US protection and India

A global trade war cannot be good for anyone. India will not remain unscathed if things begin to hot up and there is retaliation against the US duties from China and the European Union

The irony that the country US President Donald Trump is likely to hurt the most with his tariffs on steel and aluminium is the US itself is now well established. America does not have the capacity to supply all its metal demand. It will take a few years if not decades to revive production in the scrap heaps that its long abandoned metal factories have turned into in the manufacturing corridor appropriately termed the rust belt. The result: higher costs of production for sectors and reduced competitiveness that have steel as a key input like aerospace, construction, canned goods and pipelines. There are incidentally 140,000 workers in the US steel industry and 6.5 million in the steel-consuming industries. The numbers should tell a clear story of what the net benefits of steel tariffs will be. Ditto for aluminium.

Then there is the business of the titfor-tat retaliation from steel and aluminium producers who threaten like the European Union to put punitive tariffs on American exports such as bourbon and blue jeans and you have another chunk of US workers who are likely to bear the impact of misguided trade policy.

However, the fact that the US does the maximum damage to itself by protecting does mean that India will be unscathed. Yes, India does not export a lot of steel and aluminium (2 per cent of America’s total steel imports and 1 per cent of aluminium imports are from India) to the US but that might not be reason enough to exult. The Indian metals industry depends a lot on exports to the global market. Its metal exports have risen sharply in the last few years and are now an important driver of overall exports to the global market. In 2016-17, while overall exports grew by 5 per cent, iron and steel shipments went up by 58 per cent, and the aluminium and associated articles recorded a rise of 23 per cent.

What the US protection does is to reduce the size of the global market for metals and increase competition among producers for a piece of the action in the “unprotected” or residual segment of the global market. This could imply both a drop in export volumes and a fall in profit margins. Clearly economies that have larger domestic “absorptive” capacity are better off. China, ostensibly the target of America’s ire, has a much larger home market than India.

This leads to an interesting implication. More the US waters down its tariffs and makes concessions to trading partners (like Canada and Mexico) less the compulsion for these producers to flood the residual market. India thus stands to gain if there is “selective” protection by the US even if it is not a direct beneficiary. However, that might not be enough and we have to do our own bit. For one thing, US protection strengthens the case for putting more traction under domestic infrastructure projects that tend to be heavy guzzlers of metals.

All this is straightforward. The more puzzling bit has to do with the fate of the rupee in all this. Some analysts have crafted a neat story of higher costs of imported metals leading to increased inflation pressures to which the US central bank responds to with more interest increases than anticipated currently. Higher US rates will pull in more capital leading to dollar appreciation.

This might sound logical but has its problems. There are two things about the current tilt in US economic policy that currency markets do not quite like. The first is the recently announced tax cuts that leave a gaping hole in the budget. Budget deficits could well add up to a trillion dollars a year for the next few years. The second are the import tariffs— the dollar and the stock market sold off sharply in response to the announcement of the tariffs. Thus the current environment is negative for the dollar.

It might not be that difficult to see why this is the case. Both fiscal expansion and protection add to current account pressures (protection by raising the cost of imports) and leaves the US with a massive twin deficit problem. Add a couple of sub-plots to this story like China, the biggest holder of US treasuries selling its holdings instead of buying additional offerings of US bonds as a retaliatory gesture, and you start wondering how these imbalances will be funded. One scenario that seems eminently possible is a sharp rise in US interests coupled with a falling dollar.

A falling dollar means a rising rupee and that’s clearly not a happy prospect in a world where rising protection is eating into global trade volumes. That said, the rupee-dollar rate in isolation might paint too grim a picture. What becomes critical is its performance vis-à-vis competitor currencies. Thus the fact that the rupee in 2018 has quite categorically lost its position that it enjoyed in 2017 as the region’s best performing currency might actually give cause to cheer.

Finally there is a reasonable chance that the US will remove the tariffs or offer so many riders that they cease to matter. This is not based on a wing and a prayer but instead draws on recent history. Steel tariffs are not new. The George W Bush administration imposed a steel tariff in 2002 that cost the economy approximately 20,000 jobs in the downstream sectors and were withdrawn by 2003.

That said, there is a limit to which one can put a positive spin on protection. The fact is that a global trade war cannot be good for anyone. India will not remain unscathed if things begin to hot up and there is retaliation against the US duties from China and the European Union. It might be sensible to reassess a fresh our growth prospects for the year keeping the risk of a full-blown trade war in mind.

The author is chief economist, HDFC Bank