalalabad, and from Jalalabad to Wesh and Noshki. Here they are unloaded and carried across the border by pack animals and human carriers.
On the Jalalabad route, mules and donkeys carry the goods across the border. These are re-loaded onto trucks and finally stored in large godowns in Bara. Occasionally, the routes get blocked because of tribal infighting over control of the smuggling routes.
The Dubai-Karachi route is the main channel for quasi-legal trade. The term refers to trade in Indian goods stamped with a certificate of origin other than India. These goods are re-routed through Dubai, an act which validates the new origin. In effect, the trade shows up in official trade statistics as exports from the country (whose origin is stamped) to Pakistan.
In minority of cases, trade shipments are conducted through what is known as the "switch bill of lading." In such an arrangement, ships containing items banned in Pakistan are supposed to travel to Karachi via a third port (eg Dubai). However, in reality the ships travel directly from an Indian port to Karachi.
The ship's bill of lading, which shows its origin, is switched in the documentation to Dubai. While the cost of obtaining a switch bill of lading is low - approximately 50 dollars - in effect, the shipment needs to consist primarily of banned Indian items. If the vessel carries consignments destined for many countries, it is not viable for it to dock in Karachi.
THE FIVE MINOR ROUTES ARE:
-- Delhi-Amritsar-Lahore
-- India-Sukkur
-- Mumbai-Karachi (boats, launches)
-- India-Singapore-Karachi
-- Mumbai-Kabul-Bara
STUDY FINDINGS: The study confirmed the lower end of the range of guesstimates, valuing illegal trade at about 500 million dollars. Six items (of a total of 17) constitute 84 percent of the total import value. These are, in order of priority, cloth, pharmaceutical machinery, cosmetics, tyres, medicine and livestock.
Exports from Pakistan, at 10.37 million dollars, are a fraction of imports. A notable aspect is the balance of informal trade overwhelmingly in India's favour. It is probable that informal exports have been underestimated, as we did not have access to information from India.
However, even if the correct figure were higher by a factor of five, it would not make much of a dent in the imbalance. This has important trade and industrial policy implications and we address these a little later.
Smuggled goods from China have replaced a large chunk of Indian items in the last three or so years. Some of the items that have been completely or partially replaced are bicycles, electronics, rubber tyres of trucks, buses and cars, cosmetics, cloth, jewellery and razor blades.
Our guesstimate of Chinese illegal trade, which is rapidly growing, is anywhere from two to three billion dollars. The popularity of cheap and reasonable quality products across a large choice spectrum became increasingly evident during the course of the study.
This is likely to have important implications for government revenues and local industries. It also underscores the need for an independent study on the subject.
THE SCOPE FOR SWITCHING: As mentioned earlier, the configuration of bans, tariffs, and duties and transaction costs, both in the formal and informal sectors, determine the likelihood of informal trade being converted to formal trade.
Basically, informal transaction costs are compared with tariff rates. It determines the extent of tariff reduction required to switch to formal trade.
The overall message is that it will require a significant reduction in tariffs to change the status quo for almost four-fifths of the trade. For example, on the Bara route, the total transaction costs are about 10 percent of the value of a container of winter suiting.
The duty and sales tax come to about 40 percent. If the ban were removed, it would require a 30 percent tariff reduction to divert informal to formal trade channels.
Thus trade liberalisation is necessary in giving India MFN status, but not a sufficient condition for substantive switch in the mode of trade. The existing tariffs and procedural restrictions would, in addition, need to be reduced substantially.
This was also borne out in the interviews with stakeholders. Particularly in Bara where transport costs are high, importers were not unduly concerned. They thought the combination of tariffs and procedural requirements would more than offset the high transport costs they needed to factor in to their prices.
The exception is the Dubai-Karachi route, which accounts for about one-fifth of the informal trade. Transiting to MFN status suggests that such trade would switch to formal channels.
Another unexpected aspect is secondary effect of trade liberalization. It relates to opening more proximate access routes, such as cross-border trade, between the two countries (Delhi to Lahore, Mumbai to Karachi), which can induce an increase in smuggling, thanks to a combination of existing tariffs and lower transport costs.
Ultimately, it leads us to the conclusion that providing MFN status to India may not be enough of a stimulus to divert informal to formal trade - in fact, it could actually increase the volume of illegal trade. For the trade modality to change from illegal to legal, we need to transit into a free trade regime, a la SAFTA.-Courtesy: SDPI Bulletin
(To be concluded)