At the end of two days of bilateral trade talks, Pakistan agreed to give its neighbor by early next year a small list of items that India cannot trade in with Pakistan. Both sides hope to do away with the list altogether by the end of 2012, freeing up all trade between the two countries, Indian Commerce Secretary Rahul Khullar told reporters.
"The move to full normalization of trade relations shall be sequenced," the two nations said in a joint statement at the end of the talks.
Two weeks ago, Pakistan's Cabinet approved a decision to give India most-favored nation status. India gave Pakistan the status in 1996 and had since pressed Islamabad to reciprocate.
Pakistani Commerce Secretary Zafar Mahmood said his government wants a complete normalization of bilateral trade, where all goods can be traded freely between the two countries.
Granting most-favored nation status means the two countries can trade on equal terms, typically giving each other low tariffs and high import quotas.
The World Bank estimates annual trade between India and Pakistan is around $1 billion and could grow to as much as $9 billion if barriers are lifted.
Tuesday's decision to normalize trade ties marks another milestone in the rocky relations between the nuclear-armed nations, who have fought three wars since gaining independence from Britain in 1947.
Earlier this year, India and Pakistan decided to restart wide-ranging peace talks. Last month, Pakistan quickly returned an Indian helicopter and its crew, which had strayed across the tense border. Also last week, top leaders of both the countries met and vowed to resolve their long-standing problems.