Strategy review in light of the US tariffs - 3

 …continuing from yesterday.

In my view, assimilating the impact of a sustained Indo-US trade standoff in a personal investment strategy is an extremely complicated task, for three reasons – (i) Indo-US relations are very deep and wide; (ii) Indo-US trade relations go much beyond import and export of goods and service; (iii) Indo-US trade relations are intricately intertwined with strategic, geopolitical and social relations.

Hence, the impact of a prolonged standoff in the trade relations may not be confined merely to a couple of thousand Indian exporters, having a material exposure to US markets. In my view, a noticeable impact could be felt at economic, political, geopolitical, and financial levels.

As of this morning, we do not know about the progress in back-channel negotiations. But visibly both the sides appear to have hardened their stance. India has outrightly rejected the reasons cited by the US administration for imposing penal tariffs, viz., purchase of crude oil from Russia, as unreasonable and completely untenable. The US President has extended the tariff moratorium for China (the largest buyer of Russian oil) by another 90 days. He is attending a meeting with the Russian president tomorrow. In my view, this is indicative of a different design behind these tariffs, rather than the stated one (also read Tariff Tantrums).

I hope that a sense will prevail and the Indo-US relations get normalized soon. Would be even better if this normalization of relations is part of a larger global resolution, in which the US and other major trade partners like China, Russia, Japan, and EU also come to a sustainable agreement. This could usher a new phase of global economic growth, in which India could be a meaningful partner.

However, if parochialism, hyper nationalism and/or vested business interests override the spirit of cooperation and globalization, and a broad-based resolution is denied, India faces economic and geopolitical challenges that would require material policy changes, including foreign, trade, fiscal and monetary policies.

If I were to imagine a worst-case scenario in Indo-US relations, I would draw a picture using the following colors and shapes.

·         The US maintains penal tariffs, or even increases it further. The US businesses find it unviable to import from the Indian vendors. For generic goods and commodities, they shift to alternative sources (partially or fully) in the next 6-9 months. For specialized goods like specialty chemicals, auto components, pharmaceuticals, polished precious stone and jewelry, etc. the US importers may adopt a India+1 strategy. They may focus on developing alternative suppliers over the next 1-2 years and shift a part of their sourcing to such alternative vendors.

·         The US administration brings services and remittances also within the ambit of tariff/taxation. More non-tariff restrictions are (VISA, qualifications, numbers, minimum pay etc.) also imposed on Indian workers and students. This might force more Indian companies to establish onshore entities in the US and increase local hiring. Alternatively, some Indian companies may choose to establish entities in the foreign jurisdictions with favorable terms of trade with the US.

·         The US may restrict technology transfer to India by the US entities, hampering the growth of the manufacturing sector and R&D initiatives.

·         The US may increase strategic engagement with the neighbors of India, especially the hostile neighbors like Pakistan and Bangladesh, to put geopolitical pressures and keep the borders insecure.

·         The US may also incentivize/pressurize its close allies to review their relationships with India.

·         The US administration may sanction certain Indian entities on the pretext of criminal activities, supporting war, unethical business practices etc., particularly impacting their global business and financing deals.

·         The global economy also suffers, as the Political instability and unpredictable economic policies in the U.S., erodes confidence in the US economy and financial system. The foreign capital begins to move out of the US, causing sharp volatility and decline in the US asset prices, pressing the USD lower and bond yields higher, and a potential stagflationary condition.

·         Several Indian MSME's face severe financial stress as they lose their US business. Some of them fail to survive as they are unable to develop alternative markets in time. Many downsize their operations. Several medium and large businesses establish overseas entities with a local employee base. Unemployment rises. There is some incremental stress on the financial system. Consumption suffers. Realty demand falls. Government faces fiscal pressures as growth declines and the deflationary trend strengthens.

If I close my eyes and visualize this picture, it frightens me to the core. If I try to assimilate even a part of this to my investment strategy, I would end up holding almost zero risk asset (equity). I would therefore refrain from any such exercise.  

If you ask me “whether this worst-case scenario is possible?”, I would say “yes”. If you ask me what is the probability of this occurring, I would say “very low” but not “zero”.

I would like to believe that a broader global trade agreement may happen in the next 3-5 months, and Indo-US trade relations normalized to pre 2025 level, at least. In the meantime, I would, however, rationalize my portfolio to reduce the weightage of smallcap companies having over 20% revenue exposure to the US. In the mid and large cap space, I would only review the companies with over 20% revenue exposure to the US, provided they have significant debt on their books and are trading at a premium valuation (more than 20% premium to their long-term average valuation).

 

Also read

Strategy review in light of the US tariffs

Strategy review in light of the US tariffs - 2

Tariff Tantrums

New chapter in Indo-US relations

Speculating Trump’s second term

Ambivalent