President Trump’s ‘Liberation Day’ reciprocal tariffs came like a bolt from the blue. Across the globe, stock markets crashed. Trump responded: ‘some pain has to be endured to achieve some long-term goals.’ Soon, surprising everyone including the US administration, the US bond market crashed. The safe haven US sovereign bond, the bedrock of the global financial markets, crashed, sending the US bond yields spiraling up. The 10-year yield spiked to 4.5 percent, spreading panic in financial markets. President Trump, who had earned notoriety for flip-flopping on tariffs, was forced to declare a hasty retreat from the ‘Liberation Day’ tariffs. The reciprocal tariffs imposed on all countries except China were paused for 90-days; the baseline 10 percent tariffs on all countries will continue; and the retaliatory tariff on China was raised to 145 percent and later to 245 percent. Within a few days, President Trump again flip-flopped exempting phones, computers and many consumer electronics imports from China from reciprocal tariffs. The Trumpian world of flip-flop tariffs is, indeed, chaotic and unprecedented.
Reciprocal tariffs are not reciprocal
It can be argued that the US running an unsustainable huge trade deficit of $1.2 trillion is justified in imposing some reciprocal tariffs on other countries, particularly on those with whom the US is running a huge trade deficit. If a country is imposing, say, an average 15 percent tariff on imports from the US, the US is justified in imposing an average 15 percent reciprocal tariff on that country. But the reciprocal tariffs announced by Trump are far from reciprocal. The formula used to calculate reciprocal tariff is devoid of economic logic. According to this formula, the ‘discounted reciprocal tariff’ on a country would be half the ‘tariffs imposed on US’. And the ‘tariffs imposed on US’ are calculated by dividing the trade deficit of US with the country concerned by the exports of that country into US multiplied by 100. For example, India’s trade deficit with US in 2024 was $46 billion and Indian exports to US was $87billion: 46 divided by 87 multiplied by 100 is 52. Half of 52 is the ‘discounted reciprocal tariff’ of 26 percent imposed on India. Using trade deficit as the basis of reciprocal tariff is illogical.
Stagflation in the US? Impact on global growth?
An inevitable consequence of Trump tariffs will be a spike in US inflation. The higher costs of imports will be largely passed on to the consumers. Higher prices mean lower demand. This demand compression will impact production and growth. Inflation and growth stagnation can cause stagflation with profound negative consequences. High inflation will land the Fed in a tight spot restricting its ability to cut rates and provide monetary stimulus to growth. The unprecedented huge uncertainty has paralyzed investment decision-making. We don’t know whether the US will tip into a recession this year. Even if it avoids a recession, the US’ GDP growth this year will dip below 1 percent. Chinese GDP growth is likely to decline to around 3.5 percent. Globally, investment will take a hit. Contraction in global trade and dip in investment can pull down global growth in 2025 from 3.3 percent estimated earlier to 2.3 percent or even lower.
India will be less impacted
Contraction in global trade and global growth will impact all countries, including India. However, India will be one of the least impacted economies since we are a domestic consumption-driven economy. In the worst-case scenario, India’s growth may dip to 6 percent for FY26 against the estimated 6.5 percent. India’s macros are in a sweet spot. The fiscal and CADs are under control and, more importantly, CPI inflation has been steadily coming down to touch 3.34 percent in March. This is well within the RBI’s comfort zone of 4 percent. RBI’s shift to accommodative monetary policy indicates more rate cuts to come.
Fiscal and monetary stimulus augurs well for Indian economy
This monetary stimulus, along with the fiscal stimulus provided in the 2025 Budget through big income tax cuts, can ensure 6 percent GDP growth in FY26. India can turn out to be a preferred destination for FPIs since most other emerging markets have a much higher exports (to US) to GDP ratio and, therefore, are more vulnerable to growth slowdown.
We see another 75 bp rate cut by the MPC in this rate cutting cycle since inflation is trending down. This monetary stimulus along with the fiscal stimulus provided in the Budget through income tax cuts can keep growth in India resilient despite the global uncertainty.
Domestic consumption themes will outperform
The poor earnings growth of around 5 percent in FY25 has rendered the Indian market valuations high. Nifty at 24000 is trading at above 20 times FY26 estimated earnings indicating stretched valuations. A sustained rally will happen only when earnings revive. Meanwhile, investors can focus on fairly valued large caps like financials which have been resilient even in this weak volatile market. Other domestic consumption themes like telecom, aviation, hotels, healthcare and digital companies will provide support to the market even when Trump tantrums hurt the external-linked sectors.
