Key Constraint: Low Knowledge Connectivity and Bilateral Trust

on land ownership, and some sector restrictions. There is significant variation across countries in different attributes of the FDI arrangements. Most arrangements have or are moving forward with special economic zones and reforming investment promotion agencies. India has moved to liberalize its investment arrangements, starting with manufacturing, extending to retail services in 2006 and to services, more broadly, in 2016. However, retail and e-commerce continue to be difficult to liberalize.

The outward investment arrangements in South Asia are largely restrictive, discretionary, and nontransparent, with India having the most progressive arrangements. India and Sri Lanka have OFDI arrangements that have an “automatic route” and a “government approval route,” but in all other countries, approval from the central bank is required for all OFDI. This approval process has been liberal in Pakistan. Bhutan and Nepal have essentially banned OFDI. Bangladesh’s arrangements were also very restrictive, but a few outward investments were approved following legislation in 2015. Afghanistan and Maldives and have no explicit legislation or procedures for approval that are publicly available, but they appear to allow investment abroad on a case-by-case basis.

Region-specific polices exist in both inward and outward investment arrangements. India’s IFDI arrangements gradually liberalized its region-specific policies to allow Sri Lanka, Bangladesh, and Pakistan to invest in India in 2004, 2007, and 2012, respectively. However, all investments from (IFDI) and to (OFDI) Bangladesh and Pakistan are required to go through the “approval route.” India extended the approval route requirement for all neighboring countries with a common land border in April 2020.

Low and polarized knowledge connectivity characterizes South Asia. Much has been written about high intraregional trade costs due to high tariffs and paratariffs on relevant products for regional trade, nontariff measures, low-quality transportation and logistics infrastructure, and inefficient trade facilitation at land borders. However, no attempt has been made to assess the extent of information barriers. Figure O.2 presents a measure of bilateral knowledge connectivity across the 56 country pairs in the region. The measure is based on responses to questions on how well informed South Asian entrepreneurs were of opportunities in regional economies, on a scale of 1 (lowest) to 4 (highest). An average bilateral score of 1.9 (between “not at all” and “not very well” informed) indicates low overall knowledge connectivity. The results also indicate a polarization of knowledge: entrepreneurs are familiar with India and one or two nearby countries but know little about the rest of the region. For example, Nepali entrepreneurs know about opportunities in India in general and the North Eastern Region of India, but know much less about Sri Lanka, Maldives, Pakistan, and Afghanistan. India is an exception in two ways—first, most Indians have balanced knowledge about their neighbors, and second, most of the neighbors are familiar with India. Similar results were obtained with respect to the level of networks within the region.