Can India dodge the fallout of US-China trade war and decoupling push?

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2025-05-11 Indian fabrics

A customer looks at curtains at a market in Srinagar, in Indian-administered Jammu and Kashmir, on May 11. India’s excessive raw material protectionism forces Indian manufacturers and exporters to either source fabrics from China or lose export sales. © Reuters

Ritesh Kumar Singh

Ritesh Kumar Singh is founder and chief executive of policy research at Indonomics Consulting in New Delhi.

Amid the intensifying trade and tech war between China and the U.S. — unleashed by President Donald Trump’s tariff brinkmanship — the U.S. is directly and indirectly pressuring its trade partners to decouple from Chinese supply chains.

India is heavily dependent on the U.S. market. The U.S. is India’s top export destination, accounting for roughly 20% ($ 87.4 billion) of India’s total outbound shipments of $437.4 billion in FY2024/25. Given this, the current U.S. administration could compel India (and other trade partners) to delink from China by imposing stringent sourcing restrictions, either through the use of preferential (such as the India-U.S. Bilateral Trade and Investment Agreement, currently under negotiation) or non-preferential rules of origin.

However, moving away from China in the short run is not feasible as the government of Prime Minister Narendra Modi’s localization efforts are, at best, a work in progress due to multiple obstacles, including its failure to rein in India’s administrative machinery that zealously guards its discretionary power without any accountability, especially with respect to business facilitation and tax certainty. That makes running manufacturing operations commercially unviable in the country, which makes investors jittery. Also, matching China in pricing or scale is not easy.

The policy of maintaining a strong currency — which is done to support net importers and large infrastructure companies with foreign currency-denominated loans who seek to minimize or avoid hedging costs — further disadvantages Indian exports, making India less attractive as an alternative manufacturing and sourcing hub.

Moreover, the high costs of doing business coupled with a stronger rupee forces Indian suppliers to cut their operating costs by increasingly sourcing their inputs and intermediates from China, which offers unmatchable scale and pricing advantages. Rather than reducing, this further increases India’s dependence on China.

Thus, it’s no surprise that China supplies more than 70% of the key starting materials (KSM) and active pharmaceutical ingredients (APIs) used by India’s generic medicine companies. For antibiotics, India depends on China for 90% of the APIs needed for essential drugs such as penicillin, azithromycin and cephalosporins.

For fermentation-based antibiotics such as ciprofloxacin and norfloxacin, the dependency is 100%, with nearly all requirements met by China. Even when APIs are produced locally, the key starting materials for many of these drugs are still primarily sourced from China. Similarly, China accounts for 65% to 70% of India’s electronics imports, including mobile phone parts, semiconductor chips, displays and batteries, and supplies 75% to 80% of the lithium-ion batteries used in electric vehicles. It also supplies 90% of India’s requirements of rare earth magnets which are critical to electric vehicle propulsion systems.

Despite hikes in import duties on solar cells and modules, and preference to local suppliers in government procurement through policies such as the Approved List of Models and Manufacturers (ALMM), China remains the dominant source of polysilicon, ingots and wafers, and supplies 50% to 60% of solar cells, which are assembled into modules as domestic supplies are costlier as well as inadequate.

Consequently, any serious attempt to reduce this reliance — whether prompted by Trump’s tariff brinkmanship or independently — would substantially increase the costs of transitioning to green energy. Therefore, addressing the challenge of excessive reliance on China calls for a calibrated, multipronged approach that prioritizes gradual decoupling alongside a series of internal reforms to genuinely enhance ease of doing business in India.

The federal government may reimburse import duties embedded in exports, but it doesn’t compensate for cost disadvantages arising from unfavorable exchange rate policy. That calls for a market-determined exchange rate with a devaluation bias. Thus, the Reserve Bank of India should intervene only to check wild currency market fluctuations.

altA Maruti Suzuki vehicle assembly line in Manesar, in the northern state of Haryana, India, in 2023. India’s steel industry produces some of the world’s most expensive steel, prompting downstream industries, including automotive, to seek cheaper imports, with China meeting the demand through competitive pricing.   © Reuters

India’s policymakers must understand that increases in import duties on key industrial inputs often penalize higher-margin domestic sales (of value-added products), which typically cross-subsidize export sales in a country where the export basket is dominated by undifferentiated products with little to no pricing power. Consequently, any constraints on domestic sales — whether due to higher import duties that increase input costs or the elevated cost of doing business driven by growing regulatory complexity — end up discouraging exports.

India’s excessive raw material protectionism — which favors large domestic corporations controlling the supply of synthetic fibers, in particular polyester staple fiber (PSF) and viscose staple fiber (VSF), which are key inputs for the textile value chain — forces Indian apparel manufacturers and exporters into two choices: either source textile fabrics (to make apparel) from China, which offers lower prices, or lose export sales.

Due to the high cost of local non-cotton textile fabrics and relatively higher wages, Indian fashion retailers are increasingly sourcing apparel from Bangladesh, which uses cheaper Chinese fabrics that can enter Bangladesh duty-free as they are meant for export to India after being converted into garments using cheap local labor. This again increases dependence upon China.

Shielded from import competition, India’s steel industry produces some of the world’s most expensive steel. This prompts downstream industries — such as automotive, capital goods, real estate and construction — to seek cheaper imports, with China meeting the demand through competitive pricing. However, to counter rising imports of competitively priced steel (often labeled as dumped or subsidized by India’s steel lobby), New Delhi frequently raises import duties rather than lowering them to foster market competition, which could reduce domestic steel prices and discourage the use of imported steel.

Ending excessive raw material protectionism and promoting genuine ease of doing business by cutting down on regulatory cholesterol will help lower the cost of doing business and encourage localized supply chains. India must curb the harassment of small and medium-size enterprises by state goods and services tax (GST) inspectors and streamline the endless filing and reporting requirements by replacing them with quarterly tax payment and annual filing similar to income tax.

In addition, the authority to set import duties needs to be taken away from the Ministry of Finance, which is guided by only one motive: revenue consideration. That has resulted in higher duties on raw materials than finished goods, and has discouraged manufacturing of value-added products in industries like chemicals and textiles. That’s not sustainable if India aims to position itself as a credible alternative to China as the world’s factory.

Moreover, India must seek temporary exemptions for sourcing from China under its trade agreement with the U.S. that is currently under negotiation. Otherwise, its exports to the U.S. will suffer even if India secures a free trade deal with Trump’s administration. For the pharmaceutical sector, two concessions from the U.S. would help: no insistence on “WTO plus” intellectual property rights (which effectively means ever-greening of patents), and flexibility to use Chinese key starting materials and APIs for production of generic drugs. India also can’t switch off China in the solar sector in one go without jeopardizing its green energy ambition and hence needs time to adjust.

While the U.S. remains India’s top export destination, China continues to be its major source of critical inputs and intermediates that can’t easily be wished away, at least in the short run. Failing to take this reality into account while devising rules of origin will boost inflation and undermine India’s export competitiveness.

The article appeared in the asia.nikkei

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