India Faces Tariff Heat. Will It Spark Economic Reform?

With the right political will, Trump’s tariff can serve as a catalyst for structural reform, writes Deepanshu Mohan.

Donald Trump's recent imposition of a 25 percent tariff on Indian merchandise goods, effective 1 August 2025, transcends mere commercial friction.

(Photo: PTI)

US President Donald Trump’s latest tariff imposition, along with an undisclosed penalty, on India, offers a critical reflection on the complex state of geopolitical landscape—as intricate and dynamic it is—witnessing a significant inflection point in the weakening of US-India bilateral relations.

The US' recent imposition of a 25 percent tariff on Indian merchandise goods, effective 1 August 2025, transcends mere commercial friction.

India now seems more alienated than ever before in the global geo-economic landscape, while facing higher protectionist measures from the US at a time when its relationship with China, the other dominant world leader, remains troubled.

The unilateral tariff-action by Trump, who has now weaponised tariffs as a political leverage tool more than an economic measure, seeks to achieve two-goals:

• Create uninterrupted market access for US goods into the Indian market, which according to Trump currently face "obnoxious non-monetary trade barriers";

• De-link India’s growing and enduring trade and military ties with Russia (a point that has been made more strongly by other US Republican leaders in the recent past against India).

India’s Strategic Refusal to Compromise

From India’s own perspective, its firmness to not compromise its trade-position and policy preferences by giving too much of leeway to American trade negotiators, while protecting its agriculture, dairy, and MSME sphere, offers strategic clarity.

Some might perceive a positive in India’s refusal to compromise with the US terms and conditions on achieving a trade pact that was in American interests. 

India’s long-standing preference for maintaining an independent negotiating and trade-policy space, pursuing targeted compromises over sweeping pacts, may be evident in its steadfast refusal to concede on sensitive areas like agriculture and dairy to American policymakers.

While a firm stance is not merely defiance for its own sake; it constitutes a principled defence of strategic sovereignty, reinforcing India’s image as one presenting credibility, where its core national interests are non-negotiable, irrespective of external pressure. 

Economic Fallout and Exposure Risks

At the same time, the current tariff imposition leaves India and the Narendra Modi government at a vulnerable footing too. 

India’s exchange rate and capital account mobility, drawing investment inwards into India, is also heavily reliant on an open, transparent relationship with the US, which has now been adversely affected under a higher tariff imposition, which as a signal, will also make American businesses more wary of investing in India.

Major export sectors, including textiles, electronics, footwear, gems, jewellery, pharmaceuticals, and petrochemicals, with substantial US exposure, confront the immediate threat of being underpriced by rivals. 

Trade Shock and Macroeconomic Pressure

With India's goods trade with the US totalling approximately $129 billion in 2024 and a rising trade deficit on India's side, the new tariffs represent a notable external shock for trade-focused sectors too apart from the short-term effects of this on India’s rupee value and foreign investment position.

Beyond the immediate impact on merchandise trade, any ripple effects of these tariffs, once into effect, may extend across broader macroeconomic terrain, influencing investor sentiment, rupee valuation, and GDP forecasts. This author earlier warned the effect of American tariffs on India as potentially growth shaving over time, impacting interlinked sectors like pharmaceutical and automotive exports.

More than that, India’s weak export competitiveness across sectors at a broader level might be acutely challenged over the coming months, and these rising trade barriers are expected to contribute to persistent depreciation pressure on the rupee.

The Indian rupee recently dropped close to Rs 87/USD, triggering Reserve Bank of India (RBI) intervention to stabilise markets. Despite such intervention, analysts often view the rupee as overvalued by approximately 8 percent, a factor limiting export competitiveness.

While central bank intervention is anticipated to continue, it may not necessarily provide strong appreciation support. India has judiciously spent tens of billions in reserves (eg, net purchases of $1.7 billion) to smooth volatility.

Diplomatic Friction and Strategic Isolation

This delicate balancing act underscores the intricate relationship between trade policy and macroeconomic stability.

India's robust foreign exchange reserves, recently standing at around $697 billion, and low external liabilities, may marginally offer a crucial buffer, one that is depleting over recent months, offering little resilience in this tightrope walk (trade policy-macroeconomic stability), presenting profound implications for India’s financial scenario.

Furthermore, the broader political friction, linked to US concerns over India’s enduring ties with Russia and its "Make in India" policies, compounds risk to the bilateral relationship, which one can see as the more serious collateral damage of the latest tariff announcement.

It represents a low point in Trump-Modi’s projected ‘friendship’ at a time when the Indian government is being questioned in the Monsoon Session of the Parliament for explaining the role of the US, as claimed by Trump repeatedly in the recent India-Pakistan conflict.

A no-trade partnership with the US and a less-entwined American bond will further alienate India and its ‘Vishwaguru’ ambitions even more, given its pre-existing troubles with China at the border, at a time when both, US and China, are emerging as dominant anchors in an increasingly bipolar world order.

From Tariffs to Reform: A Window of Opportunity?

India’s own economic weaknesses and relatively low export-competitiveness level across sectors driven by a low private investment-growth position present little opportunity for it to carve a niche for itself, while trying to diversify partnerships, and seek favourable terms of trade in FTAs with the EU, the UK, and other critical trade partners.

At a time when consumption demand is low, jobless growth position continues to expand, while inequality rises, India seems to offer little in its bargaining chips beyond an ‘enormous market size’, which is less appealing to those seeking greater trade with a sound macro-economically positioned partner.

From an internal, monetary policy position too, the RBI confronts a challenging policy trade-off: between cutting rates to support growth and maintaining currency stability amidst imported price inflation, particularly for critical commodities like oil, as India’s currency weakens (vs US dollar) inherently escalates inflation risk.

A hawkish US Federal Reserve and sustained dollar strength further intensify pressure on the rupee and India’s policy choices.

While the projected narrative emanating from New Delhi is one of calculated defiance, India and the Modi administration will be wise to try and achieve a medium-term diplomatic resolution with the Trump administration and move towards a more entwined trade and economic relationship purely for strategic reasons.

At the same time, India is strategically doubling down on export diversification while pursuing deeper ties with the EU, ASEAN, Latin America, and Africa, to reduce interdependence on any single market. For some, the recently concluded Free Trade Agreement (FTA) with a UK, lauded as a "trendsetter," exemplifies a blueprint for balanced, mutually beneficial trade cooperation that New Delhi now views as more sustainable than approaches dictated by a single dominant partner.

Can Crisis Spark Reform?

At the same time, if one had to see a silver lining in all of this for India’s internal context, Trump’s tariff challenge, with the right political will at the domestic-national level, can serve as a potential catalyst for profound internal and structural reform.

A smart, more assertive government can progressively undertake critical factor market reforms (land, labour) along with a deeper cut on regulatory-excesses to drive stagnated private investment up, both, from domestic and external sources, while increasing consumption demand amongst middle and low-income groups for a demand-side push (something the current government has failed to do). 

India’s economic liberalisation history in the past were also triggered by crisis episodes of 1991 and the 1998 sanctions, suggesting a historical precedent for transforming adversity into an opportunity. A potential disruption with the American government may offer a strategic opportunity for structural adaptation and enhanced resilience, forcing a critical re-evaluation of existing vulnerabilities and forging pathways to greater self-reliance. 

The will, however, to do so at a large level, appears weak in the current Modi government, which has more obsessed in securing power at all costs than in engaging meaningful economic reform.

Ankur Singh, Saksham Singh and Anania Singhal contributed to this column.

(Deepanshu Mohan is a Professor and Dean, OP Jindal Global University. He is a Visiting Professor and Fellow at LSE, and University of Oxford. This is an opinion piece and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for the same.)