Nepal and the US-India tariff tiff

Indian Prime Minister Narendra Modi and US President Trump have had a love-hate relationship. The two populist leaders have now fallen out, threatening a full scale Indo-American trade war.

Many of Nepal’s exports to the United States like garments and rugs are also what India sells to the US. So, after Donald Trump announced additional tariffs on Indian exports to total 50%, Nepal could have an advantage.

But this is only if the government plays its cards right and develops a long term strategy to boost export of items in which it has comparative advantage, and find new export products.

The recent fallout ostensibly comes after India ignored western sanctions and continued to purchase Russian oil, and could be linked to Trump’s meeting with Russian president Vladimir Putin in Alaska on Friday in which he wants to use India as a bargaining chip.

“Trump has not honoured any international trade agreements, making the global trade regime unstable,” says economist Posh Raj Pandey. This could mean that the US could still pull back on tariffs, just as he has given China a reprieve of another 90 days this week.

Compared to other South Asian countries, including India, Bangladesh and Sri Lanka, Nepal faces a relatively low tariff rate of 10%. Theoretically this could put Nepali exports at an advantage for items like garments and other products like tea. But it also carries its own risks.

Some 64% of Nepal’s imports are from India, and US tariffs could make those products more expensive. A stronger USD vis-a-vis the INR would also devalue the Nepali rupee and increase the cost of imports from India of raw material for its exports, for example, garments.

The manufacturing sector in Nepal has never reached its true potential, its main export items to India are soya and palm oil which are actually just bulk imports of the same oils repackaged for export. Domestic production lacks capacity to keep up with demand.

“Nepal’s productive capacity must be increased in order to boost exports, and the market should be diversified for Nepal to take advantage of a competitive market,” says Pandey.

Indian exporters could try to reroute their finished products through the open border with Nepal, changing the tag from ‘Made in India’ to ‘Made in Nepal’ to avoid US tariffs. China did this by relocating its factories to Vietnam in the past, but such re-labelling may result in punitive measures.

“It is not worth the risk, we should be careful. Besides, there is no domestic value addition in such cases,” states Kharel.

Nepal has a trade deficit with the US of Rs7.64 billion, which is probably why Trump has not increased tariffs on Nepal’s exports to more than 10%. Nepal’s main exports to the US are ready-made garments, dog chews and carpets. Nepal had preferential market access to the US, but did not take much advantage of it.

“Nepal’s garment export to the US stands at Rs2 billion, and we could try to increase production and export more to take advantage of relatively lower tariffs, but reaching production worth Rs10 billion is not practical and Nepal does not have the capacity either,” says Pandey.

Furthermore, if Nepal increases exports to the US and creates a trade surplus, it may raise eyebrows in Washington and Nepal could be slapped with higher tariffs if Trump is still around.

In a modern multilateral world, Donald Trump has pressed ahead unilaterally, using tariffs to arm-twist allies to get all kinds of concessions, even those not related to trade. Trump thinks he is doing this to protect the domestic US industry, but it is already backfiring with higher domestic consumer prices.

Adds Pandey, “Trump has used the tariffs as a Swiss Army knife to cut through everything. The tariffs are used as an instrument for national security, to increase investment and even to end conflict.”

Trump claimed he initiated the ceasefire between India and Pakistan over their recent conflict by threatening both countries with tariffs. New Delhi denied Trump’s claims, while Pakistan acknowledged his role, even nominating him for the Nobel Peace Prize.

REGIONAL HEGEMON

“India had wanted to establish itself as a regional hegemon by aligning itself to the West,” says Paras Kharel, executive director at South Asia Watch on Trade, Economics, and Environment (SAWTEE). But the tariff tiff with India may have thrown that strategy off kilter.

Most countries use diplomatic channels to resolve existing trade issues. However, Trump has chosen the path of coercive diplomacy, which was seen in his response to issues like migration and the use of veto power at the United Nations.

India is the world's third largest consumer of oil, with Russia accounting for 30% of the country’s oil imports. Russia was also the largest arms supplier for India, but that has decreased in recent times, as India shifted towards the US, Israel and France.

India is the largest arms importer in the world, and is making more and more purchases from American manufacturers of weapons systems. But India has already retaliated by cancelling planned imports of military equipment from the US.

Uncertainty looms large as Trump’s volatile flip-flopping upends global trade. The unpredictability was underlined by Trump extending his tariff truce for China by 90 days, saying Beijing "has been dealing with it nicely". The tariff threat on Indian exports could also be similarly postponed if New Delhi appeases Trump with compromises.

But Modi seems in no mood to give up India’s national interest, especially by allowing American agricultural imports. Modi is all set to visit China for the first time in seven years for the Shanghai Cooperation Organisation (SCO) Summit on 31 August in Tianjin.

This could signify the beginning of a major realignment in geopolitical alliances in the Asia-Pacific. Nepal is a small player, but when India and China are buffeted by global turbulence, it will rock Nepal as well.

Nepal therefore needs to boost trade capacity to take advantage of new opportunities. Says Pandey, “Nepal needs to diversify its exports, find new markets and seek alternative finance sources.”