Department of Economics, Delhi School of Economics, University of Delhi

India-Bangladesh Trade Relations: Problem of Bilateral Deficit

Author(s): SUPARNA BASU and DEBABRATA DATTA
Source: Indian Economic Review, New Series, Vol. 42, No. 1 (January-June 2007), pp. 111-129
Published by: Department of Economics, Delhi School of Economics, University of Delhi
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Indian Economic Review, Vol. XXXXII, No. 1, 2007, pp. 111-129

India-Bangladesh Trade Relations:

Problem ofBilateral Deficit

SUPARNABASU
Department of Economics
Asutosh College, The University of Calcutta
Kolkata, India
AND
DEBABRATADATTA
Department of Economics
Asutosh College, The University of Calcutta
Kolkata, India

Abstract

The paper analyzes the reasons behind persistentbilateral trade deficit of Bangladesh
with India and hence faces
with India. It finds thattheBangladesh has export similarity
high export competitiveness. The lack of match between Bangladesh export and Indian
import also generates a constraint of complementarity. The paper uses different trade
related indices likeRCA and Cosine measures to examine the extentof trade similarity
and complementarity in inter-industry bilateral trade. The possibility of intra-industry
tradebetween the two countries is also studiedwith the help of G-L indices. Finally,
an econometric time series analysis is done to identify the determinants of Bangladesh
bilateral export and trade deficit. Export has been found to be of random nature and trade
deficit has a perverse relation with exchange rate, driven by flow of remittances. The

paper suggests that Bangladesh should pursue an exchange rate policy and
appropriate
aim at increased diversification in her export structure in order to avoid Dutch disease

and to reduce the bilateral trade deficit.

Key Words: Trade Deficit; Trade Complementarity; Intra -Industry Trade; Cointegration

JEL Classification: F14

1. INTRODUCTION

The study of the trade relation between India and Bangladesh shows that Bangladesh

experiences chronic bilateral trade imbalance in her trade with India. Both India and

Bangladesh are members of SAARC and also of several other regional blocs e.g.
BIMSTEC, IOR-ARC etc. They are also
signatories plurilateral of various preferential
trading agreements like Bangkok Agreement, SAPTA, Global System of Trade Preferences
(GSTP) etc. These bodies are to promote regional trade but huge bilateral trade deficit
becomes a contending issue in regional cooperation between the two countries and remains

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 112 Suparna Basu and Debabrata Datta

a major topic of discussion in India-Bangladesh trade talk.

Economic theory may question the concern over bilateral trade deficit of Bangladesh.
Some commentators on Bangladesh trade argue that multilateral trade balance, not the
bilateral one should be? the proper point of reference1 as the trade deficit with a single
partner may be offset by trade surplus with others. Notwithstanding the theoretical validity
of such argument, the trade deficit between India and Bangladesh may be an important
issue of research for the following reasons.

Bangladesh economy suffers from chronic trade deficit vis a vis India since its
formation in 1971 and barring a few years bilateral trade deficit of Bangladesh with India
is highest in comparison to the trade deficit with all the other countries. Thus trade deficit
with India contributes significantly to the total trade deficit of Bangladesh. While exchange
rate adjustment is an aggregative measure to tackle total trade deficit of an economy, it

may also be necessary to look at specific demand and production related problem for each
trading partner and address the problem by country wise and commodity wise measures
in order to improve export performance. Hence, bilateral trade deficit with India, being
the most important component of the total deficit of Bangladesh becomes an automatic
choice for study in order to achieve balance in total trade account.

Again, bilateral trade relations highly affect the political-economic relations of the
countries concerned, and hence the trade imbalance between two neighboring countries
assumes importance. If the trade pattern remains one-sided, the country with persisting
deficit may harbour feelings of deprivation of the access to the market of the trading
partner. Regional cooperation is likely to be disrupted in such a situation. It succeeds only
when benefits are mutual and the relatively less developed nations like Bangladesh are
also able to get their due share of the gains from expansion of trade in the region.

There is also a view in the literature that bilateral trade imbalance between India and
with Bangladesh producing a few goods and importing many lead to can
Bangladesh
deindustrialization and unemployment in Bangladesh.2 Given the geographical proximity of
the two countries development gap between the two countries may lead to the problem
of illegal migration from Bangladesh to India. So in the larger socio economic perspective,
the problem of trade imbalance deserves attention, both at policy and academic level.

For empirical analysis of bilateral trade, we have Gravity model as the framework.
more at the
Existing literature in international trade, however, focuses on bilateral trade
policy level than at the theoretical level. For example, US trade deficit with Japan and
China has received major attention at the policy level (Janow, 1994, Feenstra et al. 1998).

Similarly, the policy issues of Bangladesh-India trade deficit are discussed in several

papers. Zaki Eusufzai (2000) has made a detailed studyof deficit for theperiod 1973
1 See Williamson (1999)
2 See Zaki Eusufzai (2000)

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India-Bangladesh Trade Relations: Problem of Bilateral Deficit 113

1996.Chaudhury(1995),Bakht (1994),Taneja (2001) have consideredtheIndia-Bangladesh

trade and focused on the informal trade between the two countries. All these authors
show that apart from official trade, there is a sizeable informal trade between the two
countries and Taneja shows that India enjoys a trade surplus with Bangladesh even in
informal trade account.3 Our analysis however is based on official bilateral trade deficit

figure and given the findings of the literature that sum of formal and informal trade
balance of Bangladesh is also in deficit, our results, based on official trade data maintain
their relevance.

The rest of the paper addresses the following aspects of Bangladesh-India trade
relations:
1. the pattern of comparative advantage in the two countries and their implications,
2. the similarity and complementarity in the trade pattern of the two countries,
3. role of intra-industry trade in bilateral trade relation,
4. significance of factors other than comparative advantage that influence Bangladesh
export to India and her bilateral trade deficit.
The methodology, sources of data and the period of analysis are discussed inAppendix.

2. ANALYSIS AND RESULTS

With a view
to developing the analytical perspective of India-Bangladesh trade, we
present at the outset the recent trends (1990-2001) in the bilateral trade pattern of
Bangladesh in Tables 1-3. Table 1 shows the major contributors to trade deficit of
Bangladesh in this period. It is observed that barring the years-1990, 1991 &1993, trade
deficit with India has always remained the highest among the country-wise figures. While
Bangladesh export to India increasedfromUS $ 22 million inl990 toUS $ 59.8 million
in 2001, the importfromIndia rosemuch more sharplyfromUS $ 170million toUS $
1013 million over the same period. As a consequence, the importance of trade deficit with
India in total trade deficit of Bangladesh has considerably increased, registering a rise
from 7.5% in 1990 to 51.4% in 2001. This bilateral trade deficit has also recorded a
as a percentage to 2% during this
significant increase of Bangladesh GDP, from 0.6 %
period (Table 2).
Commoditycomposition(Table 3) of bilateral tradeduringthisperiod shows thatthe
export of Bangladesh to India depends heavily on a few items while India exports a more
diversified set of goods to Bangladesh. Only three broad groups, namely textile articles,
chemical products and animal products together constitute 90% of export of Bangladesh
to India, although their individual shares experience fluctuations over time. The important

3 Most of the items that enter illegally from Bangladesh are of third country origin and traders use
to India
this channel to evade high tariff and trade restrictions on
these goods by India. With the liberalization of
trade by India, these goods will enter India directly from the producer country and as a result, informal trade
deficit of Bangladesh is likely to increase further.

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 114 Suparna Basu and Debabrata Datta

Table 1

BILATERALDEFICIT(INMN US$) OF B'DESH WITH DIFFERENTCOUNTRIES

countries/year 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Japan -417 -254 -242 -445 -457 -495 -569 -385 -392 -488 -783 -659
China -99 -126 -199 -198 -287 -583 -622 -564 -519 -526 -657 -766
Korea -155 -169 -210 -275 -325 -410 -359 -373 -327 -285 -336 -391

Singapore -360 -259 -183 -137 -187 -373 -297 -236 -407 -643 -742' -791

India -148 -166 -280 -367 -462 -958 -997 -759 -1124 -974 -895 -953

Source: IMF, Direction of Trade Statistics Yearbook, various issues.

Table 2
BANGLADESH-INDIABILATERALTRADE(INMN US$)

Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

B'desh exp to Ind 22 23 4 13 24 36 21 37 55 50 50 59.8

B'desh imp from Ind 170 189 284 380 486 994 1018 796 1179 1024 945 1013
bilateral deficit-B'desh -148 -166 -280 -367 -462 -958 -997 -759 -1124 -974 -895 -953

b.t.d.as % of total t.d.

(B'desh) 7.5 9.5 44.9 21.2 22.6 28.8 27.7 27.6 38.3 38.1 32.2 51.4

b.t.d.as % of gdp
(B'desh) 0.6 0.7 1.2 1.5 1.8 3.3 3.2 2.3 2.6 2.1 1.9 2.0

Source: IMF, Direction of Trade Statistics Yearbook, various issues.

Note: b.t.d. refers to bilateral trade deficit.

items of Indian export to Bangladesh are: textile articles and vegetable products. They

together contribute on an average 40% of total import. Textile products have the distinctive
characteristic of being important both in the export and import side.

We make a preliminary analysis of the bilateral trade figures in terms of Graph I for
the entireperiod of our study (1974-2001). The graph shows that thepath of bilateral
tradedeficithas almost coincidedwith thatof importexcept fora briefperiod of 1979
85. Export figures are small and therefore, path of export lies much lower than that of

importand themagnitude of tradedeficit ismostly determinedby importfigures.From

1991 onwards, the importance of import in bilateral trade has so much increased that

import and trade deficit graphs have nearly merged into one.

In the next part of our analysis, we have computed different trade related indices as
used in the literature to analyse the bilateral trade pattern. In order to study the potentiality
of trade between Bangladesh and India we have calculated Revealed Comparative
Advantage (RCA) indices of different years at 3-digit level of SITC classification. Table
4 shows thatforbothBangladesh and India,RCA indicesexceed unityonly forunskilled

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 India-Bangladesh Trade Relations: Problem of Bilateral Deficit 115

Table 3
COMPOSITION OF BANGLADESH-INDIA BILATERAL TRADE
_COMMODITY
A: Export of Bangladesh to India inmn US$
Year Live animals& Product of chemical or Textile & textile
animal products allied industries articles

1990 13.31(76.32)
1993 .14(.76) 6.82(38.17) 7.47(41.78)
1996 4.68(7.51) 35.01(56.25) 21.37(34.35)
1999 6.94(8.82) 20.98(26.66) 44.74(56.87)
2000 5.58(6.83) 21.18(25.91) 47.74(58.41)
2001 4.30(7.22) 17.18(28.75) 34.05(56.97)

B: Importof Bangladesh from India inmn US$

Year Vegetable Mineral Chemical Textile Base Machinery Transport
Products Products Industries Articles Metal Equiment

1990 24.9(8.2) 14.0(4.6) 12.4(4.1) 139.1(45.6) 15.9(5.2) 53.0(17.4) 15.8(5.2)

1993 23.9(5.6) 55.4(12.9) 25.7(5.9) 197.5(45.9) 29.7(6.9) 35.2(8.2) 21.1(4.9)
1996 78.7(9.1) 71.8(8.3) 66.4(7.7) 333.3(38.4) 64.5(7.4) 74.1(8.5) 51.5(5.9)
1999 146.7(22.9) 55.8(8.7) 46.3(7.2) 177.7(27.8) 54.5(8.5) 33.9(5.3) 40.6(6.4)
2000 169.0(23.7) 78.3(10.9) 74.6(10.5) 77.4(10.9) 70.7(9.9) 65.9(9.3) 56.1(7.9)
2001 203.7(20.1) 76.2(7.5) 73.5(7.2) 188.6(18.6) 85.5(8.4) 102.8(10.1) 78.9(7.8)

Source: Computed from DGCI&S, Statisticsof the foreign tradeof India by countries,various issues.
Note: Figures within brackets give percentages.

lab- intensive industrial products. This indicates that both countries, being labour-abundant,
have specialized in the production of unskilled labour intensive commodities. Neither of
them has comparative advantage in the production of human capital intensive, technology
intensive or physical capital intensive products. Thus there is a similarity in the nature of

comparative advantage of the two countries. However, RCA indices for unskilled lab
intensive products are higher for Bangladesh than for India, while RCA indices for all
other categories, though less than one for both countries, are lower for Bangladesh. This

implies that relative participation of Bangladesh is more in unskilled lab- intensive

commodities in world trade but less in capital or technology intensive products compared
to India.

5 gives the number of commodities inwhich India or Bangladesh

Table has Revealed

Comparative Advantage in different years and it is observed that figures for India far
exceeds the corresponding number for Bangladesh in all the years. Consequently, the
coefficientof variationofRCA indices is less forIndia thanforBangladesh. This implies

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 116 Suparna Basu and Debabrata Datta

Table 4
RCA INDICESFOR INDUSTRIALPRODUCTS
Unskilled lab intensive Human k intensive Techonology intensive Physical k intensive
Ind B'desh Ind B'desh Ind B'desh Ind B'desh

1990 2.5
3.6 0.4 0.03 0.31 0.1 0.37 0.004
1995 5.72.3 0.4 0.01 0.29 0.15 0.48 0.083
1998 2.5
8.9 0.5 0.03 0.27 0.06 0.52 0.064

Source: Computed from United Nations, Foreign Trade Statistics of Asia and the Pacific, various issues.

Table 5
SIMILARITYOF INDIAEXPORT-EXPORT
AND EXPORT-IMPORT
& B'DESH
Year no of commodities COV of RCA (>1) common export-import export-exportsimilarity
with RCA>1items similarity (Indian (B'desh
B'desh India B'desh India pt. of view) pt. of view)
1990 6519 464.84 202.66 10(53) 0.041 0.24
0.52
1994 6223 388.96 98.10 14(61) 0.017 0.33
0.57
1995 6223 390.07 113.51 11(48) 0.037 0.31
0.53
1996 7124 397.42 97.61 14(58) 0.016 0.33
0.53
1997 6822 383.72 106.23 14(64) 0.018 0.31
0.48
1998 6124 383.82 114.17 15(63) 0.009 0.29
0.49

Source: Computed from United Nations, Foreign Trade Statistics of Asia and the Pacific, various issues.
Note: Figures in parenthesis show common items as a %age of comparative advantageous goods of Bangladesh.

India's ability to specialize inmore diverse lines of production compared to Bangladesh.

Following Balassa (1967), it can be inferred that, India, being a large country unlike
Bangladesh, enjoys the advantages of a more balanced resource endowments and a wider
home market which get reflected in her diversified export basket.

However, the number of commodities in which a country has comparative advantage

is not the sole determinant of bilateral trade balance. It may be possible that a country
can have good export potentiality even with a few goods if it has very strong comparative

advantage in those goods, which have large demand in the other country. But if these
limited numbers of goods are such that the other country also has comparative advantage
inmany of these goods, then the country with fewer comparative advantageous goods will
be in a handicapped position in the context of bilateral trade. Bangladesh faces this type
of problem while exporting to India. Our calculations (percentage values in Table 5) show
thatmore than 50% of items in which Bangladesh has comparative advantage also figure
in the Indian list, barring the year 1995. The similarity in the pattern of RCA's, therefore,
may be ascribed as one of themajor constraints of Bangladesh in expanding her bilateral

export.

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India-Bangladesh Trade Relations: Problem of Bilateral Deficit 111

Considering the observation that there are a significant number of items inwhich both
countries have comparative advantage, it is useful to see the similarity between export
structures of the two countries. The similarity of export structure is studied by Cosine
measures of export-export similarity and its high value for a country implies competitive
export structure. Low value indicates low competitiveness and implies compatibility between
export of one country and import demand of another country. The competitive export
structure constrains export prospects of a country, while compatibility favors bilateral
trade.

measures
The Cosine (Table 5), calculated from the sides of both Bangladesh and
India, show
lower figure for India in comparison to that of Bangladesh. These export
similarity indices for Bangladesh are high because there are only a few items, which are

exported by Bangladesh and not by India to the rest of the world. On the other hand there
is sizeablenumber of goods that India exports but Bangladesh does not, and hence the
export similarity indices for India is low. This implies that India is a major competitor so
far as Bangladesh export is concerned but India's exports do not face similar
competitiveness. These findings from export similarity indices suggest difficulties of

Bangladesh in increasing exports to India.

In this context of trade similarity, we also study the degree of compatibility between
the export structure of Bangladesh and the import structure of India. The greater the
match between the export supply of Bangladesh and import demand of India, the higher
will be the scope for Bangladesh to expand her export business to India. The values of
Cosine measures of export-import similarity (Table 5) at 3-digit level of SITC classification
are found to be extremelylow (highestfigure is 0.041 in 1990) for all theyears. This
reflects that exports of Bangladesh to the world and imports of India from the world have
low complementarity to each other. To summarize, at the existing state of technology and
pattern of production, the export potentiality of Bangladesh as measured by RCA indices
are not only limited in number but is also constrained by similarity with India's export
structure and hence, lack of compatibility with India's import structure.

2.1 Intra-industry Trade between Bangladesh and India

Until now, the bilateral trade has been from the point of view of inter?
discussed
industry trade. But trade between countries with similar development level may also take
place in similar products resulting in intra-industry trade. Since India and Bangladesh
share such similarities, both being LDCs, the intra-industry trade between them assumes

particular significance. Furthermore, the potentiality of intra-industry trade is high in the

context of Bangladesh-India trade relation, as there is common border between the two
countries on both sides of Bangladesh4.

4 For example, the Eastern Districts of Bangladesh may import (export) a particular product from (to) Northeast
India, while the Western Districts may export (import) the same product to (from) the rest of India in order
to reap the transport cost advantage.

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 118 Suparna Basu and Debabrata Datta

With a view to studying the intra-industry trade, we have computed the Grubel
Lloyd (G-L) indices at ITC (HS) 8-digit level.We find that therehas been a marked
increaseover timein thenumberof commodities(from1 in 1990 to 34 in2001) forwhich
G-L index exceedsindicating rising opportunities for intra industry trade (Table 6).
0.5,
Through out the period of study, manufactured products account for lion's share (more
than 95%) of intra-industry trade between Bangladesh and India. Although both the
countries are developing, intra-industry trade on primary commodities is almost non?
existent. Since manufactured items dominate world and bilateral exports of both countries,
it is not surprising that it dominates intra-industry trade also. However no clear industry

pattern of intra-industry trade can be identified as the data show domination by different
manufacturing industries in different years.

Table 6
TRADE BETWEENB'DESH AND INDIA
INTRA-INDUSTRY
Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

disaggG-L
no of itemswith
G-L(>.5)
all goods 1 2 2 1 4 4 8 8 10 15 18 34
manuf 1 2 2 1 3 4 6 8 10 15 18 32

aggG-L 0.001 0.005 0.008 0.012 0.013 0.011 0.014 0.009 0.013 0.009 0.016 0.025

iit/aggtra 0.7 0.54 0.65 8.94 12.77 5.48 6.8 2.92 4.17 2.83 5.69 11.09

Source: Computed from DGCI&S, Statistics of the foreign trade of India by countries, various issues.

We have also computed the aggregateG-L Index in order tomeasure the

(Gljk)
extent of intra-industry trade between Bangladesh and India. The aggregate G-L Index
assumes very low values as the India-Bangladesh intra industry trade flow shows lop?
sided patternwith India exportinga wide rangeof ITC (HS) 8 digit itemstoBangladesh
in exchange for a limited number of products imported from Bangladesh. However, the

aggregate G-L Index has shown high growth of intra-industry trade during the 90's (from
.001 in 1990 to.025 in2001) and its importanceinbilateral tradehas also been increasing
(Table 6). The percentage of intra-industry trade to total bilateral trade was only 0.7 in
1990 but thereafter, it has registered significant increase to reach the double-digit figure
of 11 by 2001.

Regarding the factors that influence intra industry trade (iit) between countries, theory

suggests that higher the degree of income equality between any two countries, the higher
is theproportionof iit to totaltrade. (Balassa, 1986; Culem and Lundberg, 1986). In the
- India
context of Bangladesh trade, it implies reduction in the difference in per capita
income of the two countries is likely to raise iitbetween them. The stages of development

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India-Bangladesh Trade Relations: Problem of Bilateral Deficit 119

of the countries concerned also have an impact on iit between them. In our context, it
means that as Bangladesh moves ahead in the path of development, iitwith India will also
grow. Economic integration is also supposed to influence positively iit between countries
(Grubel& Lloyd, 1975; Balassa, 1979). It indicatesthatwith liberalizationofBangladesh
and India, iitbetween them is likely to increase. The higher degree of product differentiation
and product innovation is also expected to result in high levels of iit (Caves, 1981;
Greenway,Hine & Milner, 1995). In view of the findingthatBangladesh export is less
diversified compared to India, the above theory suggests that the rise in relative diversification
of Bangladesh economy will encourage iit with India.

In order to quantify the influence of these theoretically suggested factors on Bangladesh

Indiabilateral iit,thefollowingregressionequation as proposedby Balassa (1986) can be
estimated:

i
c* y =
1+ expi-?Zy)
where Z. is a vector of explanatory variables. Given that G-L indices lies in the scale
?
ofOto
l(0<G L<l),
Balassa postulates a logistic function. However, iit between

Bangladesh and India before 1990 is almost non-existent, and therefore we do not get the
values of aggregate G-L index for a sufficient long period of time that would make the
results of the econometric exercise meaningful. So we leave this work for future research.

2.2 Long run dynamics of trade relation

Having analyzed, on the basis

of different trade indices, the supply constraint faced
by Bangladesh export, we now examine themacro economic determinants of Bangladesh
export and bilateral trade deficit from long run econometric perspective. Theory postulates
that export demand depends on exchange rate and foreign national income endogenously
and on trade barriers of importing countries exogenously. In order to study the demand
for export of Bangladesh, we have considered the time series data of real value of

Bangladesh export to India (RBEX), taka per rupee real exchange rate (REXRT), real
income of India (RGDPI). All three variables are found to have unit root when ADF and
PP tests are applied (Table 7). However first differences of log values are found stationary
on the basis of above tests and therefore we conclude that all these three variables are

1(1).We thenapply the two likelihoodratioteststodeterminetherankof thecointegration

space of these three variables. First order lag was chosen for the underlying VAR model
where the residuals are serially uncorrelated. Both the calculated trace and maximum

eigen value statistics do not reject the null hypothesis of zero cointregrating vectors (Table
8A). This implies thatduring theperiod under study there is no long run relationship
among these variables. Since the variables are found not to be cointegrated, we do an
unrestricted VAR analysis on the firstdifferences of the variables with a dummy introduced

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 120 Suparna Basu and Debabrata Datta

to capture the effect of liberalization that India underwent since mid eighties5. This
dummy,denoted byDUMTARIFF, is given thevalue of 1 till 1986 and 0 thereafter
and
treated as exogenous in VAR analysis. We take into account the extra ordinary variations
(shocks) inGDPI and RBEX in the formof dummy i.e. DUMGDPI (-1 in '79, '91 &
0 elsewhere) and DUMEXP (-1 in '77, '85 & '91, +1 in '79) respectively. The estimated

explainedbyDUMEXP while GDPI, REXRT are

figuresshow thatexportis significantly
found not to Granger cause RBEX at 5%
level of significance (Table 9). Variance
decomposition analysis also supports this result. The upshot of this result is that export of
Bangladesh to India is basically of random nature. This substantiates our observation that

Bangladesh has not been able to create a stable market for her goods in India and supply
constraint handicaps Bangladesh export performance.

Table 7
TESTS FOR UNIT ROOT INTHE DATA
ADF PP

variables level/ Lag No Constant, Constant, No Constant, Constant, conclusion

first order constant, No trend trend constant, no trend trend
diff. of ADF No trend No trend

RBEX Level -.072845 -1.4726 -1.245 -.32676 -2.745 -2.6814 KD

first -2.3705 -2.3641 -2.3710 -5.5644 -5.4542 -5.3905 KO)
diff
REXRT level -.88690 -.56950 -2.4902 -.89294 -.51451 -2.4601 KD
first -2.2239 -2.6162 -1.9646 -5.6032 -5.5549 -5.8756 K0)
diff
RGDPI level 8.9104 .54945 -1.8249 8.1261 .46862 -1.9876 KD
first -1.0829 -3.0659 -3.6565 -1.6861 -3.9847 -4.0255 KO)
diff
RBTD level .50673 -.41021 -1.8237 .67069 -.16185 -1.7542 KD
first -2.7409 -2.8516 -3.0934 -6.4759 -6.4505 -7.5960 KO)
diff
RGDPB level 3.3304 -1.4586 -2.7552 3.8317 -1.5445 -2.8208 KD
first -5.8999 -8.5562 -8.2281 -5.6682 -8.0227 -7.7583 KO)
diff
RREM level .32492 -2.1709 -4.0252 2.1114 -3.0773 -1.6794 KO)
Notes: 1) truncation lag for PP test =1
2) 95% critical value for no constant, no
trend= -1.95
3) 95% critical value for constant, no trend = -2.86
4) 95% critical value for constant, trend = -3.41

5) conclusions are drawn following Enders(1995)

However, since trade deficit ismainly determined by import, removing export supply
constraint cannot be enough to reduce the trade deficit sufficiently. Food and textile items
are the major constituents of Bangladesh import. A careful look at the composition of
import shows that the years in which food import recorded abnormally high values, total

5 Although new economic policies were introduced in 1991, the trade liberalization process started from mid 80s.

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India-Bangladesh Trade Relations: Problem of Bilateral Deficit 121

Table 8
JOHANSEN-JUSELIUS MAXIMUM LIKELIHOOD COINTEGRATION TESTS

A. RBEX, REXRT, RGDPI B. RBTD, REXRT, RGDPI, RGDPB

Null alternative statistic 95% Null alternative statistic 95%

critical value
critical value

max
max
r=0 r=l 11.8159 25.4200 r=0 r =1 32.5750 31.7900
r<l r=2 6.9588 19.2200 r<l r =2 12.3117 25.4200

r<2 r=3 5.1343 12.3900 r<2 r =3 7.9142 19.2200

^max

r=0 r>l 23.9089 42.3400 r=0 r>l 58.5270 63.0000

r<l r>2 12.0930 25.7700 r<l r>2 25.9520 42.3400

r<2 r>3 5.1343 12.3900 r<2 r>3 13.6403 25.7700

Notes: 1) r stands for the number of cointegrating vectors.

2) when
Amax
and
^trace
tests conflict,
Amax
is usually preferred for trying to pin down the number

of cointegrating vectors as it has the sharper alternative hypothesis Enders (1995)

since = 0 is rejected for each of the variables

3) ?(A*,) RBEX,REXRT,RGDPI,RBTD, RGDPB,
we restrict the trend to lie in the cointegration space.

import of Bangladesh from India also registered significant increase. This suggests that

Bangladesh is a compulsive importer of food. When her agriculture performs well,

Bangladesh need not import food thatmuch and her total bilateral import falls. Stabilization
in agricultural production will help Bangladesh to reduce the need for food imports and

consequently, curtail her trade deficit with India. But the nature of textile imports is totally
different from that of food items. Bangladesh import of textile goods from India comprises
raw materials and textile-related machinery, which help her in export of ready-made
garments to the world as well as to India. Thus, the reduction of textile imports will not
be fully costless.

After we find thatBangladesh bilateral export is random and import ismostly compulsive,
we focus on Bangladesh bilateral trade deficit as a whole and analyze its relation with
other variables. For this purpose, we take real values of Bangladesh bilateral trade deficit
(RBTD), realGDP of Bangladesh (RGDPB), realGDP of India (RGDPI), real exchange
rate between taka and rupee (REXRT). The last two variables contain a unit root, as
stated earlier. So we conduct ADF and PP tests on RBTD and RGDPB only. The results
(Table 7) show that both variables are non-stationary in levels but stationary in first
differences. Therefore we conclude, RBTD and RGDPB are also 1(1).

Next we investigate the long run equilibrium relationship among the four variables

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 122 Suparna Basu and Debabrata Datta

Table 9
UNRESTRICTED VAR OF RBEX, REXRT, RGDPI: EXOGENOUS VARIABLES INCLUDED
DUMTARIFF, DUMGDPI, DUMEXR
(26 observations used for estimation from 1976 to 2001)

Dependent variable/ Regressor D(RBEX) D(REXRT) D(RGDPI)

D(RBEX(-1)) -.019835 .019168 -.2174E-3
.12185 .022188 .0086310
-.16277[.872] .86389[.398] -.025185[.980]
D(REXRT(-1)) 1.1434 -.17434 .086920
1.1888 .21646 .084204
.96178[.348] -.80539[.430] 1.0322[.314]
D(RGDPI(-1)) 3.0101 -.31751 .84789
1.5976 .29090 .11316
1.8841[.074] -1.0915[.288] 7.4929[.000]
DUMTARIFF -.076630 .044559 .0098942
.15197 .027672 .010764
-.50423[.620] 1.6103[.123] .91916[.369]
DUMGDPI -.012900 .022274 .084339
.31607 .057551 .022387
-.040813 [.968] .38703[.703] 3.7673[.001]
DUMEXP 1.4983 .060947 -.032594
.22066 .040179 .015630
6.7899[.000] 1.5169[.145] -2.0854[.050]

R-Squared .70990 .22079 .36538

R-Bar-Squared .63738 .025988 .20672

Notes: 1) D( ) denotes first difference of the variable in parenthesis

2) Corresponding to each variable,first,second and third row represent coefficient, standard error and
t-values with probabilities in parenthesis respectively.

RBTD, RGDPB, RGDPI andREXRT. In applyingthemaximum likelihoodprocedure,the

VAR model. The likelihoodratio statistic
lag lengthof order 1 is takenfor theunderlying
Amax (Table 8B) suggests one cointegrating vector that includes all four variables. Since

cointegration does not imply causality in any particular direction, we firstnormalize RBTD
and the corresponding error correction term (ECM) is found to be significant in case of
REXRT only, implyingthatour initialchoice of RBTD as thedependentvariablewas a
wrong one. So we treat REXRT as the dependent variable in the cointegrating equation.

ofRBTD (-0.100916) in thecointegrating

However thesignof theestimatedcoefficient
relation seems to be surprising. How can exchange rate appreciate when trade deficit is

deteriorating? During the period under study, the value of taka has not been determined
in themarket, but managed officially. One possible explanation in this context may be that

Bangladesh govermnent need not depreciate taka against rupee even in case of huge

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India-Bangladesh Trade Relations: Problem of Bilateral Deficit 123

bilateral trade deficit as she gets the support of remittances. The healthy growth of
remittance permits Bangladesh to consume importables without corresponding adjustment
in its own currency.

To assess the validity of the above hypothesis on the role of remittance, we include
real value of Bangladesh remittance (RREM) in our analysis. We first perform unit root
tests on RREM. Both ADF and PP tests show stationarity at levels (Table 7). Hence
RREM is 1(0). We, therefore, incorporate RREM as exogenous in our analysis and
reestimate VECM (Table 10) accordingly. The statistically significant negative relation of
RREM with D(REXRT) confirms our hypothesis that increase in remittance reduces the
rate of depreciation of Bangladeshi taka in relation to Indian rupee. Thus Bangladesh
could maintain high trade deficit with India without depreciation of her currency. This

explains the exchange rate perversity i.e. a relation in the cointegrating equation, opposite
to the theory, between taka per rupee and bilateral trade deficit.

Table 10
COINTEGRATING EQUATION AND VECTOR ERROR CORRECTION: RBTD, REXRT,
RGDPI & RGDPB; EXOGENOUS VARIABLES: DUMTARIFF, DUMGDPI, DUMBTD, RREM
(26 observationsused for estimationfrom 1976 to 2001)
ECM(-l) = REXRT(-l) + 0.1009163422*RBTD(-1) + 0.3961592007*RGDPB(-1) + 0.8167052807*
RGDPI (-1) - 0.07246728067*(@TREND(74)) - 12.50480441

Error Correction: D(REXRT) D(RBTD) D(RGDPB) D(RGDPI)

ECM(-l) -0.945947 -1.993134 0.859236 0.095567

(0.32567) (1.41466) (0.49620) (0.11505)
(-2.90462) (-1.40892) (1.73165) (0.83064)
D(REXRT(-1)) 0.048981 0.304687 -0.632166 0.113614
(0.24701) (1.07298) (0.37635) (0.08726)
(0.19829) (0.28396) (-1.67972) (1.30195)
D(RBTD(-1)) -0.013494 -0.364204 0.019705 -0.005886

(0.04482) (0.19469) (0.06829) (0.01583)

(-0.30108) (-1.87072) (0.28856) (-0.37176)
D(RGDPB(-1)) 0.141529 0.446028 -0.454551 -0.016611

(0.15549) (0.67544) (0.23691) (0.05493)

(0.91018) (0.66035) (-1.91863) (-0.30238)
D(RGDPI(-1)) -0.068736 1.388230 -0.196552 0.287788
(0.41154) (1.78765) (0.62703) (0.14539)
(-0.16702) (0.77657) (-0.31347) (1.97945)
0.119936 0.288659 -0.031446 0.056097
(0.09754) (0.42371) (0.14862) (0.03446)
(1.22956) (0.68126) (-0.21159) (1.62788)
DUMTARIFF 0.024625 -0.169992 0.064231 -0.027311

(0.05515) (0.23955) (0.08402) (0.01948)

(0.44654) (-0.70964) (0.76445) (-1.40184)

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 124 Suparna Basu and Debabrata Datta

Error Correction: D(REXRT) D(RBTD) D(RGDPB) D(RGDPI)

DUMGDPI -0.034413 0.087979 -0.031118 0.089638

(0.06110) (0.26540) (0.09309) (0.02158)
(-0.56323) (0.33149) (-0.33428) (4.15282)
DUMBTD -0.018091 1.008579 0.087403 -0.027533

(0.06838) (0.29704) (0.10419) (0.02416)

(-0.26455) (3.39539) (0.83889) (-1.13971)
RREM -0.029393 -0.039214 0.025761 0.000365
(0.01468) (0.06377) (0.02237) (0.00519)
(-2.00229) (-0.61497) (1.15181) (0.07029)

R-squared 0.587473 0.687275 0.486226 0.722888

Adj. R-squared 0.355427 0.511367 0.197228 0.567013

Notes: 1) D( ) denotes first difference of the variable in parenthesis

2) Corresponding to each variable, first, second and third row represent coefficient, standard error and
t-values respectively.

3. CONCLUSION

India and Bangladesh belong to Indian sub-continent, have geographical proximity and
have pursued similar policies towards achieving economic development. Naturally this has
resulted in similarity in the export structure of two countries. But India enjoys advantages
of largeness and diverse resource base, which makes the overall production structure of
India more diversified and scale efficient than that of Bangladesh. This is one of the
reasons behind India enjoying a bilateral trade surplus. This observation is consistent with
the result, termed as triangular trade6 in theory, that bilateral trade imbalance can emerge
if demand and production pattern vary across countries.

The analysis of the trade dynamics of Bangladesh economy shows that export to
India has a negligible role in financing import. The resulting trade deficit is being financed

by remittance for which the exchange rate moves in the perverse direction perpetuating
the deficit. This helps Bangladesh to sustain its level of absorption and welfare. But

although remittance can meet short run requirements, it does not signify any transformation
whenmajor part
of theeconomy towardsachievinggreaterproductionability,particularly
of remittance comes from unskilled workers. Moreover, the remittance is critically dependent
on the immigration policies of foreign governments, the liberalization of which is not an
immediateagendum in theworld forum.This places a limiton thegrowthpotentialityof
remittance, which makes the growth in trade deficit unsustainable, with the risk of sudden
decline inwelfare. Further, the use of remittance inmaintaining high value of Bangladeshi
taka against rupee may give rise to Dutch disease7 in that country, slowing down the

6 Davis & Weinstein (2002)

7 Discovery of natural gas reserve in Netherlands was responsible for appreciation of Dutch currency that led
to decline in industrial export.

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India-Bangladesh Trade Relations: Problem of Bilateral Deficit 125

process of industrialization. This makes the Bangladesh trade deficit a matter of concern
and hence arises the need for appropriate exchange rate policy and use of remittances
for development of Bangladesh economy so that she can finance her import not just by
remittance but also mostly by export of more goods and services. Moreover, a suitable

exchange rate policy can also promote intra-industry trade, which is presently at a low
level.

The need of Bangladesh economy is to diversify and produce new items of production
so as to tap the large market of India and reap the benefits of increasing returns. The
recent discovery of natural gas reserves in Bangladesh may be helpful in this regard.8 If
this promotes rapid industrialization, Bangladesh, following a suitable exchange rate policy
can take advantage of Indian trade liberalization and improve her bilateral trade position.

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8 See Jakir Hossain (2000) for the prospect of natural gas in Bangladesh.

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APPENDIX

Methodology, data sources & period of analysis.

We use the indexof Revealed ComparativeAdvantage (Chen, 1992) to identifythe

products in which a country has comparative advantage as reflected by her actual export

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India-Bangladesh Trade Relations: Problem of Bilateral Deficit 127

performance. It is defined in terms of the share of product i in total export of country j

relative to the share of product i in global exports. Thus, RCA indices can be written as:

where RCA., is the index of revealed comparative advantage of country j in product i

X is the exportof good i by countryj

X is the totalexportof countryj
is the total export of product i by all the countries of the world
X.w
is the total world exports
Xw
RCA., takes values between zero to infinity.Only when it exceeds unity, country j is
said to have revealed comparative advantage in product i. The underlying idea is: if a
country has comparative advantage in producing a certain product, itwill obviously specialize
in production of that commodity. As a result, the product will have larger share in the

country's total export compared to its share in world exports, making RCA greater than
one. Thus, the products for which a country has RCA values exceeding one reflect the

country's revealed comparative advantage.

The extent to which the export structure of Bangladesh matches with the import
structure of India is measured by computing the Cosine measure (Panchamukhi and
others, 1995) as follows:

lXikMjk
COS j r

Where k = 7,2,.,K
Xik = export of Bangladesh in commodity k to the world
= in
Mjk import of India commodity k from the world

The value of Cosine measure lies between zero and one. There is no trade

complementarity between the two countries when the measure takes the value zero and
trade structure of two countries will be perfect complement to each other when the
measure assumes the value one. The closer is the value of the measure to unity, the

higher will be trade complementarity between the two countries. The measure gives only

potential trade between two countries on the basis of their existing trade patterns. It
neither the process of realizing the potential nor accounts for the factors
talks about

underlying trade behaviour of two countries. It may also be noted that, unlike Finger
Kreinin measure of trade similarity, the value of Cosine measure will not necessarily
decline with disaggregation of data and similar to Finger-Kreinin measure, the value of
Cosine measure will not necessarily increase with the increase in commodity concentration

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 128 Suparna Basu and Debabrata Datta

in the export and import vectors. The Cosine measure is further used to compute the

degree of export similarity of Bangladesh and India. While the lower value of themeasure
indicates greater degree of specialization in exports, the higher value implies a highly

competitive export structure of two countries.

The measures described so far deal primarily with inter-industry trade. But bilateral
trade may also take place on intra-industry basis. Therefore, Grubel-Lloyd index for

measuring intra-industry trade is employed in the study. The index takes the following
form:
k k\
Ij? _j?

8;=i-UL?Vxioo k
X.k + X IJ ?

where k=l,2,.yK

gk is intra-industry trade index in commodity k between countries i and j

Xk is exportof commodityk fromcountryi (countryj) to countryj (countryi)

(X?k)

=
The index is symmetric, gk gk and its value ranges from zero to unity. When

either of two countries i and j alone exports commodity k to its bilateral trading partner,
k
in inter-industry trade. At the other
gtj will be zero, implying complete specialization

extreme, when exports of two countries to each other in commodity k are equal, gk will
be unity, indicating intra-industry trade is at its optimum. However, the index is sensitive
to the level of aggregation of data. The more aggregative the commodity grouping is, the
greater will be the extent of over-estimation of intra-industry trade. The aggregative
version of G-L index, namely,

Gk = jgk X^+X?
k=i

underestimates intra industry trade if there is large trade imbalance at the aggregative
level. Thus, following Grubel & Lloyd, the present study employs adjusted aggregate G
L index, which is written as follows:

-*d--xlOO
.
K K

i<x*+x*)
k=\ k=l k=\

In order to examine the influence of different factors on Bangladesh export to India

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India-Bangladesh Trade Relations: Problem of Bilateral Deficit 129

and her bilateral trade deficit, we test for possible relationship among various macro
economic indicators of these two countries e.g. exchange rate between the currencies of
the two economies, GDP of two countries etc. Since OLS technique cannot be applied
to time-series data unless they are found to be stationary, we first determine the order
of integration of the variables under consideration, by employing Augmented Dickey-Fuller
(ADF) and Phillips-Perron (PP) unit root tests. When the variables are found to be

integrated of order one 1(1) according to these tests, we apply Johansen-Juselius maximum
likelihood method to search for long run cointegrating relation among the relevant variables.
If the two corresponding test statistic, namely & the null hypothesis of no
lmax 1^ reject
cointegration, 1(1) variables have long run equilibrium relationship among them, represented
by one or more cointegrating equation. Then, if the system is out of equilibrium, theremust
be some inbuilt adjustment mechanism, which will restore the system again in equilibrium.
In order to capture the response of different variables to deviation from long run equilibrium
we estimate the corresponding Vector Error Correction Model (VECM). Although
cointegration implies existence of long run relationship, it does not indicate the direction
of causality between the variables. Therefore we apply Granger causality to VECM in
order to identify the causal direction. Finally, we apply diagnostic tests to VECM.

The data sources are:

a) United Nations : Foreign Trade Statistics of Asia and the Pacific, various issues
b) IMF : Direction of Trade Statistics book, Year various issues
International Financial Statistics, various issues
c) DGCI &S, INDIA : Statistics of foreign trade of India by countries, various issues

Data obtained from United Nations publication have been used in estimating Cosine
measure and RCA indices. Data on macro-aggregates obtained from International Financial
Statistics have been analysed to explain the behaviour of Bangladesh export to India and
her bilateral trade deficit. These data have been deflated by suitable price indices and then
transformed to their natural logarithmic form for econometric analysis. Finally, intra
industry trade indices are based on data from DGCI &S, India.

Period of analysis:

The various indices have been computed using the data of last twelve years to reflect
recent scenario in concerned respects. However, relationship among time series variables
can be established and tested only in the context of long-run: hence, the behaviour of

Bangladesh export to India and her bilateral trade deficit are examined for the period 1974
to 2001.

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