New Delhi refuses to bow to the trade diktat of the United States. This is generating high tensions between the two countries, concerns for the Indian economy and financial turbulence in India.
At the start of the trade war, the Indian economy was seen as one of the potential winners. Some were already predicting that India would become the new workshop of the world, replacing China.
Relations between the Indian Prime Minister and the American President were indeed warm. There was every reason to hope for a quick trade agreement. Beyond the economic aspect, the United States had a close relationship with India to counter its common enemy, China.
Almost a trade embargo
However, as the months passed, this good understanding gradually disappeared altogether. The breaking point was reached on August 27 when Trump decided to tax certain labour-intensive Indian products such as clothing, precious stones and shrimps at 50%.
A tariff at this level is practically the equivalent of a trade embargo that threatens many companies that depend almost exclusively on the American market. Millions of jobs could disappear as the Indian economy already does not create enough jobs to incorporate the 12 million young people who enter the workforce each year.
Diplomatic turns
Officially, the United States has tightened tariffs to denounce Indian purchases of Russian oil. This is only a pretext, according to New Delhi, which has no problem pointing out that the United States has not stopped buying uranium, fertilisers and chemicals from Russia despite the invasion of Ukraine.
And rather than bow to American demands, Narendra Modi has decided to move closer to China, the great rival that caused the death of 20 Indian soldiers in clashes in 2020. For the first time since 2018, the Indian Prime Minister travelled to China for an important regional summit where he was in conversation with the Chinese and Russian Presidents.
Battered by the United States, its primary foreign customer, India is looking for new markets to sell its goods. The Indian economy also needs foreign capital. It is trying to attract Chinese investors to develop its atrophied manufacturing sector and provide the millions of jobs that its idle youth lack.
A mainly domestic economy
The 50% US tariffs on Indian goods could reduce GDP growth by 0.5% this year. But with economic activity still rising close to 6%, India's economy will remain one of the most dynamic in the world.
India is indeed a relatively closed country. Exports to the United States, which are crucial for specific sectors, account for only about 2% of the country's GDP.
To cushion the impact of the trade war, the Indian authorities also have the means to support domestic demand. The Central Bank has already cut its key interest rate three times this year from 6.50% to 5.50%. For its part, the Indian government will reduce VAT on nearly 400 product categories, effective September 22.
Several everyday consumer goods, such as butter, oil, and soap, will be taxed at 5% compared to 12% and 18% previously. The system will also be simplified by going from four different rates to just two, and by standardising the different taxes applied in each state.
Simpler and lower overall, the new tax will reduce merchants' fees and consumers' bills. This will ease inflationary pressures, supporting household consumption and allowing for further monetary easing.
The price for warming the economy
The trade war will delay the development of the Indian economy. Fiscal support for domestic consumption comes at the expense of investment in infrastructure, which needs to be upgraded to exploit the country's economic potential.
Trade uncertainties are also slowing down the plans of foreign companies to set up. And this situation is likely to continue because the two main American demands, the end of Russian oil purchases and the opening of the Indian agricultural market, are unacceptable to New Delhi. The Indian economy needs the cheap Russian energy to contain inflation.
And while uncompetitive agriculture still provides the primary income of half of Indians, opening up this sector to foreign competition is impossible today.
But India's financial markets are being impacted by the trade uncertainty. Since the all-time high reached in June, the Indian stock market has been very volatile and down slightly overall. The rupee is penalised by the rapid reduction in the key rate and has fallen to a historic low against the euro.
No trade agreement is to be expected in the short term, and, as a result, Indian financial markets will remain unstable in the coming months. But there is no doubt that Indo-American relations will calm down sooner or later.
A well-diversified stock market
India has no economic assets to make the United States bend, but it is politically indispensable in the American fight against China. The sudden rapprochement between New Delhi and Beijing is first and foremost a signal sent to Washington. And it was perfectly received, with Trump immediately advocating appeasement.
Beyond the current turbulence, given the country's economic potential, the Indian stock market is interesting. It has outperformed emerging markets over the past four years and is well diversified with the financials sector (29% of capitalisation), consumer (20%), new technologies (10%), industrials (9%), energy (9%), commodities (8%) and healthcare (6%).
However, due to its high volatility, it is not recommended for the most risk-sensitive investors. Buy Indian stocks as part of a moderate or somewhat more aggressive portfolio. View our comprehensive asset allocation recommendation here.