Recent data shows that lower-income Indian states like Uttar Pradesh, Rajasthan, and Bihar are growing faster than richer ones after the pandemic. This convergence is driven by increased public capital expenditure. However, sustaining this momentum faces challenges from revenue pressures and rising current spending.
The strength of the Indian economy rests on the strength of its states, as national GDP is the sum of state gross domestic products. According to Pranjul Bhandari, chief India economist at HSBC, lower-income states have significant catch-up potential that can generate strong growth under the right conditions.
In the pre-pandemic period (FY13-FY19), there were no signs of convergence; lower-income states grew more slowly, leading to divergence. But in the post-pandemic era (FY19-FY25), lower-income states are growing faster on average, particularly Uttar Pradesh, Rajasthan, and Bihar. This shift occurred during and after the pandemic, when lower-income states might have been expected to suffer more.
The key explanation lies in public capital expenditure at the state level. Emerging states like Assam, Uttar Pradesh, Rajasthan, and Bihar have invested substantially more in infrastructure in recent years. Such spending strengthens the physical backbone for economic activity, signals a reform-oriented government, and crowds in private-sector investment.
Strong state revenues are crucial for public capex. Immediately after the pandemic, central transfers to states increased, and even as GST compensation ended, capex loans to states began, keeping revenues elevated. However, the Centre's tax revenues are now weakening due to tax cuts and lower nominal GDP growth, potentially reducing state revenues, as 41 percent of the divisible tax pool is shared with states.
State revenues declined in FY25, and rather than cutting capex, states widened fiscal deficits. Additionally, a wave of new or enhanced cash transfer schemes ahead of state elections has raised current expenditures. States like Chhattisgarh, Madhya Pradesh, Rajasthan, Odisha, Telangana, and Andhra Pradesh have maintained capex through election cycles so far.
The Centre could expand the capex loans programme to support states, which has grown from Rs 120 billion in FY21 to Rs 1.5 trillion in FY26. States must implement reforms, such as the Industrial Relations Code raising the layoff threshold from 100 to 300 employees, with states able to increase it further. Opportunities exist to attract FDI into labor-intensive manufacturing like textiles and footwear amid global supply chain shifts.
In conclusion, India's emerging states show early signs of faster growth. If they sustain public capex and capitalize on reforms, they could drive India's rising global position.
