Donald Trump’s Tariff Strike: How Potent Is It For India?

The apprehension over the possible new tariff rate to be imposed by the USA on our imports had created quite a bit of turbulence in the markets. The rupee had fallen since July 28, as had the stock market, as they turned jittery over the prospects. The announcement did finally come on the 30^th, with the US announcing a 25% tariff on Indian goods with an additional penalty for dealing with Russia. The latter has not yet been specified and would be open as of now. What does all this mean for us?

The 25% tariff rate is marginally lower than the 26% rate announced in April, and it should be remembered that there has been no deal with the USA as of the present. Where deals have been signed, as with the EU, the UK, and Japan, the rates have come down to the 10-15% range. It does look like that when the Indian government is able to strike a deal with the USA, this rate could also come down to a similar range. However, for the present, the 25% rate would hold.

The USA is our major export partner, accounting for between 15% and 20% of the total export, and hence, any change in the demand matrix will affect them. This is more so considering that Indonesia, Vietnam, and Korea have gotten away with lower rates of 19-20%. The question will be as to how our exporters respond to this challenge if the competing country is able to sell cheaper because of the cost factor. There will, hence, be some rebalancing to be done where exporters lower their costs or share the tariff burden by absorbing a part to retain the market share. At the aggregate level, a fall of 10-15% in exports to the USA can affect the GDP growth by around 0.2%. This may not be very significant, given that the economy is to grow by 6.5%, according to the RBI.

The challenge will be at the industry level, especially so as the SMEs get caught in the web. This holds for pearls and precious stones, engineering, garments, leather products, etc. There is uncertainty on the rate for electronics and pharma, but these two industries are also dependent to a certain extent on the USA. These industries need to look at alternative markets too to ensure that the potential loss of the US market is compensated. Therefore, the micro effects would be significant, while the macro picture would not really be affected much. This is so, as India is basically a domestically orientated economy. While it is true that economies that grew at high rates have always done so on the back of exports, the lacunae for us has helped in this situation.

The stock market has been affected for sure, as the indices started lower on Thursday. However, as has been seen in the past, there would be a correction soon in a couple of trading sessions once there is calm on the tariff front. There could be more announcements coming for other countries, which can keep the market jittery. But it should revert to normal once this blows over.

As tariffs for all countries would be above the threshold of 10%, intuitively it can be seen that inflation will inch upwards in the USA, given that it is the largest importer of goods. This being the case, there is a case for the Fed to turn even more hawkish. Hence, the possibility of rate cuts has come down as the Fed will be cautious, given the high potential of inflation rising. This also means that bond yields would be at a higher level that will turn foreign investment towards the USA. This will not be good news for emerging markets, as there can be a deflection of funds.

This entire tariff structure, coupled with the Fed holding on to rates for longer, would mean that the dollar will get stronger, which has already been witnessed. This, in turn, will pressurise other currencies, which tend to depreciate. This is where the game begins, as almost all countries will be happy to see this deprecation. These new varying tariffs would affect the competitiveness of all countries as they look at their nearest competitors. In this game, a depreciation will be welcome, as it will provide the price advantage as companies can cut their prices in the American market.

Hence, this new trade order will turn the focus on the RBI, which has to be more active in the forex market and take a call to ensure there is a balance between the depreciation of the rupee that is warranted with volatility, which can be self-fulfilling.

Finally, the threat of additional tariffs for having deals with Russia needs to be put in perspective. India now imports a good quantity of around 35% of oil requirements from Russia. When the price had escalated to $120-140/barrel in 2022, we were able to procure at a lower rate, which helped to balance our external account. However, as the international price of crude has stabilised in the region of $60-70/barrel, while Russia still maintains its position as supplier of the crude, the discounts have come down. In fact, at times oil from Iraq is cheaper than that from Russia. Therefore, even if there is some rebalancing of oil procurement, the overall impact on the oil import bill may not be that significant.

On the whole, the new tariff policy of the USA towards India would be a minor disruption. The macro picture would remain largely unaffected, though industries affected would have to strategise. The bond market has been unaffected, though the rupee will be volatile for some more time. Stocks should correct soon once this shock is digested. The government is working on a deal with the USA, which, when struck, should blunt this impact appreciably.

The author is Chief Economist, Bank of Baroda and author of ‘Corporate Quirks: The Darker Side of the Sun’. Views are personal.