(UPSC GS Paper III – Indian Economy: Growth, Federal Finance, Infrastructure)
Context (Introduction)
India’s recent growth story shows an important shift: several historically poorer States are now growing faster than richer ones, driven mainly by sustained public investment in infrastructure and supportive Centre–State fiscal coordination.
What Has Changed in India’s Growth Pattern?
- Earlier Divergence, Now Convergence: Before the pandemic, richer States consistently outpaced poorer ones; after FY19, lower-income States began growing faster, reversing the earlier trend.
- Key Catch-Up States: Uttar Pradesh, Rajasthan and Bihar have shown a clear improvement in relative growth performance.
- Why This Matters Nationally: Since India’s GDP is the sum of State GSDPs, faster growth in populous lagging States significantly lifts overall national growth.
- Unexpected Post-Pandemic Outcome: Contrary to fears, poorer States did not suffer lasting damage from COVID and instead improved growth momentum.
- Early but Broad-Based Trend: The convergence is recent but visible across multiple States, suggesting structural change rather than a one-off rebound.
- Inclusive Growth Signal: Narrowing regional growth gaps strengthen the foundations of long-term, inclusive development.
The Main Engine: State Capital Expenditure
- Public Investment Drives Growth: Higher State spending on roads, urban infrastructure and logistics emerged as the strongest factor explaining faster growth.
- Infrastructure Catch-Up: Emerging States sharply increased infrastructure investment, improving connectivity and reducing costs for businesses.
- Crowding-In Private Investment: Public capex boosted investor confidence, encouraging private firms to invest alongside the State.
- Stronger Growth Multipliers: Capital spending generates more output and jobs than routine revenue spending.
- Governance Signal: Sustained capex signals policy stability and reform intent, shaping long-term growth expectations.
- Complements Central Projects: State investments filled critical gaps around national highways, railways and logistics corridors.
How Centre–State Finance Made This Possible
- Post-Pandemic Revenue Support: Higher transfers after COVID improved State finances and enabled investment.
- Capex Loans to States Programme: Low-cost, ring-fenced loans ensured funds were used only for capital projects.
- Rapid Scale-Up: The programme expanded significantly over six years, giving States predictable funding.
- Protection of Capex: States chose to widen deficits rather than cut infrastructure spending.
- Fiscal Coordination Success: Cooperation between Centre and States reduced pro-cyclical investment cuts.
- Stability Despite GST Changes: Capex loans cushioned States even after GST compensation ended.
Risks to the Convergence Momentum
- Slower Central Tax Growth: Recent moderation in nominal GDP growth and successive direct and indirect tax cuts have slowed the Centre’s gross tax revenues. Since around 41% of the divisible tax pool is shared with States, any slowdown directly compresses State revenues, as seen in the decline in aggregate State receipts in FY25 after several years of steady growth.
- Rising State Fiscal Deficits: To protect capital expenditure, many States allowed deficits to widen post-pandemic. As a result, several States are now operating close to or above 3% of GSDP, limiting their capacity to absorb future revenue shocks without cutting spending.
- Expansion of Welfare and Cash Transfers: Ahead of recent State elections, governments in States such as Rajasthan, Madhya Pradesh, Chhattisgarh and Telangana expanded cash transfer and subsidy schemes. While socially important, these schemes raise committed revenue expenditure and reduce fiscal space for infrastructure.
- Risk of Capital Expenditure Squeeze: State budgets show that when revenue pressure intensifies, capex is often the first adjustment variable. With revenues already softening in FY25, prolonged stress could force States to scale back infrastructure projects.
- Uneven Fiscal Capacity Across States: Richer States have stronger own-tax bases and borrowing capacity, while poorer States remain more dependent on central transfers. This makes emerging States such as Bihar and Assam more vulnerable to revenue volatility.
- Fragility of Policy Continuity: Infrastructure investment requires multi-year commitment, but past experience shows that changes in political priorities or fiscal stress can abruptly interrupt capex cycles, diluting long-term growth benefits.
What Needs to Be Done to Sustain Catch-Up?
- Expand Capex Loans Programme: Larger and more predictable multi-year funding can stabilise State investment planning.
- Protect Infrastructure Spending: Capex should be prioritised over short-term revenue expenditure.
- Use Deregulation Fully: States must implement labour and business reforms to convert infrastructure into jobs.
- Attract Labour-Intensive Manufacturing: Emerging States can leverage wage advantages in textiles, footwear and furniture.
- Link Capex with Private Investment: Public projects should be designed to crowd in private capital.
- Leverage Global Supply-Chain Shifts: States can integrate into mid-tech manufacturing as firms diversify production locations.
Conclusion
India’s future growth hinges on sustained State-led convergence. With State capital expenditure now exceeding 4% of GDP and the Centre targeting Viksit Bharat by 2047, emerging States are poised to drive growth. If infrastructure investment, fiscal discipline and reforms continue, convergence can deepen. However, revenue stress and policy discontinuity could derail progress, making long-term Centre–State coordination essential.
Mains Question
- “India’s growth story is increasingly being written at the State level.”
Discuss this statement in light of recent trends in State finances, infrastructure investment, and regional development. (250 words, 15 marks)
Source: Indian Express