Foreign ministers at the South Asian summit in Islamabad have agreed on the framework for a regional free trade zone, a senior Indian official says.
Tariffs should start to lower in 2006
Indian foreign secretary Shashank said the deal would improve India-Pakistan ties and called the summit "historic".
Tariffs should start to come down for the seven nations in the group by the beginning of 2006, he said.
The deal was hammered out ahead of a three-day meeting of national leaders at the summit, starting on Sunday.
Mr Shashank said: "In the long term, all this will contribute to achieving bilateral progress.
"This is an historic summit where many momentous decisions have been made."
A free trade zone would encompass the seven members - India, Pakistan,
Nepal, Sri Lanka, the Maldives, Bangladesh and Bhutan.
The foreign ministers also reportedly agreed on measures to combat terrorism
and on a social charter which would try to raise living standards in
South Asia and improve access to government.
The region holds about 25% of the world's population, but the average annual per capita income is just $450.
Smaller nations had reservations about the free trade zone
Business analysts say the nations need to reduce tariffs from
25-30% to between nought and 5% over five to 10 years.
They say Pakistan and India's $1.5bn trade, which now passes through unofficial channels and third countries, could double with the free trade zone.
A free trade deal has been discussed for years, but India-Pakistan rivalry and fears among the other nations that they might be swamped with cheap goods have delayed any moves.
It is believed a phasing-in approach will allay some of those fears.
One Western diplomat told the Reuters news agency the immediate economic benefits of a free trade agreement might be limited.
"But in terms of symbolism and politics it's huge," he said.
The BBC's economics correspondent Andrew Walker says the agreement will need a lot of more detailed negotiation before it becomes a reality.
He says regional trade deals have become increasingly popular, with more than 200 now in operation around the world.
Mr Shashank said a formal announcement would be made after
the end of the foreign ministers' talks on Saturday.
Any implementation of free trade agreements would still depend on further progress on political issues.
Indian Prime Minister Atal Behari Vajpayee arrives in Islamabad on Saturday but there is still no confirmation whether he will hold direct talks with Pakistan's leaders on the thorny issue of Kashmir.