India's recent trade deal with the United States—slashing tariffs from 50 to 18 per cent—has been hailed as a diplomatic victory. Prime Minister Modi expressed gratitude, markets breathed easier, and Indian exporters finally saw relief. Yet this reprieve may prove temporary if President Trump succeeds in his parallel assault on the US Federal Reserve.
The connection isn't obvious at first glance. But for India—already grappling with capital outflows and rupee volatility—these issues are deeply intertwined. A politicised Federal Reserve could unravel the very economic stability that makes trade deals meaningful.
Why the Fed matters for India
Donald Trump's confrontation with the Federal Reserve transcends routine policy disagreement. It represents a fundamental challenge to one of the most carefully constructed institutions of modern economic governance—one explicitly designed to resist executive pressure. Federal Reserve Chair Jerome Powell, once lauded as a steady custodian, is now branded "stupid" and "incompetent" for refusing aggressive rate cuts on demand.
For India, this matters because Fed credibility underpins global financial stability. Research from the Asian Development Bank indicates that a 1 percentage point increase in US policy uncertainty translates to capital outflows of approximately 0.3 per cent of GDP from emerging Asian economies. India, which attracted over $81 billion in foreign investment in 2025, remains particularly vulnerable. The rupee's slide to ₹91-92 against the dollar—before recovering to ₹90.31 following the trade deal announcement—illustrates how dependent India's currency stability is on US policy predictability.
Why Independence matters: Lessons from the 1970s
The Federal Reserve's independence emerged from painful lessons learnt during the 1970s, when governments believed they could permanently trade marginally higher inflation for lower unemployment. Political pressure compelled central banks to maintain loose monetary policy and inflation expectations became unanchored. The consequence? Stagflation: simultaneous high inflation, anaemic growth and deep social unrest.
The remedy came through the transformative Volcker shift. Central banks received long tenures for governors, decision-making was decentralised and significant autonomy was afforded. This was deemed essential to address the "time-inconsistency problem": elected leaders face persistent incentives to prioritise short-term growth, whilst price stability demands discipline spanning years and decades. Independent central banks emerged as a firewall between politics and monetary policy.
Comprehensive empirical studies examining over 150 central banks across five decades reveal a clear causal relationship: greater independence generates enhanced policy credibility and lower, more stable inflation. A 2018 IMF working paper found that countries with highly independent central banks experienced inflation rates approximately 2-3 percentage points lower than those with politically subordinate monetary authorities. Research in the Journal of Economic Literature demonstrated further that independence reduces inflation volatility by up to 40 per cent in developed economies.
Trump's demands: Politics over Economics
Trump's campaign against the Fed strikes at the heart of this credibility. His demands for drastic cuts, targeting levels around 1 per cent even outside recessionary conditions, are grounded less in macroeconomic fundamentals than political expediency. The Federal Reserve currently maintains rates between 4.25 and 4.5 per cent, which officials argue is appropriate given 4.1 per cent unemployment and core inflation at 2.8 per cent—above the Fed's 2 per cent target.
Paradoxically, however, politicising central banks often produces worse outcomes even by a leader's own metrics. When credibility erodes, central banks must act more aggressively in subsequent quarters to reassert control, inflicting sharper slowdowns than necessary. Turkey provides a cautionary tale: President Erdoğan's interference—including dismissing three central bank governors between 2019 and 2021—contributed to inflation soaring to 85 per cent by October 2022. The Turkish lira lost over 80 per cent of its value against the dollar between 2018 and 2023.
What renders this moment especially perilous is Trump's willingness to weaponise governmental institutions against the Fed. Encouraging criminal investigations into Powell over administrative matters transmits a chilling message: asserting independence carries personal risk. This is how institutional erosion typically unfolds. Independence is not always abolished through legislation, but hollowed out through intimidation and drift. Research from the Bank for International Settlements found that even perceived political pressure can increase inflation volatility by 15-20 per cent over five-year periods.
Kevin Warsh: A Trojan Horse?
The nomination of Kevin Warsh as the next Fed chair appears superficially reassuring. Warsh served as Fed governor from 2006 to 2011 and is widely regarded as intellectually serious. Markets responded calmly, relieved Trump eschewed an overtly partisan loyalist.
Yet Warsh has been characterised as someone who will "never let you down"—a revealing phrase from a president who equates independence with betrayal. Having built his reputation as an inflation hawk after the 2008 crisis, Warsh's positions have shifted markedly. He has begun echoing White House arguments and praising Trump's "pro-growth" agenda.
Some analysts contend Warsh's dovishness may evaporate once constrained by data and institutional norms. Others warn Trump's genuine objective may be a subtler reshaping of the Fed's mandate. Curtailing its regulatory reach and nudging it closer to Treasury priorities would leave the central bank prone to dangerous procyclical tendencies.
Global ramifications: Dollar dominance at risk
Because the dollar serves as the world's primary reserve currency—comprising approximately 58 per cent of global foreign exchange reserves—the implications extend far beyond American borders. A politicised Fed raises risk premia on US assets and encourages diversification away from the dollar. The dollar's share of global reserves has already declined from 71 per cent in 1999 to 58 per cent today.
For emerging markets, consequences could prove severe. Countries like India remain particularly vulnerable. When dollar credibility weakens, emerging market currencies face depreciation pressures. A weaker rupee increases import costs, fuel inflation, and forces the Reserve Bank of India into tighter monetary policy—potentially stalling growth just as India seeks to capitalise on its trade agreement with Washington. An 18 per cent tariff matters little if currency volatility erases export competitiveness.
Lessons for India
The episode carries profound implications for India. The RBI's credibility depends not solely on statutory mandates, but on political restraint. India experienced tensions when former RBI Governor Urjit Patel resigned in December 2018 amid reported disagreements with the government. The government invoked Section 7 of the RBI Act for the first time in the central bank's 83-year history, seeking consultations on diluting capital requirements. The RBI ultimately transferred ₹1.76 lakh crore to the government, whilst former Deputy Governor Viral Acharya warned that "governments that do not respect central bank independence will sooner or later incur the wrath of financial markets".
When central banks are perceived as operating under political pressure, investors demand higher risk premia: a dynamic that becomes particularly costly during episodes of currency stress. Countries maintaining central bank independence such as Germany, Switzerland, Chile and South Africa have consistently achieved superior inflation outcomes and lower borrowing costs than those where political interference persists.
The price of lost credibility
Trump's war on the Federal Reserve tests whether mature democracies can preserve institutional guardrails under populist pressure. Monetary credibility accumulates slowly, dissipates rapidly, and proves devastatingly expensive to lose. The 1970s required nearly a decade of painful adjustment to restore credibility, including deliberate recession that pushed US unemployment above 10 per cent.
The consequences will reverberate globally. Developing nations dependent on stable dollar funding, trading partners reliant on predictable US monetary policy, and investors worldwide will all bear the costs.
For India, the recent trade deal offers breathing room, but it cannot substitute for the deeper institutional stability that only an independent Federal Reserve can provide. The question is whether democracies can defend these institutions before irreparable damage is done.
(The author is a research associate at the International Centre for Applied Ethics and Public Affairs (ICAEPA), an independent research organisation based in Sheffield)