Trump tariff, new penalty to put India under fire

According to Pranjul Bhandari, chief economist, India and Indonesia, HSBC, the elevated tariff rate, if levied, could shave off over 0.3 percentage points from India’s growth, and the penalty rate could erase more. “From another lens, the announcement could reinvigorate negotiations on the India-US trade deal. We find that India has lowered oil imports from Russia in July,” she adds.

With 25 percent tariffs, India will be paying higher than emerging markets Asian peers like Japan and the European Union, potentially putting India at a disadvantage. It is also higher than the current 10 percent reciprocal tariffs that India (and the rest of the world) faced and only a shade lower than the 26 percent reciprocal tariffs announced on April 2 or ‘Liberation Day'.

According to Sonal Varma and Aurodeep Nandi, economists, Nomura, the reciprocal tariff rate of 25 percent may be temporary, and might settle for lower, as negotiations will continue after August 1. “However, the best-case outcome would still be tariffs in the 15 to 20 percent range, which is disappointing, considering India’s more advanced stage of negotiations,” they say.

Among emerging market peers, Vietnam, Indonesia and Philippines have lower tariffs than India (20 percent); Korea has tariffs similar (25 percent) while for Bangladesh (35 percent) and China (55 percent) the number is higher.

The Federal Open Market Committee (FOMC) decision to not tinker key interest rates did not surprise the markets. Federal Reserve Chair Jerome Powell said interest rates are in the right place to manage continued uncertainty around tariffs and inflation, tempering expectations for a rate cut in September, Bloomberg reported.

In their post-meeting statement, officials downgraded their view of the US economy, saying “recent indicators suggest that growth of economic activity moderated in the first half of the year”. The Federal Reserve had previously characterised growth as expanding “at a solid pace”.

The committee’s decision to hold steady once again defies the intense pressure from US President Donald Trump to cut rates. Powell added that the Fed looked through the tariffs by not hiking and keeping them where they are. “This will not placate US President Donald Trump, who has been vocal in demanding aggressive cuts. Following the finalisation of major trade deals by the August 1 tariff pause deadline, Trump will likely renew his attacks on Powell,” say economists at DBS.

While the markets have been disappointed by the higher tariffs embedded in the so-called trade deals, they should take some relief that these agreements signalled a temporary closure to July’s trade tensions. The careful management of the US-China trade relations through extending the tariff truce should reinforce this stability, even if risks remain, according to economists at DBS. 

Also read: Can Trump's tariff war derail India's manufacturing dreams?

Growth pangs

Even as India is still negotiating with the US on the tariff hike, the 25 percent rate is anticipated to slow down domestic economic growth by multiple notches.

Nomura economists maintain FY26 gross domestic product (GDP) growth forecast at 6.2 percent year-on-year, but flag a downside risk of 0.2 percentage points. “We had assumed a baseline reciprocal tariff of 10 percent on India, so if tariffs sustain at 25 percent, then this would hit GDP growth by adversely affecting exports to the US, eroding any benefits due to trade diversion, hurting profit margins and reducing investments, and leading to job losses for MSMEs,” they say. Over the medium-term, they still expect India to remain a beneficiary of the China plus one strategy.

The US is India’s largest export destination, accounting for 18 percent of total exports and 2.2 percent of GDP.

According to Kapil Gupta, chief economist, Nuvama Institutional Equities, the key takeaway from Trump’s tariffs is that the US trade deficit may begin to narrow.

“This is more so because the dollar has also dipped 8 to 10 percent, further eroding US consumers’ purchasing power vis-à-vis imports. Finally, US interest rates also stay elevated, and the Fed is delaying rate cuts. All this would work to narrow the US trade deficit, which could be a deflationary impulse for the global economy (hurting global growth/trade/earnings), unless surplus countries (China, Germany) boost domestic consumption timely and sizeably,” Gupta elaborates.

“At these tariff rates, if the burden of higher tariffs is equally split between Indian producers and US consumers, it could directly shave off 0.3 percentage points from India’s GDP growth. The penalty rate, if levied, would shave off further from growth, and there could be an indirect growth drag as well, led by lower capital inflows, investment, and such like,” says Bhandari.

India’s bilateral goods trade surplus with the US has doubled over the last 10 years, growing to $40 billion in FY25 from $20 billion in FY15. Key items India sells to the US are electronics, precious stones, pharmaceutical products, textiles, and machinery. Major items India buys from the US are mineral fuel, precious stones, machinery and electronics.

Despite the hullabaloo, there are few who are optimistic that the resilience of Indian economy will not be hurt despite the steep tariff hike with an additional penalty.

Aastha Gudwani, India chief economist, Barclays, feels the Indian economy is relatively closed, with domestic demand as the mainstay of growth. She does not see the 25 percent tariff meaningfully impacting GDP growth, pegging the likely impact at 30 basis points.

“As things stand, we estimate that the effective average US import tariff on Indian goods is at 20.6 percent in trade-weighted terms. This is sharply higher than both the pre 'Liberation Day' tariff rate of 2.7 percent and the 90-day pause tariff rate of 11.6 percent. In contrast, India's import tariff on US goods is lower, at 11.6 percent in trade-weighted terms,” Gudwani explains.

Despite India being among the first countries to engage with the US on trade, with multiple rounds of negotiations, the two countries failed to reach an 'interim' deal before the August 1 deadline.

“Our estimate of potential GDP threat was 0.2 percent when the 26 percent rate was announced, and hence we stand by this number. This is why our forecast was 6.4 percent to 6.6 percent, with the lower number being linked to the tariff rate to be imposed,” Madan Sabnavis, chief economist, Bank of Baroda, says. He feels that macros would be bruised, though not dented, as the growth story is quite firm and stable. 

Agrees Aditi Raman, associate economist, Moody's Analytics. “While the US is India's largest trade partner, the Indian economy is relatively more domestically oriented than most of the region and relies far less on trade. Pharmaceuticals, gems, and textiles are key sectors that are likely to be hit. A point of contention is market access to the key agricultural and dairy sector, which India has historically been reluctant to grant,” Raman adds.  

Oil: The deal breaker?

The US pressure on India to diversify from Russian oil and military purchases is an additional challenge, say Varma and Nandi.

India’s oil imports from Russia currently account for 35 percent of its total oil imports. Separately, the US accounted for 4 percent of India’s crude oil imports (in volume terms) in FY25, falling from 9 percent in FY21. India could reduce its reliance on Russia by sourcing more from the Middle East and ramping up LNG imports.

“However, costs could be higher at the margin, weighing on the current account. In an ideal scenario, India could have switched from Russian oil to US oil to ensure a better trade balance. But unilateral imposition of tariffs and penalties could make this substitution more difficult. India may still use oil as a bargaining lever in further trade negotiations with the US,” say Varma and Nandi.

In 2021, India was buying 3 percent of its annual oil imports from Russia. Over the last five years, it lowered its purchases from the Middle East and the US.

Sabnavis also agrees that when global crude oil prices were stable in the lower trajectory, the discounts from Russia were not really been significant. Hence, even today if imports are reckoned from countries like Iraq, there would not really be pressure on the current account deficit of India.

Russian oil costs $3 to $8 per barrel cheaper than Middle Eastern or US grade on a landed-cost basis, but a likely 100 percent secondary tariff will mostly offset any such gains from discounted prices. 

Ebb & flow: Markets & money

Even as Trump’s social media post about a 25 percent tariff hike was a surprise, Indian markets remained somewhat unmoved on the following day of trade. However, analysts expect the tariff hike to impact overall earnings and valuations of equities and Indian currency. With certainties around tariff and a possibility of further negotiations between the US and India, markets are expected to stay volatile and turbulent.

“The higher tariffs on India (versus expectations) could potentially weigh on capital flows,” say analysts at Nuvama Institutional Equities. According to their estimates, the indirect impact of capital flight from Indian equities is likely to be more dominant and could weigh on small and midcaps and high-beta domestic cyclicals like real estate, NBFCs and industrials.

On the other hand, an Indian rupee depreciation could help IT and it could potentially outperform given the now-low relative valuations. The Indian rupee has been weakening over the last few weeks, hovering around a five-month low.

Others concur. According to analysts at Goldman Sachs, every 5 percentage points increase in US tariff rates could cause an 80 basis points incremental hit to MSCI India EPS from direct and indirect channels. Therefore, they estimate about 2 percent incremental hit to EPS if the new tariffs are enforced. Only 2 percent of MSCI India total revenues are derived from goods exporting sectors.

While Indian equities have significantly lagged broader emerging equities in 2025 so far, analysts at Goldman Sachs are concerned that the underperformance is likely to extend in the near term.

“While incremental EPS impact is likely to be moderate, a weak Q2 reporting season so far and ongoing tariff uncertainty could delay our expectation of the second half of FY26 earnings recovery and weigh on market sentiment and foreign flows,” they add, expecting the Indian rupee lag in spot appreciation for the rest of the year.

The Fed action has also made the dollar stronger, indicating depreciation of all currencies, including the rupee.