1 Characteristics of India’s Informal and Formal Trading with Nepal: A Comparative Analysis∗

The large and vibrant informal trade between India and Nepal continues to thrive despite trade liberalisation in the two countries. This calls for an in-depth analysis of India's informal trade with Nepal. 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 implying that informal trade takes place due to the inefficient institutional set up in the formal channel