Liberalising heavily restricted trade and investment flows is now the driver of peace efforts between the neighbours, whose fragile ties were shattered when Pakistani militants attacked the Indian city of Mumbai in 2008.
“India has taken an in-principle decision, as a part of the process to deepen our economic engagement, to allow foreign direct investments from Pakistan in India,” said Trade Minister Anand Sharma at a news conference with his Pakistani counterpart.
Despite thousands of years of shared history and culture and a combined population of 1.4 billion people, cross-border trade remains paltry - a legacy of three wars since their independence from Britain in 1947.
Under current rules, Pakistani citizens cannot directly invest in India. Investment flows are unlikely to surge, but the move will go some way to addressing concerns by Pakistani businessmen that India places too many restrictions on them.
More than 600 Pakistani businesses are in New Delhi this week at a trade fair to promote their products to the Indian market.
In the face of some domestic opposition, the government of Pakistan President Asif Ali Zardari last November vowed to grant India most favoured nation status, which ends restrictions that require most products to move via a third country.
The move was hailed by India and the two countries are now focused on resolving economic issues before moving on to more intractable problems such as the disputed region of Kashmir.
Sharma also said an agreement to relax restrictions on visas for Pakistani businessmen was almost ready.
Later on Friday, Sharma and the Pakistani trade minister, Makhdoom Amin Fahim, will open an expanded border trade terminal at Wagah, between the Pakistani city of Lahore and India’s Amritsar.
With a capacity to handle about 600 trucks a day, the border crossing is expected to help bring trade to $8 billion annually from the current level of $2.6 billion, Indian industry chamber ASSOCHAM said in a study published this week.