23 May 2019

India Waits Warily for a U.S. Trade Salvo

The prospects of a U.S.-India trade war — which would be marked by U.S. tariffs on a wide range of Indian imports — will hinge on the outcome of a possible U.S. investigation into India's trade practices. India, which recognizes it's a lower priority in U.S. trade negotiations, will be more likely to negotiate a trade package once a new government is formed after its national elections conclude later this month.  If India chooses to continue buying Iranian oil, it will buy a reduced amount under a rupee-based payment mechanism to avoid U.S. sanctions.

There's nothing like a common rival to bring two countries together — at least on defense. India and the United States, both eyeing China's rise with concern, are moving closer militarily. Their common strategic interest in countering China, however, does not equal an alignment on other issues: The United States is pushing India to further open its markets to American commerce, halt purchases of Iranian oil and ease recent e-commerce regulations that could impede foreign investment. The demands, in fact, have even fueled speculation that India could emerge as a new front in U.S. President Donald Trump's trade war.

The Big Picture

New Delhi has recently grown closer with Washington, but their relationship is exposing India to U.S. demands over trade barriers and Iranian oil imports. In its 2019 Second-Quarter Forecast, Stratfor noted that Prime Minister Narendra Modi would likely hold off on making any trade concessions to the United States until the results of the Indian elections are revealed later this month. Regardless, India will struggle to accommodate U.S. wishes as it balances between appeasing Washington and safeguarding its core interests, including protecting its domestic industry and preserving its partnership with Iran.

Given its limited ability to retaliate, India will seek to avoid any larger trade disputes with the United States, a vital export market. Even so, the prospects for a confrontation will ultimately depend on how the United States chooses to act. Washington has shown it has no qualms about launching trade disputes with other Indo-Pacific partners, including Japan and South Korea. To be sure, India remains a second-tier concern amid the administration's more pressing trade issues with China, the U.S.-Mexico-Canada Agreement (USMCA), Europe and Japan. But if Washington resolves these disputes — and remains unsatisfied with progress in its trade talks with New Delhi — the risk of a U.S.-India trade war will grow, hurting businesses on both sides of the divide.

Curtailing India's Favorable Access

India, which enjoyed a $24 billion trade surplus with the United States last year, benefits from the Generalized System of Preferences (GSP), a program that the United States initiated in the 1970s to boost trade with developing countries. In April 2018, however, the U.S. trade representative began a review of India's tariff benefits under the GSP after industry groups representing the U.S. dairy and medical devices sectors complained that Indian barriers to trade were limiting their exports. Then, last month, Trump triggered a 60-day review period in Congress to revoke India's GSP status. India has sought to accommodate U.S. interests, yet it also has core concerns that it must safeguard, particularly in its dairy industry, where reverence for cows and vegetarianism in Hinduism entails stricter requirements on the production of milk. At the same time, it wishes to cap prices on medical devices to ensure affordability.

By itself, a decision to revoke India's GSP benefits would have a minimal impact economically, raising tariffs on only about 10 percent of its exports to the United States. But the decision to pursue that course is as much about the program itself as it is about India, with the White House arguing that the GSP has outlived its usefulness. At the same time, the program has become emblematic of a broader debate playing out at the World Trade Organization, with mature economies such as the United States and the European Union on one side and developing countries such as India and China, which are seeking the right to identify as "developing" nations to justify their trade practices, on the other. Under a program like the GSP, the United States has given preferential access to U.S. markets to poor and developing countries without reciprocal access to their markets.

Nevertheless, the GSP debate marks an escalation in the U.S. trade dispute against India, as it could trigger $235 million in retaliatory tariffs from New Delhi. But a more serious escalation would occur if the U.S. trade representative launches an investigation into Indian trade practices under Section 301 of the U.S. Trade Act of 1974. If the representative determines that India is engaging in unfair trade practices, it could legally justify imposing tariffs on a wider range of the goods and services that India exports to the United States. This, naturally, would present problems for India, since the United States is its largest export destination. India, which exported $83.2 billion in goods and services to the United States last year, has already offered Washington concessions in its dairy and medical device sectors — in spite of its special sensitivities on the matter — but the measures have failed to alter the administration's course. For the moment, India is holding off on taking any further action that could upset its ally: On May 14, it moved for the eighth time to delay imposing retaliatory tariffs in an effort to keep the dispute on ice. The next move, accordingly, is Washington's.

Disputes Over Energy and E-Commerce

Energy has emerged as another area of contention between the United States and India, particularly as Washington has threatened to impose secondary sanctions against companies that buy Iranian oil. That's a problem for India, which counts Iran as a key supplier. Over its last fiscal year, which ended March 31, India imported 23 million metric tons of crude from the Islamic republic, accounting for 11 percent of its total imports (Venezuela, another Indian supplier, is also under sanctions). In November, the United States granted a sanctions waiver to a group of countries, including India, in exchange for a reduction in their imports. The four state-owned Indian firms that continued to purchase Iranian oil duly scaled back their purchases (Iranian shipments to India fell from an average of 500,000 barrels per day (bpd) year-on-year to 277,000 bpd in April).

Today, Indian firms are reported to have halted all shipments of Iranian oil — though New Delhi is negotiating with Washington to exempt shipments of some 4 million metric tons of oil already en route. And following Iranian Foreign Minister Javad Zarif's visit to New Delhi on May 14, India has announced it will make a final decision after its new government is formed on whether to continue to import Iranian oil. If New Delhi does renew its imports, it would likely do so under a rupee-based payment mechanism in order to sidestep U.S. sanctions. Washington, in turn, would then have to decide whether to enforce oil sanctions against India or hold off as it did with sanctions targeting Russian arms customers after India signed a multibillion-dollar agreement to buy S-400 air defense systems.

So long as New Delhi is convinced that India is of secondary importance for Washington, it will delay talks on negotiating a trade package until after it forms a new government.

Finally, while e-commerce is disrupting brick-and-mortar retail operations all over the world, it's also at the heart of an intensifying clash in India between the needs of foreign investment and domestic politics. On Feb. 1, New Delhi began implementing new regulations pertaining to foreign-backed e-commerce platforms. The regulations, which Prime Minister Narendra Modi's government announced in December 2018, aim to create neutral e-commerce platforms through various means, including measures to prevent firms like Amazon India and Walmart-owned Flipkart from selling products in which they own a stake. Modi unveiled the plans ahead of India's national elections, in part because the government's demonetization campaign in 2016 and a new goods and services tax in 2017 hit small-business owners and traders hard. U.S. Commerce Secretary Wilbur Ross, however, has complained that the regulations could hurt future American foreign direct investment in India.

Entering Washington's Radar

Expectations shape behavior. So long as New Delhi is convinced that India is of secondary importance for Washington, it will delay talks on negotiating a trade package until after it forms a new government following election results later this month. India's position in other trade talks — the Regional Comprehensive Economic Partnership with other countries in the Indo-Pacific — highlights New Delhi's approach, as it is tying the phased liberalization of tariffs to better market access for its robust information technology sector. Incidentally, the American tech sector — a favored destination for Indian IT professionals — has become another bone of contention: Trump's emphasis on hiring U.S. workers has led his administration to tighten U.S. H-1B visa policy, which complicates entry for Indian applicants, the program's biggest beneficiaries. This remains a key concern for India, so New Delhi is likely to seek assurances on this front as part of any bilateral trade package.

India will look to soothe tensions with the United States by exercising restraint in its talks as it negotiates a mutually beneficial trade package. Even as the two maintain divergent positions on commerce, their mutual rivalry with China will cultivate closer defense ties, as evidenced by joint anti-submarine warfare drills featuring Indian and U.S. P-8 aircraft in April — the same month that the administration moved to revoke India's GSP benefits. In the end, the United States and India view each other as lucrative markets with untapped potential, so any efforts to contain their disagreements will ensure that lingering opportunities — including U.S. interest in a $15 billion Indian air force contract — are not lost.

But ultimately, the fate of the countries' bilateral trade relationship rests with the United States, which has not spared other strategic allies, such as Japan and South Korea from trade threats, to say nothing of the hard line its taken on China. And as the United States moves beyond addressing its top-tier trade concerns — the USMCA, China, Europe and Japan — Washington's gaze will turn toward New Delhi. As it does, the chances of a clash over trade will only grow.

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