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The militant attack at Pulwama in Jammu and Kashmir on February 14 that claimed lives of 40 Indian security personnel heightened the already tense situation in India-Pakistan relations. India blamed Pakistan for providing support and shelter to the terrorists who launched the suicide attack. As an instant retaliatory measure, New Delhi adopted trade tool and revoked Most Favoured Nation (MFN) status of Pakistan. Consequently, it has also imposed 200 per cent tariff on all the importables from Pakistan.
MFN is a founding principal of the World Trade Organisation (WTO). General Agreement on Tariffs & Trade (GATT) originally agreed in 1947 and so referred to as GATT 1947 and subsequently, with some revisions, in 1994 (referred to as GATT 1994) as part of the Uruguay Round negotiations that created the WTO. The first article of the agreement calls for MFN treatment saying 'trade concessions granted to one Member are applied immediately and without conditions to all other Members' of the organisation. The term 'Most Favoured Nation' is a misnomer. Actually, it is not to provide a single country any special favour but to extend similar favour to all other countries if the same is extended to any country. There are, however, legally allowed exceptions in the GATT articles and many countries are practicing the exceptions.
Both India and Pakistan are founder members of the WTO and also its predecessor, GATT. Interestingly, the original GATT articles provide a 'tricky scope' to both the countries not to provide MFN status to each other. Paragraph 11 of Ad Article XVI in the Annex-I of GATT, 1947 said: "Measures adopted by India and Pakistan in order to carry out definitive trade arrangements between them, once they have been agreed upon, might depart from particular provisions of this Agreement, but these measures would in general be consistent with the objectives of the Agreement."
Taking cue from this paragraph, Pakistan is yet to provide MFN status to India. In fact, Indo-Pak official bilateral trade was suspended for eight years (1965-1973). After the resumption of trade, two countries used positive list approach. It was in 1996, one year after the formal inception of WTO, India granted MFN status to Pakistan. But Pakistan continued with 'positive list' approach in importing from India until 2011 when the country switched to 'negative list' approach. Currently, around 1200 Indian products are in the list which means these are not allowed for import in Pakistan.
Nevertheless, annual bilateral trade between the two countries, now at $2.40 billion, is heavily tilted to India. Export from India in FY18 reached $1.84b which was $1.64b in FY17. By withdrawing MFN status and imposing 200 per cent additional duty on all Pakistani products, India makes import from Pakistan costlier. The measures are mostly symbolic and have little impact on Pakistan's export to India. Moreover, Pakistan may also retaliate by rising tariffs on Indian goods or move to WTO against India's decision of withdrawing MFN status. But, any retaliatory tariff imposed by Pakistan will also make import from India costly which may increase domestic price of some products.
Now, by withdrawing Pakistan's MFN status and imposing higher tariff, does India instigate a trade war with Pakistan? So far, Pakistan doesn't retaliate and any trade war is yet to start. But, escalation of Indo-Pak geo-political tension coupled with trade friction will affect the already low regional trade in South Asia. Intra-region trade in South Asia stood at $53.78 billion in 2017, a rise by 17 per cent over the previous year. But the ratio of intra-regional trade to the region's global trade was 5.55 per cent in 2017 which was 5.63 per cent in 2016. In fact, the ratio has been hovering around 5.0 per cent for the last two decades. Higher tariffs, along with a number of non-tariff barriers (NTBs), keep the intra-regional trade low. South Asia's average tariffs in 2016 were 16.3 per cent, while the global average was 6.3 per cent, according to an estimation of the World Bank. It also showed that the tariffs of goods included in the sensitive lists of the member countries apply to almost 35 per cent of intra-regional trade in South Asia.
Under the South Asia Free Trade Area (SAFTA) agreement, 2016 was the deadline to reduce all customs duties to zero except the sensitive list items. In reality, some tariffs are still there. Moreover, SAFTA negotiation has been almost stalled since 2015 and so the next course of action to fully liberalise trade by reducing all tariffs to zero is yet to be finalised. In 2015, three countries confirmed to cut down tariff rates of different items in sensitive lists from zero to five per cent range by 2020. These are Bhutan, India and Pakistan. Afghanistan also made commitment to do this by 2030. Bangladesh and Nepal set similar deadline but didn't make any confirmation while Sri Lanka's decision was pending. Thus, full elimination of tariffs in South Asia and consequently the emergence of free trade area appears a distant dream while SAARC outlined to form an economic union by 2050. The average tariff rates of different countries in South Asia are still high (See Table). The higher rates make the tariff reduction process slower.
Moreover, there are many non-tariff measures (NTMs) and a good number of them have turned into NTBs when applied to restrict import certain products from certain countries. By establishing South Asian Regional Standards Organisation (SARSO) in 2011 which commenced operation in 2014 in Dhaka, the member countries of SAARC expressed their intention to harmonise product standards across the region. This harmonisation of standards will be helpful to address the NTBs. But, SARSO is moving very slowly. So far, SARSO has finalised 11 sets of standards for a few food items, metallic materials and fluorescent lamp.
The latest Indo-Pak trade friction has for the time being been taken over by India's launching of air strike inside Pakistan territory to crush some terrorist hideouts on February 26. The real extent of Indian attack and Pakistan's response is still unclear because of opposing claims. But the whole thing makes the region's peace and security vulnerable further. This may also leads to further trade frictions and trade restrictions. The dream of a free trade area in the region may also shatter as a final consequence.