Impact of Trump’s tariff policies on Sri Lanka and global trade

Tuesday, 8 April 2025 00:07 - - {{hitsCtrl.values.hits}}

Sri Lanka’s apparel industry, which accounts for the majority of its exports to the US, is facing significant challenges

Introduction: The US trade deficit and Trump’s tariff strategy

The United States has long experienced a significant trade deficit, importing more goods than it exports. In 2024, the US recorded a massive deficit of $ 295.40 billion with China and $ 123.46 billion with Vietnam. Other countries, including Mexico, Ireland, Japan, South Korea, and Taiwan, also contributed to the overall trade deficit. The US faced a combined trade deficit of over $ 620 billion with its five largest Asian trading partners—China, Japan, South Korea, Taiwan, and Vietnam—in 2024. As a result, the US holds the largest trade deficit in the world, reaching a record $ 1.2 trillion in 2024. Despite its relatively small role in global trade, the US maintains a negative trade balance with Sri Lanka, which amounts to around $ 2.7 billion.

On 2 April 2025, US President Donald Trump announced sweeping tariffs on imports from around 90 countries, including reciprocal tariffs of 10% across-the-board taxes on all imports into the US. This move, which Trump labelled “Liberation Day”, was designed to reduce the US trade deficit, particularly with countries like China, the European Union, and others. Under this policy, some countries would face only the universal 10% tariff, while others would face higher, specific tariffs. For example, countries like the United Kingdom, Brazil, and Singapore would face only the 10% tariff, while countries like Cambodia, Laos, Vietnam, Sri Lanka, Myanmar, Bangladesh, Thailand, and China would face higher taxes, with Sri Lanka’s tariff set at 44%. Trump’s rationale for these tariffs was simple: “Reciprocal means they do it to us, and we do it to them.”

Understanding the rationale behind Trump’s tariffs

Trump’s tariff policy is primarily designed to address the growing US trade deficit. By imposing high tariffs on foreign goods, the US hopes to reduce imports and encourage domestic production. The strategy aims to replace income taxes with these tariffs, making foreign goods more expensive and less competitive, theoretically boosting US manufacturing. However, several fundamental weaknesses and risks are associated with this approach.

The inherent weaknesses of Trump’s tariff policy

Trump’s tariff policy is fundamentally flawed, as it disregards established economic principles and global trade dynamics. Trade taxation, criticised since Adam Smith’s Wealth of Nations (1776), is considered a “beggar-thy-neighbor” strategy. In recent decades, the global trend has been toward liberalised trade regimes, under the leadership of the World Trade Organization (WTO). Trump’s tariffs represent a sharp break from this trend, reversing decades of progress.

The assumption that other countries will not retaliate is highly naive. Countries like China have already responded with retaliatory tariffs, and the European Union has expressed objections. Additionally, Trump’s belief that US industries can thrive while relying on imported raw materials—or his assumption that the US can easily replace these imports—is problematic. Higher production costs due to tariffs will lead to price increases for consumers, hurting domestic industries and possibly resulting in inflationary pressures. Moreover, replacing income taxes with tariffs on external trade poses its own set of practical and economic difficulties.

There may be a hidden strategy behind this approach, however. When a larger country imposes tariffs on a smaller one, the smaller country’s goods become less competitive. As a result, these countries may lower their prices to remain competitive, despite the tariff, allowing the larger country to benefit both from the tariffs and the continued flow of cheaper goods.

Global reactions and escalating trade tensions

Following Trump’s tariff announcement, stock markets in both Asia and Europe saw deep losses. The S&P 500 index in New York fell by 4.8%, its largest drop since the COVID-19 pandemic. European markets also suffered significant declines, with Frankfurt losing 5%, Paris dropping more than 4%, and London falling 3.8%. Tokyo’s Nikkei index closed 2.8% lower, and Japanese Prime Minister Shigeru Ishiba called Trump’s tariffs a “national crisis.” Despite these market movements, Trump remained confident, dismissing the downturn and predicting that stocks would “boom.”

Within 48 hours of Trump’s declaration, China retaliated by imposing 34% tariffs on US imports. China also warned it would file a complaint with the WTO and implement export controls on critical materials like rare earth elements, essential to consumer electronics and medical technology. Meanwhile, France and other countries worldwide began evaluating their options, and the European Union prepared for talks with US officials. The global response highlighted the risk of a protracted trade war, which could potentially lead to a global recession.

The assumption that other countries will not retaliate is highly naive. Countries like China have already responded with retaliatory tariffs, and the European Union has expressed objections. Additionally, Trump’s belief that US industries can thrive while relying on imported raw materials—or his assumption that the US can easily replace these imports—is problematic. Higher production costs due to tariffs will lead to price increases for consumers, hurting domestic industries and possibly resulting in inflationary pressures. Moreover, replacing income taxes with tariffs on external trade poses its own set of practical and economic difficulties

The consequences of Trump’s tariffs for Sri Lanka nd smaller economies

For smaller economies like Sri Lanka, the impact of these new tariffs is particularly devastating. Sri Lanka’s apparel industry, which accounts for the majority of its exports to the US, is facing significant challenges. In 2024, Sri Lanka exported nearly $ 3 billion worth of goods to the US, with over 70% of these exports coming from the apparel sector. However, the 44% tariff now imposed on Sri Lankan goods will make these products increasingly uncompetitive in the US market.

The new tariff would raise the cost of Sri Lankan garments, making them much more expensive for US importers and retailers. This price increase could lead to a significant drop in demand for Sri Lankan products, putting pressure on companies like MAS Holdings, Brandix, and Hirdaramani. Smaller exporters relying heavily on US markets could face factory closures, layoffs, or production cuts, further exacerbating the challenges for Sri Lanka’s economy. Additionally, this tariff could negatively impact other vital Sri Lankan exports, such as rubber products, coconut products, and tea, all of which are important to the rural economy and employment.

Given the fragile state of Sri Lanka’s economy, which is emerging from a debt crisis and struggling with inflation, debt restructuring, and declining foreign reserves, the new tariff could undo recent recovery gains.

The potential for Trump to reconsider his strategy

Despite the aggressive nature of Trump’s tariff policies, there is a strong possibility that the US could step back from this strategy. The escalating trade war, combined with mounting internal pressures like inflation, rising interest rates, and increasing costs for imported raw materials, could force Trump to reconsider his approach.

The retaliatory tariffs imposed by other countries, including major trade partners like China and the European Union, could lead to a reduction in US export sales. As these countries increase tariffs on US goods, American exporters may see a sharp decline in demand for their products, further exacerbating the US trade deficit. Moreover, countries with large US dollar reserves might choose to diversify their holdings, potentially weakening the US dollar.

In such a scenario, the US may be compelled to reconsider its tariff strategy to stabilise its economy and restore global trade relations. The political and economic consequences of these tariffs could push the US to renegotiate or reduce the tariffs as mounting external and internal pressures increase.

What Sri Lanka can do moving forward

Short-term solutions for Sri Lanka

Regaining GSP+ status: In the immediate term, Sri Lanka should work to negotiate with the US to regain GSP+ status, which would allow its apparel exports to continue benefiting from preferential treatment. However, this would require Sri Lanka to make significant concessions, such as reducing para-tariffs, special commodity levies, and VAT on US products.
Regional cooperation: Another short-term strategy involves engaging in regional cooperation. Sri Lanka could work with other countries affected by the tariffs, such as Bangladesh, Myanmar, and Thailand, to form a collective bargaining front. Although these nations are competitors in the US market, joining forces could strengthen their negotiating position with the US and create a more powerful voice for fair treatment in international trade talks.
Strengthening trade relations with regional partners: Sri Lanka should also work to strengthen trade relations with regional partners such as India and countries in East Asia and Africa. These markets are seeing increased demand for Sri Lankan products, and pursuing Free Trade Agreements (FTAs) with these countries could help offset the negative effects of the US tariffs.

Long-term solutions for Sri Lanka

Diversifying export portfolio: In the longer term, Sri Lanka must focus on diversifying its export portfolio to reduce its dependence on the apparel sector. Expanding into high-value sectors such as technology, services, and agriculture could offer greater stability and growth opportunities. However, this shift will require substantial investment in skills development, infrastructure, and innovation.
Expanding global market reach: Sri Lanka should work to expand its global market reach beyond traditional trade partners. This could involve exploring new emerging markets in Asia, Africa, and Latin America, where demand for Sri Lankan products is growing. By diversifying its export destinations, Sri Lanka can reduce its vulnerability to shifts in US trade policies and global market dynamics.
Improving domestic competitiveness: Sri Lanka must improve its domestic competitiveness through economic reforms and enhancing its industrial capabilities. This could involve fostering greater productivity, improving labour skills, and investing in innovation across various sectors. By strengthening its competitive edge, Sri Lanka can become a more attractive trading partner and improve its resilience to external trade pressures.

Conclusion: Strategic approaches for Sri Lanka’s future

Sri Lanka’s immediate challenges due to Trump’s tariffs require tactical short-term solutions, such as negotiating GSP+ status, forming regional coalitions, and strengthening trade with nearby countries. However, for long-term economic stability, Sri Lanka must focus on diversifying exports, seeking new global markets, and investing in structural reforms to bolster its competitiveness. By taking both short-term and long-term actions, Sri Lanka can navigate the turbulent trade environment and build a more resilient and sustainable economy.

(The writer is Senior Lecturer in Economics, Department of Economics, University of Ruhuna.)

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Impact of Trump’s tariff policies on Sri Lanka and global trade

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