Do it yourself

The US administration has imposed a 25% penal tariff on the goods imported from India, with few exceptions. The reason cited for this penal action is continued import of crude oil from Russia by the Indian refiners, despite the US administration insistence that sales proceeds from such oil sales are being used to finance the Russian war on Ukraine. These tariffs are over and above the MFN tariffs prevalent prior to 7th August 2025, and 25% reciprocal imposed with effect from 07th August.

Considering the exemption for several items that are critical for the US supply chains, e.g., mobile phones, certain metal items, pharma, semiconductors, energy etc., the effective tariff rates on Indian exports to the US are estimated to be ~33%.

India has termed this penal action “unfair, unjustified, unreasonable”. The public stance of the Indian government is that buying Russian oil is critical for our energy security, and it is our prerogative to decide from where to buy. 

Considering the current seemingly inflexible stance of both the parties on this issue, it would not be unreasonable to assume that these penal tariffs may stay, at least for a few more months, till a breakthrough in trade talks is achieved. Reportedly, the Indo-US bilateral trade talks are continuing and the negotiators are hopeful that a bilateral trade agreement (BTA) may be achieved in the next few months.

However, assuming the worst case (penal tariffs stay for a longer term than presently estimated), the repercussions could be serious for the Indian economy, in general, and exporters in particular. Some of the consequences of sustained penal tariffs could be listed as follows. Please note that these are based on worst case assumptions and not a base case.

Capital and jobs drain: If the penal tariffs sustain, a large number of SMEs, catering mostly to the US demand, especially in sectors like textile, jewelry, carpet, could think of relocating their manufacturing base (fully or partially) to a more tariff friendly jurisdiction like UAE, Oman, Egypt etc. This would result in material capital outflow and loss of jobs for local workers.

Job losses and labor migration: The loss of business due to lower exports to the US is likely to affect the labor-intensive SME sector the most. Various estimates are suggesting a loss of over one million manufacturing jobs directly. There could be material secondary job losses also as exporters scale down their businesses and workers migrate to their native places. This could adversely impact the already struggling private consumption growth and household savings.

Capital controls: India has traditionally run a trade surplus with the US. Loss of exports to the US market, may erode this surplus, adversely impacting the overall trade balance of India. To manage this widening of trade deficit, the government might consider, like it did in the 2013 BoP crisis, imposing some capital controls like reducing limits under LRS remittance, capital investments (outbound FDI) through automatic route, etc. It may also consider liberalizing rules for FDI in sectors like retail trade, increasing competition for the local businesses.

Uncertainty over pharma and services: As of now, pharmaceuticals and services are not covered by the reciprocal and penal tariffs. These two together form ~45% of total Indian exports to the US. If the two sides are unable to find a solution to the current impasse, the US may consider imposing some tariff or non-tariff barriers on pharma and services also. Though not on the board this morning, in the back of minds it must be bothering many entrepreneurs and investors. Even the global corporations making large investments in setting up GCCs in India, would be mindful of this risk and slowdown their future investment plans.

India+1: Presently, it may not be viable for a lot of American importers to immediately replace Indian imports with other countries. However, to mitigate a long-term risk, American importers might explore developing vendors in other countries, even if it costs a fraction higher. This clouds the long-term prospects of export growth for the Indian vendors, even if the present tariff impasse gets resolved in the next few months.

Wider sanctions: To increase pressure on India, the US administration may enhance the scope of penal tariffs to non-tariff restrictions (effectively sanctions like 1998) to include sale of critical defense components, and technology transfer agreements etc. This may adversely impact, for example, the plans to develop local fighter jets and develop a local semiconductor ecosystem.

Remittances: Sanctions and/or fear of sanctions can materially affect remittances from the US to India. On the positive side, many NRIs can accelerate their remittances to preempt remittance tax, restrictions on remittances to India or freezing of assets on some convoluted pretext (This has already happened with Russians and Iranians). On the negative side, VISA restrictions, cancellation of Green cards and H1Bs etc., may impact remittances adversely to some extent.

Uncertainty for tech workers and students: For the past many years, India has sent the largest number of tech workers and students to the US. Escalation in trade conflict could impact this trend adversely. Moreover, dark clouds of uncertainty may engulf the workers and students already present in the US or planning to travel to the US in near term. There are already reports of several Indian students (present and prospective) suffering from extreme stress and depression.

Rise in Chinese threat: To mitigate the impact of the US tariffs and potential sanctions, the Indian government has already enhanced its engagement with the Chinese government and businesses. Reportedly, India has shown inclination to relax several restrictions on the Chinese businesses, capital and products. This is in spite of the past history of mistrust and deceit, and recent Chinese participation (against India) in Operation Sindoor. A liberal access to the Chinese capital and technology might seriously compromise the security of the country; and potentially create a gulf between the government and defense establishment.

I am definitely not suggesting that the government of India should accede to the unfair and unjust US demands and sign an unfavorable trade agreement. I have just listed some pointers for adjusting investment strategy, should things take a turn for the worst.

 Last week I  had written (see here) about how the fourth letter of the English Alphabet “D” has gained prominence in the financial market jargon. In particular, I find three “Ds”, viz., Digitalization, Deflation and Demographics most relevant for the economy and therefore markets.

A recent speech of Dr. Michael Patra, Deputy Governor of RBI, as published in the latest monthly bulletin of RBI (May 2023), highlighted some more ‘D” factors that are ushering India into a new age. Besides demographics & Digitalization, Mr. Patra emphasized on Diaspora, Diversification, Diplomacy, Dynamic Federalism, and Decarbonization as key factors in transformation of the Indian economy. The following are some excerpts from his speech:

Diaspora: An outward reflection of India’s demographic bonus is the vibrant expansion of Indian communities across the world. Over the years, our perceptions about the diaspora have also transformed from ‘brain drain’ to ‘brain gain’, spurred by the contributions that Indians have made in various fields in the global arena, including information technology, entrepreneurship, international politics, medicine, arts and culture, with some of them becoming Nobel laureates. It is estimated that over 90 out of 1078 founders of about 500 unicorns in the US are persons of Indian origin.

The Indian economy has been a beneficiary of this dynamic and industrious diaspora. India currently receives the highest flow of remittances in the world at US $ 108 billion in 2022, up by 24.6 per cent from a year ago, and accounting for 3 per cent of India’s GDP. Additionally, Indians residing abroad hold deposits in Indian banks cumulating to US $ 136 billion at the end of February 2023.

Diversification: The Indian economy is undergoing a quiet but fundamental transformation encompassing all its sectors. Perhaps the most striking transformation is occurring in India’s exports of services which have demonstrated pandemic-proofing, rising by above 25 per cent per annum since 2020, and providing valuable support to the viability of the external sector. While software and business services are the main drivers of this robust performance, advances in IT have not only made services more tradable but also increasingly unbundled: a single service activity in the global supply chain can now be fragmented and undertaken separately at different geographical locations. Jurisdictions have accordingly been decentralising and diversifying their supply chains to ensure business continuity. These factors have led to a new channel of IT-enabled services - large multinational corporations (MNCs) are setting up Global Capability Centres (GCCs), which are offshore offices, delivering a wide array of services across IT sector verticals.

India is also becoming a hub for engineering R&D (ER&D) centers as leading multinationals develop their centers of excellence (CoEs) across different business domains. The National Association of Software and Service Companies (NASSCOM) estimates that India will add 500 GCCs by 2026. They are going to be hiring. India’s citizens of the future should prepare for this revolution. The world is coming to our doorstep to fill world-class jobs.

Diplomacy: India is prioritising a reformed multilateralism that creates a more accountable, inclusive, just, equitable and representative multipolar international system for the 21st century. Our priorities include addressing the macroeconomic implications of food and energy insecurity; climate change; strengthening Multilateral Development Banks (MBDs); debt sustainability; strengthening financial resilience through sustainable capital flows; financing inclusive, equitable and sustainable growth; leveraging digital public infrastructure; climate financing; and opportunities and risks from technological change.

Dynamic Federalism: Increasingly, the quality of life and the business environment in India is going to be defined by shifts in the focus of public policy that foster competitive federalism among India’s states in achieving the aspirational goals of sustainable economic development. The freedom to compete allows each state to design, experiment, innovate and reform, given its unique features and challenges, while emulating best practices achieved by peers. An example of the power of competitive federalism is the drive among states to attract private investment, both domestic as well as foreign, by showcasing investment opportunities in each state. The spirit of competitiveness is being promoted at the highest policy levels.

As our states compete for a place in the sun, they will nurture business growth, put in place the best physical and social infrastructure and provide us with improved basic amenities, clean energy, and better health and societal outcomes. Along with foreign investment bringing in new technologies and ideas, we are moving into a national ethos of wider consumer choices and a better standard of living.

Decarbonisation: India and other developing economies are highly vulnerable to climate change due to their limited capabilities in climate science and technology and insufficient funding for adaptation and mitigation. The relative costs of transitioning to a greener path are higher for them than for the advanced economies; undertaking the transition can even push them several places down the development ladder. From the developing world, India has emerged as a leading voice on global climate action that is mindful of climate equity and justice considerations.

India has co-founded the International Solar Alliance (ISA) with France in 2016 and announced a National Hydrogen Mission to increase the dependency on green energy. The Mission LiFE, i.e., Lifestyle for the Environment, launched in 2022, is now a global movement to connect the powers of the people for the protection of the earth.

Dr. Patra ended his speech by invoking Victor Huge’s words- ““Nothing else in the world…not all the armies…is so powerful as an idea whose time has come.” He, like millions of us, too believes that India’s time has come and we must seize it. There are formidable trials and challenges ahead, but they can be overcome if we exploit the comparative advantages.