Asia FX Talk - Reciprocal tariffs - an eye for an eye?

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Market Highlights

The dollar strengthened and risk assets fell heading into the weekend, as markets parsed the net impact of tariff developments, a decent January US non-farm payrolls, and amid signs of rising inflation expectations indicated by the U of Michigan survey.

In particular, President Trump said on Friday that he plans to announce reciprocal tariffs on many countries by Monday or Tuesday this week. He did not identify which countries would be hit but suggested it would be a broad effort, and could also be done in place of the universal 10-20% tariffs mentioned previously. Meanwhile, Trump said that tariffs targeting automobiles were also under consideration. We have been placing a somewhat lower probability on reciprocal tariffs given the likely meaningful increase in administrative costs in implementation, coupled with the requirement of legislation if this were done on a full reciprocity basis across all countries.

While the details are still unknown, we note that India looks more vulnerable in this regard. Our analysis shows that US tariffs on India could rise to above 15% in theory from ~3% currently, if full reciprocity were enforced in theory. This in part reflects the high tariff rates India places on its agriculture sector, coupled with a long-tail of products with tariff rates of 10% or higher. Meanwhile, countries such as Indonesia, Thailand and Vietnam could see their weighted tariff rates by the US rise to ~7-10%.

We still view full tariff reciprocity as quite unlikely, even as we acknowledge the left tail risks for countries such as India. We note that India’s government has already been proactively addressing Trump 2.0’s concerns on the tariff front by cutting custom duties most notably on higher profile items such as Harley Davidson high-end motorcycles, and has also been accepting the deportation of unauthorized immigrants. All these comes ahead of Prime Minister Modi’s upcoming trip to meet Trump on 13 Feb, and we think the good relationship between Trump and Modi historically should imply negotiation being more likely than not.

Regional FX

Asian currencies were mixed to weaker on the back of developments around tariffs coupled with the non-farm payrolls print. The Reserve Bank of India cut its key repo rate by 25bps, bringing it to 6.25% from 6.50% previously. While this was in line with our forecasts (see IndiaPulse – Let it go), we note that heading into the policy meeting there was speculation of a larger rate cut, perhaps leading to USD/INR rising quickly above 87.50 this week before settling down today at 87.42. We were of the view that a jumbo rate cut at this juncture would be a policy mistake given significant global uncertainties, and as such take it as a positive for FX that they did not do so. We sense from the press conference that the new RBI Governor leans dovish, even as he is cognisant that there are “no free lunches” with policy trade-offs between achieving financial stability and promoting growth. In addition, his comments suggest to us he is willing to allow more flexibility in the Indian Rupee, saying that INR is “market-determined” and RBI’s key policy is not to target any specific INR level or band. We maintain our forecasts for RBI to cut the repo rate by another 50bps, bringing it to 5.75% by the end of FY2025/26. For now, we maintain our USD/INR forecast of 88.50 by the end of calendar year 2025, even as we acknowledge that the current spot rate has already exceeded our 1Q forecast. Our key message to clients remains the same - the path of least resistance is for further INR weakness, with some underperformance against other Asian currencies, and with depreciation being more front-loaded before tapering off later in the year. Today’s policy meeting has reinforced our views.