Where US tariffs can really hurt

India’s exports of steel and aluminium to the US are not significant; protectionist American tariff hikes are unlikely to immediately dent the Indian metals sector. The impact, however, may come through an indirect route.

Written by Sunny Verma , Anil Sasi | Updated: March 13, 2018 6:54:37 am
The US has announced a 25% tariff on steel imports from all countries except Canada and Mexico. (Reuters)

The Trump administration last week announced a 25% tariff on steel imports and 10% on aluminum. Canada and Mexico, the top two overseas suppliers of the metals to the US, were exempt. The European Commission reacted with outrage, which included implied threats of a retaliatory trade war.

The decision, made under a section of a rarely used American federal Act of 1962, may not, however, have any immediate or direct impact on the Indian metals sector. This is because only about 4% of Indian steel exports and 2% of aluminium exports are headed to the US. A greater worry for India could be the indirect impact: the potential cascading inflationary impact of the decision in the US itself. Here’s how.

Impact on India’s metals sector

A Morgan Stanley report pegged India’s steel exports to the US at less than 1% of the total Indian production, and about 4% of India’s steel exports. According to Kotak Institutional Equities data, India’s aluminium exports are just 2% of the total US imports of the metal. Going forward, a bigger concerns that extends beyond the immediate concern from a commodity/export good perspective for India would be if the Trade Expansion Act of 1962, Section 232(b), which gives the US the right to investigate whether certain imports, or high levels of certain imports, pose a threat to its national security, is expanded to products other than metals, which constitute a bigger share of India’s export basket.

Cascading inflationary impact

Within the US domestic economy, higher inbound steel and aluminum escalates the threat of higher consumer prices caused by importers passing on their increased costs for raw materials, which could then force the Federal Reserve to frontload its interest rate glide path — that is, raise rates faster than it would have done otherwise. An increase in interest rates in the world’s largest economy has implications for emerging economies such as India, both for the equity and debt markets. The Fed is so far on track to raise interest rates at least three times this year; market analysts, however, say Fed Chair Jerome Powell could rates more than thrice to prevent the US economy from overheating.

The Fed is also slated to pursue its scheduled reversal of the easy money policy, or the so-called quantitative easing of the last decade, going ahead. The American central bank had said in September 2017 that it would start shrinking its balance sheet by selling the treasury bonds and mortgage-backed securities that it had accumulated after the Lehman Brothers crash in 2008, in order to inject liquidity in the markets. From $ 20 billion a month at present ($ 12 billion of treasury securities that are being allowed to mature each month without being replaced, alongside another $ 8 billion of mortgage-backed securities), the sale of such securities is slated to go up in the coming months, according to available details from the January 30-31 meeting of the US Federal Open Market Committee. With this, the Fed would gradually wind down the $ 4 trillion in holdings that it acquired during the phase of quantitative easing.

Even a minor disruption in the US financial markets can have major implications for India. These three external risk factors — higher tariffs, rising interest rates and elevated bond sales — come at a time when the domestic banking system is grappling with a renewed stress of bad loans and the fallout of the PNB scandal. The Indian economy, especially the financial markets, will need to brace for significant volatility and stress from the combined effects of global and domestic challenges.

Impact on interest rates and debt market in India

The US is the world’s largest steel-consuming nation, and higher tariffs on imports is likely to push up its domestic inflation. For India, the impact will be significant through the channel of interest rates. Yields in the US market have been inching up since mid-2016, and have risen from a low of around 1.5% per year to 2.88% now. The yield on benchmark US bonds hovered around 5% in 2007, a year before the start of the global recession that forced the central banks of developed countries to cut interest rates to near-zero. While a reversal to pre-2008 levels will only be gradual, the rise in yields could be faster than anticipated.

The Indian government securities market has been falling for the past seven months on cues of rising US yields and projections of increased local inflation. The yield on benchmark 10-year government bonds has risen from 6.5% last August to 7.86% on Friday. When yields rise, prices of bonds fall, resulting in mark-to-market losses for PSBs. Indian banks, stressed by bad loans, may have to incur mark-to-market losses of up to Rs 20,000 crore in the January-March quarter, analysts say.

Impact on equity markets

Rising interest rates in the US could mean a potentially rough ride for the Indian equities market. Higher US rates lead to outflows from emerging market bonds and equities as investors look to chase higher returns in their home country. While a surge in domestic inflows, especially mutual fund money, is a reassuring factor for Indian equities, higher interest rates do make the option of investors borrowing cheap money in the US and investing in Indian equities significantly less attractive. The benchmark Indian equity indices have already fallen by more than 9% from their peaks since January. However, rising global interest rates also signal a strengthening economy, which could have a positive impact on international trade and domestic growth.

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