In trade negotiations, as in chess, sometimes you need to accept a temporary disadvantage to secure a better long-term position, points out Sonal Varma, chief economist (India and Asia ex-Japan) at Nomura.
The announcement of 25 per cent tariffs by the United States on imports from India, coupled with a 25 percent penalty for Russian energy and defence purchases, marks a disappointing turn in India-US trade relations and appears particularly harsh, given that India was among the first to engage the US in negotiations.
India faces higher tariffs than Vietnam (20 per cent), Indonesia (19 per cent) and other Asian competitors, despite being at a more advanced stage of negotiations.
This disparity raises questions over both the negotiation strategy and the broader geopolitical dynamics at play.
However, viewing this setback through a broader lens, the announced tariffs may well prove temporary, serving as negotiating leverage rather than a permanent arrangement.
The scheduled visit by the US trade delegation to India at the end of August suggests dialogue channels remain open and productive, with the possibility of lowering tariffs, although US trade deals with other countries suggest the best-case outcome would still be tariffs in the 15 to 20 per cent range.
The inability to negotiate better tariff terms will lead to a short-term economic cost, but this needs to be assessed against the longer-term challenges that could have arisen by agreeing to all of US demands, such as the loss of policy flexibility, precedent-setting concessions and domestic political consequences.
While other nations secured quick, often verbal deals, India has pursued a more thorough process aimed at a comprehensive trade agreement.
The penalty for Russian energy and military purchases adds another layer of complexity, as India's strategic autonomy in energy and defence procurement has become entangled with trade negotiations.
India can reduce its reliance on Russian oil imports by sourcing more from West Asia and ramping up LNG imports, although costs could be higher.
The country needs to carefully navigate its relationship with Russia while maintaining a productive dialogue with the US and ensuring energy security.
Measuring the economic impact
The economic impact of these tariffs depends on their duration and scope. Significant uncertainty remains on this front, including on the penalty rate.
Currently, sectors under ongoing Section 232 investigations -- such as pharmaceuticals, semiconductors & electronics, among others -- are exempt from reciprocal tariffs.
This means India's effective tariff rate is lower than the announced 25 per cent rate, although still higher than our prior expectations of around 10 per cent.
If tariffs sustain at these levels through FY26, then we estimate that the immediate impact would shave 0.2 percentage points from our FY26 gross domestic product (GDP) growth forecast of 6.2 per cent.
The US is India's largest export destination, accounting for about 2.2 per cent of GDP.
For many product categories, exports to the US account for 30 to 40 per cent of India's global exports, highlighting the significance of maintaining competitive access to the US market.
Small and medium enterprises (SMEs) in the export chain are especially vulnerable. These businesses, often operating with limited working capital and razor-thin margins, may struggle to absorb the additional costs.
The ripple effects could extend to employment, particularly in sectors like textiles and gems & jewellery, where SMEs play a crucial role.
India could also lose its competitive advantage in the marine food products sector, where it has built significant market share in the US for items like shrimp and prawns.
Pharma and electronics are not subject to reciprocal tariffs, but they could face a heavier burden later, when the Section 232 sectoral tariffs are imposed.
India will also lose out on any potential trade diversion benefits in the near term.
The reciprocal tariffs matter for gaining a relative tariff arbitrage over competitor countries.
Most Association of Southeast Asian Nation (Asean) economies have negotiated a tariff rate of about 20 per cent, which means India's relative tariff advantage, even if the final rate is negotiated lower, will not be as significant as was believed earlier.
However, this should not overshadow India's longer-term attractiveness in the global supply chain.
The broader China Plus One strategy continues to favour India, driven by factors beyond tariff considerations.
Recent investments in electronics and other sectors demonstrate that companies are looking at diversification and India's structural advantages, rather than just tariff arbitrage.
The momentum in low- and mid-tech manufacturing sectors, including electronics assembly, textiles and toys suggests India's integration into global value chains is likely to continue, despite these headwinds.
India's policy strategy
India's policy response to the trade challenges needs to be multi-pronged and carefully calibrated.
On the trade front, India should maintain its strategic approach to negotiations while showing flexibility on specific issues.
While agriculture and dairy remain sensitive due to domestic political considerations, there's room for compromise in other areas, such as autos or by increasing US purchases.
The focus should be on securing a balanced deal that protects core interests while demonstrating India's commitment to trade liberalisation and addressing legitimate concerns about non-tariff barriers.
Over the medium term, export diversification becomes even more critical.
Recent free trade agreements with the United Kingdom and ongoing negotiations with the European Union, New Zealand and others are in the right direction.
These efforts need to be accelerated to reduce dependence on any single market.
This is also an opportunity to accelerate structural reforms.
In addition to fast-tracking its negotiations, the government should also consider targeted support for affected exporters, particularly SMEs, through measures like interest rate subvention and enhanced export incentives, while maintaining fiscal discipline.
The banking sector could play a role by ensuring adequate working capital support to affected sectors.
Monetary policy will also have to play a role in cushioning the impact.
Soft domestic demand and adverse trade developments suggest downside risk to growth, at a time when inflation is low.
Currency depreciation, if sustained, can add to imported inflation, but any pass-through should be limited and more than offset by other disinflationary forces.
Inflation is likely to moderate to 2.8 per cent in FY26, well below both the Reserve Bank of India's forecast of 3.7 per cent and its 4 per cent target.
This means that the RBI's rate-cutting cycle is not over, despite the change in its stance to neutral.
We see room for the terminal repo rate to settle 0.5 percentage points lower at 5 per cent by the end of this year.
In summary: Overall, US tariffs do present a near-term challenge, but India's policy response should be more strategic than tactical, based on a calibrated cost-benefit analysis.
In trade negotiations, as in chess, sometimes you need to accept a temporary disadvantage to secure a better long-term position.
Feature Presentation: Aslam Hunani/Rediff
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