Sudipto Mundle: The best way forward for India’s trade policy amid Trump’s tariffs

On the immediate issue of US tariffs, setting aside exempted items, about 70% of Indian exports to the US will be impacted by the 50% tariff rate. That works out to about 7.4% of total Indian exports and less than 1.6% of India’s GDP. Estimates suggest that the adverse impact on India’s GDP growth would be to the tune of 0.5% or less.

In other words, the macroeconomic impact of the 50% tariff will be quite limited.

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The problem is that its impact is concentrated on a few employment-intensive export sectors, like textiles and apparel, gems and jewellery, and agricultural and marine products, especially shrimp. To avoid bankruptcies and worker layoffs in these sectors, the government must immediately launch special assistance packages for affected enterprises. 

Of course, there will be winners as well as losers. The Indian consumers will benefit from the lower prices of affected products in the domestic market: cheaper jeans, jewellery, shrimp, etc. They would similarly enjoy lower prices if India lowered its import tariffs under US pressure. Conversely, if India retaliates with steep tariff hikes on US imports into India, it will expose Indian consumers to higher prices while extending even higher protection to local producers already protected by high tariffs. 

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On the US side, US consumers will be paying higher prices, since tariffs have been hiked for all countries, if not as much as for India. Prices would be higher even for import-substituted products because high-cost domestic US production will survive only thanks to drastically-raised tariffs. US inflation will rise and the adverse income effect of higher prices on aggregate demand will lead to a reduction in domestic production, adjusted for import substitution. There is a high probability  of the US economy suffering stagflation—high inflation and negative growth. 

Returning to India’s options, beyond a special relief package for the worst-affected sectors, India’s response should be embedded in a broader revision of its trade policy to adapt to the upended global trading system. 

The huge size of the US economy, accounting for over a quarter of global GDP, has emboldened Trump to indulge in disruptive policies. However, the US accounts for only about 11% of global trade. If all other members of the World Trade Organization (WTO) continue trading with one another in full compliance with WTO rules, 90% of global trade could continue as before—more so if countries diversify their trade away from the US, as is already happening. 

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But this cannot go beyond a point because of strategic geo-political considerations. 

Instead, trade will mostly continue to be increasingly channelized through regional free trade arrangements like the Regional Comprehensive Economic Partnership (RCEP) or the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). India needs to become part of at least one of these as a top priority in trade policy reform, while simultaneously pursuing free trade agreements (FTAs) with the UK, EU, Qatar and others. This will require a significant reduction in India’s high tariffs, which should be its second trade policy priority.

Maintaining high protectionist tariffs at the cost of consumers and exporters will severely hurt India’s economy in the present global environment. Eventually, that will translate to a high cost in domestic politics. 

Third, much must be done to strengthen India’s trade competitiveness. The government’s focus on  infrastructure and logistics is welcome. But it also needs to significantly lower the compliance burden of doing business and nudge enterprises—public and private—to invest in cutting-edge technologies. Finally, it should work to rapidly improve the very low skill profile and low productivity of the average Indian worker.

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In the broader geopolitical domain, Trump’s quixotic behaviour goes with a clear recognition of power. He is tip-toeing around Russia and China, which he clearly respects, perhaps because they could incinerate US cities if he provokes them to war. But he is concerned about a potential threat from Brics. He has hit the other two major Brics economies, Brazil and India, hard because they lack such strike capacity or a monopoly over strategic goods like rare earth magnets and rare minerals. 

He shows scant respect for G-7 allies because they depend on the US umbrella for their security. Most of them have been grovelling, but some have stood up to his bullying. India has no such dependence and can pursue its policy of strategic autonomy. It needs to strengthen strategic cooperation with the US in the Indo-Pacific and needs US investments and cutting-edge technologies. It should work towards these goals, ignoring Trump’s provocations. Russia and China have reached out and will seek to strengthen ties at the forthcoming SCO summit, with Russia helping to improve India-China relations.

While welcoming such initiatives, especially if a reset in ties with China helps secure supplies of special magnets and rare earths, India must stay vigilant. Russia is a reliable friend, as seen during its intervention to block the 7th fleet when former  US president Richard Nixon deployed it to threaten India in the 1971 war. It is also a reliable supplier of defence equipment and oil. 

China, though, uses every opportunity to keep India down and has increasingly encircled us, not just through its partnership and defence alliance with Pakistan—as seen in the recent India-Pakistan war—but its economic and strategic cooperation with all our other neighbours: Nepal, Bangladesh, Myanmar, Sri Lanka and the Maldives. 

These are the author’s personal views.

The author is chairman, Centre for Development Studies.