India’s Informal Trade with Nepal: An Exploratory Assessment

The large and vibrant informal trade between India and Nepal continues to thrive despite unilateral/bilateral/regional/multilateral trade liberalisation in the two countries. This calls for an indepth analysis of India's informal trade with Nepal. Using insights from the New Institutional Economics informal and formal institutions engaged in cross-border trade are contrasted. The objective in juxtaposing formal and informal institutions in performing similar transactions viz., engaging in crossborder international trade is threefold: first, to understand how informal trading markets function vis-à-vis formal trading arrangements second, to analyse formal and informal trading arrangements particularly in the context of the relative importance of institutional factors vis-à-vis trade and domestic policy distortions, and third, to see whether informal trading arrangements provide better institutional solutions than formal trading arrangements. The analysis, carried out on the basis of an extensive survey conducted in India and Nepal reveals that informal traders in India and Nepal have developed efficient mechanisms for contract enforcement, information flows, risk sharing and risk mitigation. Further, informal traders prefer to trade through the informal channel because the transaction costs of trading in the informal channel are significantly lower than the formal channel implying that informal trade takes place due to the inefficient institutional set up in the formal channel. Moreover, lower education levels of informal traders could be an important deterrent for using the formal channel. Finally, the analysis of discriminating characteristics of formal and informal traders in India and Nepal indicates that transaction cost and education level are the two common discriminating factors. An important policy implication from the study is that unless the transacting environment of formal traders improves, informal trade will continue to coexist with formal trade, even if free trade is established in the SAARC ...