Problems of Bilateral Trade Deficit between Bangladesh and India: A 2SLS Regression Analysis

Abstract

This study investigates the factors that determined the bilateral trade deficit of Bangladesh against India. The results of the Johansen cointegration test indicated that there were long-term associations between the trade deficit of Bangladesh real income levels, and the bilateral RER of both countries. Results from the two-stage least squares regression analyses indicated that a 1% increase in the real income levels of Bangladesh and India aggravated the bilateral trade deficit of Bangladesh by 4.61% and 3.98% respectively while a 1% real appreciation of the bilateral real exchange rate was found to reduce the deficit by almost 6%, ceteris paribus. Results also showed that Bangladesh faced persistent deficits in its bilateral trade balance against India due to its exports being comparatively less elastic than its imports engagements with India. The paper also sheds light on the anti-dumping policy pursued by India that has contributed to the unbalanced trade between the two economies. Contribution/Originality: This study contributes to existing literature by analyzing the elasticities of Bangladesh's imports from and exports to India. It is relevant from the perspective of policy implications to understand the degrees of responsiveness of Bangladesh's import demand and export supply leading to the nation's trade deficit with India. 1. INTRODUCTION Welfare gains from the opening up of closed economies to engagements in bilateral and multilateral trading activities is believed to spawn economic welfare within the trading economies which, if executed under the appropriate trade regulations, can result in the nations' consuming beyond their respective production possibility frontier (Heckscher and Ohlin, 1991; Baldwin, 1992; Suga and Tawada, 2007). However, although the benefits from trading activities are conceptualized to ensure welfare gains for all the participatory nations in general, sometimes inefficient trading arrangements result in vast inequalities with respect to the unequal distributions of the gains from trade (Lincoln, 2001; Fajgelbaum and Khandelwal, 2016). As a result, more often than not, international trade under such circumstances results in welfare losses particularly for the relatively smaller trading partners as opposed to the comparatively larger counterparts (Markusen, 1981; Hamilton, 1985; Redding, 1999). International trade under suboptimal trading frameworks often leads to the exploitation of one trading partner by the other which ultimately contributes to the large trade deficit for the economy that is at the receiving end of such unfair treatments (Feenstra, 1995; Irwin, 2010). The imposition of undue trade restrictions, that favor a

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