Trump's 25% tariff on India is a negative-sum game. There is no easy way out

Indian Express

5 days ago

Written by Arya Roy Bardhan
Donald Trump has slapped a 25 per cent tariff on Indian imports into the United States. He posted on social media that the US has never been able to do much business with India, given the latter's high tariff structure and other non-monetary trade barriers. Moreover, India's military and energy purchases from Russia have led the US administration to impose additional penalties (to be decided later). While the Indian government studies the implications of this move, not much analysis is needed to understand that this is a negative-sum game.
Are tariffs harmful?
Tariffs are not just a tax on imports – they are effectively a consumption tax. Just as it narrows the profit margins for Indian exporters, it also drives up the prices of Indian imports in the US. In 2024, the US imported goods worth $87.4 billion from India, resulting in a trade deficit of $45.7 billion, accounting for nearly 2 per cent of its entire deficit. While the US imports a little over 3 per cent of all its goods and services from India, nearly a fifth of Indian exports are shipped to the US market. Although both nations will suffer from the fallout, India finds itself in a far more precarious situation given the trade structure.
Before the tariff wars, India's effective tariff rate on US imports was around 12 per cent, while India faced 2.2 per cent tariffs. The over ten-fold jump in tariffs will not only hurt Indian exporters but also risk trade diversion. The US might simply import more from other countries: American importers of textiles or seafood can turn to suppliers in Vietnam, Indonesia, Ecuador or others that face less harsh tariffs, crowding out Indian exporters.
The shocks are not limited to trade: Currency markets have already reacted to the tariff announcement. The Rupee has weakened as a response to Trump's announcement. While a depreciated rupee will make Indian goods slightly cheaper globally, the exchange rate adjustment cannot compensate for a 25 per cent price hike in the US. On the flipside, a weaker rupee will raise India's import costs, pushing up domestic inflation.
Is 25 per cent a lot?
The 25 per cent tariff can wipe out India's comparative advantage in labour-intensive goods overnight. If exports to the US remain at similar levels as last year, Indian importers will be looking at an indirect $22 billion tariff bill – over 0.5 per cent of India's GDP. Whether it be textiles, pharmaceuticals or gems and jewellery, the tariff is high enough to eat away the entire margin of producers. These sectors can be severely hit, leading to output and employment losses. The shocks will not be limited to the exporting sectors but will be transmitted to the entire economy through value chain linkages. Recently, India became the largest exporter of smartphones to the US, overtaking China. This was driven primarily by Apple's efforts to gear up smartphone production in India during the US-China rift.
Smartphone production and exports have become large in India, with its share in total electronics rising from 9.9 per cent to 44.4 per cent over the last decade. The Performance Linked Incentive (PLI) scheme attracted foreign firms, which led to greater production, exports and employment. In a way, the PLI subsidised Apple's production in India, with the intention of buttressing an infant industry to a globally competitive stage. Now, Apple is being threatened to cut back production in India and come back to the US, which could potentially negate all benefits and leave India's state expenditure worthless. However, it might be difficult for the US to turn away from Indian assembly plants due to its market share and the similar tariff rates faced by competitors. It would also shoot up American iPhone costs, which can turn into a serious political misstep.
Not just smartphones but all the leading export sectors can lose the edge they gained via the PLI – the tariff bill is equivalent to the Rs 1.97 lakh crore PLI budget. As a result of the tariff and penalty package, if half of US orders disappear, Indian goods exports will fall by $ 40 billion, shaving 1 per cent off India's GDP in 2025-26. To minimise the damage, India must respond with measured negotiation, market diversification, enhanced competitiveness, and safeguarding of affected sectors. If the tariffs linger, the shocks could accelerate reforms and a pivot to new markets, ultimately making India more self-reliant and broad-based. However, the damage during the transition is too large to be left to the markets.
No easy way out
India can soften the blow of Trump's 25 per cent tariff by acting on two fronts at once. First, it can offer quick, temporary tax refunds or cheaper loans to the exporters that sell most to America, while using its 'Make in India' plans to push those same industries into higher-value goods and advanced technology. Second, it should quickly seal new trade pacts with the EU, Gulf and other markets so that exporters are not tied to a single buyer.
Legal recourse should be considered by filing a case at the WTO. For its part, the US could gain by striking a fair trade deal, much like the UK-India agreement, that lowers duties, protects jobs, and keeps supply chains steady on both sides. Only an appropriate agreement can turn this into a positive-sum game.
Bardhan is a Junior Fellow at the Observer Research Foundation