Tariff-related turbulence lies ahead as the US upped the ante with reciprocal tariffs, with India also in view; India’s tariff rates are higher than the US and Asian peers, which makes the economy susceptible to retaliatory as well as reciprocal tariff action.
Radhika Rao
Executive Director and Senior Economist
DBS Bank
Mumbai, February 26, 2025: 4Q24 (3QFY25) real
GDP growth is expected to improve to 6.3% yoy
from 5.4% in 2QFY; latter was the slowest in seven
quarters.
A catch-up in government capex spending, passage of
idiosyncratic factors including unfavourable
weather, better kharif crop output, festive
demand, and better production numbers are
few of the factors which should lift 3QFY25
output.
This is counterweighed by an absence of pick-
up in corporate profitability and service sector
activity, signaled by slowing credit growth and
moderation in GST collections.
External trade fared well as services and
merchandise shipments improved. Notably,
monthly service exports surpassed goods
shipments in January 2025, pointing to
improved resilience in the trade account.
We are also mindful of revision to past data,
which can materially change the quarterly
growth profile, including the first half of FY25.
Bearing that uncertainty in mind, we retain our
forecast for growth to average 6.3% this year.
With downside risks to the latter and February
inflation expected to edge towards the 4%
target, the central bank is poised to stay on a
calibrated dovish path. We expect at least 50bp
more cuts in this cycle after a 25bp reduction
in February.
Liquidity measures will be equally crucial to
facilitate policy transmission. On this front, the
central bank supplemented ongoing measures
with a 3Y USDINR buy/sell swap of the largest-
ever notional amount of $10bn, due on
February 28. Expectations are that partially
hedged ECBs and fresh issuance would tap into
this auction. This follows the RBI’s earlier six-
month $5bn USDINR swap auction on January
31 (which will reverse on August 4), with market
participants pinning hope on a longer duration
swap in recent weeks to provide longer
duration relief. We also recall that the RBI
conducted two buy/ sell auctions in March-April
2019, about three weeks apart for $5bn each.
Since late 2024, the RBI has infused ~INR 3trn
worth of durable liquidity, tapping a
combination of VRR auctions, swaps, and open
market operations.
Banking system liquidity remained at a deficit of
INR 1.9trn (7D average) in late-February, even if
narrower than INR 2.5trn in end-Jan, driven by
FX intervention and frictional drivers like tax
outflows and currency in circulation flows.
Notably, the RBI’s outstanding net forward
dollar sales had jumped sharply to $67.9bn as
of December 2024, signaling measures to
stabilise the currency.
Tariff turbulence ahead
• US’ premise
News flow on potential trade and tariff action
from the US continues to trickle in. While the
jury is out on whether these will be imposed or
are negotiating tactics, there is heightened
uncertainty amongst key stakeholders. In mid-
February, the US government proposed to
impose a ‘Fair and Reciprocal Plan’, which not
only covers import tariffs but also non-trade
barriers, including value-added taxes and
exchange rates, amongst others that might put
US firms at a disadvantage. The official release
highlights the motivation for the US to correct
longstanding trade imbalances. Examples were
cited including Brazil, which has an 18% tariff on
ethanol imports from the US, whilst the US tariff
on ethanol is low at 2.5%. India also finds a
mention, with the average applied MFN tariff at
39% vs. US’ 5% highlighted as a mismatch,
besides India’s 100% tariff on US motorcycles
(vs. US’ 2.4% on Indian motorcycles).
Besides mainstream tariffs, data on non-tariff
barriers shows that US has a larger number of
commercial policy interventions (as a proxy for
non-tariff barriers) than India. VAT rates are
higher in the European countries compared to
Southeast Asia and India.
• India’s trade linkages
The US runs a trade deficit with India, with the
bilateral gap doubling between 2015 and 2024.
While India’s share in US imports stood at 2.7%
in 2024, the US is India’s largest export
destination (18% share), led by sectors like
pharma, electronics, pearls & semi-precious
stones, iron & steel, textiles, mineral fuels, etc.
The annual goods trade deficit widened considerably
in the past four years.
While the issue of tariffs and trade barriers is
high in the goods trade, North America, the US
in particular, is an important destination for
India’s service exports. Software capabilities as
well as services through GCC (Global Capability
Centres) have pushed up the trade balance in
favour of India.
Tariffs under the scanner
India’s tariff rates are higher than the US and
Asian peers, which makes the economy
susceptible to retaliatory as well as reciprocal
tariff action. The trade-weighted average tariff
rate in 2023 stood at 12% vs 2.2% in the US.
India’s rate on agricultural products was high at
65% (2022) on average, but imports under this
category amounted to 5% of total imports. The
rate on non-agricultural product lines was 9%,
amounting to the bulk of the imports – see
chart.
India imports more raw materials and
intermediate goods from the US, whilst it
exports more consumer goods. Key categories
of India’s exports to the US have changed in
recent years, with electrical machinery and
electronics rising to the top, followed by legacy
sectors like pharma, pearls, semi-precious
stones, chemicals mineral fuels etc – see table.
Mapping product categories by differing tariff
rates – those levied by India on purchases from
the US and US imposes on India (see chart),
shows that across-the-board India’s tariffs are
higher, giving merit to the debate over the need
for India to balance the trade/ tariff
arrangement. Out of the top categories,
sectors ranging from iron & steel, pharma,
electronics, chemicals and precious stones
face a tariff gap of 5% to 22% (average 9%).
Negotiations
India’s Prime Minister Narendra Modi visited
the US in mid-February to kickstart negotiations
on trade and investments. As a pre-emptive
step, India had lowered sector-specific import
tariffs in the February’s budget.
For example, basic customs duty on luxury cars,
chemicals, solar cells, and machinery was
lowered, besides a reduction in the peak import
tariff from 150% to 70% and the average tariff
rate falling to 11% from 13% earlier. Effective
duty rates, however, stay high as an Agriculture
Infra Development Cess in the range of 5% to
70% was raised on around 32 items, including
luxury cars.
Post the bilateral meeting, India assured that
various means would be explored to narrow the
trade imbalance, including increasing energy
purchases (initial target at $25bn), defence
equipment (F-35 warplanes), etc. On defence,
higher purchases will add to the existing US-
origin arsenal, including Hercules and Apache.
The launch of an Indian Ocean Strategic venture
coincides with Meta’s undersea cable project.
India is also likely to reassess laws to allow US
nuclear energy participants and cooperation in
the sector. Other sectors in focus will be AI,
chips, security, IMEC corridor (convene
partners within the next 6 months), amongst
others.
• Way forward
Higher energy imports
Under Trump 1.0, India had begun to increase
energy imports from the US to lower the trade
deficit and more is likely under the latest push.
The breakdown of key import markets for crude
purchases shows that the US is India’s 5th
largest crude oil supplier, after Russia and the
Gulf countries in the first 8MFY25.
The US will seek to increase its market share in
the Indian crude import basket, besides seeking
a larger pie of the LNG pool. The substitution
effect is unlikely to materially improve India’s
trade deficit (with a risk of deterioration at the
margin on the count of prices and currency) as
a narrower the trade deficit with the US will be
offset by a potential widening in deficits with
other trading partners.
Bilateral trade agreement
In the post-meeting statement, India and the US
agreed to negotiate the first tranche of a
mutually beneficial, multi-sector Bilateral Trade
Agreement (BTA) by fall of 2025. Both sides
have committed to designate senior representatives
to advance these negotiations
and to ensure that the trade relationship fully
reflects the aspirations of the COMPACT
(Catalyzing Opportunities for Military
Partnership, Accelerated Commerce &
Technology). The proposed BTA aims to
strengthen and deepen bilateral trade across
the goods and services sector and will work
towards increasing market access, reducing
tariff and non-tariff barriers, and deepening
supply chain integration. We note that the
proposed BTA doesn’t constitute a traditional
free trade agreement, i.e., FTA (much broader
in scope and results in overall trade
liberalisation), but rather aims to improve
terms of trade under which “Mission 500” i.e.,
aim to double bilateral trade to $500bn by 2030
will be achieved. Given difficulties in passing the
‘trade pillar’ in the existing US-led Indo-Pacific
Economic Framework for Prosperity (IPEF)
platform, for which India is a signatory,
achieving a satisfactory common ground will be
a challenge.
Sectors under watch
− Pharma: The US is the largest market for
India’s pharma shipments (dominated by
generic drugs), with the country accounting
for close to a third of the total segment’s
exports. Sectoral estimates are that India
imposes 10% tariff on imports from the US,
while the latter’s at a modest 0.2% according
to WTO data. Top Indian drugmakers are
heavily dependent on US exports, with the
latter accounting for almost half of sales for
few of the firms. While a uniform tariff
increase will retain India’s lead, reciprocal
action will raise costs for domestic firms and
narrow margins. The pharma sector was
highlighted as one of the target sectors,
besides semiconductors and automobiles,
for the US’ reciprocal action.
− Electric Vehicles: Terms of an existing policy
that promoted the manufacturing of EVs
(cars for a start) might be modified, likely
beginning with the need for the carmakers to
show a smaller turnover of INR 25bn in the
second year compared to the revenue
targets of INR50bn in the fourth year and
75bn in the fifth year, according to the
. The draft policy, released last year,
had mandated a concessional import duty of
15% on completely knocked down units of
electric cars for five years (for cars above
$35k and above) against an initial
investment of at least $500mn. From release
to approvals and eventual imports, the
timeline will likely extend from March to
August/ September. Notably, US EV player
Tesla reportedly plans to start its retail
operations in 2H25. It remains unclear for
now if the US carmaker will assemble cars in
India to avail of the reduced tariff. For now,
plans are presumably to import fully built
cars from Germany, one of its three
manufacturing facilities around the world.
− Electronics/ semiconductors: The share of
electronics in India’s exports continues to
rise, climbing to the third spot just behind
petroleum products and engineering goods
in 8MFY25. According to industry estimates
cited by the press, the average duty on
India’s electronics imports is 9% compared
to 1% in the US (fourth-fifth are zero-duty
bound), signalling a significant gap and hence
likely reciprocal action. Clarity is awaited on
how the reciprocal action might be
undertaken – based on HS codes or average
tariffs in a category or average MFN rates –
with the impact likely to be dictated
accordingly.
India’s semiconductor ecosystem is still in its
early stages and is unlikely to attract
counteraction for now. Currently, five
projects are underway, including an ATMP
(assembly testing marking and packing)
facility by US’ Micron. Moreover, players
expect India’s semiconductor manufacturing
to operate under a contract manufacturing
model owned by Western countries or
Northeast Asia, thereby minimising impact.
Conclusion
Impact on India’s growth from slower trade
activity is likely to be small as net exports
accounted for less than 3% of GDP on average
in recent years. Nonetheless, at the sectoral
level, the impact will be asymmetric as we
highlighted in the relevant section. The US is
likely to draw confidence from incremental
action in the coming months, albeit further
concessions from India will be expected. This
will be no easy feat as countries that run a
substantial deficit with the US would move to
lower or cut the tariffs on their purchases to
avoid counteraction from the US. However, that
would conflict with the Most Favoured Nation
(MFN) clause (would amount to treating
different countries differently). For now, India is
better positioned to negotiate a deal with the
new US government vs Europe and China. We
expect continuous two-way dialogue between
the two countries to counteract any one-sided
action on trade barriers. As a counterbalance,
India-UK trade talks have also resumed,
intended to strengthen trade and investment
ties.
