Tariffs and a potential global slowdown are likely to hurt India’s economy in the short term. Our back-of-the-envelope calculations show that possible reciprocal import tariffs levied by the US could cut GDP growth by about 0.3 percentage points. The sectors where India has the highest tariff differential with the US are agriculture, autos, and pharmaceuticals. There could be an indirect impact too. Global uncertainties could weigh on foreign direct investments (FDI), including those heading to India.
But can this challenging backdrop be turned into an opportunity in the medium term? After all, in the past, India has reformed best during periods of crisis. We go back in history to see what has worked in the past, and what has not. While at it, we do a reality check by asking whether rising protectionism around the world, intense competition for FDI flows and China’s excess capacity will limit opportunities.
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We analyse India’s economy over two periods — the “high growth” decade of 2000-01 to 2009-10, when India’s growth soared, alongside its rising share of global exports and investments; and the “lower growth” decade of 2010-11 to 2019-20, when all three metrics softened. How can India escape “lower growth” and ascend to “high growth”?
One of the key differentiating factors between the two periods was import tariffs, which fell in the former but rose in the latter. In fact, India’s tariff rates are amongst the highest globally, and have been hurting exports even before the Trump administration put them centre stage. Non-tariff barriers are also rife. Quality Control Orders (QCOs), which are meant to ensure quality and safety of imports, but double up as non-tariff barriers, have been on the rise in recent years.
How have high tariffs hurt India? The economy has not fully plugged into global supply chains. One reason China became stronger in exports was because it was open to imports before it became self-sufficient. Meanwhile, protectionist tendencies in India led to a premature clamping down on imports in the “lower growth” period, hurting its export potential.
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India’s FDI story also sheds some light. After soaring in the pandemic period, FDI has fallen sharply. We break down FDI into more capital-intensive high-tech investments, and more labour intensive mid-tech investments, and find that it’s the former which rose rapidly during the pandemic, and then fell sharply too.
Our sense is that global competition for FDI in high-tech innovative sectors has been rather high, and much of the FDI went to advanced economies, in several instances where large government incentives made it attractive. In fact, a quarter of global FDI flows in 2023 went to the US alone.
While India was forging ahead with its high-tech ambitions, what it may have overlooked was mid-tech FDI in labour-intensive manufacturing sectors like food, apparel, furniture, and toys. These flows stagnated in the “lower growth” period. In fact, India did not gain much in these sectors as did the ASEAN countries, especially Vietnam, during the first Trump presidency.
But if supply chains are rejigged again during the second Trump presidency, due to higher tariffs on large exporters, and the world looks for new producers, India may get a second chance.
If the sectors where Vietnam made most progress during the first Trump administration are a reflection of where global opportunities from supply rejigging lie, we note that India is already a player. India’s exports in sectors like electronics, apparel, furniture, and footwear are 15-40 per cent of Vietnam’s exports. This shows India’s large footprint and that there’s room to grow. After all, wage competitiveness is on India’s side.
Some may worry about the challenges of growing exports at a time of excess capacity in China. Here, we find that China has overcapacity in several sectors like electronics, electrical appliances, and automobiles, but not as much in consumer-facing mid-tech sectors such as furniture and apparel.
To succeed, India needs to make changes. And there is good news here. Potential US tariffs may have become a catalyst for reforms.
One, India has begun to lower import tariffs. In the February budget, import tariffs were cut for consumer items like high-end motorcycles, as well as intermediary inputs such as smartphone components, solar cells, and chemicals. Recent reports show that more tariff cuts in sectors like automobiles, chemicals, pharmaceuticals, and medical devices are being considered.
Two, the Indian administration has spoken about the benefits of becoming more open to regional FDI. Here, mid-tech FDI would likely be a good starting point, even if the more sensitive sectors like defence are kept relatively closed.
Three, India plans to sign a bilateral trade agreement with the US by late 2025, and also fast-track a trade deal with the EU. Reports suggest that it plans to buy more energy and defence equipment from the US. In turn, India could benefit from lower tariffs on its exports to the US. Indian textile exporters, for one, have long decried the preferential access to US markets enjoyed by economies that already have FTAs.
Four, the rupee has become more flexible, which is important to keep exports competitive, and gives manufacturers the confidence to set up and export from India.
And India does not have to look too far for models to emulate. Its success in services exports demonstrates the power of moving up the value chain, from basic (for example call centre services) to high-tech (complex professional services). Perhaps a similar learning-by-doing process while moving up the value chain will help manufacturing too.
But let’s not get ahead of ourselves yet. For similar success in the exports of goods, reforms that have just begun will have to run deep.
The writer is chief India economist, HSBC
