Policy Research Institute - PRI Bangladesh

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Trade gap with India

Published: Monday, Feb 08, 2010


Trade gap with India

Monday, February 8, 2010
Sadiq Ahmed


BANGLADESH'S large and growing trade deficit with India is often used by critics as an indication of India's dominance in its relationship with Bangladesh, and by implication, serves as a rationale for why it is a bad idea to engage in more cooperation with India. What is amazing is that not just political opponents but also NGOs, business leaders and even some professional economists use this argument. Is this a valid concern? Should our trade gap with India matter?

To understand the underlying economic arguments, it is instructive to first look at the facts of Bangladesh's country/region-wise direction of trade. The table below shows that the largest trade deficit of Bangladesh is with China (US$3.8 billion), followed by India (US$2.8 billion), and the Middle East (US$2.4 billion). At the same time, Bangladesh has a huge trade surplus with Western Europe (US$5.8 billion) and the USA (US$2.9 billion). These numbers illustrate the following fundamental principle of global trade. A country should export to markets that fetch the highest price for its products and import from countries with the lowest price for their imported products. With 200 plus countries in the global market, it would be a rare coincidence that a country that fetches the maximum price for our exports is also the country that is the cheapest source for our imports. So, the concept of "balanced trade" with any specific country is not an economically meaningful concept.

Applying this logic to Bangladesh, it is hardly surprising that Bangladesh sends most of its exports (RMG) to the OECD countries where it gets the best price. Similarly, it is hardly surprising that China, followed by India and the Middle East, are the most important sources of our imports. These countries provide the cheapest sources for our industrial raw materials, food items and fuel. Given this, it is very natural that Bangladesh has huge trade surpluses with Western Europe and the USA while, at the same time, it has large deficits with China, India and the Middle East. Just as we celebrate our trade surpluses with Western Europe and USA, we should not decry our trade deficits with India, China or the Middle East.

Imagine what will happen if all countries start worrying about bilateral trade gaps and take preventive measures. Western Europe and the USA will then impose huge tariffs to prevent RMG exports from Bangladesh and close the gap, while Bangladesh will impose prohibitive tariffs on imports from China, India and the Middle East. The net result for Bangladesh (and for other countries) will be a huge loss of trade and corresponding welfare loss. Bangladesh will lose out on exports, both through high tariffs from Western Europe and the USA, as well as from much more costlier imports of industrial raw materials. Other countries will similarly lose.

Consider another important result from the table. There is a large trade gap in Bangladesh on aggregate (US$7.4 billion). Moreover, this trade gap has been growing. Again, this is not a surprising result. This overall trade gap is simply a reflection of the large and growing earnings from remittances. Indeed, the remittances have grown faster than the trade gap causing a surplus in Bangladesh's current account balance over the past four years or so. This surplus reached US$2.5 billion in FY 2008-2009, implying that we are not using all our available foreign resources for imports. So, if investment in infrastructure picks up, as is likely, ceteris paribus we will see a further increase in our trade gap.

Does this mean we should not worry about the trade gap? The answer is yes. The variable we need to monitor is the current account balance and not the trade gap. If we have a large and growing current account deficit not matched by foreign aid and private capital flow, then we should take monetary, fiscal and exchange rate measures to correct this gap. If we have a large current surplus, then we have a huge positive balance on the services account, owing to inflow of income from factor and non-factor services, and it is most likely that we will have a large trade gap (unless we are rapidly accumulating foreign reserves).

However, all effort must stay focused on expanding exports at the global level, including India and China. Our tiny exports to China, India, Japan, Korea and the Middle East suggest that there may be scope for market expansion. However, this should be secured through export creation and not diversion. The barriers to exports are mostly within: incentive policies, trade logistics, and infrastructure constraints. These must be addressed. To the extent that further and better cooperation with India and other neighbours allows Bangladesh to ease the trade logistic and infrastructure constraints (e.g. through better connectivity and trade in power), this should be encouraged.

With rapid trade liberalisation, even in India, the global trade regime today, in non-agricultural commodities, is much more liberal than in the recent past. As a result, behind-the-border problems are a much bigger constraint on non-agricultural exports than trade restrictions in partner countries. Nevertheless, if trade partners, as well as India, are engaged in discriminatory trade practices, including non-tariff barriers, they need to be taken up at the highest level and resolved. These must be based on well-researched and documented facts rather than anecdotes and populist misperceptions.

Sadiq Ahmed is Vice President of the Policy Research Institute (PRI). He formerly served as the Chief Economist and Director Economic Management of the South Asia Region of the World Bank in Washington D

Last Updated on Thursday, 02 December 2010 08:30