India’s economic trajectory is ultimately shaped by the performance of its states. National GDP is nothing more than the aggregate of state gross domestic products (GSDPs). When poorer states grow faster than richer ones, the country benefits from both higher overall growth and reduced regional inequality. Whether such convergence is actually happening has therefore become a critical macroeconomic question.
Why state convergence matters for national growth
States with lower per capita incomes typically have greater “catch-up” potential. If supported by the right policies and investments, they can sustain faster growth for extended periods, lifting national GDP growth in the process. Historically, this has been the path followed by many large economies that successfully reduced regional disparities while accelerating development.
For India, convergence across states is not only about equity but also about scale. A handful of fast-growing laggard states can significantly alter the national growth story.
From divergence to early signs of catch-up
An examination of the past 12 years, split into pre-pandemic (FY13–FY19) and post-pandemic (FY19–FY25) phases, reveals a sharp contrast. Before the pandemic, poorer states tended to grow more slowly than richer ones, indicating divergence rather than convergence.
The post-pandemic period, however, tells a different story. Lower-income states have, on average, grown faster than their higher-income counterparts. Large states such as Uttar Pradesh, Rajasthan and Bihar show a clear pivot toward stronger relative growth. While this trend is recent and still fragile, the shift is notable.
What makes this development surprising is its timing. Conventional wisdom would suggest that poorer states would be hit harder by a crisis like the pandemic. Instead, many managed to improve their growth performance both during and after this shock.
The decisive role of state capital expenditure
Several factors could explain this turnaround — changes in economic structure, improvements in infrastructure, technology adoption, or human capital. Among these, one factor stands out: public capital expenditure by states.
Emerging states such as Assam, Uttar Pradesh, Rajasthan and Bihar have sharply increased infrastructure spending in recent years. State-level capital expenditure strengthens the physical backbone of growth, improves connectivity and logistics, and signals policy seriousness. Crucially, it also crowds in private investment, multiplying its impact on growth.
This capex-led strategy appears to be the most convincing explanation for why lagging states have begun to close the gap with more advanced ones.
Revenue strength and the sustainability challenge
Sustaining high public capex depends heavily on state finances. When revenues are strong, states are more willing to invest — an effect that is especially pronounced among poorer states. In the immediate post-pandemic years, central transfers to states increased. Even after the end of GST compensation, special capex loan schemes from the Centre helped keep state revenues buoyant.
That environment is now changing. Central tax revenues are weakening due to tax cuts and slower-than-expected nominal GDP growth. Since a large share of central taxes is devolved to states, this directly affects state finances. The impact is already visible: state revenues declined in FY25 after several years of steady growth.
So far, states have protected capital spending by allowing fiscal deficits to widen. But deficits are now elevated, and prolonged revenue stress could eventually force a cutback in capex.
Populist pressures and fiscal trade-offs
Revenue constraints are not the only concern. Many states have expanded cash transfer and welfare schemes, often in the run-up to elections. This has pushed up current expenditure and added to fiscal pressures.
Several states have so far managed to maintain their capex thrust despite these pressures, even through election cycles. However, if such schemes remain expansive over time, they risk crowding out productive capital spending. The key policy challenge is whether states can balance short-term political spending with long-term growth investments.
How the Centre can support convergence
One way to sustain the capex-led convergence process is for the Centre to expand support to states, particularly through capex loan programmes. These loans are ring-fenced for capital expenditure, cannot be diverted to revenue spending, and encourage states to increase their own investment.
Over the past six years, the size of this programme has expanded significantly. This may be the right moment to further scale it up, broaden its scope and provide multi-year clarity. Predictability would allow states to plan large infrastructure projects more effectively and strengthen the growth impulse.
The role of reforms at the state level
The onus is not only on the Centre. States must actively leverage the reform space available to them. Recent deregulation initiatives and labour law reforms have lowered barriers to industrial expansion. In particular, higher thresholds for layoffs without prior approval can make states more attractive to large, globally competitive firms.
States that move quickly to adopt and deepen these reforms can position themselves as manufacturing hubs, especially as firms seek alternatives in reconfigured global supply chains.
Manufacturing opportunities and global supply chains
Global manufacturing is undergoing a shift, opening opportunities in labour-intensive, mid-technology sectors such as textiles, footwear, furniture and toys. India’s emerging states enjoy a natural wage advantage in these sectors. Combined with improved infrastructure, simpler regulations and flexible labour laws, this advantage can translate into sustained industrial growth.
Other countries have demonstrated how quickly such opportunities can transform regional economies. For India, the window is open — but it will not remain so indefinitely.
What to note for Prelims?
- National GDP is the aggregate of state GSDPs
- Pre-pandemic period saw divergence in state growth rates
- Post-pandemic period shows early signs of convergence
- State capital expenditure is a key driver of catch-up growth
What to note for Mains?
- Analyse the role of state-level public capex in India’s growth story
- Discuss fiscal constraints facing states and their impact on development spending
- Examine how labour and industrial reforms can aid state-level convergence
- Evaluate the importance of global supply chain shifts for emerging Indian states
