India must seize Trump shock as moment for deep structural reform

The Trump trade shock is a chance to push long-overdue reforms, rather than tinker with tariffs to appease the US

US President Donald Trump has finally delivered on the worldwide trade disruption that he had long threatened. Besides a general tariff increase of 10 per cent, almost all countries have been slapped with tariff hikes of various magnitudes.  In retaliation, several countries are likely to impose counter-tariffs, and the world may witness a wave of protectionism, crippling economic activity. It is highly likely that the US will slide into recession and that global growth will decline. With compression in exports, most countries will have to revise their growth forecasts downwards. Some of the stronger exporters to the US are likely to initiate countermeasures, as China has already done. Many countries will seek to realign their trade channels, accelerate trade negotiations to conclude pending agreements, or undertake domestic reforms to enhance competitiveness. Clearly, we are set to witness a flurry of interventions on both external and domestic policy fronts.

 

India is likely to be adversely impacted by the Trump tsunami, though the effect may not be as devastating as initially feared. Some estimates suggest it could erode gross domestic product (GDP) growth by 0.3 percentage points. Of course, the full impact will become clear only after the waves of countermeasures settle. It is also true that much of India’s growth in recent years has been driven by domestic consumption and public capital formation.  This, however, should not lead to complacency. 

 

Every country that has registered high growth over long periods has relied on exports as a major engine. Our goal of accelerating growth to become a Viksit Bharat cannot be realised by focusing on domestic consumption and investment alone.  Complacency may set in on the grounds that tariff increases on our competitors are higher and that India is relatively better off, as there can be trade diversion in its favour in some cases. However, the increase in tariffs, countermeasures by other countries, and the overall deceleration in global growth are bound to reduce the demand for our exports.  Policymakers should take this as an opportunity to embark on initiatives to reverse the protectionist trend that we have adopted since 2017, speed up the structural reforms to impart greater competitiveness to Indian manufacturing, and fast-track ongoing trade negotiations, including a rethink on joining the Regional Comprehensive Economic Partnership.

 

When confronted with such situations, there is a tendency to tinker with tariff lines to appease the US. It is important to resist this temptation and instead use the opportunity to undertake comprehensive reforms to ease the domestic constraints adversely affecting competitiveness. The government should treat this as a 1991 moment—an inflection point—and initiate reforms in both domestic and external policies, keeping in mind the overarching goal of becoming a developed country by 2047.

 

There is broad consensus that the trend of increasing tariffs since 2017 needs to be reversed to promote greater openness to trade and investment. The temptation to increase tariffs, at least in part, is due to our failure to undertake domestic reforms.  It is clear that the government will have to bite the bullet and free up the land and labour markets. Measures must be initiated to encourage labour-intensive manufacturing by incentivising small and medium enterprises to increase their scale and adopt better technology and competitive practices. In this, the state governments, too, will have to play an important role by implementing labour reforms and freeing up the land market to enable enterprises to access these factors of production at reasonable rates.  Governance reforms are critical, and the slogan of “single window clearance” should not turn into a separate window for each clearance! We still have a long way to go in ensuring the basic public good provisions of protecting property rights and enforcing contracts.

 

Liberating financial markets to ensure adequate and reasonable borrowing rates for businesses is a critical element in enhancing competitiveness, and this requires serious fiscal reforms. The most important reform needed here is to make the cost of public-sector borrowing as high as that of the private sector, and the first step in this is to do away with the statutory liquidity ratio (SLR) requirements.

 

At present, commercial banks are required to park 18 per cent of their demand and time liabilities in Union and state government bonds. Combined with the sovereign guarantee, this gives the government sector a significant advantage in both access to and cost of borrowing. Freeing up the SLR requirement can help reduce borrowing costs for private businesses.  Although commercial banks have been holding more than the required SLR in recent years, it is important to begin freeing up the financial market and make governments recognise that their borrowing has an opportunity cost on the economy. This, along with a better-calibrated, rules-based fiscal policy that recognises the ground reality of declining household sector financial savings, is important.

 

One of the low-hanging fruits for easy pickings to impart competitiveness is the reform of the Goods and Services Tax (GST) to make it comprehensive and get rid of the burden of domestic trade taxes on exports. The avowed objective of replacing cascading-type domestic consumption taxes with a destination-based GST was to relieve the burden of domestic trade taxes and make our products more competitive in the export market. However, by excluding petroleum products, electricity, and real estate from the base GST, significant cascading element has continued. In 2022-23, for example, the domestic consumption taxes excluded from GST base constituted 41 per cent of the total domestic indirect taxes. These include excise duty on petroleum products levied by the Centre, and sales tax, motor vehicle tax, passenger and goods tax, and electricity duty levied by the states. In other words, 41 per cent of the domestic consumption tax is not subject to zero rating in exports.  As petroleum products are used in transport, the cascading from the tax is universal. The revenue reasoning advanced for excluding these items from the GST base is exaggerated. What is required instead is better tax administration and more effective application of technology for enforcement. It is reported that during April-June this year, the central officers alone have detected 25,397 cases of evasion involving ₹1.95 trillion, of which ₹464 billion was due to input tax credit fraud. The undetected amount is anybody’s guess (https://shorturl.at/mtRFW). Simplification of the tax system and effective application of technology will generate revenues that can more than compensate the loss from rationalisation.  It is time policymakers at both the Central and state levels realise this and work towards making GST simpler and more comprehensive.  The opportunity presented by the Trump tsunami should not be missed.

 

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The author is chairman, Karnataka Regional Imbalances Redressal Committee.  The views are personal