Good and bad of tariff cuts on US imports

Prime Minister Narendra Modi’s meeting with United States President Donald Trump earlier this month marks a crucial moment in India-US relations. 

Building on the discussions from Trump’s first term, this time, the leaders focused on key trade dynamics, including reciprocal tariffs, expanding oil and gas imports, and increasing India’s procurement of US military products in the coming years.

India faces growing macro-economic challenges amid international trade tensions. These include the threat of tariff escalations from the US, the ongoing rupee depreciation, inflationary pressures, and uncertainties around foreign investment.

Recent tariff adjustments, particularly those in response to immediate pressures from the US, signal India’s willingness to engage in further trade negotiations. 

The question is whether these short-term diplomatic efforts to address immediate US trade demands and prevent potential disputes are affecting its broader strategy for long-term economic growth and global trade integration. 

Impact of tariff cuts

Traditional trade theory and policy literature suggest that the gains of a North-South Free Trade Agreement (FTA) are lower for countries of the Global South due to limited trade creation or diversion effects. 

The recent Modi-Trump meeting signals a similar outcome — the threat of reciprocal tariffs remains, even as India is being pushed to lower tariffs for US goods to mitigate any trade disputes. Reciprocal tariffs imply that the US will impose tariffs on every country that taxes US imports.

For India, this protectionist stance prompted by the Make America Great Again (MAGA) agenda presents several challenges and opportunities.

The US focus on reducing trade deficits could lead to increased tariffs on Indian exports, affecting sectors such as IT, pharmaceuticals, and textiles. This could slow India’s economic growth and challenge its ambitions of self-reliance. 

Under mounting pressure from Washington, India is also being urged to ramp up its oil and gas imports, a shift that risks fostering trade diversion rather than trade creation. 

This strategic recalibration could compel India to scale back its energy purchases from Russia, potentially straining long-standing economic ties with Moscow, while reshaping the country’s energy import landscape.

One potential area to make up for the losses could be capitalising on the US push to reduce dependence on Chinese manufacturing and technology. This could open the doors for India to position itself as an alternative production hub. 

Discussions on concessions to the US, such as reduced tariffs on American exports like liquefied natural gas and military equipment, indicate an effort to strengthen bilateral ties.

In a strategic move ahead of Modi’s visit to the US, New Delhi unveiled a series of tariff reductions to strengthen trade ties. 

These include duty cuts on high-profile US exports including bourbon whiskey, motorcycles, ICT products, and metals.

Slashing tariffs on bourbon whiskey from a steep 150% to 100% marked a significant concession to US trade interests. 

Other imported liquor products, though, continue to face 150% tax, maintaining a protective shield over India’s domestic spirits industry.

Shift towards greater trade liberalisation

Traditionally, India has maintained high tariff barriers to protect key domestic industries such as agriculture, pharmaceuticals, and automobiles. 

However, this approach has often led to trade disputes with the US, with the Americans consistently advocating for greater market access. 

The Trump administration has labelled India as the tariff king and pushed for tariff reductions that would favour American exports. 

This position was reiterated by Trump at the recent meeting; Modi responded by committing to double bilateral trade to $500 billion by 2030. The two leaders also agreed to seal a trade deal by fall of 2025.

The move to phase out tariffs and restructure them to push for more liberalisation, however, began even earlier. In its Budget of 2023-2024, the Indian government announced the removal of seven tariff lines. This year, the trend has continued with the removal of seven additional customs tariffs for industrial goods, aiming to create a more streamlined tariff system and enhance the ease of doing business.

Stabilising domestic economy

Despite these cuts, the threat of a looming tariff dispute remains.

It can escalate India’s existing macro-economic challenges by putting additional pressure on the rupee, inflation, interest rates, and foreign direct investment. 

A weakening rupee, for instance, can drive up import costs, further fuelling inflation. 

Earlier this month, amid escalating pressure on the rupee and fading investor confidence, the Reserve Bank of India (RBI) took a bold corrective action, injecting a hefty $11 billion into the foreign exchange market to arrest volatility and restore stability. The intervention proved effective — it propelled the rupee to 86.47 per US dollar (as of February 12), a swift recovery from its record low of 87.95.

To further ensure economic stability, the government could lower tariffs on essential and intermediate goods. This will ease inflation by cutting production costs. 

In turn, this would relieve pressure on the RBI to raise interest rates, providing greater flexibility in monetary policy. This balance is crucial, as high-interest rates can stifle investment and consumer spending. India’s tariff reforms also align with its ambition to become a global manufacturing hub. 

Lower trade barriers make India a more attractive investment destination, aligning with its Atmanirbhar Bharat (self-reliant India) initiative.

However, for these measures to be effective, they should also include broader regulatory and policy improvements to enhance global competitiveness.

Permanent shift versus temporary fix

India’s trade policy adjustments suggest a strategic alignment towards greater integration into global value chains. 

Policies such as Production-inked Initiatives (PLI) schemes aim to enhance competitiveness and attract investment. 

This scheme provides 4-6 per cent financial incentives to eligible companies based on their incremental sales of products manufactured within India. The incentives have increased production worth $131.6 billion, and created nearly one million jobs in the last four years, the government has claimed.

Real integration into the global value chain requires more than tariff cuts, though. It demands supply chain efficiency, regulatory transparency and comprehensive trade agreements.

While these reforms do indicate a shift towards further trade liberalisation, the timing of the tariff restructuring suggests only a tactical element aimed at pre-empting US trade actions.

The Modi government’s diplomatic strategy is a tightrope walk — balancing trade liberalisation while protecting domestic interests.  

Such tariff reforms can then be seen as both an economic necessity and a political manoeuvre.

Whether these reforms mark a permanent policy shift or serve as temporary adjustments remains to be seen. 

(Anusree Paul is Associate Professor, School of Management, BML Munjal University, Haryana.)

This article was first published under Creative Commons by 360info.

Disclaimer: The views expressed above are the author's own. They do not necessarily reflect the views of DH.