Impact of US Tariffs and Trade Relations with India

Overview of Tariffs

The United States has announced a 25% tariff on imports from India, as well as unspecified penalties for Russian energy and defense purchases. This development presents a setback in Indo-US trade relations, with India facing higher tariffs in comparison to other Asian competitors such as Vietnam and Indonesia.

• India is subject to higher tariffs despite being engaged in advanced negotiations with the US.
• The tariffs might serve as a temporary negotiation tactic rather than a permanent measure.
• A US trade delegation is expected to visit India to discuss potential tariff reductions, aiming for a best-case scenario of 15-20% tariffs.

Negotiation Dynamics and Strategic Autonomy

India faces challenges in maintaining its strategic autonomy in energy and defense procurement, with penalties linked to purchasing Russian energy and military supplies.

• India may need to pivot towards West Asian crude and LNG imports to reduce reliance on Russian oil, with potential cost implications.
• India's strategic approach in negotiations looks to secure a comprehensive trade agreement rather than quick, verbal deals.

Economic Impact

The economic ramifications of the tariffs hinge on their duration and scope, with potential implications for India's GDP and specific sectors.

• Sectors like pharmaceuticals and electronics are currently exempt from reciprocal tariffs.
• If maintained through FY26, tariffs could reduce the GDP growth forecast by 0.2 percentage points.
• SMEs, especially in textiles, gems, and marine food products, could face significant challenges due to their dependency on US markets.

Trade Diversion and Global Supply Chain Positioning

India might miss out on trade diversion benefits in the near term due to the tariffs, but its long-term attractiveness in the global supply chain remains robust.

• The "China Plus One" strategy continues to benefit India, emphasizing diversification beyond tariff considerations.
• Investments in electronics and low to mid-tech manufacturing sectors are indicative of India's growing integration into global value chains.

Policy Recommendations

India's policy response should be multifaceted, balancing strategic negotiation with flexibility on specific issues.

• Focus on export diversification and free trade agreements with the UK, EU, and other regions to reduce market dependence.
• Consider targeted support for affected exporters and SMEs through interest rate subvention and export incentives.
• Ensure the banking sector provides adequate working capital support to affected sectors.

Monetary Policy Considerations

Monetary policy will need to cushion the impact of tariffs against a backdrop of soft domestic demand and low inflation.

• Inflation is forecasted to moderate to 2.8% in FY26, below the RBI's target.
• A potential rate cut could lower the terminal repo rate to 5% by year-end.

Conclusion

While US tariffs pose immediate challenges, India’s strategic and well-calibrated policy responses can enhance its long-term trade position.