Arun Jaitley will present the last budget of the Narendra Modi government’s current term on 1 February. It will be an interim rather than a full budget . The interim budget will likely be the last macroeconomic policy statement by this government before the 2019 Lok Sabha elections. This is a good time to look back at the macro strategy—and not the economic reforms record—over the past five years.

The Modi government took office at a time when the Indian economy was still recovering from the macroeconomic policy errors of its predecessor. High inflation, high fiscal deficits and high current account gaps had led to a run on the rupee in the middle of 2013. P. Chidambaram tried to tighten policy after he took over the finance ministry from Pranab Mukherjee. Raghuram Rajan at the Reserve Bank of India (RBI) had also begun to increase interest rates.

Jaitley continued with the macro stabilisation. The focus was on fiscal discipline. The Indian central bank was also given a formal inflation target. There was a big stroke of luck. Global oil prices collapsed in the dying months of 2014. India got an economic boost from this positive shock to its terms of trade with the rest of the world. The big dilemma was whether to pass on this benefit to households through lower domestic fuel prices or use the windfall to strengthen public finances through tax hikes. The Modi government did well to choose the latter course.

The improvement in net exports provided a temporary boost to economic growth. There were also deeper challenges to be addressed. India was depending too heavily on private consumer spending. Corporate investment had fallen off a cliff because of excess capacity, balance sheet stress and weak banks. Arvind Subramanian had argued that the government needed to boost public investment to fill the gap created by weak private investment. The oil bonanza had provided the fiscal resources, but public investment did not take off in a big way. Private investment continued to struggle.

The RBI was also focused on its stiff inflation target. Headline inflation halved over the tenure of the Modi government. Hikes in minimum support prices were modest till 2018. Inflation was muted partly due to deflation in food prices. Critics of inflation targeting argue that Indian farmers have borne the burden of the new monetary policy regime. It is a serious concern. However, what cannot be disputed is that Indian inflation is now closer to global inflation.

The sharp decline in the domestic investment rate helped reduce the current account deficit, which is the difference between domestic investment and domestic savings. The improvement in the current account masked the fact that the domestic savings rate has drifted down over the past decade. There could be external stress in case investment cycle turns without an improvement in the savings rate.

A narrowing trade gap combined with strong capital inflows pushed up the rupee, despite dollar buying by RBI. That was the story in many other Asian economies. The overvaluation of the rupee was one reason why exports stagnated. Foreign demand for Indian goods was not strong enough to balance weak domestic demand. There was an opportunity after world trade began to recover in early 2018, but that was just when Indian supply chains were disrupted because of demonetisation followed by the transition to the goods and services tax (GST).

The macro stabilisation worked. India is in a far better place today than it was six years ago if one looks at the three main indications of economic stability—inflation, fiscal deficit, current account gap. There is no shortage of critics who argue that India needed some combination of higher fiscal deficit or lower interest rates to push economic growth. But the policy choices have to be seen against the backdrop of what happened prior to 2014, when India was seen as one of the five most fragile emerging market economies.

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The focus on macro stability was welcome. However, there was not enough done to deal with the twin balance sheet problem, excess corporate leverage that was mirrored by mounting bad loans in banks. Policy responses to growth slowdowns because of excess debt are very different from the policy responses to growth slowdowns because of demand shocks.

Economic growth did recover. India now seems to be headed into another cyclical slowdown. The more persistent worries are structural. The combined fiscal deficit is inching up. Corporate investment seems to be recovering but is still weak. Export growth is sluggish despite the recent synchronized recovery in major global economies. The bad loans crisis may have peaked, but banks will need a lot of capital. The savings rate is too low to support a robust investment recovery.

The growth rate that can be sustained without macro instability—call it potential growth or whatever—is still below its level a decade ago. Supporters of the Modi government will be quick to point out that India continues to be one of the best performing major economies in the world. The question is whether that is enough to create the income growth as well as jobs needed for a stronger assault on poverty.

The Indian economy is far more stable than it was when Jaitley entered the finance ministry nearly five years ago, but some of the deeper structural challenges to economic growth are still staring us in the face.

Niranjan Rajadhyaksha is research director and senior fellow at IDFC Institute. Read Niranjan’s previous Mint columns at www.livemint.com/cafeeconomics

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