Trump's GSP threat: Why India's economic situation calls for cool heads

President Donald Trump just piled another problem on to the already-full slate of Indian Prime Minister Narendra Modi. By removing zero-duty access for $6.3 billion of Indian goods, the US leader threatens growth at a time when India’s economy can least afford it.

The country’s unemployment rate was at a 45-year high of 6.1% in the year to June 2018, while economic growth in the March quarter of 2019 slowed to a five-year low of 5.8%, data released Friday showed. Publication of the jobless statistic was held back until after Modi won last month’s general election and took his oath for a second term on Thursday, though it had leaked anyway.

Demand for Indian goods in the rest of the world needs to perk up to create space for GDP growth and job creation. Trump’s trade action is, therefore, bad news. With the domestic auto industry in a tailspin, losing duty-free access to the US could lead to closures of some of India’s less-competitive small engineering firms. India is the largest beneficiary of the so-called generalized system of preferences, or GSP, under which developed countries encourage developing economies to industrialize.

By targeting India, Trump isn’t opening another front in the trade war, after China and Mexico. He is sending a warning shot that the US expects New Delhi to do more to prove it’s a Washington ally.

The US has a history of wielding the GSP privilege as a stick, as I wrote in March when the tariff action against India was first announced, most famously using it to effect regime change in Chile in the 1980s. In India’s case, Washington’s goals could range from arm-twisting New Delhi to stay away from Iranian crude oil to pressuring it to tone down the growing rhetoric – and regulatory action – around data sovereignty. The Trump administration will be loath to see India mimicking China’s strategy of building its own e-commerce, search and fintech champions, keeping out Amazon.com Inc., Google and Paypal Holdings Inc.

Another long-standing friction between the two countries involves cheaper generic drugs. India meets almost  40% of US demand. Should Trump drive a hard line around poor quality and price fixing, the consequences for India’s economy could be serious.

By appointing Subrahmanyam Jaishankar, a former ambassador to both the US and China, as his new foreign minister, Modi has acknowledged the gravity of the trade war. Being in the camp of either superpower is risky. On the one hand, India has to reduce its $53 billion bilateral trade deficit with the People’s Republic; on the other, it has to squeeze itself on to the shortlist for a non-China-centered global electronics supply chain. India’s 5G network rollout will see the government grappling with the question of whether it should join Trump’s ban of Huawei Technologies Co. or strike a more conciliatory tone with its neighbor and largest trading partner. Just as any new deal with the US will be multifaceted, any bargain to be struck with China will also have to include a long-simmering border dispute, and getting Beijing to influence India’s relations with Pakistan, currently at their nadir.

The loss of GSP privileges is an economic challenge, but it’s also a diplomatic opportunity. Having won a landslide electoral victory, the Indian leader doesn’t need to respond in kind to the White House’s machismo just to please voters. On the contrary, this is a chance to reconsider some of India’s sillier regulatory decisions of the last six years, such as curbing the maximum price of heart stents and knee implants by as much as 70%. That was an own goal because it kept the more US innovative versions out of India, and gave a windfall to Chinese device producers.

India’s economic situation calls for cool heads. Investment is anemic, consumption is faltering, and all domestic balance sheets – for households, companies, banks, shadow financiers and the government – are stressed. Trump has thrown down the gauntlet. Modi should respond by instilling more pragmatism into India’s trade and investment policies.