Trade_war_research_paper (1).docx

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TRADE WAR 2018 AND IMPACT ON INDIA Manasvi Nagpal and Jigyasa Gautam

1. ABSTRACT U.S. President Donald Trump has instigated a global trade war citing unfair trade practices and poor unemployment in the United States. What started as a series of allegations and threats against China has become a reality since March 2018. On March 8, 2018, the U.S. President imposed a 25% and 10% tariff on steel and aluminum respectively under Trade Expansion Act of 1962- which allows the president to impose tariffs based on the recommendation of U.S. Secretary of Commerce. Valued at US$3 billion for China, it sparked an immediate retaliation-China imposed an equal tariff on US goods. However, when a trade war happens, it just doesn’t affect the two economies involved but all the economies open to world trade. It comes as no surprise here that India is getting dragged into this. The titfor-tat raising of tariffs have caused global trade hostilities to reach an all time high, and involve the world’s biggest economies- US, China, India, EU, and Russia. In this paper we try to study the positive and negative impact of the ongoing trade war on India.

2. INTRODUCTION

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A trade war is an economic situation where countries raise protectionist barriers against each other to protect local industries from foreign competition and also to promote exports over imports. It may take the form of imposing tariffs and quotas on foreign trade as well as currency manipulation to favor local industries. Trade war can commence if one country perceives another country’s trading practices to be unfair. Trade war between two countries can affect other countries which were not initially involved in the trade war. 2018 China-United States trade war was started in April 2018 in which the US imposed tariffs on steel and aluminum imports from China, as well as Canada and countries in the European Union. On July 6, U.S. imposed 25% tariffs on $34 billion worth of Chinese goods as a part of President Donald Trump’s tariffs policy. In response to this China imposed similar tariffs on U.S. products. According to President Trump, imposition of tariffs was necessary to protect intellectual property of U.S. businesses, to protect national security and to reduce the U.S. trade deficit with China, which stood at $375 billion in 2017. The U.S. is claiming so on the basis of Section 301 of Trade Act of 1974. Trump believes that Beijing has exploited the WTO enabled global trade framework to its advantage. According to the South China Morning Post, the real target of Trump’s trade war is ‘Made in China 2025’ programme- an initiative to transform China into an advanced manufacturing powerhouse. While the ongoing trade war between the U.S. and China has sent alarm bells ringing, India can end up as a major beneficiary if it plays its cards right.

3. REVIEW OF LITERATURE The literature on trade war is large. Few of the findings are: Bouet and Laborde (2017) stated that even for the United States, initiating a trade

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war is not the right policy for improving domestic welfare and GDP, and trade war could be significantly damaging for trading partners. Johnson (1953) analyzed the case of trade wars based on the optimum tariff argument and was the first to clearly demonstrate that large countries can benefit from a trade war whereas small countries always lose. Lin Lu and Miajie Yu (2017) stated that the high U.S. import tariff will bring a catastrophe in international trade. If the U.S. launches a trade war against the rest of the world and the other countries retaliate, then the global total imports will drop by 10.73%. As per an article in The Economic Times, dated September 22, 2018, since there is a tariff imposed on Chinese imports into the U.S., there is a threat of those imports finding their way into India. A July 26, 2018 article published in The Economic Times cites an official report by the Parliamentary Standing Committee on Commerce which expressed concern about India’s widening trade deficit with China, which could be exacerbated by China exporters redirecting goods elsewhere in a bid to fend off supply issues caused by U.S. trade tariffs. The report went on to cite solar panels as the main product being dumped into India. As stated by The Indian Express on April 12, 2018, even a minor disruption in U.S. financial markets can have major implications for India. The three external risk factors- higher tariffs, rising interest rates, and elevated bond sales- come at a time when the domestic banking system is grappling with a renewed stress of bad loans.

4. OBJECTIVES OF THE PAPER 4.1. The primary objective of the paper is to study the effect of tariff imposition by the United States on India’s exports and imports of Steel and Aluminum.

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4.2. Second objective of the paper is to study the impact of US’s Iran sanctions on India’s oil imports. 4.3. Studying the impact on India’s exchange rate is the third objective of this paper. 4.4. Fourth objective of the paper is to study the impact on Indian financial markets. 4.5. We also try to identify those areas which could open up more opportunities for Indian exporters amid the US-China trade war.

5. RESEARCH METHODOLOGY Our study is a descriptive and explanatory study. This paper is based on secondary data. The data has been collected from internet, newspaper reports and articles, magazines etc.

6. TRUMP’S FOUR RULES OF CONDUCTING A TRADE WAR Here are four rules for conducting a trade war, President Donald Trump style: 1. Assume that you will win it effortlessly- In March 2018, Trump advisor Peter Navarro predicted that no country would retaliate against our tariffs. His reasoning was based on the fact on the fact that they are the biggest market in the world, so other countries have too much to lose. However, refusing to cooperate with this theory, Canada, China, the European Union and Mexico have all imposed retaliatory tariffs. President Trump himself has made the closely related argument that

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their trade deficit guarantees their success because, “when you’re already $500 billion down, you can’t lose!” 2. Make sure your tariffs are designed to inflict maximum damage on your own country’s companies- The administration’s tariffs on imported steel and aluminum harm companies that use those inputs to make their own products, and these companies employ more Americans than the steel and aluminum industries themselves. 3. Take on as many countries simultaneously as you can- The Trump administration has many concerns when it comes to trade. It objects to bilateral trade deficits, to other countries’ trade barriers against their exporters, to currency manipulation, to intellectual property theft and forced technology transfer. It has moved in quick succession against China’s practices and nearly all of the world’s steel and aluminum producers. 4. Don’t feel that you have to make your negotiating demands clearTrump administration officials do not seem eager to clear up any confusion. Kevin Brady, the Republican chairman of the House Ways and Means Committee, recently commented, with a hint of exasperation that “today there are no serious trade discussions occurring between the U.S. and China, no plans for trade negotiations anytime soon, and seemingly little action toward a solution.” We now discuss our objective-wise findings:

6.1. IMPACT ON STEEL AND ALUMINIUM Amidst the US-China trade war, India seems to be an attractive destination for steel makers, as it’s the world’s fastest growing major

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economy. According to Bhaskar Chatterjee, secretary general at Indian Steel Association, duties imposed by the US would trigger “trade diversion” from other steel makers. As much as 80 million tons of steel or 17% of global exports based on World Steel Association data- could be diverted to markets such as India, according to Seshagiri Rao, joint managing director of the country’s top mill, JSW Steel Ltd. According to an article in Business Standard, dated September 20, 2018, The Aluminium Association of India (AAI), (which represents the entire spectrum of the domestic industry that manufactures and trades in the metal), says that the escalating trade war between the U.S. and China is harming India’s primary industry. The association states that inward shipments of the metal are not just hurting the domestic industry but are also creating a foreign exchange outgo of about $4.5 billion, in a scenario of growing trade deficit. Aditya Birla Group’s Hindalco Industries, state owned National Aluminium Co and Anil Agarwal- led Vedanta Ltd are the top three players of the domestic aluminium industry. Their combined annual output of four million tonnes can cater to the entire domestic market, where consumption is usually 3.1-3.6 metric tonnes. Excess production is exported by these companies. In such a situation, aluminium imports into India become totally nonessential. In the letter to the PMO, the association stated that the deficit in merchandise trade rose 50 per cent year-on-year to $162 billion in FY18, from $108 billion in FY17 and that imports grew 21 per cent surpassing export growth of 10 per cent during the period under review. In FY18, aluminium imports hit a peak of 1.96 million tonne, causing a forex outgo of $4.5 billion. “If imports of non-essential aluminium products are stopped it can reduce trade deficit by the same quantum ($4.5 billion) and bring it down to 2.8 percent,” said the top producer. There are some aluminium products used in the auto sector of the country which the domestic industry does not produce. The industry in its discussion with the government officials clearly stated that imports of such products could continue but the non-essential

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imports such as those of primary or scrap aluminium need to be clamped down. Quantitative restrictions on imports of the metal, imposition of end-use certification other than for the manufacture of an alloy used extensively by auto industry, minimum import price and import duty hike are some of the measures that were discussed in the meeting. In India, import of primary aluminium attracts a duty of 7.5%, while scrap import is at 2.5% duty.

6.2 IMPACT ON OIL US’ sanctions on Iran effectively prevent any company from doing business with it, by limiting Iran’s access to dollar, gold and precious metals. India buys the most Iranian oil after China, and Iran is India’s second largest oil supplier. Thus it is difficult for India to stop doing business with Tehran. As per an article in The Economic Times dated September 05, 2018, India is likely to tell the US that it won’t be able to cut oil imports from Iran after the sanction kick in from November 4, 2018. India’s refineries are heavily dependent on supplies from overseas, including Iran and giving up this cheaper option will be tough when retail prices are likely to be at an all time high in the country. Also, pricing of oil is very important for India as a no. of factors such as economic growth and inflationary trends are tied to it. Brent crude is currently hovering around an uncomfortable $80/barrel. If the current market conditions continue, once the sanctions on Iran are implemented, oil prices are likely to go higher, pointed out CARE

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Ratings in its 24th September report.

SOURCE: THE ECONOMIC TIMES

Net oil imports have contributed to more than 40% of the trade deficit for India in the previous two fiscal years. According to Ashray Ohri of ICICI Bank Ltd, expecting a surge close to 30% in India’s crude basket, we see the net oil bill to cost close to $100 billion and contribute to almost 50% of the trade deficit this fiscal. Corporate India will suffer incrementally, as rising oil prices coupled with a depreciating rupee, will increase cost pressures for domestic market producers. In particular, the margins of paint companies and lubricant makers will be under threat. Airlines will get squeezed further at a time when they are unable to raise airfares enough and rupee depreciation will increase their dollar denominated costs.

6.3. IMPACT ON INDIAN RUPEE According to an article in the Business Today dated June 20, 2018, here are reasons why an escalating trade war with US will further weaken the currency value against the US dollar: (a) US is one of the largest trading partner- China is India's largest trading partner and in 2017-18 the total trade between the countries amounted to $89 billion. US come second in the order, with total trade value of $74 billion. This shows that the US is a very big trading partner

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of India with both nations having exports and import relations for decades. (b) India runs trade surplus with the US- Though China is the largest trading partner of India, the country has a negative trade balance with China, which means that India's exports to China are lower than what China imports from India. So this trade is very favourable for China. But in case of the US, India runs a trade surplus. India exports more to US than what it imports from US. The trade with US is very favourable for India, which means we export more than we import from them. This brings much needed dollar inflows into the country. If the trade war with US escalates, this will widen our trade deficit and also current account deficit. (c) Domestic Industry will be hit- An escalating trade war with the US has potential to impact the domestic industry especially pharmaceuticals, apparel and textiles, iron and steel, mineral fuels and also fisheries. All these industries are manpower intensive. At a time when unemployment is a big issue in India and economy is also slowly coming back to normal, a trade war with US will impact the economy's growth momentum. In fact, investors and mutual funds in the market are betting big on pharmaceuticals as this sector hasn't participated in the rally in the last 2-3 years. If any duties are introduced, this sector will see some bloodbath in the stock market, which will push the stock valuations lower. (d) India's import items from the US are critical- India's highest imports from US are very critical in nature like nuclear reactors, boilers, mineral fuels, aircrafts, space crafts, medical equipments etc. Any higher duty on these products will impact India's key sectors. While the US or its companies could absorb the impact, India and Indian companies don't have the kind of strength, which a developed country has to absorb the higher costs.

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As per an article in Quartz India on August 13, 2018, rupee closed the day at Rs.69.93, its weakest ever. The 1.56% decline was also the currency’s sharpest-day fall since September 2013. Already, higher crude oil prices, a widening trade deficit, and the exit of foreign investors from India have shaved off 8% from the rupee’s value this year.

6.4. IMPACT ON INDIAN FINANCIAL MARKETS A big matter of concern for India could be the indirect impact. Within the US domestic economy, higher tariffs on a range of imported products increases the threat of higher consumer prices, caused by importers facing increased costs of raw material. This could force the Federal Reserve to raise rates faster than it would have done otherwise. An increase in interest rates in the US has implications for emerging economies such as India, both for the equity and debt markets. The Fed is so far on track to raise interest rates at least two

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times this year; market analysts, however, say Fed could potentially raise rates faster to prevent the US economy from overheating. The Fed is also expected to pursue its scheduled reversal of the easy money policy of the last decade. The central bank had said in September 2017 that it would start shrinking its balance sheet by selling treasury bonds and mortgage-backed securities that it accumulated after the Lehman Brothers crash in 2008, in order to inject liquidity in the market. With this, the Fed would gradually wind down the $4 trillion in holdings that it acquired during the phase of quantitative easing. Even a minor disruption in US financial markets can have major implications for India. The three external risk factors — higher tariffs, rising interest rates, and elevated bond sales — come at a time when the domestic banking system is struggling with a renewed stress of bad loans. The Indian economy, especially financial markets, will need to support for significant volatility and stress from the combined effects of global and domestic challenges.

Outflow of money For India, the impact of inflation action by the Fed will be significant through the channel of interest rates. Yields in US markets have been increasing since mid-2016, and have risen from a low of around 1.5% per annum to over 2.8% now. The yield on benchmark US bonds remained around 5% in 2007, a year before the start of the global recession that forced central banks of developed countries to cut interest rates to near-zero. While a reversal to pre-2008 levels will only be gradual, the rise in yields could be faster than anticipated. The Indian government securities market has been falling for the past seven months on cues of rising US yields and projections of increased local inflation. When yields rise, prices of bonds fall, thereby resulting in mark-to-market losses for Public Sector Banks. Indian banks, stressed by bad loans, may have to incur mark-to-market losses of up to Rs

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20,000 crore in the January-March quarter, according to analysts. Rising interest rates in the US could mean a potentially rough ride for the India’s equity market. Higher US rates will lead to outflows from emerging market bonds and equities as American investors as well as other foreign investors will look to chase higher returns in the U.S. While a surge in domestic inflows is a reassuring factor for Indian equities, higher interest rates do make the option of investor borrowing cheap money in the US and investing in Indian equities significantly less attractive.

6.5. EXPORT OPPURTUNITIES FOR INDIA IN TRADE WITH US AND CHINA According to report published by the Confederation of Indian Industry (CII) on August 06, 2018, India can focus on numerous goods for expanding its exports to the US and China markets following the hike in duties by both countries on imports from each other. As per CII’s analysis, the goods that India should focus on for the US market include items in the categories of machinery, electrical equipment, vehicles and transport parts, chemicals, plastic and rubber products. Sectors like apparel and textiles, footwear, toys and games and cell phone manufacturing are becoming competitive industries in India and need to be encouraged, noted CII. CII has suggested that the trade dialogue with the US should be strategized taking into account India’s competitive advantage in these products and foreign direct investments from the US should be encouraged by boosting confidence of US companies in India’s business climate. An article in Business Today, dated August 28, 2018, cited a study by the commerce department which claims that India can capture the Chinese commodity market vacated by US exports in the face of the higher

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import duties Beijing has slapped on them. The study has analysed and identified at least a hundred products where India can replace US exports to China, which totalled around $130 billion in 2017. These retaliatory tariffs provide a window of opportunity for enhancing India’s exports to China. If Indian exports can successfully capture the US’s share of the trade pie, the massive bilateral trade gap with China will also come down. The products where US exports to China overlap with Indian exports are of particular interest. Fresh grapes, cotton linters, flue-cured tobacco, lubricants and chemicals such as benzene are a few lines where the value of US exports to China is pegged at above $10 million and India also exports these items to China. There is scope to increase our exports in these products because of the tariff differential and the substantial demand in China. The good news for India is that while China has imposed tariffs of 15-25% on these goods coming from the US, other countries are subject to only 5-10% duty, the most favoured nation (MFN) rate applicable for members of the World Trade Organisation. Moreover, India has been granted additional 6-35% Duty concessions on the MFN under the Asia Pacific Trade Agreement, which makes Indian exports all the more competitive at present. Then there are products that India exports to the rest of the world except China, such as oranges, almonds, walnuts, durum wheat, corn and grain sorghum. Significantly, the US exports of these products to China are in excess of $10 million. Taking the case of Corn, for example, India exported $143.6 million worth of the commodity to the world in 201718 while China imported $600 million of it in the same period. While American corn is subject to 25% duty, APTA countries can get up to 100% concessions on corn exports to China- and that spells a windfall for India.

7. CONCLUSION:

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1. A trade war would slow down global growth overall, worsening India’s already dismal export numbers. World Trade Organisation (WTO) reduced its estimate for the growth in global trade in 2018 to 3.9% from 4.4%. 2. There are possibilities of ‘trade diversion’ that may flood the Indian markets with steel and aluminium imports. 3. The biggest impact could be on the rupee which is already battling historic lows against the US dollar. 4. The rising price of oil as a result of US sanctions threatens to widen India’s current account deficit, impacting India’s macroeconomic stability. 5. Increase in interest rates in the US has implications for emerging economies such as India, both for the equity and debt markets. There can be a reduction in investment flows for India. 6. India can seek the opportunity to reduce its own trade deficit against China. 7. India may be able to gain some traction in textile, footwear, garments and gems and jewellery if Chinese exports to the US slow down.

8. REFERENCES 1. Bouët, A., & Laborde, D. (2017). US Trade Wars with Emerging Countries in the 21st Century: Make America and Its Partners Lose Again. 2. Guo, M., Lu, L., Sheng, L., & Yu, M. (2018). The Day After Tomorrow: Evaluating the Burden of Trump's Trade War. Asian Economic Papers, 17(1), 101-120. 3. Johnson, H (1953), Optimum Tariffs and Retaliation. Review of Economic Studies 21(2), 142-153. 4. https://www.india-briefing.com/news/us-china-trade-waropportunities-india-17335.html/

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