Limited regional integration barrier

South Asia is one of the most dynamic regions in the world, but it is also one of the least economically integrated. Intra-regional trade accounts for just 5% of total trade, compared with 25% in the Association of Southeast Asian Nations (ASEAN). With shared history and culture, the South Asia region has a huge potential for economic integration but issues on national identity and internal consolidation have caused political tensions and mistrust between countries, and as a result, intra-regional integration is limited.
By building common interests across borders, regional integration could enhance stability in this volatile region - which is home to 570 million or 44% of the world's poor - and pave the way for countries to cooperate on urgent and shared climate change-related challenges which aggravate the risks to sustainable growth.
A latest World Bank study (Global Economic Prospects - January 2016: South Asia) has identified South Asia's limited regional integration as one of the factors undermining its potential for a quick economic take off. Average trade costs between country pairs in South Asia are 85 percent higher than between country pairs in East Asia reflecting flows of goods and capital across borders are low compared to other regions. Exports have increased by much less over the past two decades than in other regions.
While the larger countries in the region predominantly trade outside the region, India is the dominant trading partner for the smallest countries in the region: Bhutan (mainly hydroelectricity), Nepal (textiles, agriculture, tourism) and Afghanistan (for which, Pakistan too is a major trading partner).
A number of factors are said to be at work for the low regional integration: poor transport connectivity within South Asia and to global markets; poor trade facilitation policies reflected in high costs of trading across borders in general; and restrictions on doing business with countries within the region that are in some cases due to strained political relations and have contributed to substantial numbers of South Asians migrating overseas in search of better employment opportunities.
While global non-integration has reduced exposure to global shocks in the short-term, these very factors limit the potential of South Asian firms to fully benefit from the strengthening demand in the United States and Europe over the medium term. The degree of integration at the regional level, measured by flow in goods, capital and ideas, is very low. This is despite shared cultural ties, extensive common borders, and high population densities with large populations living close to border areas.
Although economic linkages between South Asia and the rest of the world have deepened in recent decades, progress has been slow and uneven. High-income countries and China account for the bulk of exports earnings, portfolio investments, FDI and aid. Regional integration, meanwhile, has lagged considerably. The exceptions are within-region remittances: the Bangladesh-India migrant corridor, for instance, is the third largest in the world.
Unilateral trade liberalisation measures introduced in the late 1980s and 1990s have led to rising trade flows between South Asia and the rest of the world. Still, the degree of integration remains much lower in South Asia than in other major developing regions, with exports amounting to a fifth, or less, of GDP in most countries. Moreover, export flows tend to be highly concentrated, with the European Union and the United States as major trading partners notwithstanding a recent shift of India and Pakistan toward East Asia and Sub-Saharan Africa.
Relative to GDP, capital flows to South Asia are lower than those to East Asia and the Pacific and Europe and Central Asia regions, reflecting underdeveloped capital markets as well as inflow restrictions in some countries. They are dominated by banking sector flows, mainly from the United Kingdom. Financial integration is limited by restrictive domestic policies. For instance, in India, notwithstanding some gradual liberalization over the years, and in Sri Lanka non-resident holdings of government debt remain capped.
India receives over 90 percent of the region's FDI and portfolio inflows, a substantial share of which originates from Mauritius and Singapore (low-tax countries with which India has double taxation treaties). In recent years FDI has tended to head into services rather than mining or industry.
China has made substantial investments into the region in recent years, in extractives in Afghanistan, renewable energy in Nepal, port construction in Sri Lanka, and manufacturing and infrastructure in Pakistan. Within-region FDI accounts for only a small share of all FDI inflows. Bhutan, Nepal, Maldives and Sri Lanka do, however, receive non-negligible amounts of FDI from India. Cross-border investments from India have flowed into energy and public sector-linked investment in Nepal; chemicals, food processing, banking and garments production in Bangladesh, and a similarly diverse range of sectors in Sri Lanka over the past decade.
Within-region migration flows are also substantial: the Bangladesh-India migrant corridor is the third largest in the world (after the Mexico-US and Ukraine-Russia corridors), with more than 40 percent of Bangladeshi emigrants located in India. India also hosts large numbers of migrants from Bhutan, Nepal and Sri Lanka, and Pakistan from Afghanistan.
Although the bulk of aid flows to South Asia originate from OECD countries, among non-OECD countries both India and China are increasingly important sources of development finance (mixing grants, loans and project finance). The recently signed US $46 billion China-Pakistan Economic Corridor (CPEC) agreement should see rising investment in energy, port and transport infrastructure in Pakistan over the next few years.
India, meanwhile, allocates nearly a two-third of its foreign aid budget to Bhutan, and significant amounts to Nepal, Afghanistan, Sri Lanka and Bangladesh. Several countries run sizable merchandise trade deficits with India, including Nepal, Bhutan, Bangladesh and Sri Lanka. Large imports from India include mainly capital goods (in Bhutan, related to hydropower investments), other production-side inputs and food in the smaller landlocked countries. In Bangladesh, for instance, these comprise mainly cotton for the garment sector, food and other consumer goods.
Limited global and regional economic integration in South Asia partly reflects business environments that have constrained the ability to do business across borders and policies that have weighed on competitiveness, growth and job creation. For instance, an improvement in South Asia's infrastructure to around 50 percent of East Asia's could improve intraregional trade by about 60 percent.