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The imposition of a 25% tariff by Donald Trump on Indian imports into the United States has sparked considerable debate and concern regarding the potential economic repercussions for both nations. Trump's rationale, as expressed on social media, centers on the perception that the US has historically struggled to engage in substantial trade with India due to the latter's high tariff structure and various non-monetary trade barriers. Furthermore, India's ongoing military and energy acquisitions from Russia have prompted the US administration to contemplate additional penalties, the specifics of which are yet to be determined. While the Indian government is currently assessing the implications of this development, the consensus among economists and trade experts is that this move represents a negative-sum game, where both countries stand to lose. The immediate impact of tariffs extends beyond merely taxing imports; they function as a consumption tax, directly affecting consumers. This mechanism narrows profit margins for Indian exporters while simultaneously inflating the prices of Indian imports within the US market. In 2024, the US imported a substantial $87.4 billion worth of goods from India, resulting in a trade deficit of $45.7 billion, which constitutes approximately 2% of the US's overall trade deficit. Although imports from India account for a modest 3% of the total goods and services imported by the US, nearly a fifth of Indian exports are destined for the US market. This trade structure underscores the vulnerability of India, as it stands to suffer disproportionately from the adverse effects of the tariff war. Prior to the recent tariff escalations, India's effective tariff rate on US imports was around 12%, while India faced a significantly lower 2.2% tariff rate. The more than tenfold increase in tariffs will not only burden Indian exporters but also create the risk of trade diversion. American importers may opt to source goods from alternative countries, such as Vietnam, Indonesia, or Ecuador, where they face less stringent tariffs. This shift could potentially marginalize Indian exporters and reduce their market share. The currency markets have already responded negatively to the tariff announcement, with the Rupee experiencing depreciation. While a weaker rupee could make Indian goods marginally cheaper in the global market, this exchange rate adjustment is insufficient to offset the 25% price hike in the US. Conversely, a weaker rupee will increase India's import costs, leading to increased domestic inflation. The magnitude of the 25% tariff is substantial and could potentially eradicate India's comparative advantage in labor-intensive industries overnight. If exports to the US remain at similar levels as in the previous year, Indian importers will face an indirect tariff bill of approximately $22 billion, equivalent to over 0.5% of India's GDP. Sectors such as textiles, pharmaceuticals, and gems and jewellery are particularly vulnerable, as the tariff could erode their profit margins, leading to output and employment losses. The impact extends beyond exporting sectors, as these shocks propagate throughout the entire economy via value chain linkages.
The smartphone industry in India has experienced significant growth, driven by Apple's efforts to ramp up production in the country amidst the US-China trade tensions. Smartphone production and exports have grown substantially, with its share in total electronics rising from 9.9 per cent to 44.4 per cent over the last decade. The Performance Linked Incentive (PLI) scheme, designed to attract foreign investment and boost domestic manufacturing, has played a crucial role in this transformation. The scheme incentivized Apple to expand its production in India, with the goal of developing an infant industry into a globally competitive player. However, the new tariff poses a threat to this progress, potentially forcing Apple to reconsider its production strategy and potentially return to the US, thereby negating the benefits of the PLI scheme and rendering India's state expenditure ineffective. The PLI, in a way, has subsidized Apple’s production in India, with the intention of buttressing an infant industry to a globally competitive stage. Now, Apple is being threatened to cut back production in India and come back to the US, which could potentially negate all benefits and leave India’s state expenditure worthless. However, a complete reversal of Apple's production shift may not be feasible due to the company's significant market share and the comparable tariff rates faced by competitors. Such a move would likely increase the cost of iPhones for American consumers, potentially triggering a political backlash. The impact of the tariff extends beyond smartphones, threatening the competitiveness of other leading export sectors that have benefited from the PLI scheme. The potential tariff bill is equivalent to the Rs 1.97 lakh crore PLI budget. If half of US orders were to disappear as a result of the tariff and associated penalties, Indian goods exports would decline by an estimated $40 billion, reducing India's GDP by 1% in 2025-26. To mitigate the damage, India must prioritize negotiation, market diversification, enhanced competitiveness, and the protection of affected sectors. While the long-term effects of the tariffs could potentially spur reforms and a transition to new markets, ultimately making India more self-reliant and broad-based, the short-term disruptions are likely to be substantial. India can mitigate the impact of Trump's 25% tariff through a two-pronged approach. Firstly, by providing immediate, temporary tax refunds or offering cheaper loans to exporters with significant sales to the US, while simultaneously promoting the 'Make in India' initiative to encourage industries to transition to higher-value goods and advanced technology. Secondly, by swiftly securing new trade agreements with the EU, Gulf states, and other markets to diversify export destinations and reduce reliance on a single buyer.
Furthermore, India should consider pursuing legal action by filing a case with the World Trade Organization (WTO). The US, in turn, could benefit from a fair trade agreement, similar to the UK-India agreement, which lowers duties, protects jobs, and ensures stable supply chains for both countries. Only an appropriate agreement can turn this into a positive-sum game. The article emphasizes the need for India to adopt a proactive and multifaceted approach to navigate the challenges posed by the imposed tariff. This approach encompasses short-term financial relief, strategic diversification of export markets, and a long-term commitment to enhancing competitiveness and promoting value-added manufacturing. The article also suggests that the US has an opportunity to rectify the situation by engaging in constructive negotiations and forging a fair trade agreement that benefits both nations. Without a collaborative and mutually beneficial resolution, the tariff is likely to result in negative economic consequences for both the US and India.
Source: Trump’s 25% tariff on India is a negative-sum game. There is no easy way out