Blowing in the Wind

IT ALL BEGAN WITH Harley Davidson motorbikes. One day in February this year, US President Donald Trump railed against a 100 per cent tariff levied by India on the iconic product. Within no time, Prime Minister Narendra Modi intervened to bring down its import duty to 50 per cent, a move that Trump acknowledged but was not enough to placate him. It is another matter that these bikes account for 0.05 per cent of the bilateral trade between the two countries.

Perhaps it was a sign of things to come. In June, India increased tariffs on imports from the US as diverse as Bengal gram, lentils, certain nuts, apples, pears, flat-rolled stainless steel and certain types of iron and steel, among 30-odd items. These were retaliatory measures against US tariffs on steel and aluminium products from India. Funnily enough, India excluded tariffs on bikes above 800 cc from this list. It was an early taste of the escalating global trade war for India.

This is not the first time that India and the US have experienced friction in their economic relations. The normalisation of relations between the two since the end of the Cold War is littered with examples of trade and market access being a sticking point. But during all these decades—specifically from the time of Bill Clinton until Barack Obama in the White House—care has been taken by both sides to keep political and strategic ties hermetically sealed from the economic relationship. Ring-fenced from all other concerns, the strategic relationship has progressed steadily. With Trump at the helm now, however, there is genuine uncertainty about relations between the two countries. What complicates matters is that Trump sees trade and security through the same, narrow prism. It has become clear that his efforts to ‘secure a better deal for America’ will have real and negative economic consequences for India.

Three issues confront India that can prove deleterious for the economy. One, Trump’s insistence on protectionism will badly affect India’s exports and imports over time. Two, India along with other countries has been issued a fiat against oil imports from Iran. Finally, the strategic relationship—one that is so important for India, given the geopolitically fraught region it is located in— too is up in the air.

The immediate threat on the horizon from this mixing of strategic and economic policies concerns India’s imports of oil from Iran. In the first ten months of fiscal 2017-18, India imported 18.4 million tonnes of crude oil from Iran, roughly 8.3 per cent of the 220.4 million tonnes imported that year. After the US withdrew this May from the Joint Comprehensive Plan of Action (JCPOA), the peace deal that was put in place by the Obama administration to limit the threat from Iran’s nuclear activities, India and other countries faced a deadline of November 4th to reduce imports from Iran to zero. The US is particular that Indian and Chinese companies give up imports if they do not want sanctions to kick in.

This queers India’s pitch in many ways. Iran was India’s third largest supplier of oil after Iraq and Saudi Arabia. The quantity of oil impacted—under a tenth of the total shipped in—seems replaceable, but may not be so. There are a number of factors at work. A country imports crude oil based on its specific characteristics, depending on the requirements of its refining infrastructure. Alternatives are possible but take time to arrange. The issue of oil imports from Iran was a potential subject of discussion between India and the US at the cancelled ‘2+2’ talks between the ministers of Foreign Affairs and Defence and their US counterparts. With no sign of those talks, there is little exchange at the political level, leaving most issues to be dealt with by the more rigid bureaucracy.

This is not the first time that India has run into trouble with the US on Iran, a country with which India has had extensive commercial and political ties for a long time. Some years ago, during Obama’s presidency, a similar situation arose when the US issued a fiat to reduce imports from Iran. Threatened with similar sanctions, Delhi ceased its use of the Asian Clearing Union, a clearing house based in Tehran that allowed a smooth settlement of accounts for oil-related imports and exports, among other items. Instead, it was forced to use third party banks to clear its accounts, something that became increasingly difficult as the US tightened its screws on entities dealing with Iran. Over time, India’s ability to conduct trade with Tehran became so difficult that the latter began to issue occasional threats, leaving a bitterness in relations that persists even today. When those sanctions were finally lifted, India cleared its outstanding dues of $6.5 billion for oil imports from 2012 to 2016. India saw its Iranian oil imports fall to 6 per cent of the total in 2013, down from 16 per cent in 2008. Since then, this figure has risen again— to about 600,000 barrels per day. Delhi is expected to reduce it to nothing within the next three to four months.

The US wants India to reduce its crude oil imports from Iran to zero by November

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On paper, the consequences of higher oil prices can be calculated directly in terms of the cost it is expected to impose on the economy and—less reliably—on consumers. In practice, the situation plays out in complex ways with political factors coming in, especially in a pre-election year. There are two scenarios that can be envisioned.

If increases in global oil prices are fully passed on to consumers, it will lead to higher inflation as the cost of transportation— the main channel through which these costs work their way through the economy—goes up. This affects virtually all goods and many services as well. This may not be acceptable to the Government in a high-pressure election year. The other option is for the Government to bear the cost, which would result in a higher than publicly declared fiscal deficit. This, in turn, would have a debilitating effect on the economy. For one, it would make it harder for the Central Bank to ease interest rates. For another, it would leave the Government with precious little fiscal space to carry out the much-needed investments, which have been anaemic at best in recent years.

One recent estimate of the impact was made by HSBC India economists. In an exercise undertaken to study the possible trajectory of inflation in 2018-19, they forecast an increase of 1.3 percentage points over the 4.1 per cent figure for 2017-18, placing it at 5.4 per cent this fiscal year. Of this rise, 0.4 per cent was pinned on higher crude prices in the year ahead; 0.3 per cent on higher Minimum Support Prices (MSPs) recently announced by the Government; and another 0.6 per cent on other macroeconomic conditions that include the rupee’s depreciation and the closing gap between actual and potential growth in the year ahead.

Higher inflation is not the only broad effect of an increase in crude oil prices. By HSBC projections—based in turn on RBI estimates—every $10 increase in the global price of oil per barrel shaves off 0.1 per cent of India’s economic growth rate. Further, this increase can add to the fiscal deficit, depending on the assumptions made. If half the increase in prices is passed on to consumers, it will increase the fiscal deficit by nearly 0.2 per cent of GDP, while a full pass-through—unlikely in a pre-election year, though until recently, 80 per cent of the cost increases was passed on to consumers—will lead to an increase of more than 0.3 per cent in the deficit figure.

How do these numbers square with the Government’s calculations? In the rolling targets of fiscal indicators—issued in its Medium Term Fiscal Policy Statement along with the Budget this year—the fiscal deficit is expected to go down to 3.3 per cent of GDP in 2018-19. If the potential increases in oil prices are included, this arithmetic could go awry: the deficit may inch up significantly from 3.5 to 3.6 per cent—a virtual repeat of the breach in 2017- 18’s target. This has adverse consequences. For one, it signals that India cannot get its fiscal house in order; for another, its impact on investment and growth could be negative, unless offset by positive countervailing factors. It is not as if the Government is not aware of this possibility. In the aforementioned Policy Statement, it expects major subsidies—food, fertiliser and petroleum—to go up. ‘In Budget Estimates 2018-19, major subsidies have been estimated at Rs 264,336 crore, which shows an increase of Rs 34,620 crore as compared to the Revised Estimates 2017-18.’

Every $10 hike in the global price of oil per barrel shaves off 0.1 per cent of India’s economic growth rate

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Global oil prices are hard to predict and often show volatility and swings that few—if any—economic models can capture. Since July 2017, there has been a slow but steady incline in crude oil prices. These prices may or may not follow a similar upward path next year. But that is cold comfort for India. The country needs to solve the problem of Trump’s Iranian oil deadline, and if an alternative source of supply has to be found, it is safe to assume that prices will harden, given the scale of purchases made by India. While 8 per cent of total oil imports may not seem like much, the ratio is deceptive. Oil markets are organised differently from those of other commodities. Very often, oil deals are made on the basis of long-term purchase agreements. In contrast, ‘spot markets’, where purchases are made on a current basis, tend to have higher prices. India can hardly afford to be a big buyer in spot markets.

SO WHAT SHOULD be done? The choices that India faces are difficult. On the one hand, the General Election less than a year ahead makes it hard for the Government to take tough corrective steps. On the other, it is now in a much harsher global environment than it inherited in 2014. Protecting its export markets is one issue, and sheltering the domestic economy another. Neither can be delinked from the other and seen in isolation.

“We have to stop dealing with slogans and clichés and start dealing with realpolitik,” Vivek Dehejia, a professor of economics at Carleton University in Canada tells Open in response to what needs to be done. Professor Dehejia says India’s ‘Look East’ policy sounds good, but the country depends a great deal on the US. “You have to secure your relationship with the US. Dealing with a mercurial Trump is not easy, but you have to find a modus vivendi with the US,” he adds.

It is also imperative that India avoids needless trade disputes with the US. One recent example is that of medical implants and devices where India imposed price caps on products that were imported, most of which were made by US manufacturers. The result was that many companies producing these goods withdrew from the Indian market. “All that was done was to annoy the US without any benefits to Indian patients. This has the makings of a major trade dispute now,” says Professor Dehejia. Economic theory suggests price interventions in goods markets should be subject to domestic policy choices and not trade policy.

Beyond these immediate steps lies an uncertain world. If global trade becomes a casualty in Great Power politics, India could lose out. Once a country loses an export market, it is difficult to regain that slice of trade again. Even if exports are priced competitively against those of other exporting countries, chances are that changes in tastes and preferences in the export market may make Indian goods ‘unviable’. This is perhaps one reason why in the wake of the 2008 economic crisis the Government of the day offered aggressive assistance to Indian exporters in a bid to enable their survival. The trouble with this remedy is that it is also hard to wean exporters off it, as the last Government discovered. Exporters can always cite difficult conditions that call for continued assistance. The point at which these concessions— export subsidies, concessional trade arrangements and other organisational privileges—should be withdrawn is not easy to determine.

Finally, there is a strategic issue at hand. What should India do in a world where trade horizons are receding and the wave of globalisation that began in 1991, is almost at an end. Should it focus more on its ‘home market’—something that Marxists have always favoured—or should it continue to search for new export markets even if the going is likely to get tougher still? So far, there is no debate on the matter and the policy horizon appears blank. It should, however, be remembered that India’s strong economic performance since the unshackling of its economy in 1991 had a huge trade component. A domestic market of 1.3 billion people— a substantial fraction of which now has buying power—can seem like a solution to a crisis of exports. But that is a deceptive argument which lacks the support of empirical evidence.

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Siddharth Singh

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