Tariff tensions accelerate India’s reform story

Tensions are flaring between India and the US.

Washington’s introduction of not just a baseline tariff of 25 per cent, but a further 25 per cent for India’s continued purchase of oil from Russia, has naturally created uncertainty among investors.

Negative headlines aside, we see this less as a story about short-term disruption but rather one about longer-term opportunity. Pressure has previously acted as a catalyst for positive structural reform in India and with US President Donald Trump increasing trade pressure, we expect a renewed momentum in enacting economic reforms.

Higher tariffs will slow India’s growth outlook, but even in a downside scenario, the macro impact looks set to be relatively contained. Moody’s predicted a drag of 0.3 per cent on the Indian economy if 50 per cent tariffs were introduced. Even then, real GDP growth is still expected to be close to 6 per cent.

Given India’s structural reliance on domestic consumption rather than exports, the shock appears to be manageable. Prime Minister Narendra Modi has taken swift counter steps to support Indian households and stimulate demand with a recent goods and services tax cut proposal, expected to offset some of the potential external hit.

The shift in focus onto boosting local spending has already helped Indian equity markets return to pre-tariff levels within weeks, signalling investor confidence in the nation’s resilience.

It’s important to remember the US cannot afford to disengage from India completely. India manufactures around 50 per cent of all medicine consumed in the US; it plays a central role in IT services; and is rapidly expanding its role in high-value manufacturing. Even as tariffs were raised globally, mobile phone exports (most notably from Apple’s India-based facilities) were deliberately excluded, underlining Washington’s recognition of India’s strategic importance.

A shift in tone

It’s not just about economics. The current tensions reflect a deeper shift in geopolitical tone.

The implementation of the highest tariffs in Asia has rattled Indians, as they grapple with an unprecedented about-turn from US policymakers who, until earlier this year, had spent two decades strengthening diplomatic ties through initiatives such as the ‘Howdy Modi’ summit.

The shift seems to have begun during stalled free trade talks, with India refusing to open its politically sensitive agricultural sector to US imports. This triggered accusations from US presidential adviser Peter Navarro and Treasury secretary Scott Bessent that India is benefiting from cheap Russian oil, claiming its moguls have made more than $16bn at Ukraine’s expense.

Whether or not this extrapolation is true is a moot point — and likely a strategy aimed at pressuring Delhi to help rein in Vladimir Putin. What’s more telling is that this confrontational approach represents a deliberate shift in strategy by the US, one that reverses an earlier strategy of tacitly encouraging India to fill the vacuum in Russian crude demand left by the EU embargo, to stabilise global energy prices and contain inflation.

The reality is India cannot decouple from Russia easily. More than half its military hardware is Russian sourced, and the Russian-Indian relationship has historically proven more stable than its US-India counterpart over the past half-century.

Tipping point

We believe India could partially offset the direct fiscal impact of tariffs with targeted stimulus. However, the lost opportunity in goods manufacturing, particularly in sectors like jewellery and leather could have deeper long-term consequences if heavy tariffs persist.

Both countries appear to be waiting to see who blinks first. But if neither does, the US could inadvertently accelerate India’s pivot towards deeper Brics integration, potentially undermining the dollar’s global dominance.

If the Brics — representing 40 per cent of global GDP and population according to July IMF figures — start to abandon dollar-based trades, the global financial order could shift faster than many expect. 

We believe President Trump ultimately wants a deal for Russia’s President Putin to end the war, and for India to open its agricultural sector. If that happens, tariffs may be rolled back. But if not, the longer-term ramifications for both the dollar and the Brics alliance could be significant and lasting.

Opportunity in adversity

So, how will India respond beyond short-term stimulus?

History shows external shocks often accelerate reform. A clear example came in 2019, when Mr Modi’s government restored economic momentum with sweeping corporation tax cuts.

India has been criticised for its trade barriers, property ownership restrictions, complex labour laws, and judicial inefficiencies. While these have shielded domestic firms to an extent, they’ve also deterred foreign capital.

Mr Modi has shown he can adapt under pressure though. Since 2014, India has undertaken some of its most significant reforms in decades. But there is still more to do. And this is where US pressure could again serve as a catalyst.

If Delhi uses this moment to accelerate liberalisation, improve transparency and foster a more competitive private sector, it could turn the current headwinds into a tailwind for future growth.

Long-term view

Investors should be cautious about overestimating the risks posed by US tariffs alone. India’s exposure to US trade flows is mitigated by its large and robust domestic economy, and its government has shown a proven ability to counter external shocks with reform.

If history is any guide, the latest bout of pressure from Washington has real potential to accelerate internal reform and increase India’s appeal as an investment destination over the coming years.

Andy Draycott is portfolio manager of the Chikara Indian Subcontinent Fund