India may become surprise victim of US-China trade war, says Rabobank

India’s economy will be hit hard by a combination of a global tariff war and the US Federal Reserve’s monetary tightening cycle, according to a study by economists at Rabobank International.

A tariff war will reduce exports and lead to imported inflation, which will hurt Indian purchasing power and investments, according to the Rabobank study. That could mean as much as 2.3% of missed GDP growth for India by 2022.

“Many countries could end up being caught in the middle,” economists Hugo Erken, Raphie Hayat and Marijn Heijmerikx wrote about the current trade spat between the US and China. “India could fall victim to adverse trade policies” of the US or China or both.

They cite three possible scenarios how this could happen:

China targets Indian exports because the nation is regarded to be an American ally India chooses not to side with the Donald Trump administration and the US has a go at Indian exports India retaliates against the US.

The last scenario is likely to cost the Indian economy the most, they wrote.

This goes against the argument that India is relatively insulated from a trade war, given its low share of total world exports of just 1.7%. President Donald Trump has threatened tariffs on $150 billion of Chinese imports in retaliation for alleged violations of intellectual property rights, while Beijing has vowed to retaliate on everything from American soybeans to planes.

Besides a possible trade war, a faster-than-expected tightening of US monetary policy will lead to capital outflows. Rabobank’s models estimate India losing $22 billion in capital flows by 2022, with the scenario getting complicated further, in case political instability hits India. India goes into its general elections early next year.

In such an event, the Rabobank model sees the rupee depreciating sharply and the missed capital flows will amount to $32 billion by 2022, they wrote.

“If India uses its foreign reserves in such a case, interest rates could rise sharply as liquidity decreases,” they wrote, adding that even though India’s reserves are substantial, markets might still become concerned about the prospects of further declines. “All in all, these developments will create major speed bumps on India’s road to economic prosperity.”