As Trump tariffs loom, India shouldn’t look a gift horse in the mouth

Trump has billed April 2 as the launch of sweeping duties that are the centerpiece of his plan to rebalance global trade

Anupam Manur and Shikha Tomar

It took all of six days for US President Donald Trump to enter into a tariff-illegal immigrant deportation skirmish with Colombia, setting the tone for the Trump 2.0 era. As it is becoming evident, this era is going to be marked by turmoil and rapid changes. A part of this starts in their own backyard, where the trade officials are scrambling to devise a reciprocal like-for-like tariff plan for all the goods traded with hundreds of the United States’ trading partners, a task which is estimated to take no less than six months, but had a deadline of less a month, due tomorrow.

It is true that the US has a large trade deficit with most of its partners and that most of its partners levy a higher average tariff rate than it does. The flip side of this is that the US has the largest capital account surplus – the rest of the world is willing to lend to the US to finance its imports. Nevertheless, to judge the efficacy of the proposed solution of higher tariffs on reducing trade imbalance and protecting domestic industry, it would be instructive to look at the outcomes of the previous instance of a trade war initiated under Trump’s first presidency.

Lessons from history

Unfortunately, the trade deficit cannot be wiped away by higher tariffs, as that would require genuine increases in American productivity in manufacturing and for the industry to be competitive in the world market. Counterintuitively, higher tariffs will make American products much less competitive and can increase the trade deficit. This is what happened during Trump’s first trade war, where the combined U.S. goods and services trade deficit increased to $679 billion in 2020, compared to $481 billion in 2016, the year before Trump took office, according to Politico.

Further, despite the President’s promises, most of the burden of the tariff will be borne by the American people. Looking back at the previous instance, the average increase in prices of the targeted goods for tariffs was about 22%. In certain sectors such as automobiles, the American consumer shouldered a 100% pass through and bore the entire incidence of tax.

Even in terms of output and employment, the US lost out in the first round. The net loss to the economy was nearly $25 billion in the year after the tariffs came into effect in 2018. Finally, because of retaliatory tariffs on the US by EU and China, the Trump administration had to provide $23 billion in aid to farmers for trade-related losses. The big highlight here is that the first trade war cost the US nearly 300,000 jobs and a reduction of about 0.3% to 0.7% of its GDP. This time around as well, the chances of a US recession has suddenly shot up as a result of the ongoing trade war. Read this, this and this.

US-India trade relations

While shooting itself in the foot, these tariffs threaten to impact many other countries as well and India risks being caught in the crossfire of a global trade war. If US carries through on the tariff plan for India, India’s exports could diminish by about $2-$7 billion in the next year. It could also shave off 5-10 basis points of our GDP growth.

To be fair, Trump’s complaints against India on the disparity of tariff imposition are not without justification. In 2023, India imposed an average weighted tariff of about 11% on imports, which was 8.2 percentage points higher than what the US charged on Indian exports. In particular, American exporters do face very high tariff differentials in some key sectors like Agriculture, meat and processed food which is as high as 33%, followed by automobiles (23%), diamonds, gold and products (13%) and chemicals (9%). Some items within the agriculture sector have really high tariff differential like alcohols and wines with 122%, dairy products (38%), fish, meat and processed foods (28%).

The recent spate of auto tariffs by the US can hurt India’s growing auto parts industry, which is reasonably well integrated into the global supply chains.

India’s trade surplus with the US has increased by 65% between 2018 to 2024, making the US as India’s largest trading partner and the only country among its top 10 trading partners with which it has a trade surplus. This makes it very crucial for us to play our cards right amidst Trumps’ tariff threats.

India’s options going ahead

India has four possible responses to the April 2 ‘liberation day’ deadline: (1) retaliate with reciprocal tariffs on all key product lines (a la Canada), (2) concede to all U.S. demands and adopt a "zero for zero" strategy, (3) do nothing and prepare to absorb the impact of tariffs, or (4) appease Trump with tariff relief on certain products while working towards an FTA.

Given that the existing high tariff rates by India does more harm to the Indian economy than being beneficial, retaliation and increasing tariffs should be immediately eliminated as a strategy. Just like the external pressure by the IMF in 1991 gave an impetus for domestic liberalisation, the Trump tariffs can be used as a justification to finally liberalise trade in India. The only reason to adopt phased liberalisation (option 4) versus an immediate one (option 2) is to manage the domestic political economy and to provide time for readjustment in sensitive sectors such as agriculture. Even within such sectors, there are certain product lines where high tariffs make very little sense - alcohol and wines, some dairy products (whey, for instance), dry fruits, honey, etc.

By making concessions on products which should not have had such high tariffs in the first place, India can signal to the US that it is still a reliable trading partner and can bargain for preferential market access, especially in areas where other countries will get embroiled in a tariff battle. A stable, low-friction trading relationship with the US is still in India’s best economic interest and if we are forced to play towards it, so be it.

Shikha Tomar is a student, and Anupam Manur is a Professor, at the Takshashila Institution’s public policy programme.