India can turn US tariff tensions into a trade win, says Raghuram Rajan

US tariffs on Indian goods are a pressure tactic, says Raghuram Rajan, who outlines how India should play smart on trade, FDI, car tariffs, and dairy safeguards

The United States imposing a 25 per cent tariff on India from August 1 should be viewed as a temporary punitive tariff and an attempt to coerce India into accepting US demands, Raghuram Rajan, finance professor at University of Chicago Booth School of Business and former governor of the Reserve Bank of India (RBI), told Shreya Nandi in a video interview. Rajan pitched for lowering of car tariffs significantly but suggested the need to be sensitive while deciding on global agreements, especially in the case of small dairy and agriculture producers. India should address issues like regulatory unpredictability and tax uncertainty that are likely deterring foreign investments, he said. Edited excerpts:

 

India and other countries are either negotiating trade deals with the US or are bracing for tariff increases. How do you see these developments affecting global trade, and what are the potential gains for the US?

 

There is obviously going to be some disruption in global trade. Every country is negotiating a special package, which is not uniform and that creates some concern because a more-efficient producer of a particular good is able to find that it is being tariffed at a higher rate. The supply chain will be moved to a less-efficient but lower tariffed entity. There's going to be some attempt at transshipment and there is going to be some realignment of supply chains as a result.

 

For example, China, which has high tariffs imposed on it by the US, may try to ship to Mexico and avoid the tariff. To prevent that, there will be a lot of inspections.

 

For the US consumer, the cost of many of these products is going to go up. The American President says the foreign producer will pay the tariff, but we know that in practice the cost of the tariff is borne by the producer to some extent, but also by the consumer and importer who's bringing product into the country. The relative share depends on how competitive the industry is. All this has to play out fully.

 

We already see some prices are rising in the US. The more the prices rise, the lower the budget the US consumer has to buy all that they want. That means they will shrink their spending. That will affect US demand also.

 

Now, again, it’s very early days. Everybody has been predicting these effects, but we haven't seen either the goods price inflation seriously. You're starting to see some signs of it, as well as the slowing demand, which would be reflected in, for example, companies laying off people because they see demand falling off.

 

Most economists, including me, believe that it would be a matter of time. But of course, there's a lot else going on in the global economy. For example, the stock market in the US is at all-time highs, and that tends to increase sentiment. I don’t think it can compensate for the falloff in demand. It can help a little bit. That explains a little why some of the adverse effects are more delayed. Broadly, slowing in the second half [of the year] in the US and some rise in prices, which makes it harder for the Fed to cut interest rates sharply.

 

Do you think India is on the right path to tackle this disruption?

 

It does seem that what emerges from these kinds of negotiations is sort of a broad intent. Here is the kind of tariff structure you would be subject to. Of course, the details have to be negotiated, including, for example, what happens in pharmaceuticals, where there's a separate Section 232 investigation going on from the US; what is the broad tariff structure India will be subject to. The details matter. What kind of agreements does India enter? For example, on FDI (foreign direct investment), on the kind of non-tariff barriers that it imposes.

 

It could be a relatively beneficial situation for India if, firstly it manages to negotiate lower tariffs than some of its competitors.

 

Second, that it brings down its own tariffs in a number of areas where they've been creeping up, allowing for more competition within India. That can be very beneficial for the Indian consumer. Competition can be very beneficial in some areas for Indian producers, putting some pressure on them to do a better job than they've been doing so far. We can convert this into something which is a little more win-win rather than lose-lose.

 

It’s important for India to think about areas where it wants the US to move. For example, when we’re selling services in a big way to the US, is it possible that some of the barriers to entry for our services are brought down? For example, can we find ways that some of our highly qualified doctors can satisfy those degree requirements and provide service at a distance? Can we find ways that medical tourism can be enhanced, for example, by the US allowing Medicare and Medicaid to pay for some of the operations done in India. We have excellent eye doctors. It would be cheap for them to provide that service. But also, you could do that and have somebody fly over to India, get the operation, and go back to the US at a cheaper rate than it would cost the US to provide that service. We can be far more innovative in what we ask the US. Given that there's a package deal, why not do it?

 

Which are the sectors where India should reduce tariffs?

 

Well, I think the focus of the US administration is very much on cars. Cars are the macho industry that every country wants its own industry to flourish. There's no reason why we can't bring down car tariffs significantly across the board and subject our car industry to more competition.

 

We are close to the USA's August 1 reciprocal tariff deadline. Without an interim deal, India will be subjected to a 25 per cent tariff. How will this impact India?

 

I think this should be seen as a temporary punitive tariff (and an attempt to coerce India into accepting US terms). I am surprised because I thought the government enjoyed better relations with the US government. I guess when we say everything is transactional, we should expect others to treat us similarly.

 

At any rate, there will be some exclusion for products that have already been shipped, otherwise, that would be too disruptive. Second, I'm sure that every Indian exporter has been trying to ship ahead of the deadline because they know the only direction is upwards, not downwards. Buyers in the US have already built up sufficient inventories of these kinds of goods. What we'll see is while the i's are being dotted and the t's are being crossed, the exporters in India will slow down exports or allow stuff to pile up in warehouses both here, but also if they've been clever in bonded warehouses in the US, and wait till the tariff situation is clarified.

 

The real problem is we’re going up from 3 per cent tariffs in the US to, you know, 15-20 per cent tariffs across the board. That certainly is disruptive to every country, but also to the US. In the short term, exporters in India will adjust and have been adjusting. I think the issue really is where this settles down after the month or two, maybe that they need to finalise.

 

How can India make the most out of a trade deal? In which areas India should be cautious?

 

We certainly should work hard as we have on improving our infrastructure, on reducing the impediments to doing business. We have an opportunity to also credibly announce that we will treat foreign investors (FDI) on the same playing field as Indian investors — that we will not discriminate against them. Maybe even set up our own structures to commit to doing so, because I think this is the way to attract foreign direct investment. Some of the southern states have been rolling out the red carpet to get a lot of investment in. Any investment whether in manufacturing or services is beneficial to India. This is an opportunity as companies are looking at their supply chains and rethinking it in the light of tariffs. If we can send the signal that we are open to these kinds of investments in a big way, we may attract some of this. Even if it is initially because of the US market, they may think of the global market and produce by India for that. Any kind of disruption is also an opportunity.

 

There's an opportunity for Indian business to be bolder, more aggressive, and Indian states to also join hands with Indian business and say, we would like more investment here, but also we can be part of your global supply chain.

 

There are areas where we are more vulnerable. I mentioned cars where we have a good domestic industry, which is also exporting across the world. That can stand up to competition. I'm not as worried about the cars and may benefit from the new technologies being brought in. I do worry that some of our small producers, especially in areas like dairy, certain forms of agriculture, could be subject to global competition, which need not necessarily be fair if the other side is subsidizing in a big way, and everybody subsidizes agriculture. Until we have a full recognition of all the subsidies that everybody is providing, and even so, because our producers are typically small farmers, small dairy producers. It's something that we need to be very, very sensitive to while deciding on global agreements.

 

I would try to look for win-win situations. Are there ways that we can work with the US while not exposing some of our small producers to a whole lot of competition? I've mentioned in other fora the possibility that we invite FDI in some of the value-added areas — agri industry, maybe places where we can offer some sort of concessions to the US.

 

There has been a decline in net FDI and at the same time there has been an increase in disinvestment and repatriation. What do you think of this trend and what could be the main reason behind this?

 

I worry about it because, earlier we used to say the big problem for India is the logistics, infrastructure. Over the last few years, we've improved the logistics and infrastructure considerably. Given all that, we have to do some soul searching. Why is foreign investment not coming in? The old answers no longer satisfy so much.

 

I think part of what may be at play is that we need to also think about the soft infrastructure we have. What kind of business environment, tax certainty do they expect? Some of our past tax claims have created a lot of anxiety in domestic and foreign business that they can come and claim something way down the line and then we're stuck for years in court. I have heard government officials also talk about this as a problem. They need to solve it because it's very easy for the tax authorities to levy claims and then say it'll get settled in the courts because nobody wants to take the responsibility of writing off a large claim and then finding there's a commission of inquiry against them because there's an accusation of corruption, etc. We need to find a way to ensure that every claim is not litigated right until the end, no matter how peripheral and how nonsensical the claim might be.

 

I think the government understands this, but it needs to act, to ensure, not just on the tax issues, but also on the regulatory side. Suddenly, certain regulations are brought into favour by domestic producers, hurting foreign direct investment. That kind of uncertainty should be diminished as much as possible.

 

We have to work on skilling our own people so that the workers they have access to are good. If we work on all these fronts, but also engage foreign direct investment, like some states are doing. Tamil Nadu has this entity called Guidance, which tries to bring in foreign investors, smoothing the path for them, helping them deal with some of the roadblocks that typically investors face. If we can do this, not just for foreign investors, but even for our own domestic investors, I think that will be really beneficial for the country. See this as an opportunity movement and do what it takes and see the FDI numbers as a mark of whether we are succeeding. That number should go up.

 

Do you think lifting restrictions on Chinese investments can boost FDI? Is it time?

 

The issue with China is very complicated. We have had a number of border conflicts with them that also needs to be taken into account. So long as we're not overly dependent in any industry on Chinese production, especially if that Chinese production is in India rather than outside. It's better that it be in India than it be outside.

 

In some areas, the Chinese are certainly at the frontiers of technology. Take, for example, batteries, EVs (electric vehicles). If we can learn from some of that, then I think that would be really good for our own industry, our own capabilities. What is important is to invite Chinese FDI in a reasonable way. Treat them fairly, but also keep tabs on it so that you don't become overly dependent both on imports, but also on domestic production.

 

There is also more scope for joint ventures. That is something that we should explore more; that is, can we sort of bring in Chinese production and joint ventures so that they do benefit from the domestic market.

 

We have a sense of confidence that our own Indian producers are learning some along the way. Again, it has to be that these are genuine joint ventures, not fronts. We should try a range of possibilities.

 

It is a shame that the world's second largest economy is at our doorstep, but if we limit ties to it and we don't learn from it, that would be a problem. We need somewhere in between being totally untrusting to being totally trusting and that golden mean we need to find, maybe with some experimentation.

 

You have been a critic of the production linked incentive (PLI) scheme. While the government says it has attracted investments, but there have been implementation challenges. Do you think there’s a need for course correction?

 

The answer is none of us knows. I'm not even sure the government knows because the way these statistics are trotted out. We have no idea what the starting point is, what the additionality is, and what the cost of it was. What would be ideal for every government scheme in the country is transparency. Here are the numbers, and you go work them out and see what makes sense, what doesn't. Every once in a while, there's some announcement of numbers and we have no idea what they are. I am a believer that, especially for large government schemes, we should have an evaluation process also. Does it work? Did it do what was advertised when we started the scheme? What exactly has happened, in terms of value addition for the country. Is it successful? Is it not?

 

I have no idea what the data actually say. There's no clean study. By clean study, I mean having an independent academic institution. Look at what the numbers say and make it appealable to everyone, so you don't have just your favorite economists running the numbers and telling you the answer that you want.

 

I'm sort of open to the idea that maybe some investment encouraged in certain areas may create some feedback effects, which create more investment.

 

I do worry that, for example, in cell phones, some of the biggest investment is coming from Apple, which really needs to diversify outside of China. Is this a PLI scheme or is it China plus one that is at work here? We don't know. I love the fact that Apple is producing more, but as you know, a lot of it is still assembly and it hasn't gone beyond that. Apparently there are more efforts in this direction. Do we really need the subsidies for it? Or do we need to make doing business in India easier? Apple would come anyway given the large Indian market as well as the need to diverge away from China.

 

Nobody is going to turn down a subsidy, but do we need it? Is it creating what we want? I think that we need to study better. That said, I'm all for bringing whatever manufacturing jobs we can to this country. I think we have to be really careful that what we absolutely need is a self-sustaining process. Subsidies can temporarily be useful; longer term, they won't, because you can't keep subsidizing your way to production.

 

A major IT company has announced it plans to lay off 12,000 employees. You had earlier said that India should focus more towards high-value manufacturing. In an era of artificial intelligence (AI), what should be the way forward for India? What is the future of jobs?

 

I think that we need a multi-pronged strategy. For sure, at the higher end, we need to increase the skill base of our population, have more creative people who can sort of benefit from AI rather than get substituted by AI. The lower end of programming will be and has been substituted by AI. There are AI platforms which allow you to pick big chunks of code to do what you want. Now you have to be the clever person who brings all that together in a package that you design to perform the task that you need. That requires a higher order of skills than writing those programs. Those programs are now being sort of AI-ed away.

 

In every area, whether it's consulting, whether it’s accounting, all these areas where we are now providing more services to the world, we need to constantly ensure that we are on top of AI, but we're also one step ahead in terms of having the skills to bring it together in a creative way. I don't think that we'll substitute humans entirely but humans will have to know how to use all these. That could help in expanding the role of those services.

 

At the same time, those services aren't going to create the jobs that we need, which is mass job creation. We need to focus also on much more moderately skilled jobs, which are not going to be substituted by AI for the foreseeable future. Plumbing, carpentry, construction. Construction is a big area where India has tremendous needs. These are places where we can upskill our workers, more masons, more carpenters of higher quality. I think the growing urbanization of India will create many, many jobs for all these people.

 

There are also very job-intensive industries like tourism, and we can attract many more tourists into India, which will happen if we can improve the tourist infrastructure, hotels in smaller places, airports, and attractive railway stations. Those are the ways we will enhance those kinds of jobs.

 

The third would be, manufacturing, agri industry, where we can create more jobs, but we don't necessarily need to be the exporter to the world in each of those areas because we have a large domestic market. I would try for jobs everywhere we can get them, but I would recognize there is a job sort of deficit in India today. We need to work very hard on multiple fronts, both at the higher end, but also at the moderate and lower end to create the skill base to generate the jobs that we absolutely need.

 

India and the UK recently signed a trade agreement. India's average tariff will go down to 3 per cent once the trade deal kicks in. Do you believe such tariff liberalisation is necessary across the board?

 

I do think that some of our greatest sense of success and expansion was when we opened up the economy in the late 1990s and early 2000s and it was under multiple regimes. It was in the series of regimes that came after the Narasimha Rao government, coalition governments, and it came under the NDA under Prime Minister Vajpayee. That was a time when the Indian industry was subject to much more competition, but also felt a sense of confidence that it could compete with the rest of the world. While being careful, the direction of travel has to be to not just increase tariffs, as we've seen in the last few years, but bring them down to subject our industry to more competition, but in a sense, allowing them to participate more in the globe and global supply chains, et cetera. This is a much more difficult time to do it than the early 2000s because there's a sense that the world is closing up. But if you become part of supply chains, if you can assure countries, they will also have foreign producers; they'll have access to growing Indian markets. We have a $4-trillion plus economy. This could be a beneficial move for us.

 

Therefore, don't restrict your tariff reductions just to the US. Work on making it available to everyone. That way you're not hostage just to US sort of exports to India. You've opened up to everyone else. As we said earlier in the program, also explore how you can benefit from being next to the second largest economy in the world.

 

Being diversified can be a source of national strength also. Now that every country wants to exert its nationalism, being diversified across countries can be quite helpful.

 

I also wanted to get your perspective on the state of the economy. So policymakers are saying that private players are not investing enough. What could be the possible reason for this, and can be done about this?

 

Well, this is an old puzzle. In 2014-2015, when I was in the RBI, we wondered about why private investment wasn’t picking up. Now it's 10 years later, and still we don't see private investment picking up, and it hasn't really picked up over this whole period.

 

One argument is private investors are getting far more efficient and able to do more with the same capital that they had. Maybe. How do we grow at 6 per cent a year without significant additional investment? It may also be that they are just under-confident; they worry in the same way as foreign investors, the same reason that foreign investment is not coming. They worry about changes in policy, changes in tariff structures. From the infrastructure perspective, they should be investing more given the tremendous increase in spending.

 

They make promises we will invest every time investment is coming next quarter, next year. When you look at the numbers, it doesn't show this generalized increase in investment. With the uncertainty coming down, once this tariff structure is renegotiated, it might make sense for the government to try and create more credibility about both the rules of the game as well as the tariff structures going forward and urge industry to invest more, but unfortunately, I don't see any silver bullet here. I think given all that, liberalizing to the extent possible and focusing constantly on simplifying doing business in India and encouraging more small and medium industries to come up, all of which can help. In perhaps increasing the level of investment. I don't think there's any button that I think is obvious to push at this point.

 

We are seeing a rise in agriculture non-performing assets. Do you think NPAs in agriculture loans are a ticking time bomb?

 

I haven't studied this. I do think that NPAs don't necessarily stay down once you've brought them down.

 

As you bring them down, the risk tolerance of lenders goes up. Their search for new areas to lend to goes up.

 

Sometimes they make the old mistakes, but sometimes they make new ones. This is the history of lending, right? You made bad loans to infrastructure projects, you cut back on infrastructure, and your NPAs came down, but then you start making retail loans, which you don't have as much sort of knowledge and experience with. Then you overlend to retail, and then you find that those loans start going bad. The reality is we need eternal vigilance on the quality of lending and risk management has to be a constant process.

 

I think you're seeing some concerns in NBFCs in some of the banks on NPAs going up, not just to agriculture, but to other areas also. And I think we can't afford to reduce our vigilance here.

 

It's one of those where I think you need to understand where it's coming from and why it's coming before acting with a heavy hand, because we also don't want to constrain growth significantly and credit is a part of growth. I would think the RBI is certainly looking at this very carefully.

 

The US has passed legislation on cryptocurrency. However, India has not been very clear about its stance on crypto. As a former RBI Governor, what’s your stand on crypto?

 

I think the use case for cryptos, the socially useful use case, is still up in the air.

 

I can see countries with an iffy currency, a currency that the local people don't trust, where cryptos, stablecoins, are replacing that currency. India doesn't have that problem. Fortunately, the rupee is a trusted currency, both domestically and increasingly internationally, now that we have managed to contain inflation at a reasonable level.

 

Given all that, using cryptos or stablecoins as a substitute for the currency because you don't trust the domestic fiat currency, that's not an issue in India. There is legitimate worry that, in the absence of a use case, a lot of cryptos are based on the speculation of being an asset.

 

We see the price go up, we think it'll go up indefinitely, and people buy into it, often youth with modest means, sometimes borrowing to invest in those assets. So that becomes a source of worry.

 

I think being cautious is not a bad thing. That said, there are genuinely interesting technologies emerging in these areas which facilitate transactions. The US has passed the Stablecoin Bill. You can argue about the details and whether it's fully appropriate, and it has to, over time, be revisited in the light of experience. It does allow for the possibility of greater transactions using crypto media. This is different from cryptocurrency as a speculative asset. Stablecoins as a means of payment, and maybe it can be faster, smarter than existing means of payment.

 

I would say the use case is still not fully established, but certainly the use of Stablecoins within the crypto domain has certainly increased.

 

I think it's important for India to keep abreast of these technologies. To certainly be part of the central bank digital currency movements that are happening across the world. At the Bank of International Settlements in Basel, there's a working group. There are working groups focused on this. India has to be part of that because it doesn't want to be left out. How much it has to move and when it has to move, it can decide that.

 

I would say, don't ban all these activities. Contain them in a way that you feel comfortable, but allow for technological progress to happen because you don't want to be left out.

 

There are a number of Indian entities that are actually participating in creating the infrastructure for all this. That's a development that we should welcome.

 

It has to be more nuanced than ban or fully accept. It's a careful understanding of what we can benefit from and where Indians are actually participating in a way that creates more capabilities in this country. I would just take a more nuanced view.  Should the government make its stance on crypto clear? 

Well, I mean sometimes ambiguity has its own value. The details matter here. Rather than encourage a free-for-all, investing in cryptos without any constraint to whoever chooses to do so, which may create the kind of problems that we saw – for example in derivative markets – I would instead say a steady understanding of where we would benefit more from and opening up, creating rules in those areas might be useful rather than complete laissez-faire in this area.

 

It does require engaging with the participants, engaging with the various structures so as to understand how we can benefit. This is not going to go away in a hurry.

 

It may end badly. It may end in a way that generates a whole new set of technologies that the financial sector moves towards.

 

As you know, even big banks are contemplating entering the digital asset area in the US. We can't hide our head in the sand forever, as we have done in many other areas, and take a much more nuanced stance. Maybe take a little bit of risk, but not too much.