External pragmatism, internal reforms can turn US tariffs into opportunity

Any sectoral costs of a US trade deal must be compared to the costs of not having a deal. External pragmatism coupled with internal reforms can yet turn this impasse into an opportunity

The global trading order has been upended more dramatically than even the sceptics had envisioned under Trump 2.0. A multilateral, rules-based system has been uprooted and replaced with coercive bilateral mercantilism. What’s worse, tariffs have been weaponised for reasons far beyond trade. From fentanyl to judicial rulings in sovereign countries, to purchases of crude, to geopolitical proclivities — everything is now fair game. 

The implication is a byzantine spaghetti bowl of tariffs imposed by the United States. Consequently, the US effective tariff rate is creeping up towards 18 per cent — levels last seen in the 1930s. But US equity markets continue their unabated march forward. Markets keep believing the President will pull back if economic outcomes become pernicious. In turn, the administration looks at buoyant markets, seeks comfort and keeps pushing ahead. Eventually something will have to give.  Weak job numbers in the US in recent months may well be the canary in the coal mine. There’s never a free lunch in economics. As the German economist Rudi Dornbusch once noted, “Things take longer to happen than you think they will, and then happen faster than you thought they could.” 

Meanwhile, India is the latest country in the crosshairs. Tariffs have been doubled to 50 per cent. Given the sectoral tariffs and exemptions, the effective tariff on Indian imports is 34 per cent, lower only than China (42 per cent). Given India’s repeated efforts to seek a deal, the capriciousness of US policy has understandably elicited a strong reaction in India, with some commentators urging authorities to look the US in the eye, others proposing a boycott of US goods, and yet others suggesting India reciprocate with a 50 per cent tariff, thereby moving up the escalation ladder. 

But discretion is often the better part of valour. While India’s response will undoubtedly have to take into account the economic and geopolitical calculus, it’s important to be clear about the economic costs of living with a 50 per cent tariff on exports to the US — our largest export market. 

The focus by commentators thus far has been relatively narrow and static — only looking at India’s goods exports to the US, which are 2.2 per cent of gross domestic product (GDP), accounting for 20 per cent of India’s merchandise exports.  Calculations go something like this: Almost 30 per cent of India’s exports to the US (electronics, pharmaceuticals) are exempt, and the import content in several other sectors (gems and jewellery) is high, so the domestic value-add currently exposed to the US is lower, around 1.1 per cent of GDP. Based on this, analysts take comfort that the hit to growth would be a few tens of 

basis points. 

But such a static analysis is missing several components: 

* If India’s tariffs remain at 50 per cent and competitors (Vietnam, Indonesia, Bangladesh) are much lower at 19-20 per cent, India’s exports to the US will face an existential risk over time. 

* There will then be second-round impacts. Fifty per cent of India’s exports to the US are in labour-intensive sectors (textiles and clothing, gems and jewellery). These are heavy job creators, and so a stall in exports will have a knock-on impact on employment and consumption.

 

* The elephant in the room is service exports. India’s services export to the US is estimated around 6 per cent of GDP — almost thrice as large as goods exports — and is key to white-collar jobs and urban consumption. For those arguing that India should retaliate and escalate, what if President Trump responds with a tax on India’s service exports and global capability centres (GCCs)? Given the manner in which Nvidia and AMD were taxed at 15 per cent for chip sales in China, anything is possible in this environment. So India needs to be careful not to move up the escalation ladder.

 

* Most of all, the medium-term costs of not having a trade deal with the US with comparable (ideally, lower) tariffs to the rest of Asia could be felt on investment and foreign direct investment (FDI). Until recently, the expectation was India would attract lower tariffs than many of our Asean neighbours who are seen as potential Chinese transshipment hubs to the US. A tariff differential in India’s favour, coupled with the need to diversify, would serve as powerful push factors to invest in India. We would then benefit from this “China+1” impulse and better integrate into global value chains. The long-term absence of a US-India trade deal could jeopardise those prospects, the associated FDI, technology transfer, and animal spirits. 

 

Of course, India must only agree to a deal if it creates a win-win — the foundational underpinning of trade — and is in the national interest. But when evaluating any sectoral economic costs under a deal, it’s important to recognise the economic costs of not having a deal. These costs will likely be larger than the estimates put out and can only be expected to rise over time. These considerations must not be lost on negotiators as they prepare for the next round of talks. 

Of course, striking a deal will require tough bargaining as recent months have shown. Can diversifying away from Russian oil be a quick way of getting closer to a deal? Not really. 

Those who argue that the Russian discount has fallen to less than about $5 per barrel and, therefore, the cost of moving away is less than 0.1 per cent of GDP, are missing the general equilibrium impact in the oil market. If India were to move its 1.7 million barrels a day away from Russian supply, it’s very unlikely that either US shale or Opec will be able to increase supply commensurate with that. The implication: Crude prices will rise sharply around the world with its attendant consequences, whether adversely impacting India’s current account deficit or pushing up US gasoline prices and impinging on the US consumer. 

So moving away from Russian oil to secure a deal is not a panacea. Instead, negotiators will need to go back to the drawing board and look for mutually beneficial outcomes. India stands to gain from preferential access to US markets in labour-intensive sectors. The US stands to gain from India lowering tariffs on a host of sectors, barring the very sensitive ones. The very essence of comparative advantage is it can create several win-win opportunities during negotiations. 

To those who ask, “Is all this really worth it? Why can’t domestic demand fill the gap?”, it is important to remind them that only 13 economies since the Second World War have grown at 7 per cent or more for 25 years — like India needs to. They all had one thing in common: Strong export growth underpinned by strong global engagement. The size of the global market was the key source of demand in each case. So we cannot succumb to the prevailing export pessimism. Instead, we must double down on our efforts to reach a trade deal with the US so as to complement the UK deal and a potential Euro area trade deal. 

More fundamentally, growth in an era of rising protectionism will need economic reforms more than ever before. Only productivity-enhancing reforms will increase the competitiveness of India’s exports and its global market share at a time when global trade is subject to such disruption. Only sustained economic reforms will unleash other growth drivers at a time when exports are facing headwinds. India’s economic history is replete with examples of external shocks opening up space for domestic reforms. We must seize the moment. Now is the time to announce the deregulation commission — with a broad mandate and strict timelines; to implement the four Labour Codes; to double down on privatisation and disinvestment; simplify and rationalise the GST slabs; and expedite the India-Euro trade deal. These will send an unmistakable signal that India is open for business. 

In the near term, supportive fiscal and monetary policies may be needed as a balm. Until any deal is reached, targeted sectoral fiscal support, liquidity and credit lines/guarantees can temporarily cushion the blow for exporters. Meanwhile, to the extent that the balance of payments fundamentals are impacted, the exchange rate should serve as the automatic stabiliser. Recall, some exchange rate depreciation will help mitigate the punitive impact of tariffs, especially at a time of such benign inflation. But cyclical policies can only provide temporary support. They cannot be an antidote to the changing global order. Only structural reforms can. 

The public backlash on US capriciousness is understandable. But policymakers have to pull off a more delicate balancing act, recognising the new world order. Optimising India’s interests in this environment will require calmness, firmness, and cold and calculated pragmatism. Economically, much has been made about the costs of any trade deal. But these must be compared with the costs of not having one — and how these costs will grow over time. Meanwhile, we must use the current moment to double-down on the next tranche of economic reforms.

External pragmatism coupled with internal reforms can yet turn this impasse into an opportunity. Let’s not miss the forest for the trees. 

The writer is Head of Asia Economics at JP Morgan