India’s Trade Caught in the Middle

Why in News?

India–U.S. trade talks have stalled amid tariff concerns, while India faces a trade deficit with China and risks to its services exports from AI.

What is the nature of India’s external trade challenge?

• Trade With U.S.A – India runs a trade surplus with the U.S., particularly in goods.
• Trade with China – India has a persistent and structural trade deficit with China.
• India depends on China for several critical imports that are difficult to replace quickly.
• The U.S. trade surplus provides vital foreign exchange earnings.
• Higher U.S. tariffs can reduce Indian exports and increase rupee depreciation pressure.
• The exchange rate depends on the demand and supply of foreign currency.

• India’s exchange-rate mechanism – India follows a managed float exchange-rate system rather market-determined exchange rate.
  • The RBI intervenes in the foreign-exchange market to manage excessive volatility.
  • When demand for dollars rises sharply, the RBI can sell foreign-exchange reserves to increase dollar supply.
  • When there is excess dollar supply, the RBI can purchase dollars and add to its reserves.
• Persistent intervention, however, can result in depletion of forex reserves.
• This becomes more serious when combined with
  • High crude-oil import costs.
  • A structural trade deficit with China.
  • Capital outflows.
  • Geopolitical disruptions to energy supplies.

How Can AI Affect India’s Export Position?

• Automation of Routine Services – AI can automate routine coding, customer support and business-process tasks.
  • This may reduce demand for some labour-intensive IT services.
• Pressure on Services Exports – Lower demand for traditional IT services can reduce India’s service export earnings.
  • This may also reduce foreign-exchange inflows.
• Changing Global Demand – Global firms may increasingly prefer AI-based solutions over traditional outsourcing.
  • India may face greater competition from countries with advanced AI capabilities.
• Need for Skill Upgradation – India needs to shift from low-value services to AI, R&D, cybersecurity and cloud computing.
  • The workforce must be equipped with advanced digital and AI skills.
• Opportunity from AI – AI can also create new export opportunities in software, digital services and technology solutions.
  • India can become a global provider of AI-enabled services.

What are the Challenges in Export Diversification?

• Market Challenges – Many Global South markets have lower purchasing power than the U.S.  
• Building a strong presence in new markets requires time and investment.
• Infrastructure Challenges – High logistics and shipping costs can reduce India's export competitiveness.
  • Manufacturing capabilities remain uneven across sectors and regions.
• Supply-Chain Challenges – Sudden changes in export markets can disrupt established supply chains.
  • Excessive dependence on a few suppliers can create new external-sector risks.
• Skill Challenges – The shift towards AI and high-value exports requires a highly skilled workforce.
  • Skill gaps may limit India's ability to capture emerging export opportunities.
• Policy Challenges – India needs consistent trade and industrial policies to support exporters.
  • Export diversification should be gradual rather than an abrupt shift away from major markets.

What Should India Do?

• Diversify Export Markets – India should reduce excessive dependence on the U.S. market.
  • It should expand trade with ASEAN, Africa, Latin America and West Asia.
• Diversify the Export Basket – India should move beyond traditional exports and promote high-value products.
  • Electronics, semiconductors, Pharmaceuticals and engineering goods can provide greater export diversification.
  • Renewable-energy technologies and defence equipment can become emerging export sectors.
  • High-value digital and professional services can strengthen services exports.
• Strengthen Domestic Manufacturing – India should improve infrastructure and reduce logistics costs.
  • Reliable and affordable power, strong domestic supply chains, PLI schemes can support the development of globally competitive industries.
• Reduce Strategic Import Dependence – India should develop domestic capabilities in critical sectors.
  • India should diversify import sources, boost domestic production of strategic goods, and ensure no essential supply chain disruptions.
• Build AI-Resilient Services – India should develop a workforce with advanced AI and digital skills.
  • Indian firms should focus on developing AI solutions rather than only using them.
• Use Trade Agreements Strategically – India should pursue FTAs that provide wider market access for Indian exports.
  • Clear rules of origin can prevent trade-related disputes.

What lies ahead?

• India is caught between a structural deficit with China and dependence on the U.S. market for a crucial trade surplus.
• The emerging tariff and AI challenges make export diversification imperative.
• India should use this moment as a wake-up call to build a broader, more competitive and resilient export ecosystem, while maintaining constructive economic engagement with the U.S. and other major trading partners.

Reference

The Hindu| India’s trade caught in the middle