Editorial 1 : Inter-State Economic Convergence
Context
Recent data indicate that after years of divergence, India’s lower-income states have begun growing faster in the post-pandemic period, signalling early signs of economic convergence.
Introduction
India’s economic strength is fundamentally linked to the performance of its states, as national GDP is the aggregate of State Gross Domestic Products. Historically, poorer states have struggled to catch up with richer ones, raising concerns about regional inequality and uneven development. However, post-pandemic trends suggest a shift, with several lower-income states registering higher growth rates. This emerging convergence has important implications for sustained national growth, fiscal federalism, and long-term development strategy.
Core Argument
- Pre-pandemic period (FY13–FY19): Lower-income states grew more slowly than richer states, leading to divergence.
- Post-pandemic period (FY19–FY25): Evidence of convergence has emerged, with states like Uttar Pradesh, Bihar, Rajasthan, and Assam growing faster than the national average.
- This turnaround is notable because lower-income states were expected to be more vulnerable during the pandemic.
Key Factor Driving Convergence: Public Capital Expenditure
- Among various factors (human capital, infrastructure, technology, governance), state-level public capital expenditure (capex) stands out as the most significant driver.
- Higher capex:
- Strengthens physical infrastructure (roads, logistics, urban assets).
- Crowds in private investment (as noted by RBI and Economic Survey findings).
- Signals reform intent and governance credibility.
- This aligns with the Economic Survey (multiple editions) which highlights the high multiplier effect of capital expenditure compared to revenue expenditure.
Fiscal Support and Role of the Centre
- After the pandemic:
- Higher central transfers and
- Capex loans to states scheme helped states sustain infrastructure spending even after GST compensation ended.
- The scheme is:
- Ring-fenced for capital expenditure,
- Non-divertible to welfare or revenue spending,
- Complementary to central capex (e.g., Centre builds highways; states develop urban and feeder infrastructure).
- Outlays have increased sharply from ₹12,000 crore in FY21 to ₹1.5 lakh crore in FY26, reflecting its growing importance.
Emerging Risks
- Revenue Stress
- Slower nominal GDP growth and tax cuts are weakening Centre’s tax revenues.
- Since 41% of the divisible tax pool goes to states (as per Finance Commission formula), state revenues are also under pressure.
- States have so far protected capex by widening fiscal deficits, but this is fiscally unsustainable in the long run.
- Rising Revenue Expenditure
- Expansion of cash transfer and welfare schemes, especially before elections, has raised current expenditure.
- Persistent revenue spending can crowd out capital expenditure.
Way Forward
- For the Centre
- Expand and provide multi-year clarity on the capex loans to states programme.
- Ensure predictability in transfers to enable long-term infrastructure planning.
- For the States
- Leverage labour law reforms, especially provisions under the Industrial Relations Code allowing higher thresholds for layoffs without prior permission.
- Implement state-level deregulation reforms suggested by the Centre.
- Position themselves as hubs for labour-intensive, mid-tech manufacturing (textiles, footwear, furniture, toys).
- Global Context
- With global supply chains diversifying away from concentration, India’s lower-income states have a wage advantage.
- Experiences of countries like Vietnam show that combining low wages with infrastructure and regulatory ease can rapidly boost manufacturing-led growth.
- This aligns with World Bank and UNIDO assessments on industrialisation and export-led development.
Conclusion
India’s emerging states are showing early but significant signs of economic convergence, driven largely by sustained public capital expenditure. If supported by stable fiscal transfers, continued infrastructure investment, regulatory reforms, and integration into global manufacturing chains, these states can become powerful engines of national growth and strengthen India’s long-term economic position.