At a time when Pakistan’s phenomenal economic growth of the past few years under the Musharraf regime has hit a severe road block, the country’s Trade Minister Ahmed Mukhtar, who also holds the defence portfolio, announced a new trade policy on July 18, 2008. The announcement of the new trade policy has been governed by the state of Pakistan’s economy, which has been on a downward spiral since February. The trade policy states that GDP growth has come down to 5.8 per cent, while the State Bank of Pakistan estimates fiscal deficit to have touched 8.3 per cent and current account deficit 8.4 per cent of GDP. Debt-to-GDP ratio has started rising again after having declined consistently for the past few years. Rising global prices of oil, metal and food have caused severe macroeconomic imbalances in the economy, contributing to severe inflationary pressure on the economy. The new trade policy hopes to encourage investment and trade in Pakistan with the purported aim of bringing the economy, especially the bourgeoning fiscal deficit, under control. Enhancing productivity is the main focus of the new trade policy.

At this juncture, Pakistan’s exportable surplus in the agriculture sector has been reducing on account of a bourgeoning population and declining production of major crops. Major crops have declined by three per cent and forestry by eight per cent during 2007-08. The production of wheat, which is the staple diet of most people in Pakistan, has come down 6.6 per cent from last year and has resulted in severe shortages of Atta (Flour). The consequent ban on inter-provincial movement of wheat has exacerbated inter-provincial tensions and has caused severe strains on the federation. The production of cotton, which is the main commercial crop of Pakistan, has also come down 9.3 per cent from last year’s production of 12.9 million bales. Rice production is down three per cent from last year. The situation is unlikely to improve in future as the irrigated cultivable area cannot be increased, given that water available for irrigation has been reducing consistently due to silting in dams and leakages from canals, while the construction of new major dams is still mired in political controversies.

On the industrial front, the situation is equally bad; acute power shortage has hit industrial production very badly. Peak power shortage has touched 4500 MW, resulting in almost eight hours of load shedding. On top of this, Hub power company, which is currently producing 1200 MW electricity, and Uch Power plant, which produces 586 MW of electricity, have threatened to switch off the plants if their dues – Rs. 60 billion and Rs. 6 billion respectively, are not paid. Besides power shortages, the international economic environment has also impacted on industrial production and large scale manufacturing has been coming down for the last four years. The textile industry, which comprises almost half of all manufacturing in Pakistan, employs approximately 38 per cent of the country’s entire labour force and contributes over 57 per cent to total exports, is in a mess, as its cost of production has been rising consistently. Fuel prices have been raised seven times since February and cotton prices have also risen due to lower production of cotton. The export of textiles has come down by 2.5 per cent as compared to the last financial year.

There has also been a slowing down of the US economy, which accounted for more than a quarter of Pakistani exports during 2006-07. As a result, the options available to Pakistani policy makers for rectifying the increasing trade deficit are limited. The new trade policy highlights these dilemmas¬¬¬ – textiles, leather, rice and sports goods comprise over seventy per cent of Pakistan’s exports; and the United States, Germany, Japan, the United Kingdom, Hong Kong, Dubai and Saudi Arabia receive over half of Pakistani exports. Similarly, Pakistan is virtually absent in 81 per cent of products traded in the world. The trade policy therefore aims at diversification of products for export as well as destinations for export. It specifically aims to target Latin America, Africa and East Europe.

While exports during 2007-08 grew by over 13 per cent, imports sky rocketed by over 30 per cent to around $40 billion resulting in a huge trade deficit of $20.7 billion. The huge rise in imports has been attributed to the high oil import bill, which rose significantly from $7.3 billion to $11.3 billion, the import of wheat at higher prices, increase in palm oil prices, raw cotton imports due to reduced domestic production, increased import of machinery mainly those used for power generation and import of chemicals and fertilizers. As the import target for 2008-09 has been pegged at $30 billion and given that most of these factors are inelastic, the export strategy for the next year is aimed at poverty alleviation, value addition, quality enhancement and improving competitiveness.

Though a number of steps have been proposed to attain these objectives, the most significant thrust has been to open up imports from India, so as to reduce the costs of imports and enhance international competitiveness. It proposes steps to facilitate cross-border trade with India, which is going to be the cheapest option on account of lower transport costs and allows import of 136 new items from India, thereby increasing the list of tradable items with India to 1,938. Of these, 72 tariff lines include raw materials, chemicals and industrial inputs for industries. Of the remaining 64 items, 9 tariff lines are for pharmaceutical products, 2 for fruits and vegetables, 19 for fertilisers, 32 for machinery and parts, and 2 for fuel oil and diesel. Besides raw material for industries and essential food stuff to reduce prices, the import of diesel and fuel oil is most significant and has been allowed to take advantage of cheaper transportation costs. It has the potential to become the most significant component of bilateral trade. According to The Dawn, last year the total import of these 136 tariff lines stood at $2.8 billion of which $2.2 billion was only on import of POL and diesel. The policy also specifically allows import of CNG buses from India and from any Indian manufacturer who commits to set up such a facility in Pakistan. This would probably be the first ever open invitation to an Indian firm to set up manufacturing facilities in Pakistan and needs to be responded to favourably. The policy also states that Pakistan will participate in renegotiating the list of SAFTA and the Regional Agreement on Trade in services among the SAARC countries. According to The Dawn, if the new policy were to be implemented, trade with India could triple from the existing level of $1 billion to $3 billion and make India the second largest trading partner of Pakistan after China.

The trade policy analyses the limitations of Pakistan’s trade basket and has initiated bold steps to normalise trade with India. These would enable Pakistan to import cheaper raw materials from India, so as to make its own exports much more competitive. But like every other thing that is associated with India, it has been criticised by the opposition groups in Pakistan. PML(Q), which headed the previous government and is close to President Musharraf, as well as Jamat-i-Islami have criticised the new trade policy. PML(Q) has dubbed the policy as ‘India centric’ and an attempt to accord India MFN status through covert means. It has claimed that Indian goods will flood the Pakistani market and has accused the government of planning to sell the Thar coal reserves to Indian industrialists.

However, despite these provocative allegations, they have failed to draw in public support. This clearly indicates that the common man in Pakistan realises that trade with India will reduce the cost of his daily requirements considerably. The new trade policy appears to indicate Pakistan’s renewed, albeit delayed, commitment to meeting its obligations under SAFTA and is a step in the right direction.

Game theory is the analysis of strategic interaction among agents. These agents may be two or more people, firms or countries, with both taking into account how the other agent will “play”. Game theory has been employed to increase revenue at auctions, better equip challengers against incumbents in the market, and explain why bad dictators last so long.

To make predictions, we commonly assume that both agents are rational. This means that both maximize their payoff or utility. Secondly, both know each other’s payoffs. In case of a prolonged conflict, this is a reasonable assumption since it would be unlikely that one party has its costs and benefits unknown to the other. Thirdly, all players know that others are rational.

In Nash equilibrium, each player maximizes her utility given the behaviour of the other players. To illustrate Nash equilibrium, the following is a static game on the strategies of India and the United States in a simultaneous-move game of India conducting a nuclear test and US imposing sanctions.

Here, the first payoff in each box is India’s and the second is America’s. For example, if India were to test, then the United States should play “No sanctions” as it gets a higher payoff. Thus, testing for India and not placing sanctions for America are more profitable strategies for both countries. Hence, the Nash equilibrium is “Test, No Sanctions”. However, since this is a static game, it does not capture important real life scenarios. Limitations of this model include an American response after the test and not simultaneously. Here, we do not need to assume for instance that India believes that the US is rational or vice versa (the third assumption). Regardless of whether the other party is rational or not, it is always the best strategy for both countries to play the Nash equilibrium. This simple model also says nothing about the impact of the 123 agreement on India’s decision to test and the American decision to impose sanctions.

To make it more realistic, we can construct a dynamic game. It can be shown that the India-US nuclear pact would increase the autonomy of India’s strategic nuclear programme in terms of testing a bomb. To illustrate the Nash equilibrium of the strategic consequences of the India-US nuclear agreement, a three-stage game is shown below. In the first stage, the deal passes through the remaining international hurdles (IAEA, NSG, US Congress) and either comes into place or there is “No Deal”. The second stage is India’s decision to test a nuclear device, which would be contingent upon prevalent circumstances and the utility it would provide to India. The third and final stage is American reaction to the test in the form of economic, military and diplomatic sanctions.

In the event India conducts a test without the deal being passed, it is highly likely that the US will impose stringent sanctions. It is generally agreed that sanctions imposed in 1998 following the Pokhran-II tests did not have a significant long-run impact on the economy. For the purpose of modelling, let us say that these sanctions give -100 to India (short-term effects).

Since the deal has been called “fair” by independent experts, let us assume that it gives a payoff of 100 to both countries. Now assume that there is a benefit of 50 for India if it goes ahead with a test. In the event of a test after the deal, the US has a choice: it either imposes sanctions at a cost of 50 for itself but 200 for India (resulting in a payoff of 50 for itself and -50 for India), or does nothing in which case it still gets 100. India, meanwhile, basks in the glory of the deal and the test with a payoff of 150. This argument would hold if other countries follow what the US does, as is usually the case.

A relatively higher punishment for India has been assumed in case of American sanctions. India would stand to lose more in such a case because the United States is India’s major trading partner but India is not America’s major trading partner. It is also likely that many other countries would follow the American lead in imposing sanctions. Hence, India stands to lose not only because of differential trade relations between itself and the United States but also because of the close political, economic and diplomatic links among the countries of the West. However, the argument in favour of testing (after the deal) does not rest on how badly India would be hit by sanctions but on two other assumptions that could be considered realistic. First, the US would have no choice but to impose sanctions in the case of an Indian test without the deal. Second, if there is a deal, the US does have a choice of imposing or not imposing sanctions on India. With just these two assumptions, it can be argued that India has a greater incentive to test a nuclear device with the deal than without it.

To find the Nash equilibrium path, we need to start at Stage 3 and use backward induction. In Stage 3 after the Deal, a rational America will not impose sanctions, thereby allowing India to go for a nuclear test and increase its payoff from 100 to 150. It will be in America’s interest to have no sanctions after the deal has been passed since a payoff of 100 is greater than 50. Even if America threatens sanctions, a rational India would know that the threat is not credible.

On the other hand, if the deal does not pass, India may never be able to test if it wants to maximize its payoffs. This is so because US sanctions would be greater (as opportunity costs would be lower) and also because India would be energy deficient and economically less integrated, thus having lesser bargaining power.

India can thus proceed with its strategic programme fully aware that a rational America will not impose sanctions. In very few historical instances has it been the case that a policy has been Pareto improving, that is, it has benefited some people without harming others. This deal seems to have accomplished a Pareto improvement over the existing energy security situation in India along with a military security enhancement. If the goal is enlightened national interest, the deal seems to be unambiguously good, both for India’s energy security as well as for its strategic autonomy.

The shaded boxes show the Nash equilibrium path rational policies will follow.

Prakarsh Singh is Researcher, London School of Economics and Visiting Scholar at the Institute for Defence Studies and Analyses, New Delhi.

If anybody thought that a change of talk in the Bush administration’s Iran policy would be enough to induce the “isolated” Tehran to give up its intransigence and toe the western line, the July 19 meeting proved him or her wrong. Before the Geneva meeting between Iran’s chief nuclear negotiator Saeed Jalili and European Union foreign policy chief Javier Solana, the US sent feelers to Tehran. In a clear indication that Washington was prepared to change its belligerent stand towards Tehran, the Bush administration announced that William Burns, undersecretary of state for political affairs, would attend the meet. In addition, unconfirmed reports said the US was planning to open a diplomatic post in Tehran for the first time since relations were severed during the 444-day occupation of the American embassy in Tehran nearly three decades ago.

Iran welcomed the developments and said it was ready for a “comprehensive agreement” with the five-plus-one powers (the US, Britain, France, Russia, China and Germany), which initiated the latest diplomatic push to find a breakthrough to the impasse over the Iranian nuclear issue. However, despite these goodwill gestures, the Geneva talks ended in another deadlock, thanks to the complexities of the proposal the six-power bloc laid down before Iran and the latter’s increasing inflexibility.

The recent diplomatic initiative gained momentum as Solana, along with the representatives of the five countries (excluding the US) visited Tehran on June 14 with the incentive package that offered political and economic benefits to Iran. The proposal offered direct talks between the six-power bloc and Tehran but only if the Islamic Republic stops producing enriched uranium, which can be used to make electricity or fuel bombs. It also asked Iran to freeze further expansion of its enrichment activities for six months as a confidence building measure in return for the international community freezing its efforts to impose more sanctions on Iran during the same period.

Iran has long made it clear that any precondition to the talks is not acceptable. Soon after Solana’s Tehran visit, President Mohammad Ahmadinejad said that his country was open for talks with the US and other powers, but would not change its nuclear policies. According to many analysts, Iran was responding to the West’s carrot-and-stick policy in the same coin. Tehran does not want to send a message to the outside world that it is weak and vulnerable to the American and Israeli pressure tactics. When Israel carried out a major military exercise in June, which many American officials said was a rehearsal for a potential attack on Iran’s nuclear facilities, Iran responded in July with the test-firing of long-range Shahab-3 missiles which can hit Israel. The Islamic Republic has also carried out Prophet Mohammad III war games and reportedly given orders to soldiers to dig 320,000 graves in Iran’s border provinces, in which to bury the bodies of invading soldiers.

General Mohammad Ali Jafari, the head of Iran’s Revolutionary Guards, also threatened to block the Strait of Hormuz through which almost 40 per cent of the region’s oil flows, if Iran were attacked. In an apparent move to protect the oil installations in the Gulf in case of emergencies, the US, Britain and Bahrain jointly carried out a naval exercise codenamed ‘Operation Stake Net’. These war preparations and threats were going on at the same time when the Iranian diplomats were preparing a written response to the six-power group’s incentive package. Israeli commentator Uri Avnery calls it “psychological warfare”. He wrote recently that the war games and rhetoric could well be part of the strategies of both sides to increase their bargaining capacity in a possible diplomatic engagement.

Iran also understands the complex dynamics in the region very well. It knows that its former President Mohammad Khatami suspended the country’s nuclear activities owing to the pressure of the West, but gained nothing in return. Unlike the Khatami era, today’s Iran is emerging as a regional power, thanks to the wars that the US and Israel have fought in the last few years. Today, when the US is bogged down in Afghanistan and Iraq and the Hezbollah has emerged more powerful in Lebanon after Israel’s 2006 summer attack, Iran’s regional importance is much higher. Also, record energy prices would force second thoughts before planning an offensive against the world’s second-largest oil producer.

Ahmadinejad’s government has clearly indicated that it is willing for a diplomatic engagement, but not ready to give up the enrichment programme, which is a key bargaining chip in its talks with the West. The fact that Iran did not reject the latest proposal out of hand, like it did two years ago, demonstrates its willingness for talks. Besides, a powerful lobby within the Iranian establishment is increasingly critical of the way Ahmadinejad has handled the nuclear issue. This difference came into open when Ali Akbar Velayati, foreign policy adviser of Supreme Leader Ali Khamenei, publicly urged the government to accept the European package. In what was seen as an indirect attack on the president, he warned the Iranian leadership not to make provocative statements on the nuclear issue.

So what is the outcome? Ahmadinejad is playing diplomacy without giving up his nuclear intransigence. The two-page note Iran circulated in the July 19 meeting, “The Modality for Comprehensive Negotiations (Non-Paper),” clearly underscores this stand. Iranian diplomats appear to be very cautious and optimistic while talking to the media, in sharp contrast to their president’s public speeches. After the Geneva talks, Saeed Jalili reiterated that his country was ready for a comprehensive agreement with the international community. But Iran’s letter does not address the key demand of the West – ending enrichment activities. Instead, Iran has proposed at least three more meetings with Solana and six more meetings at the foreign ministerial level, which would start with the halting of sanctions against Iran. The New York Times quoted an unnamed diplomatic source saying, “If you were to try to implement it, it would take minimum of several years.”

Europe has asked Iran to respond to the “freeze-to-freeze” proposal in two weeks. Both the US and Britain have threatened more sanctions. Whether Iran would change its policy and accept the “freeze-to-freeze” proposal still remains unclear. Iran appears not to be in a mood to make concessions to the administration of President George Bush, though its quest for a diplomatic solution still remains strong. The two-page response indicates that Iran wants to buy more time, perhaps thinking that a new incumbent in the White House would be more flexible. One also has to wait for the official response of Russia and China, two powers which have resisted harsh sanctions against Iran, to the Geneva meeting. One thing is, however, clear. The Iranian nuclear crisis is unlikely to be resolved any time soon

The spate of talks and meetings between India and Bangladesh is unmatched in recent times. This pace alone sets bilateral relations apart from the five long years when the BNP-led coalition government was in power (2000-05) in Bangladesh. The recent (July 17, 2008) Foreign Secretary level talks have once again brought home the fact of how the interim government in Bangladesh without having to pander to any particular constituency has been able to constructively engage with its largest neighbour.

The Secretary level talks which were revived after a gap of two years in June last year were basically a review and stock taking exercise and included common issues of concern such as water, trade and commerce. For years the issue of sharing of river waters has plagued relations and despite a successful Ganges water treaty (1996) the talks over sharing of other common rivers like the Teesta have escaped any resolution. While the stalled water talks also resumed in 2007 after a gap of more than two years, a decision was taken to form a technical committee to address the issue of embankment protection of common rivers, which has been a cause of bilateral tension.

Prior to the meeting between Shivshankar Menon and Md. Touhid Hossain in New Delhi, the media especially in Bangladesh was keenly watching the developments regarding the transit issue. It is no secret that for long New Delhi has been hoping that Bangladesh would allow India to use its territory for accessing the Northeast. This not only makes enormous economic sense for India, but to Bangladesh as well. One Bangladeshi study has reported that the country can earn between Tk. 500 to Tk. 5000 crores per year as annual transit fee. Unfortunately, for years the subject has been hostage to political polemic without it being subjected to serious economic analysis. While Dhaka’s position might not have diluted remarkably, its willingness at least to discuss the issue is a positive development. According to the Indian proposal, Indian vehicles carrying cargo as well as passengers would enter Bangladeshi territory through Benapole land port en route to Meghalaya, Tripura and Mizoram.

This apart, the Bilateral Investment Protection Agreement (BIPA) also came under discussion. One of the main Bangladeshi complaints has been the growing trade gap in favour of India. For long India tried to sell the FTA proposal as a means of addressing this problem but that was unacceptable to Bangladesh. Given the small basket of Bangladeshi exports, one way of bridging the trade gap would be through mutual flow of investments. India removed restrictions on Bangladeshi investments early this year, which is likely to go a long way in bridging the asymmetry in trade and simultaneously also facilitate Indian investments in Bangladesh.

The last 18 months have seen a spate of activity on the bilateral economic front. Indeed, the thaw came with Foreign Minister Pranab Mukherjee’s visit to Bangladesh in February 2007 to invite Chief Advisor Fakhruddin Ahmed for the April 2007 SAARC summit in New Delhi. India’s easy acceptance of an unelected government in Dhaka along with its grant of ‘duty free access’ to eight million pieces of Bangladeshi readymade garments thawed the almost frozen bilateral ties considerably. The Bangladeshi caretaker government was more than happy to grab the opportunity and a tension-free environment was established easily. It was followed by a spate of contacts and meetings at different levels alongside the signing of various agreements. Not only did Dhaka agree to import 120,000 tonnes of diesel from Assam to help Bangladeshi farmers with irrigation, it also signed a contract with Bharat Heavy Electricals Limited for setting up a sub-station in its territory. The formal launching of the India-Bangladesh Chamber of Commerce and Industry in July last year is also testimony to the growing economic ties.

But the moot question is while the core Bangladeshi concerns are being met, albeit belatedly, what happens to India’s core concerns? Notwithstanding the assurances from the Bangladeshi side, there is nothing to indicate that Indian security concerns, which have plagued bilateral ties for decades, are being addressed satisfactorily. Dhaka has consistently denied the presence on its territory of terrorist groups which have had links with various terrorist attacks in different parts of India. It has also remained indifferent to India’s other two major concerns: Indian insurgent groups finding safe haven in its territory, and large numbers of Bangladeshis illegally entering India. New Delhi has periodically raised these problems, without much result.

The visit of Bangladeshi Army Chief of Staff General Moeen U Ahmed in March 2008 is going to be reciprocated soon by his Indian counterpart’s visit to Dhaka later this month. But will any of these meetings facilitate a better understanding of Indian security concerns? Can the Maitree Express mark a new beginning of friendship or will bilateral relations always remain hostage to political calculations at the cost of economics and overall national well being? Certainly, the extradition of ULFA leader Anup Chetia would be a gesture in the right direction to prove that good neighbourliness is a two-way traffic.