The rupee should be allowed to weaken to cushion impending trade impact

While it is to be hoped that the Indian government will continue to engage with the US, the prospect of a 50 per cent-plus tariff on US exports will have serious consequences for the Indian economy

American President Donald Trump has embarked on a policy path that has created uncertainty for the global economy at a level and scale not seen in recent decades. He has turned the basic understanding and global consensus on trade on its head. His trade policy aims to eliminate not only the overall trade deficit but also with individual countries. Fearing loss of access to the United States (US) market, several countries have agreed to sign one-sided trade deals with the US. India was one of the first to start negotiating with the US, but the two sides could not arrive at a mutually beneficial deal. Mr Trump, as a result, imposed a 25 per cent tariff on India. However, he is using tariffs not only to achieve his economic goals but also to attain other objectives. He has been particularly unfair to India and has announced an additional 25 per cent tariff for importing Russian oil. Mr Trump is scheduled to meet Russian President Vladimir Putin later this week, though it is not clear if an agreement of some sort on Ukraine will make him rethink the oil penalty.

 

While it is to be hoped that the Indian government will continue to engage with the US administration, the prospect of a 50 per cent-plus tariff on US exports will have serious consequences for the Indian economy. India exported goods worth $86.5 billion to the US last financial year. At the expected tariff level, most Indian goods will be priced out. This will affect India’s external financial position through both the current and capital accounts. Although electronics and pharma are exempt from these prohibitive tariffs for now, these sectors may soon be included in some form. Given that part of India’s imports — such as crude oil — cannot be reduced, a dent in exports could worsen the trade deficit and the overall current account deficit (CAD). Since India is running a lower CAD, the increase may not be alarming.

 

However, problems could arise from the capital account. The state of trade relations with the US and its impact on the broader economy can affect both foreign direct investment (FDI) and portfolio investment. On FDI, there are already concerns regarding increasing repatriation and outbound FDI. Net FDI in 2024-25 was just about $350 million. On the portfolio front, foreign investors have sold Indian stocks and bonds worth about $11.5 billion so far this year. The challenging prospects on both the current account and capital account will affect the rupee, which is hovering around its lowest level against the dollar. It fell about 2.3 per cent against the dollar thus far in 2025. The fall has been limited by a steep decline in the dollar itself against a basket of currencies. The dollar index has declined over 9 per cent since the beginning of the year, which is contrary to what many expected. It is being argued that this is a reflection of declining investor confidence in the US economy and the dollar.

 

Although it is too early to draw such conclusions, what is clear is that things will be uncertain and volatile. As things stand, it is likely that there will be pressure on the rupee in the coming months. India has large foreign-exchange reserves, but those should not be used to defend the rupee at this point. Hopefully, India will be able to negotiate a better deal, but that will still likely have a higher tariff. What is happening in trade is a structural shift, and a weaker rupee can help contain the impact.