Trump's tariffs are India's opportunity to boost Viksit@2047 goals

Donald Trump’s United States has finally instituted what it had long threatened. A combination of overarching tariffs at 10 per cent across all products, plus reciprocal tariffs proportional to those imposed by trading partners, will make many of our exports far more expensive than before.  India features high on the US’ list of what it considers to be unfair trade partners, due to both high tariffs and non-tariff barriers.  India has wisely remained largely silent on the US threats, and this author’s expectation and hope is that it will be temperate in its response to the US actions as well.  In my view, India has played it wisely so far, and would do well to continue with the non-reactionary approach it has charted.

 

It is quite clear that this announcement is only the beginning, and the US will impose tariffs across the board, without discriminating between its friends and not-so-good friends.  As this process plays out, there will be an immediate negative impact on the US economy.  Prices are widely expected to rise, while productivity and profitability will probably fall. Given the massive support Mr Trump enjoys within the US, he will be able to ride out the initial weeks and months, irrespective of the adverse impact on both US consumers and producers. Therefore, a reversal of the policy is unlikely soon. 

 

Of course, the long-term story may be different.  There is a reasonable probability that the US may need to reduce some, if not all, of the tariffs imposed under the reciprocal tariffs rule at some point in the future.  Moreover, based on the responses from other Western countries as well as the developing world, it appears that there could be significant movement in tariffs and also non-tariff barriers. In other words, uncertainty levels are extremely high on where tariffs will be two to three years from now.  Therefore, there are two broad challenges ahead.  Those related to the extent of tariffs, and those related to the uncertainty.  Both tariff rates and perceived uncertainty are set to rise.

 

For some time now, aggregate tariff rates in India have been rising.  Also, it is believed by many that tariff increases have provided Indian manufacturing firms the protected space needed to grow and achieve scale economies. But overall, the data is quite clear: The protection approach has not yielded any great benefits on manufacturing competitiveness in the aggregate.  There may be an example here or there, but the Indian industry’s share of global exports has stagnated, and even fallen, in recent years.  Moreover, high import tariffs have also prevented Indian industry from plugging into the global value chains that dominate international trade today. 

 

And, therefore, it is critical that India use Mr Trump’s threats to its advantage and reduce its own tariff rates. This will bring in many gains for Indian industry and the economy. First, if other countries are going to impose retaliatory tariffs on the US or not reduce their own tariffs at the very least, a significant space will open up for India to capture new export markets. Second, reduced tariff rates will open up many productive possibilities for India, more so for its micro, small and medium enterprises (MSME) sector, which is most affected when tariffs are imposed to protect large Indian industry. A corollary to that is low tariffs will open options for Indian firms to plug into the GVC networks.  Given that many global corporate networks are attempting to diversify their input sources away from China, this is indeed a key opportunity for India.

 

There is, of course, also the risk of Indian industry in some segments being overwhelmed by US imports, given its lack of competitiveness in many areas.  Therefore, India must respond in a tempered fashion.

 

First, while India must follow the larger principle of reducing its tariffs, it should not use the shock therapy approach employed by the US.  Tariff reductions will need to be staggered, spread over a period of time.  But the staggered approach should not be an excuse to postpone indefinitely.  Firms in India and globally need to be informed of the timeline so that they can undertake their investment decisions and build requisite capacities in a planned manner. 

 

Second, India will need to find other avenues to support its industry.  India’s industrial policy must now follow a new mantra: Support, not Protect. Rather than protecting industry by using tariffs and non-tariff barriers, it needs to find ways of supporting industry through other mechanisms.  The production-linked incentive (PLI) scheme is one such mechanism but not the only one.  Land prices in India, for instance, are inordinately high, partly due to laws designed to protect farmers from exploitation. The government must absorb a significant part of these costs as they are not due to inefficiency, but specific policy action.  Similarly, electricity costs are unduly high in India due to discom inefficiency, as well as India’s penchant for cross-subsidising agriculture and domestic consumers at the expense of industry.  Such costs should not be imposed on industry, it is not only unfair and inefficient, but also works against employment generation.  Therefore, if we insist on such cross-subsidisation, it should be the government, not industry, that bears the costs.

 

There are undoubtedly many synergies between the two economies: The US, with its capital-intensive economic framework, and India, with its low-cost workforce; the US, with its dominance in cutting-edge technologies, and India, with its globally respected educated workforce; the US, with its strong startup support ecosystem, and India, with its dynamic startup landscape.  The two economies have significant complementarities. Given the prospects of a US-India Free Trade Agreement, India can convert this into a great economic opportunity. 

 

While we must use tariff reductions as a general policy response, the response itself needs to be tempered.  Staggered reductions is one aspect, supporting industry through other mechanisms is another, and excluding some products from tariff reductions is yet another. 

 

Agriculture is one such sector — cereals, fisheries, and dairy, for instance, would need protection. However, even within agriculture, there are areas where India could open up more. Dry fruits, berries, and various fruits not widely grown in India are some examples. Ethanol could be another where India would do well to open up. A guiding principle could be that any agri product where India’s food security is not impacted and is not a major employment generator can be considered for lower trade barriers. 

 

Barring a few products that must be protected from an equity and security perspective, India must announce a plan of staggered tariff reductions.  Most importantly, these announcements need to be credible and the actions sustained.  They must not be dependent on future US policies.  That is, India must continue on this path even if the US reduces tariffs unilaterally in the future.  Because while India’s tariff reductions may be triggered by US actions, they should not be a defensive response but an assertive strategy for an economy aspiring to achieve Viksit@2047.

 

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The author heads CSEP Research Foundation