Shortly before Indian Prime Minister Narendra Modi’s visit to the White House, President Donald Trump declared that the United States would implement reciprocal tariffs on its trading partners.
This announcement comes at a particularly challenging moment for India, which is already facing a sluggish economy and weak demand.
During a joint news conference, Trump stated that India would purchase F-35 fighter jets and oil and gas from the United States. The two nations would also initiate discussions regarding the US trade deficit with India.
India maintains a significant trade surplus with the US, and these negotiations, alongside military and oil purchases, could have negative repercussions for its economy, especially as it navigates a period of slowdown.
With the Indian economy projected to grow at 6.4 percent for the year ending in March—the slowest rate in four years—the Modi administration unveiled income tax relief for the middle class in its annual budget earlier this month.
Following this, the central bank lowered its benchmark interest rate for the first time in nearly five years by 0.25 percent to 6.25 percent, with Governor Sanjay Malhotra emphasizing that a less restrictive monetary policy is warranted given the current “growth-inflation dynamics”.
Economists caution that the tax relief may fall short for many Indians, whose income remains beneath taxable levels and who may still be feeling the effects of the COVID pandemic, which significantly impacted their earnings.
“A large segment of the population has yet to recover post-pandemic,” notes Kaushik Basu, an economics professor at Cornell University. “Data indicates that the agricultural labor base has expanded, suggesting that agriculture may merely be a temporary refuge.”
Basu is referring to individuals who returned to rural areas during India’s strict and extended COVID lockdown and remain in their villages engaging in seasonal agricultural work due to a lack of quality job opportunities in urban centers.
Dhiraj Nim, an economist at ANZ Bank, anticipates that the tax relief will have a modest 0.2 percent effect on GDP growth.
“There may be a slight increase in consumption, but it will likely be accompanied by increased savings. Some personal loan repayments might occur,” he stated. “However, the growth in consumption is unlikely to meaningfully offset the one trillion rupees [$11.5bn] provided in relief.”
Furthermore, any economic uplift is expected to be temporary, while the challenges it aims to address are more profound, warns Alexandra Hermann, lead economist at Oxford Economics. “There is nothing in the budget that tackles employment or skills development,” she states, highlighting the need for broad and sustained growth. Presently, only about 2 percent of Indians pay income tax, and unemployment and underemployment rates remain high.
Some of India’s economic slowdown may be attributed to a natural decline in demand following the post-pandemic rebound, during which the economy experienced significant growth. Industry leaders and government officials had believed India was on a trajectory of high growth. The nation is already the fifth-largest economy globally and is projected to become the third-largest by 2030.
However, the underlying “issues beneath the growth” have now become more apparent, according to Basu of Cornell. “While inequality has persisted for at least twenty years, what we’re witnessing now has not been observed since 1947,” the year India gained independence from British rule.
Delicate Economic Juggle
The government has aimed to stimulate growth through significant investments in infrastructure projects like roads and bridges. Nevertheless, the financial support offered during the pandemic has necessitated a tighter fiscal policy to achieve the fiscal deficit target of 4.5 percent by next year. This reduction in spending could detract from some of the benefits gained through the income tax relief, Nim from ANZ warns.
Modi’s upcoming US visit occurs during this delicate economic juncture for India. President Trump highlighted India’s high tariffs on American automobiles and other products, which are designed to shield Indian industry and foster domestic employment.
India, alongside Mexico and Canada, will also engage in discussions to reduce its trade surplus, a move that may require concessions detrimental to Indian industry, especially considering purchases it can hardly afford. (New Delhi hastily slashed tariffs on Harley Davidson motorcycles in the budget.)
“It’s significant that the Indian government has deliberately avoided imposing new tariffs,” remarks Michael Kugelman, director of the South Asia Institute at the Wilson Center, a Washington, DC-based think tank. “One primary reason for this is the fragile state of economic growth.”
The Indian government also accepted its first 100 deportees from the US without official objection, despite being transported in a military plane and handcuffed. At their news conference, Modi referred to these individuals as victims of human trafficking, emphasizing the need to address the issue. However, he did not raise concerns with Trump regarding their treatment, unlike other nations that have advocated for their own deportees.
The high tariffs imposed on steel imports announced by the US are expected to impact Indian exports. Nonetheless, the Indian economy primarily relies on domestic consumption compared to other Asian economies, states Hermann from Oxford Economics.
This poses a deeper issue that is beginning to surface.
Kartik Muralidharan, Tata Chancellor’s professor of economics at the University of California at San Diego, observes that the government’s expanded food transfer program has bolstered India’s lower-income populations and potentially encouraged their participation in the economy.
However, he and others emphasize the urgent need for comprehensive economic reforms to foster greater and fairer growth.
“Typically, reforms are prompted by external challenges,” notes Muralidharan, citing how India’s economic reforms in 1991 emerged following the Gulf War and a balance of payments crisis. “We need another pivotal moment akin to ’91,” he asserts.
Basu suggests that rising inequality could be effectively addressed through “a marginally higher tax rate for the super-rich, which could then fund support for small businesses.”
He also argues that small businesses face challenges due to compliance costs associated with the Goods and Services Tax, which could be alleviated through simplification and reduction.
The government projects a growth rate of approximately 6.7 percent for the upcoming year, suggesting robust growth given the current global context. However, Nim from ANZ cautions that the “greater concern should be enhancing per capita income and ensuring better distribution so that it reaches those in need.”
