In the ever-evolving landscape of global trade, tariffs have emerged as a popular tool for nations to reshape economic relationships. Tariffs are taxes one country imposes on another country’s goods, mainly to protect local businesses from competitive foreign products or to pressure other countries into lowering their restrictions. Reciprocal tariffs are trade restrictions that one country imposes on another in direct response to trade barriers from others.
Reasons behind imposing reciprocal tariffs
As a part of his ‘Liberation Day’ initiative, the 47th U.S. President, Donald Trump, announced two sets of tariffs.
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- One was a base tariff of 10% against all countries, which in itself is a sharp increase from the pre-Trump 2.0 tariff rate of around 2.5%.
- Second was a push for country-specific ‘reciprocal tariffs’ – think of it as a tit-for-tat in trade, affecting global trade dynamics.
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A mix of economic, political, and strategic factors drove this initiative:
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- Reducing the U.S. trade deficit: The U.S. imports far more than it exports, especially from countries like India and China. With a trade deficit nearing $1.2 trillion, the U.S. administration aims to boost domestic production and dissolve this trade deficit. (A trade deficit is the difference between the value of the U.S. imports and the value of goods it exports).
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- Level the playing field: The U.S. maintains an open trade regime, yet its trading partners impose a higher tariff on their goods than it does on theirs. Therefore, these reciprocal tariffs are a way to counter this imbalance and address unfair trade practices.
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- Boost domestic manufacturing: Now that the cost of imported products has risen, these reciprocal tariffs encourage consumers to buy American-made products. This is intended to support U.S. manufacturers, protect jobs, and revitalize industries hollowed out by decades of offshoring and foreign competition.
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- America-First agenda – Reciprocal tariffs are an integral part of the political messaging to make America great again! This policy is directed towards reclaiming American economic sovereignty and gaining leverage in the trade negotiation process.
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The United States’ aggressive reciprocal tariffs policy marks a dynamic shift in U.S. trade policy since the North American Free Trade Agreement (NAFTA) and the General Agreement on Tariffs and Trade (GATT).
The Immediate Impact on India
Considering the close bilateral relations between the U.S. and India, the latter is feeling the heat. The U.S. imposed 26% blanket tariffs on Indian imports across different industries – steel, aluminium, jewellery, and textiles – which triggered a knee-jerk reaction in India. These drastic tariffs also piled more stress on an ailing global economy, sending stocks and oil prices into a tizzy.
Here are some short-term challenges that India may have to face:
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- Strain on exporters: The U.S. is one of India’s biggest export partners. With the new tariffs in place, Indian companies might face lower sales because the price hikes could scare U.S. consumers. This could also lower India’s overall exports, impacting the country’s economic growth and trade balance.
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- Retaliations and tensions: To combat losses, other countries can initiate retaliatory tariffs of their own on U.S. goods, resulting in a trade war, thereby disrupting the supply chain and creating further economic tensions.
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- Worsened economic challenges: The new tariffs are projected to reduce Indian exports to the U.S. by $30-33 billion, equating to 0.8-0.9% contraction in India’s GDP. This could further slow down India’s economic growth and weaken consumer confidence.
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- Tariffs on imported drugs: The U.S. accounted for $8.7 billion of India’s $27.9 billion pharma exports. India supplies over 45% of low-cost generic drugs used in the U.S. Any retaliatory tariffs on this front would impact both countries. Any new duties could worsen inflation, create a shortage of medicines, and lead to exorbitant prices – all this just to expand American pharma firms.
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- Slowdown in the exports of automobile parts: Tariffs on auto components, steel and aluminium articles have affected demand for automobiles and raised production costs for Indian manufacturers.
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- Supply chain disruptions in the textile industry: The U.S. and the European Union (EU) are the primary destinations for India’s textiles and apparel exports. In fact, this industry contributes 12% to exports and 2.3% to India’s GDP. However, the 26% tariff increased costs, thereby causing a demand constraint. Moreover, the MSMEs face liquidity crises and potential closures, which disrupt the entire value chain, from yarn production to dyeing and printing.
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Long-Term Impact
However, if one were to find a silver lining here, it would lie in the long-term impact of these tariffs on the Indian economy and the opportunities that may arise.
The White House has levied 46% tariffs on Vietnam and 145% tariffs on China. China retaliated with 125% tariffs on U.S. imports. However, India’s relatively lower reciprocal taxes compared to those of China, Vietnam, and Thailand can offer a competitive advantage.
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- Expanding manufacturing: Venture capitalists believe that although tariffs are a minor setback, India’s manufacturing sector can grow in the long run. The U.S. tariff regime could shrink global trade by 3% and cause a significant shift in export flow from traditional markets like the U.S. and China to emerging markets like India.
- Diversifying export markets: Additionally, India is reducing reliance on the U.S. and looking for new markets to replace some of the lost business. India and the U.K. are also working on finalizing a trade agreement. By diversifying its export strategy, India hopes to cushion the economic blow from the new tariffs.
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- Focus on regional trade: The U.S. is India’s largest trading partner, with an annual bilateral trade of $129.2 billion in 2024. Although both countries aim to double their bilateral trade to $500 billion by 2030, retaliatory tariffs could impact Indian manufacturers, especially steel firms. Therefore, India can strengthen its ties and enter into regional trade agreements with its neighbors so it is less dependent on distant markets, easily connected to nearby markets, and can bolster its economic resilience.
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- Diversifying India’s gems and jewellery industry: India’s $32 billion gems and jewellery market is also subject to the reciprocal tariffs. Hence, Indian manufacturers can consider changing their export strategies and eye markets in the UAE, Saudi Arabia, and Latin America.
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- 90-day breather: The current 90-day pause on the reciprocal tariffs (excluding China) provides a much-needed breather amidst uncertainty. Any developments in the bilateral trade negotiations with Washington can impact the export-driven sectors.
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- Enhance self-reliance: This initiative is a great opportunity to boost domestic manufacturing and push the principle of an atmanirbhar bharat (self-reliant India). With a Production-Linked Incentive (PLI) scheme targeting automobiles, electronics, pharmaceuticals, and textiles, this incentive further aims to reduce import dependency and improve value addition.
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These reciprocal measures can be observed as a broader trend towards a more isolationist U.S. policy. A move of such a global scale by the world’s largest economy – whose currency is the default global currency – can and has caused massive upheavals on the prices of different assets, such as stock markets, gold, or even currency exchange rates.
Despite these shortcomings, the long-term impact on India could act as a catalyst to improve India’s stance. This will translate through enhanced economic reforms, a stronger manufacturing base, and navigating diverse trade partnerships.
