As Global Tariff Wars Intensify, India Must Try To Fix Its Flawed Incentives
The government has announced a policy of incentives for local manufacture of electronic components. But is that enough?
The week in review was dominated by US president Donald Trump, as every week has been since his inauguration on January 20. In his latest move, the US president suspended his reciprocal tariffs on all countries, save China, on imports from which the tariff has been raised to 125%. Stocks have rallied around the world, but US government bonds have not shared the joy, after uncharacteristically joining stocks on their way down. Normally, when stocks crash, bonds go up, acting as safe haven assets. The erratic behaviour on the part of bonds is reportedly a major factor in persuading the US President to hold the tariffs he had announced on April 2 on hold for 90 days.
Markets hate uncertainty. The tariffs do not bite today, but their jaws remain open, and economic well-being could fall down their maw, three months hence. No major decision on investment — on near-shoring, friend-shoring, Just-In-Case reconfigurations of the supply chain — can be taken without clarity on what tariffs would be in place for how long on which country. This would not be known after three months, either, unless the tariffs are withdrawn entirely.
If some tariffs remain, the prospect opens up of their removal in whole or in part sooner or later or never. Only those with insane levels of appetite for risk would carry out significant investments in lines of production for which tariffs matter. Most people do not have such an appetite. Trump has ruined the investm...
The week in review was dominated by US president Donald Trump, as every week has been since his inauguration on January 20. In his latest move, the US president suspended his reciprocal tariffs on all countries, save China, on imports from which the tariff has been raised to 125%. Stocks have rallied around the world, but US government bonds have not shared the joy, after uncharacteristically joining stocks on their way down. Normally, when stocks crash, bonds go up, acting as safe haven assets. The erratic behaviour on the part of bonds is reportedly a major factor in persuading the US President to hold the tariffs he had announced on April 2 on hold for 90 days.
Markets hate uncertainty. The tariffs do not bite today, but their jaws remain open, and economic well-being could fall down their maw, three months hence. No major decision on investment — on near-shoring, friend-shoring, Just-In-Case reconfigurations of the supply chain — can be taken without clarity on what tariffs would be in place for how long on which country. This would not be known after three months, either, unless the tariffs are withdrawn entirely.
If some tariffs remain, the prospect opens up of their removal in whole or in part sooner or later or never. Only those with insane levels of appetite for risk would carry out significant investments in lines of production for which tariffs matter. Most people do not have such an appetite. Trump has ruined the investment climate in the US and hurt export-oriented investment around the world.
Tariff Wars Continued
The trade row with China has intensified. Chinese tariffs on US goods stand at 84%, and Trump has raised US tariffs on China to 125%. If, how and when these two rivals would negotiate a ceasefire and bring the rates down remains to be seen. This leaves a huge pall of uncertainty and the prospect of an increase in prices of the ordinary consumer goods that fill American shopping shelves intact.
In any case, the base tariff of 10% that Trump had announced remains. This would make for an added layer of cost for American producers and consumers. The inflationary effect of just this layer of tariffs would take time to work its way through the system. Unless the economy shows serious signs of tanking, the US central bank, the Fed, is unlikely to be in a hurry to cut rates, especially with the dollar index weakening.
That is not unwelcome in India, where the Reserve Bank of India (RBI) has brought down the policy rate by a second instalment of 25 basis points, to bring it down to 6%. Further rate lowering by the Fed would change the policy rate differential between India and the US, with implications for the exchange rate of the rupee, and further policy response by the RBI.
The rate cut leaves the Repo two percentage points and more above the level of inflation. In other words, the real rate of interest, after adjusting for inflation, has not come down much: in February 2024, the rate of inflation was 5.09%, and the Repo rate, 6.5%, yielding a real rate of interest of 1.41%. In February 2025, inflation stood at 3.61%, and the policy rate at 6.25%, signifying a real rate of interest of 2.64%, presenting an increase in the real cost of money. Inflation is expected to average to 4.2% for this fiscal as a whole. Global volatility probably constrains the RBI in bringing the nominal rate of interest down fast enough to lower the real rate of interest to something like 1.5%.
Incentives (Not)
The government has announced a policy of incentives for the local manufacture of electronic components. While India has been exporting smartphones in large numbers, all the bits and pieces that make up their innards have first to be imported, leaving the value added in India pretty small. The component indigenisation policy seeks to address this.
India has a terrible reputation when it comes to incentive design. The turnover threshold for small-scale businesses had long discouraged small firms from growing big — at least formally. The present set of incentives are linked to turnover. However, they are also linked to employment. Now, the manufacture of electronic components tends to be capital-intensive. The exponential growth in both the sophistication of artificial intelligence and the deployment of AI in the production process makes the headcount in electronics manufacture pretty variable.
Linking incentives to headcount is ready-made sand waiting to mess up the gears of the incentive mechanism. The safe-harbour provision for transfer pricing for Global Capability Centres is pegged to Rs 300 crore, leaving GCC operators wondering what was the point of such a safe harbour announced in the Budget this year.
Diplomatic Signaling
India’s Prime Minister has met the head of the Bangladesh interim government on the sidelines of a meeting of the nations on the rim of the Bay of Bengal, held in Thailand. The friendly handshake between the two leaders did not prevent India from scrapping the facility it has been providing for the transshipment of Bangladesh garment exports. The move is intended to let Bangladesh leaders know that India does not approve of their overtures to China in security matters, especially trying to leverage access to India’s landlocked Northeast in Bangla-China discussions.
On the same tour of the neighbourhood, the PM strengthened India’s relations with Sri Lanka. India and Sri Lanka have signed a Memorandum of Understanding on defence cooperation. This is welcome.
Meanwhile In Politics…
The All India Congress Committee held a session at Ahmedabad, ‘senior leader’ Rahul Gandhi running the show, rather than the nominal party president Mallikarjun Kharge. Priyanka Gandhi was absent, on a personal visit abroad. The only positive sign for the party was in a speech by Shashi Tharoor, who said, correctly, that the party needed to hold out a promise of hope and prosperity, and not just offer criticism of the ruling dispensation. On fleshing out such a picture, there has been little progress.
In another political development of significance, the Communist Party of India (Marxist), elected a new central committee and a new Polit Bureau. The new General Secretary, M A Baby, takes up the party reins at a time of marginalisation of the Left in Indian politics, leaving Kerala as the only state with a dominant presence for the CPI(M). It is also a time when the political sensibility of the nation has coarsened, turned sectarian and inimical to dissent. The challenge for the Communists is not just to work out alliances but also to fashion a strategy of holistic cultural intervention to address the democratic deficit in the national narrative. While the Left is numerically small, it has demonstrated an ability to punch above its weight in such matters.
