India must sustain its growth rate in a hostile and heterodox global environment

Any assessment of India’s growth prospects in the coming year must internalise the ominous global backdrop that the economy confronts.

Markets are abuzz with the frenetic pace of policy pivots under Trump 2.0. But the pressures imposed by the US on the rest of the world pre-dated the election of Donald Trump as US President. The sheer quantum of the pandemic fiscal stimulus in the US, combined with high levels of immigration in recent years, have powered US output to levels much above its pre-pandemic path. In contrast, European growth remains stagnant, and China has disappointed.

This relative outperformance of the US, alongside the resilience that is making disinflation challenging, is underpinning “US exceptionalism.” This has manifested in a strengthening of the US Dollar and uncomfortably elevated US bond yields—all of which have tightened global financial conditions and put sustained pressure on emerging market currencies.

Now add Trump 2.0 to the mix. The Trump economic agenda likely rests on four pillars: imposing import tariffs, slowing net immigration inflows, cutting corporate taxes, and deregulating the economy. The key question is this: will the composite impact of these policies accentuate US exceptionalism, or will they undermine it?

It’s not clear. Imposing tariffs and slowing immigration inflows (or accelerating deportations) both constitute “adverse supply shocks”—they will simultaneously hurt US growth and push up prices by pushing up wages. The inconvenient truth is that high levels of immigration made it possible for the US to contemplate a “soft landing.”

Furthermore, the most salient lesson from Trump 1.0 was that constant policy uncertainty eventually impinges on business sentiment and hurts capital investment and growth. All these will, therefore, likely undermine US growth and exceptionalism.

But the Trump agenda also has offsets. Corporate tax cuts can add more fiscal fuel to the fire even though it makes the medium-term fiscal path more untenable. Similarly, a big deregulation push could boost near-term sentiment and growth, even though it may create vulnerabilities down the line.

More importantly, however, even as global growth suffers—from some combination of heightened uncertainty and tariffs—the near-term hit to US growth may be partially offset by looser fiscal policy and deregulation.

This would be the worst of all worlds for emerging markets. Weaker global growth that depresses their exports and continuing US exceptionalism that keeps the dollar and US rates uncomfortably high—thereby impinging on capital flows to emerging markets reducing degrees of policy freedom to respond to weaker global growth.

Therefore, as one thinks about the outlook for India, one must presume the prospect of:

• Lower global growth pulled down by the heightened uncertainty of Trump’s economic policies
• A sticky US Dollar and bond yields as tariffs and deportations induce inflationary pressures, and constrain the Fed from easing in the near term
• Increased levels of excess capacity from China that are directed to other economies (including India) as the US likely increases tariffs on China
• Lower crude and commodity prices in response to slowing global growth and more US “drilling”
• The prospect of bilateral tariffs imposed on India under Trump’s “reciprocal tariff” threat

What playbook must Indian policymakers adopt to sustain high growth in this environment?

First, authorities should seek to ward off a trade war with the US. India’s effective tariff differential with the US can be construed to be higher than the difference between the weighted average tariff between the two economies (which amounts to a more modest 7 percentage points). This is because import volumes used to compute weighted average tariffs are impacted by the quantum of the tariff itself and therefore suffer from an endogeneity basis. A “simple average of tariffs” between the two economies or effective tariffs that are computed using global export shares, throw up a larger “effective tariff” differential of almost 15 percentage points.

Given this, the authorities must further reduce import tariffs—a theme pursued in the last two Budgets. Yes, in the near term this will potentially increase imports. But, in the medium term, lower tariffs increase the efficiency and productivity of domestic firms that must compete against cheaper imports, and boost exports.

Second, we must not be overly reliant on cyclical instruments such as fiscal and monetary policy to boost growth. While the Budget focused on tax cuts, the central fiscal deficit is consolidating by 0.4% of GDP this year, which constitutes a tightening of policy. Lower inflation has given monetary policy much needed space to ease liquidity and rates. But the net impact of policy next year is still ambiguous as tighter fiscal policy confronts looser monetary policy.

The only antidote is to double down on structural reform—education, skilling, health, land, labour, power, deregulation. This is imperative for at least two reasons:

First, with fiscal deficits having to reduce and absorptive capacity limits being reached, public capex has likely peaked. The investment baton will have to be handed to India’s private sector. But firing up private investment will necessitate some combination of demand visibility and animal spirits. The bar on the former is high given the excess capacity in China. The onus therefore falls on reforms that can spark animal spirits.

Second, since World War II, only 13 economies have grown at 7% or more for 25 years. They had one thing in common: high levels of global engagement. So, exports need to be an important pillar. But how to grow exports in a world that is becoming progressively deglobalised and balkanised? The only way is for India to increase its market shares in the global pie, which will entail much higher levels of competitiveness, brought about by sustained structural reform.

All told, persistent reforms are the surest way of building economic resilience. They are also the surest way of retaining control of our economic destiny, in a world likely to witness seismic heterodox economic shifts in the coming years. 

The author is Sajjid Chinoy, Head of Asia Economic Research, J.P. Morgan. Views are personal.