India Is Rewriting Its Playbook, at Home and Abroad, as U.S. Tariffs Rise

Auto manufacturers are seen as one potential winner from tax cuts India approved on Thursdau. Above, customers enter a Maruti Suzuki India showroom in Uttar Pradesh., in 2021. (Prashanth Vishwanathan/Bloomberg)

India is in recalibration mode.

The government has responded to a major disappointment in terms of trade with the U.S. by stepping up efforts to overhaul the economy, including major changes to the tax system that authorities approved on Thursday. At the same time, it is trying to repair the country’s strained relationship with China, its neighbor and rival.

Contributing to the shift is the U.S.’s decision to hit India with 50% tariffs after trade negotiations soured—a surprise given Prime Minister Narendra Modi’s strong relationship with President Donald Trump and years of efforts by Washington to cultivate a stronger relationship with New Delhi.

“The U.S. trade tariffs have shaken the government out of its policy complacency, compelling it to focus once again on domestic , find ways to support growth, and expand its outreach with other countries,” Shumita Deveshwar, chief India economist at TS Lombard, said via email.

On Thursday, India passed the biggest overhaul in its goods-and-service tax regime since its introduction in 2017. Levies will fall on a host of consumer goods—the tax on essentials like shampoo and toothpaste will go to 5% from 18%—taxes on premiums for life and health insurance will be eliminated, and the tax rates for bigger items like air conditioners and large televisions will be reduced.

Strategists see the tax overhaul both as part of a new policy push that could give Indian stocks a lift in the near term, and as an example of the various ways countries are navigating the uncertainty created by President Donald Trump’s trade policies.

Bernstein strategists Venugopal Garre and Nikhil Arela estimate the tax overhaul alone could result in a $20 billion full-year boost to households. They say it is likely to revive sluggish domestic demand that has held back the Indian stock market so far this year.

The iShares MSCI India exchange-traded fund was essentially flat at $52.44 Thursday morning but is down 7% over the past year. That compares with a 20% gain for the iShares MSCI Emerging Markets ETF.

“The sheer scale decisively ends any uncertainty around the government’s stance on boosting consumption,” the Bernstein strategists said in a research note. Though valuations for consumer stocks are already high, the duo sees potential for further gains as earnings rise.

HSBC equity strategists in Hong Kong expect stronger consumer demand. Companies in food and personal care, retailing, insurance, renewables, agrochemicals, and automotive manufacturing are the most likely beneficiaries, they said a research note. Makers of small personal vehicles and two-wheelers stand out as winners in the latter sector, they said.

The tax overhaul and other changes should help earnings growth reaccelerate in the fourth quarter, rising from single digits for the past five quarters to 14% in 2026, according to the HSBC strategists. They wrote that the policies have lowered the risk of earnings downgrades and could draw foreign investors back to the market despite the setback on trade.

Analysts had expected negotiations to be difficult given India’s history of protectionist policies, but the degree of the unraveling took people by surprise. Among the issues in the end were U.S. demands for access to India’s politically critical agricultural sector, India’s purchases of Russian oil, and Modi’s pushback against Trump’s claim to have resolved this year’s conflict between India and Pakistan.

While political consultants expect negotiations to resume, the tenor of the relationship has changed, with anti-India rhetoric building. This week, Trump called the U.S.-India trade relationship a “totally one-sided disaster.”

As a result, India is seeking to strengthen its ties with other countries. That outreach includes a very public show of unity with Russia’s Vladimir Putin and Chinese leader Xi Jinping over the weekend. Modi visited China for the first time in seven years, seeing to repair India’s relationship with Beijing.

Xi and Modi stressed the two should be partners rather than rivals, and the Chinese leader noted that it was the right choice to have the “dragon and elephant dance together.”

The thawing in Sino-Indian relations, which had been strained since a 2020 border skirmish killed Indian soldiers, bodes well for more trade and foreign direct investment for India. But Deveshwar cautioned against runaway optimism, saying the two are still fierce rivals in a deeply unbalanced trade relationship.

India both buys far more from China than it sells and competes with China in the U.S. market. And the latest tariff developments put it at a disadvantage rather than giving it the edge many had anticipated when a U.S.-India trade agreement seemed plausible.

The 50% tariff rate has ground shipments for Indian textiles, gems, and footwear to a halt, Deveshwar said. “Even if India gets greater access to the Chinese market, it won’t offset the loss of US market share,” she added.

To complicate matters, India has grown increasingly skittish about Chinese investments. In 2023, it rejected a $1 billion proposal by BYD, the Chinese electric-vehicle company, to set up a factory in partnership with an Indian firm. More recently, China’s Ant Group exited a stake in the Indian fintech Paytm as India scrutinized Chinese investments more closely.

India is also emerging as a destination for companies looking to diversify out of China, a trend that is likely to continue. While that will feed the rivalry, it is a reminder of India’s longer-term prospects.

The country remains a favored longer-term destination for investors who recognize that its relatively young population, the world’s largest, positions it for economic growth. The resetting of trade and geopolitical relationships now under way could improve India’s prospects if the government is able to use its current challenges to follow through on structural overhauls.

Write to Reshma Kapadia at reshma.kapadia@barrons.com