Do it yourself: Tariffs

Showing posts with label Tariffs. Show all posts

Tuesday, October 28, 2025

USD, Gold, Crypto and a mountain of 38trn debt

I returned to my desk after a 10-day Diwali break. As I opened my overflowing mailbox, I realized a lot might have changed in the meantime. Nifty50 is flirting with its all-time level. INR has regained some of its lost ground. Precious metal prices have cooled after a sharp upmove. There is a conspicuous thaw in the Indo-US and Sino-US relations. Prime Minister Modi, who hardly missed an opportunity to represent India at various global forums, has missed the ASEAN summit after missing the UNGA annual session, arguably to avoid a one-on-one meeting with President Trump.

However, what caught my attention was a large number of notes, reports, messages alluding to the unsustainable $38trn US government debt, and how the US government and the US Federal Reserve are conspiring to dissipate this mountain of debt by manipulating the prices of gold and cryptocurrencies (especially Bitcoins). Most messages are arguing that 2026 could be a 1933 and/or 1971 redux, when USD was devalued 69% (1933) and Richard Nixon abruptly ended Bretton Wood and turned USD into a fiat currency to sidestep a debt crisis (1971).

Several analysts(?) suspect that the US strategy is to—

(i) Create an environment of extreme uncertainty through trade war and geopolitical volatility and coax the eastern economies to accumulate gold at an elevated price.

(ii) Keep the USD weaker, rebuild the US manufacturing base, incentivize exports, discourage imports to minimize trade deficit and strengthen the core of the US economy.

(iii) Gain control over blockchain economics - suppress the value of cryptocurrencies and accumulate large reserves. Today the crypto market cap is appx US$4 trn. “Experts” are estimating it to cross US$100 trn in the next 10-12 years.

(iv) Make UST yields unattractive and gradually substitute stablecoins to devalue public debt. Manipulate the crypto prices higher and offer accumulated crypto-coins to settle the mammoth debt.

(v) Engineer a crash in prices of precious metals, inflicting severe pain on the eastern economies, which will be facing pressure anyways due to the US export competitiveness, and thus extend the USD supremacy for many more decades.

In my view, this analysis suffers from various shortcomings. It selectively chooses historical context 1933 and 1971 while ignoring demise of Roman, Mughal, British, Mauryan empires etc. Analysts seem to have assumed central banking and electoral democracy as sicut datum est or a fait accompli, in their analysis, whereas there is evidence that the autonomy of the central banks is being politically undermined; and the present form of electoral democracy is facing challenges in several countries.

The analysis also conveniently ignores that The US (and European & Japanese) debt problem is not new, but decades old. The US has been running unsustainable debt ever since the dotcom burst. It is only after the Lehman Bros. collapse that the debt has shifted from banks and household balance sheets to the government's balance sheet. Post Covid, the inflation moved from assets to grocery. It is now coming back to assets.

I would rather file these analyses into the “conspiracy theories” folder, than take it seriously and make it a basis for any change in my investment strategy.

In my view, notwithstanding how much people may dislike grocery inflation, they love asset inflation more than anything. Most of them would vote for a rise in the nominal value of their home, jewellery, and stocks, but only a few would vote for a slower pace of rise in the grocery prices. If you take asset inflation away, the political system might collapse.

In my view, under the present circumstances, the world should be worrying about the potential collapse of the post WW2 world order, while the new order still remains a work in progress. The chaotic transition might hurt the investors much more than what they would expect to gain from a 10-20% rise or fall in gold prices, a couple of percentage points change in US treasury yields, or Dollar (DXY) Index.

I found the views of Mr. Lawrence Wong, Prime Minister of Singapore, as expressed in his recent interview with the Financial Times, most pertinent in this context. (see here)

Wednesday, September 3, 2025

US Tariffs - Imagining the worst case

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.

Tuesday, August 19, 2025

It’s sunny outside, but better to carry umbrella

In his Independence Day speech, the prime minister announced that his government has proposed comprehensive reforms to the extant Goods and Services Tax (GST) structure. The proposals have been reportedly sent to the Group of Ministers (GoM). Two Groups of Ministers (comprising representatives of the State governments) — one on rate rationalization and another on compensation cess — will have to approve the proposals before they go to the GST Council for approval. The central government is quite confident that the GST Council members shall approve the proposals promptly, and it could be implemented before the forthcoming festival season. The stated objectives of the proposed GST reforms, focus on simplifying the tax system, reducing the tax burden, and promoting economic growth.

Based on the publicly available information, the key highlights of the proposed GST reforms are as follows:

Structural Reforms

Correct inverted duty structures to align input and output tax rates, reduce input tax credit accumulation and support domestic value addition.

Resolve classification disputes by streamlining rate structures to minimize disputes, simplify compliance, and ensure equity and consistency across sectors.

Provide long-term clarity on rates and policy direction to enhance industry confidence and support better business planning.

Rate Rationalization

Simplify the GST structure by reducing the current four slabs (5%, 12%, 18%, 28%) to a two-slab system (5% and 18%), with a special 40% rate for luxury and sin goods like tobacco and online gaming.

Lower taxes on essential and aspirational goods (e.g., refrigerators, air conditioners, packaged food, medical items) to enhance affordability, boost consumption, and make these goods more accessible, particularly for the common man, middle class, women, students, and farmers.

Maintain current tax incidence on sin goods (e.g., tobacco at 88%) by subsuming compensation cess into a uniform 40% rate after its expiration.

Ease of Living

Simplify compliance processes, particularly for small businesses and startups, through seamless, technology-driven, and time-bound registration.

Introduce pre-filled returns to reduce manual intervention and mismatches.

Ensure faster, automated refund processes for exporters and those affected by inverted duty structures to cut delays and build trust in the system.

Markets welcome the proposals

The Indian equity markets reacted to the proposal with enthusiasm. Despite lingering uncertainties over implementation of penal tariffs from 27^th August 2025, benchmark indices gained ~1.5%. The sectors expected to be directly benefiting from the lower incidence of GST, e.g., automobile, white goods, FMCG, insurance, cement, retail trade etc. witnessed strong buying. After almost seven weeks of sideways to weak market movement, it was a pleasant scene to witness.

In my view, the proposed GST reforms, in conjunction with the lower incidence of income-tax, expected pay commission benefits from the current fiscal year, good monsoon leading to improved rural income, stable prices, lower rates and adequate liquidity in the system shall support the Indian equity markets, especially the consumption (also see here), a sector which has been struggling for some time. Nonetheless, it would be in order to exercise some caution and not get overexcited by the GST proposals.

In particular, the traders might want to suitably factor in the following considerations in their expectations:

· GST restructuring may be overall revenue neutral, implying that net impact of the GST rate rationalization may not be significant. For example, some 5% items can go to a higher slab of18% and some 28% items may go to 40%. Besides, the compensation cess that was to end by March 2026, may get subsumed in the 40% rate for many items and become permanent.

· In the past few years passenger vehicles with higher engine capacity (SUVs and large cars) have witnessed the highest growth rate. The effective GST rates on these vehicles may not come down (or even go higher).

· The prime minister has repeatedly mentioned the urgency to control obesity. Several consumption items (e.g., aerated beverages, confectionary, fried snacks, sweets etc.) are popularly believed to be contributing to the rise of obesity amongst common people, especially youth. These goods could potentially get classified as “sin" items and qualify for the highest tax rate.

· To neutralize the fiscal impact of lower GST collection, the government may choose to cut subsidies on food and EV/solar. The pay commission award might also be rationalized to factor in the benefits of lower income tax, GST and inflation; resulting in lower rise in income than presently estimated.

· Some of the lower GST benefits may be used to set-off losses on account of higher US tariff (for businesses which are not 100% export oriented) and not passed on to the consumers.

· A major destocking exercise could happen before new GST rates come into effect. Buyers of discretionary items like cars and white goods may postpone buying till lower GST rates come into effect. 2QFY26 results may be impacted by lower sales and destocking. Though, Nov Dec may see accelerated demand and overall FY26 impact may be positive.

· Petroleum products and alcohol continue to stay out of the GST ambit.

· Not likely (but also not improbable), but the GST Council may not immediately approve the proposed changes in the GST rate structure, delaying the implementation. It will disappoint the traders and cause heightened volatility in the markets.

Thursday, August 14, 2025

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).

Wednesday, August 13, 2025

Strategy review in light of the US tariffs - 2

…continuing from yesterday.

To assess the impact of the latest changes in tariffs on the Indian exports to the US, on investment strategy and make suitable changes to minimize the adverse impact on investment portfolios, it is important to understand the dimensions of the Indo-US trade, its elasticity to tariffs, and sustainability of tariffs on various merchandise. Given the southward sloping trajectory of the Indo-US strategic relations since 2018, it may also be relevant to speculate a worst-case scenario; and find ways to assimilate that into investment strategy.

Dimensions of Indo-US trade

(Important note: The figures given in the following discussions have been taken from various sources, including the WTO, US trade department and India’s department of commerce. At various places these are reported either for calendar year or financial year. In some cases, these are provisional numbers. There could be some mismatch in terms of CIF and FoB reporting. Besides, I have rounded off numbers for convenience at many places. So please consider these data and pointers just for assessing a broader trend and not for doing any precise analysis. I would also not completely rule out any error in the figures. Readers may want to cross check where numbers appear incongruent.)

The US accounts for one fourth of India’s total exports

The US has been a key trading partner of India in the past three decades. Exports to the US account for more than one fourth of the India’s total

· In 2024, India exported goods worth US$87.3bn to the US; and it imported goods worth US$41.5bn from the US.

· India exported services worth US$41.6bn to the US, and imported services worth US$41.8bn from the US.

· India had an annual trade surplus with the US of appx US$45bn.

· Overall, in FY25, India exported goods and services worth US$821bn, and exported goods and services worth US$915.2bn. In this merchandise export were US$437.4bn, and merchandise imports were US$720.2bn

· The exports to the US constituted ~26% of India’s total exports. However, merchandise exports were slightly less at 20% of the total merchandise exports.

Pharma a key export for India, not so for the US

· Pharmaceuticals are a major part (US$11bn or ~12% of the total merchandise export to the US in FY24) of the Indian exports to the US.

· The US accounts for almost one third of India’s total pharmaceutical exports (FY24-US$31bn). Overall, the US imports pharmaceutical products worth US$180bn annually. Imports from India are thus ~6% of the total pharmaceutical imports. Ireland (28%) and Germany (21%) are major sources of pharmaceutical imports into the US.

· Pharmaceutical products are presently not subject to the reciprocal and penal tariffs announced by the US administration, effective from 07^th August and 27^th August 2025 respectively.

Precious metals, Engineering goods and Petroleum products are top exports

· In 2024, India exported US$9.2bn worth of precious stones & metals (~10% of total goods exported to the US), US$12.3bn worth of electrical machinery & equipment (~14%), US$11bn worth of petroleum products (~13%) and US$6.7bn worth of nuclear reactors, boiler, and machinery (~7.5%; exempt from the latest tariffs presently).

· Export of Textile, Apparels, etc. was appx US$5.2bn (6%).

· Telecom instruments/electrical parts worth US$2.2bn (2.5%) were exported.

Important to note that a lot of export from India to the US is done using imported raw material. A significant part of gems, precious metal, petroleum products, telecom equipment etc. is re-export of imported inputs after some value addition. Total value addition in these goods is much less as compared to textiles, carpets, pharmaceuticals etc. So, the net economic effect of slowdown in low value addition exports (almost 30% of the total exports to the US) may be much less.

The following is a summary of assessment study on India’s key exports.

High risk of loss in competitive edge

Electrical machinery & equipment — Highly price-sensitive, intense competition from China, Vietnam, Mexico; Indian exporters would lose market share quickly.

Apparel & textiles — Margins are thin, heavy competition from Bangladesh, Vietnam; high tariff would wipe out price competitiveness.

Articles of iron or steel — US can source from South Korea, Mexico, Turkey; India would see sharp volume declines.

Organic chemicals — Competitive global supply from China & Germany; would lose share unless specialized grades.

Medium risk — partial substitution possible

Machinery & mechanical appliances — Some niche segments less replaceable, but mainstream machinery will shift to other suppliers.

Optical/medical instruments — US has domestic production and EU/Japan suppliers; tariffs would hurt Indian share.

Low risk — possible tariff pass-through

Pharmaceuticals — US dependent on India for generics & APIs; short-term volumes unlikely to fall sharply, though margins may compress.

Precious stones/metals — Price elasticity lower; India could pass part of tariffs to US buyers due to skill-based competitive edge.

Mineral fuels — Mostly re-exports/refining trade; US can diversify but switching costs high for certain grades.

Items where US is significantly dependent on India

(High potential to pass on tariffs without major volume loss)

Generic pharmaceuticals & bulk drugs — India supplies 30–40% of US generic prescriptions.

Cut & polished diamonds — India processes ~90% of the world’s diamonds by volume.

Certain specialty chemicals & dyes — Limited alternative suppliers at scale.

Scenario analysis

For many Indian MSMEs — particularly in textiles, leather goods, handicrafts, small engineering components, jewelry, and carpets — the US is not just a large market; it’s often the largest, sometimes contributing 30–70% of annual revenues.

Until now, Indian exporters benefited from relatively low MFN tariffs, often 2–6% lower than competitors. The new tariff wipes out this edge, pushing landed prices above those from Vietnam, Bangladesh, or Mexico — in some cases by 10–15%.

For price-sensitive segments, that is an existential threat.

…to continue tomorrow

Tuesday, August 12, 2025

Strategy review in light of the US tariffs

The US administration has announced imposition of 50% additional tariffs (25% reciprocal and 25% penal), over and above the regular/MFN tariffs that were already in place, on merchandise imports from India. Certain items, like pharmaceuticals, that are part of separate trade negotiations, and services are presently not part of the new tariff rates and continue to be charged at the extant rates.

This level of tariff is indubitably concerning, as it makes numerous Indian MSME businesses, especially those exporting textile, leather goods, small components, jewelry, carpets etc., incompetitive; and in many cases poses an existential threat to the exporting entities. For several MSME the US market contributes a substantial part of their revenue; and these entities were enjoying some advantage over competitors due to lower MFN tariffs. They not only lose this advantage, but become materially incompetitive due to these tariffs.

These reciprocal and penal tariffs, in my view, tantamount to covert economic sanctions on India by the US. The reason cited for the penal tariffs is continued import of crude oil by Indian oil companies from Russia. The Indian government has clearly communicated to the US administration that this reason is not valid, as several other countries, including the EU, which also import crude from Russia are not subject to penal tariffs.

The situation is still evolving as the trade negotiations with the US are still under way, and these high tariffs are not permanent as of now. Nonetheless, the probability of these tariffs staying for a longer term is not zero. It is therefore important for everyone, including businesses, policymakers, and investors, to script a worse-case scenario for themselves and test their preparedness for such a scenario.

Notably, the present tariff action of the US administration is neither a surprise nor an isolated act of aggression against India. In the past 7-8 years there has been a pattern in the evolution of Indo-US relationships. Particularly since 2018, the US administration has been actively looking to base the mutual relationship on equality. President Trump seeking to rebase the relationship seeking full reciprocity from India on key economic, trade and technology issues is just a continuation of the evolving pattern. (Read more on this New chapter in Indo-US relations).

It is also pertinent to note that since 2018, the US has withdrawn the benefits under Generalized System of Preferences (GSP); materially tightened scrutiny on Indian IT and pharma compliance; persistently stalled progress on a bilateral trade deal; virtually downgraded the diplomatic status through exceptional delay in appointing an Ambassador to India (Indian mission of the US headed by an interim Chargé d'affaires during January 2021-March 2023 and January 2025 till present day; see details) and causing inordinate delays in grant of VISA appointments to Indians; disgracefully deported illegal Indian immigrants. These are some of the pointers towards the evolving pattern of Indo-US relations since 2018. The tariff spike is simply an extension of this pattern.

Some entrepreneurs, politicians, investors and thought leaders have called for a 1991 (balance of payment crisis) and 1998 like (economic sanctions post nuclear test) response to the situation. They have suggested that the government should use this opportunity to initiate some major reforms, like 1991 and 1998, to further strengthen the resilience of the Indian economy. Many of them see the current situation equivalent to economic sanction (through trade route) and suggest an appropriate response accordingly.

In my view, the Indian economy urgently needs several major reforms, regardless of the outcome of the present trade conflict with the US. The current situation does provide a catalyst and a valid excuse to implement these reforms that may cause some short-term pain to various stakeholders.

In the next few posts, I shall discuss my thoughts on the areas that need urgent reforms and changes, if any, required in the investment strategy in light of the latest US tariffs. Before that it is important to take note of the 1998 crisis, and how the situation in 2025 may be different.

Operation Shakti triggered global sanctions on India

India had maintained a policy of nuclear ambiguity since its first nuclear test in 1974 (Smiling Buddha). Over the years, global non-proliferation efforts intensified, particularly after the Cold War. On May 11 and 13, 1998, India conducted five underground nuclear tests in Pokhran, Rajasthan, codenamed Operation Shakti.

Operation Shakti, triggered a wave of economic sanctions from the US, Japan, Canada, the EU, and international financial institutions like World Bank, IMF and ADB. Notably, Russia, France, and Israel did not participate in sanctions. China issued strong condemnation but refrained from economic penalties.

Under the sanction, most of the non-humanitarian financial aid was suspended. Export of military and dual use technology to India was banned. All defense cooperation and technology transfer treaties were suspended. A freeze was put on loan guarantees and financial assistance. Lending to India by the World Bank, IMF, and ADB temporarily halted/slowed.

The extant government decided to take the global pressure head-on. It steadfastly refused to sign the Comprehensive Test Ban Treaty (CTBT) under pressure. The government also launched an aggressive diplomatic campaign to explain its position, emphasizing strategic necessity and national security concerns. Most importantly, the government unleashed several structural reforms to strengthen the domestic economy. Notably, the government divested its monopoly over core sectors like coal, power, telecom, oil & gas, civil aviation, etc. An ambitious national highway development plan (NHDP) was launched. Several fiscal incentives were provided to promote exports. A special economic zone (SEZ) policy was implemented. Several tax and other concessions were offered to the ITeS sector.

Consequently, the impact of the sanction remained contained. Reforms attracted material private capital flows from global investors. Turbulence in the market was short lived, and within a year the market scaled new highs. Sensex rose from ~3,300 in Jan 1999 to ~5,100 by March 2000, a jump of 50% in 15months.

Overall, the impact of sanctions was marginal.

The sanctions were lifted within two years as India materially helped the world in managing the Y2K crisis; unilaterally announced a “no first use” nuclear doctrine.

Situation in 2025 is different from 1998

The present situation is however materially different from the 1998 situation. First, the present trade action is limited to the US, unlike 1998 when a number of trade partners had imposed restrictions. Second, the Indian economy is now much stronger and materially more integrated into the global economy as compared to 1998. The impact of trade restrictions on the local economy, therefore, could be materially higher. Third, the political situation in India is much more stable now as compared to 1998, when the coalition was more fragile. Fourth, India has strengthened its global strategic position significantly in the past 27years. With several multilateral alliances (G-20, BRICS, QUAD etc.) and bilateral treaties, India has much stronger support from its global partners as compared to 1998.

Thursday, August 7, 2025

MPC saves one for the external shock

The Monetary Policy Committee (MPC) of the Reserve Bank of India concluded its three-day meeting on Wednesday. The committee voted unanimously to keep the policy repo rate unchanged at 5.50 per cent. The MPC also decided to continue with the neutral monetary policy stance.

The MPC noted the favorable domestic conditions like (i) inflation lower than estimates and closer to the lower bound of the policy tolerance limits; (ii) Robust growth, though below aspiration; (iii) transmission of the 100bps policy rate cuts continuing and its impact on the economy unfolding.

Urban consumer demand tepid, investment demand remains supported by govt capex

The MPC also noted that on the demand side: “Rural consumption remains resilient, while urban consumption revival, especially discretionary spending, is tepid.” However, “Fixed investment supported by buoyant government capex continues to support economic activity”.

Farm sector buoyant, services steady, industrial growth subdued

On the supply side, steady southwest monsoon is supporting kharif sowing, replenishing reservoir levels and boosting agriculture activity. Services activity also remains steady, though some high-frequency indicators recorded a modest expansion. Services PMI increased to an 11-month high of 60.5 in July 2025. Construction activity continues to exhibit resilience. However, growth in the industrial sector remained subdued and uneven across segments, pulled down by electricity and mining. While the manufacturing Purchasing Managers’ Index (PMI) remained elevated in Q1, the Index of Industrial Production (IIP) showed moderation.

Growth outlook strong, external challenges need to be watched closely

The MPC is of the view that the above normal southwest monsoon, lower inflation, rising capacity utilisation, and congenial financial conditions continue to support domestic economic activity.

The supportive monetary, regulatory and fiscal policies including robust government capital expenditure, should also boost demand. With sustained growth in construction and trade segments, the services sector is expected to remain buoyant in the coming months.

Prospects of external demand, however, remain uncertain amidst ongoing tariff announcements and trade negotiations. The headwinds emanating from prolonged geopolitical tensions, persisting global uncertainties, and volatility in global financial markets pose risks to the growth outlook.

The MPC maintained FY26 real GDP growth forecast at 6.5%.

Inflation to remain benign in FY26, to pick up in 1QFY27 on low base

The MPC that the inflation outlook for FY26 has become even more benign. Large favorable base effects combined with steady progress of the southwest monsoon, healthy kharif sowing, adequate reservoir levels and comfortable buffer stocks of foodgrains have contributed to this moderation.

CPI inflation, however, is likely to edge up above 4 per cent in Q4:2025-26 and beyond, as unfavorable base effects, and demand side factors from policy actions come into play. Barring any major negative shock to input prices, core inflation is likely to remain moderately above 4 per cent during the year. Weather-related shocks pose risks to inflation outlook. Considering all these factors, CPI inflation for FY26 is now projected at 3.1 per cent. CPI inflation for Q1FY27 is projected at 4.9 per cent with evenly balanced risks.

External sector resilient

India’s current account deficit (CAD) moderated to 0.6 per cent of GDP in FY25 from 0.7 per cent of GDP in FY24 due to robust services exports and strong remittances receipts despite higher merchandise trade deficit. Merchandise trade deficit further widened in Q1FY26. Robust services exports coupled with strong remittance receipts are expected to keep CAD within the sustainable level during the current financial year.

On the external financing side, gross foreign direct investment (FDI) to India remained strong during April-May 2025. However, net FDI moderated during this period due to higher outward FDI.

Foreign portfolio investment (FPI) inflows to EMEs have remained strong in May and June 2025. However, net FPI to India recorded outflows of US$ 0.8 billion in April-July 2025 due to outflows in the debt segment.

External commercial borrowings, on the other hand, witnessed higher net inflows compared to last year. Inflows under non-resident deposits too remained positive, albeit witnessing some moderation.

As on August 1, 2025, India’s foreign exchange reserves stood at US$ 688.9 billion, sufficient to cover more than 11 months of merchandise imports.

Overall, India’s external sector remains resilient.25 We remain confident of meeting our external financing requirements comfortably.

Liquidity remains comfortable, monetary transmission underway

System liquidity, as measured by the net position under the Liquidity Adjustment Facility (LAF), has been in surplus, on an average of ₹3.0 lakh crore per day since the last MPC, as compared to an average daily surplus of ₹1.6 lakh crore during the previous two months.

Going ahead, as the CRR cut announced in the last policy comes into effect in a staggered manner beginning September, it would further support liquidity conditions.

The comfortable liquidity in the banking system has reinforced transmission of the policy repo rate cuts to the money, bond and credit markets during the current easing cycle. In the credit market, the weighted average lending rate (WALR) of scheduled commercial banks declined by 71 basis points for fresh rupee loans (of which 55 bps is due to interest rate reduction) and 39 basis points for outstanding rupee loans from February 2025 to June 2025. On the deposit side, the weighted average domestic term deposit rate (WADTDR) on fresh deposits moderated by 87 bps during the same period. Moreover, the transmission to lending rates has been broad based across sectors.

Conclusion

In my view, the MPC sounded quite confident about the economic and monetary conditions. However, it repeatedly cited external geopolitical and trade related threat posing strong headwinds. I therefore read the latest pause on policy rates as a measure to preserve arsenal for a final push if the external environment worsens materially.

On Wednesday, the US president announced 25% extra (penal) tariffs on the imports from India, making the total tariffs to 50%, materially higher than the competitors. If a resolution to the latest implied sanctions on India, purportedly for importing crude oil from Russia, is not found, there could be significant pain in the economy in the near-term, till the policy, businesses and markets adjust to the new tariff regime.

Wednesday, July 16, 2025

In search of new leadership

The benchmark indices in India have been directionless for almost two months now. In fact, Nifty50 has yielded a return of less than 2% in the past one year. Broader market indices have also not done any better. However, there has been a significant divergence in the sectoral performances. Some sectors like financials (+13%) and pharma (+8%) have outperformed the benchmark indices in the past one year, sectors like Media (-17%), Energy (-16%), Realty (-13%), FMCG (-7.5%), and Auto (-7.5%) have materially underperformed.

In my view, this market performance implies—

· Fatigue has set in the leaders of the bull market since 2021, especially PSEs, Infrastructure, commodities, and auto. These sectors look tired and unable to lead the market any further.

· In the past one year, the market has digested (consolidated) the gains of the post Covid-19 rally in the past one year very well. It has sustained heightened uncertainty and volatility due to geopolitical events, escalation of trade conflicts, and erratic weather, showing remarkable resilience. It would be reasonable to infer that the market is not inclined to slip into a bear phase or correct materially from the current levels.

· The current earnings expectations are low to moderate. The scope for a significant disappointment is therefore low; though, there is nothing to suggest that a major positive earnings surprise could materialize in 1HFY26, things could be better in 2HFY26 when the trade normalizes, lower rates get transmitted, lower inflation and tax supports urban household consumption; and good monsoon leaves good money in the hands of farmers.

· Presently, the market may be looking for new leader(s) to lead the next phase of its northward journey.

The challenge before investors, thus, is to hazard a guess which sector or businesses will lead the next bull charge. In my view, it is as difficult a task as it could be. Nonetheless, an opinion needs to be formed to make a strategy congruent to the opinion.

Settings for 2HFY26

Several factors indicate that the second half of FY26 could bring renewed momentum to the markets. While short-term uncertainty persists, the groundwork is being laid for a stronger second half of FY26, in my view.

Southwest Monsoon progress decent

A healthy monsoon is critical for rural demand, agricultural output, and overall economic sentiment. With rainfall patterns looking favorable so far, rural incomes could see an uptick, supporting consumption-led sectors. So far, the monsoon progress is decent. Till 14th July, yesterday, rains have been normal to excess in 64% districts, and deficient 36% of districts. Reservoir levels have been reported to be above average, with 150 major reservoirs presently above 69% of their capacity (14% higher than 10-year average).

Moderate but stable economic growth

India’s GDP growth for FY26e is projected at 6.5% YoY, similar to FY25. While not a significant acceleration, this stability reduces the risk of macroeconomic shocks and provides a steady foundation for corporate earnings.

Low earnings growth expectations – room for positive surprises

With earnings growth forecasts remaining modest, the likelihood of negative surprises is low. Any upward revisions, as lower raw material prices and rates gets reflected in numbers, could act as a catalyst for market upside.

Geopolitical stability – cooling tempers

After years of heightened geopolitical tensions (Russia-Ukraine, Israel-Hamas, US-China trade wars), there are signs of exhaustion setting in. Leaders and economies are increasingly focused on stability, which could reduce market volatility and improve investor confidence.

Global trade uncertainties may diminish

Global trade uncertainties triggered by conflict in the Middle East Asia and US tariff policies have started to ease. The conflict in the Middle East has calmed with most forces exhausting their resources. The US tariff policy is also likely to stabilize in the next couple of months after lots of trial and error, providing visibility for future terms of trade and growth prospects.

…tomorrow I shall share my thoughts on the prospective leadership.