India’s States: A Re-alignment Towards Growth

The Narendra Modi-led BJP government is close to completing its first term in office, having implemented a series of far-reaching policy reforms during the past three years. During this time the political complexion of the country has radically changed, with control of many state legislatures changing hands (largely to the BJP), and the emergence of new regional leaders who are now driving key states like Maharashtra, Uttar Pradesh and Tamil Nadu, among others. While large metro and city-centric states including Maharashtra, Delhi, Tamil Nadu and Gujarat continue to remain the biggest drivers of growth within the country, several states further behind on the growth trajectory appear to be catching up. In July 2015, the Sign of the Times evaluated a series of growth, risk and scale related metrics across India’s states with a view towards analysing the vast economic and social differences within the country, as well as the implications of these inter- and intra-regional differences for policymakers and investors. This month’s Sign of the Times revisits and updates this original analysis to identify the key changes in the relative position of India’s states and how the country’s landscape has changed, as well as the implications of these changes for investment strategy and policy.

GPC’s Original States Analysis: A Recap

In order to place India’s regional economic differences into a broader context, in 2015 the Sign’s Leader analysed each of India’s state economies across a wide range of metrics including economic growth, inflation, demographics, urbanisation, literacy and human development indicators, economic freedom, fiscal performance and debt, organising these metrics into a common framework with three indices which measured relative state-level risk, growth and scale.

Based on an assessment of risk and reward (using growth as a proxy), India’s states in the original analysis could be viewed through four categories :

  1. “The Outperformers” (High Growth, Low Risk). Five large city-centric states, referred to as the “I-5 States”, emerged as the major drivers of India’s overall development, characterised by high growth, favourable demographics, a large urban population, relatively high levels of human development, and a low reliance on the agricultural sector.
  2. “The New Frontiers” (High Growth, High Risk). These were predominantly poorer states that were growing rapidly off a low base but were at a relatively earlier stage of development and still dependent of the agrarian economy, with higher risk profiles due to volatile economic growth, lower human development levels and economic freedom rankings.
  3. “The Old Economy” (Low Growth, Low Risk). The “Old Economy” were primarily South Indian states like Karnataka, Kerala and Andhra Pradesh which had older demographic profiles and were more developed and lower risk than the New Frontiers due to their stability, business-friendly policies and better human development indicators. However, they were also growing slower than the rest of the economy.
  4. “The Laggards” (Low Growth, High Risk). These were the states at risk of being “left behind” which had so far failed to participate fully in India’s economic growth. They were comparatively less urbanised, continued to remain highly dependent on agriculture, and had largely failed to put into place policy reforms that attract investment or drive development.

Revisiting GPC’s States Analysis

Using the same growth, size and risk metrics as the earlier analysis, refreshing the profiles of India’s states today reveals important changes that have occurred in the past three years , the results of which are summarised in a similar risk-reward matrix below.

At the macro (national) level, three things stand out from the new analysis: The first finding is a stark tightening and alignment of the states across the spectrum, indicating an overall reduction of disparities and inequalities and a shifting pattern of risk for reward. Visually, this is reflected in the convergence of most states towards the national average on both risk and growth, whereas in the previous analysis the scattered nature of the states, entrenched in their respective categories, had clearly stood out. This seems to indicate that a large portion of the country is potentially ready to take-off like the I-5 have done, although a few states such as West Bengal, Uttar Pradesh and Punjab remain resolutely stuck well below the average. The second finding is that this suggests nationwide systemic changes might be influencing individual state’s performance. And finally, given that the original analysis was performed less than three years ago, it suggests that these changes have been profound and rapid.

At the regional level, the revised analysis also reveals additional critical shifts that have occurred:

  1. I-5: One in, One Out. Karnataka, previously classified as an Old Economy state has replaced Haryana as an I-5 state. Over the last three years, the state was able to leverage its relatively higher levels of industrialisation, economic freedom and human development to improve productivity, and accelerate its economic growth to nearly 8% (while the rest of the economy grew at c.7%). Haryana, on the other hand, despite maintaining its impressive growth rate, saw an increase in its risk profile, largely due to its growing debt burden, and slipped into the New Frontiers category. These changes notwithstanding, it is important to note that the underlying characteristics that define India’s outperforming states remain the same. Maharashtra, Tamil Nadu, Gujarat, Karnataka and Delhi are all city-centric economies with large metros and several mid- and small-sized towns which has helped them unleash significant economic opportunities outside their farming communities.
  2. The End of India’s Old Economy. The Old Economy category was made up of four large, predominantly South Indian states that were well-developed, but growing at a slower rate than the rest of the country. Three years on, it would seem that the Old Economy is no more. Each of these states has experienced a significant uptick in growth, with economic growth rates that are in line with, or higher than the rest of the country. Unfortunately, with the exception of Karnataka, which was able to achieve this growth while maintaining its lower risk profile, each of the other Old Economy states also saw an increase in their risk profiles due to rising debt levels (Chhattisgarh and Andhra Pradesh) and/or lower human development rankings (Kerala and Chhattisgarh). The characteristics that define the economies of these states today appear to be similar to those of the New Frontier states, with high (but relatively volatile) growth offset by greater risk.
  3. More States on the Cusp of Outperformance. At the time of the previous analysis, the gap between the I-5 states and the rest of India was significant. This does not appear to be the case today, with the remaining states of India having accelerated their growth to near- I-5 levels. Andhra Pradesh and Chhattisgarh appear to be on the cusp of outperformance, driven by sustained improvements across growth and risk metrics over the last three years. While neither of these states has the industrial scale and urban base that would allow them to truly compare or compete with the I-5 states yet, each has demonstrated (a) higher than average growth, (b) a decreasing reliance on agriculture, and (c) improving development standards (literacy and HDI). Both states are rich in natural resources: Andhra Pradesh has the world’s largest uranium mine among other mineral resources and Chhattisgarh has large iron ore deposits. Andhra Pradesh, with its high ease of doing business ranking (relative to other states) and more urbanised population (including the large metro of Hyderabad, whose population has reached 10m and is growing faster than Mumbai’s), would appear to be a strong contender for the I-5.
  4. Improvements in Human Development, but Regional Variances Persist. The quality of life in India appears to have improved across the board over the last three years. The median human development index (HDI) score across India’s states increased from 0.51 to 0.62, with 11 states registering double digit improvements in their respective scores. These improvements, while commendable, do not paint a complete picture of the state of development in India. Across each of the HDI parameters – income, health and education – there are sizeable differences amongst Indian states. Kerala, for example, with an HDI score of 0.71 is closer in terms of development levels to middle-income countries like the Maldives and South Africa. At the other end of the spectrum, Jharkhand’s HDI score of 0.38 places it even lower than emerging economies such as Cambodia, Pakistan and Myanmar. While regional variances are to be expected across large countries, the magnitude of the disparities across Indian states continues to stand out. For example, in China – a country that is similar in size to India – the difference in HDI scores between its most and least developed administrative divisions is only 0.2 (vs. 0.4 for India).
  5. Rising Debt Levels Could Create an Overhang on Rather than Supplementing Growth. Debt has emerged as the primary driver of increased risk across a majority of India’s states over the last three years. The debt to GDP ratio for 14 out of 25 major states in the country has increased by an average of c. 12% over the last three years, and while this is partly attributable to the nationwide “bail-out” of state electricity distribution companies, the extent of the increase in debt levels points towards a worrying trend. Given a prevailing bank lending rate of 9.45%, increasing leverage creates a debt servicing obligation that is difficult to meet if there is a change in economic circumstances, reducing the amount of money state governments can allocate towards critical development spending. Therefore, while economic growth in these states might increase in the short-term (particularly if this is off a low base), this growth is unlikely to be sustainable in the long-run as any incremental income generated by growth is required to pay creditors, rather than being reinvested. It is also important to note that nearly 70% of the outstanding liabilities of India’s states now comprises of market borrowings. With the central government and the Reserve Bank of India focused on cleaning up India’s banking sector, states with high debt servicing obligations will likely come under increasing pressure to meet these obligations in a timely manner over the coming years.

Policy Implications

National policies with systemic impact, such as financial inclusion, the GST and demonetisation, have no doubt had an effect on the regional story. However, despite a slight convergence in the socio-economic profiles of India’s states over the last three years, regional disparities in the country need to be tackled further. The way ahead seems to call for a two-pronged approach, with a continued set of national systemic changes being executed alongside more targeted regional policies, tailored to the needs of different states to more forcefully address differing risk and growth profiles.

At the national level, stimulus remains a key requirement and this will be the subject of a future Leader of the Sign of the Times. It is already clear that the full take off of the economy requires catalysing the scaled base of India through a series of stimulus measures: speeding up the working capital cycle for small businesses, redirecting investment from the public markets to industry (or as they say in the US “from Wall Street to Main Street”,) and re-allocating liquidity from banks to small and medium-sized enterprises on a massive scale.

At a regional level, policy can begin by recognising the three categories of difference.

  1. The I-5 States. The focus among these states needs to remain moving up the economic value chain by implementing policies that incentivise companies in these states to invest in R&D and innovation. The lessons from the Asian Tigers in the 1970s shows that intellectual property development and export are a key driver of overall development level and might be a key factor in these states becoming middle-income economies. One of the greater challenges that they face (which the Asian Tigers did not face to anywhere near the same degree) is urbanisation. Coping successfully with mass urbanisation will also need to be an important policy objective for these states: a further 250m people are expected to move to India’s cities by 2030, most likely targeting cities in the I-5 states, which today already account for c.40% of India’s urban population. The governments of these states will need to not only build out necessary infrastructure but also find innovative solutions for how to re-design slums and create urban governance frameworks which allow for cities to develop and scale organically. As these states are far ahead of the country’s overall development, lessons from China suggest that they will also face growing challenges from environmental degradation, sustainability, existing infrastructure limitations and the strain on adjacent rural and “green-belt” habitats. Failure to plan for these factors risks creating natural social and economic barriers. One should fully expect that when this analysis is renewed in three years, the survivors among today’s I-5 will be those that have had the foresight to have built an advanced intellectual property economy, promoted export, absorbed and made productive mass urban populations and continually fought against environmental damage.
  2. The New Frontiers. While most of these states are already benefitting from policy reforms that have provided an initial boost of growth, policymakers in the New Frontiers states need to focus on putting in place the institutional mechanism to sustain this development over an extended time period. Many of these states continue to be relatively less urbanised, so the choice lies in either competing for some of the lower-end industrial base of the I-5s, or rapidly building cities to drive service sector expansion. In addition, investing in critical social infrastructure like education, skills and healthcare will become a necessity if they are to migrate towards higher growth, but financing these investments may prove to be challenging, given the already high debt levels that exist among many of these states. Attracting greater foreign investment provides part of the solution but this will be highly fought over among the states and will require state governments to implement a series of business-friendly reforms that incentivise both foreign and domestic private companies and investors.
  3. The Laggards. These states are in urgent need of an overhaul in strategy because they are at risk of being “left behind” as the rest of India develops. They not only already lag behind the rest, their lower growth means that the gap is growing every year, creating disparities which will be difficult for India to sustain from a social and political perspective. The big states of Uttar Pradesh and West Bengal, for example, account for 25% of the country’s population but only 14% of economic output. There is a tangible opportunity for these states to change their development trajectories quickly, however, this will require visionary leadership and a significant improvement in governance, combined with a rapid buildout of the urban centres (which have proven to drive growth in other states). A mix of national and regional political and bureaucratic conviction is needed to create mass employment much like China’s fiscal and investment policies emphasising manufacturing and infrastructure. India is at risk of creating the seeds of a future populist revolt in the nature of Brexit and Trump if it cannot come to grips with the needs of these states. The urgent need to improve the quality of governance and execution of policy reforms is much needed to stem the rot that appears to have set in.

Investment Implications

For investors, at one level, the picture remains unchanged from three years ago with most of the I-5 retaining its strong competitive position, and Karnataka (whose IT sector has long attracted tremendous foreign investment), now joining in. However, risk-return requirements are the key driver of investment and in a country of nearly 1.3 billion people, the opportunities provide various strategies for investors to follow. The key strategies that stand out include:

  1. Growth Strategies – I-5 States. The I-5 states remain the focus of foreign investment as they continue to be the primary drivers of economic growth and value creation, particularly as they rapidly approach middle-income status with the diversification of their economies and the move towards more advanced sectors and value addition. These states will lead India’s transition to the knowledge economy, and key sectors including digital technology, healthcare, and business and professional services which will be the focus on overall value creation . However, their leadership in these areas also means that well-developed public and private capital is already present in most of these states and will over time drive up the valuation of the obvious attractive companies in these states. Therefore, growth strategies will need to focus on identifying the emerging leaders in these thematic sectors with sustainable rather than simply high absolute levels of growth.
  2. High Growth with Higher Short-Term Risk – New Frontiers. Potentially, the more interesting theme for investors is the reduced gap between the I-5 and the several other states which have started implementing policies to accelerate growth which, although they may face higher risks in the short term, will tend to lower risk over time. In many cases, these states are the ones that are following the well-trodden path laid out by the I-5. While many of these states still have significantly elevated risk today, it will be important to track their progress closely to see which ones are able to further close the gap with the I-5, and which ones potentially slide back on growth or fail to reduce risk. Irrespective, the moving en masse of several states into the new frontiers bodes well for the country’s overall growth, indicating a reducing dependency on the I-5. Company selection, and regional sector leadership potential, becomes critical to investing in these states. The absence of well-developed financing for entrepreneurs provides for better pricing in these states, but without the right analysis of risk also provides for potentially misplaced investments. These states are the some of the likely recipients of mass manufacturing, basic services such as call centres and infrastructure spend.
  3. Development Capital, Scaled, Low-Cost Manufacturing and Resources – The Laggards. While at first glance these states appear to be stuck in a rut which investors might be tempted to avoid, they also have 27% of the country’s population with c.100m people living in cities (including one of the top-4 metros, Kolkata), and therefore represent the biggest development challenge for both international agencies and social impact investors. For purely commercial investors, their attractiveness stems from large labour pools, and low wages, which makes them suitable for scaled low-cost, low value-added manufacturing. In addition, there are also opportunities in natural resources including coal (Uttar Pradesh), minerals (West Bengal), and agriculture (Punjab). However, complex internal politics and archaic governance institutions and the resultant business practices in these sectors might well provide a hindrance to most commercial investors, except those that have the (i) prior experience, (ii) scale, and (iii) a level of direct government support which is necessary to navigate local complexity and find opportunities to participate in mass manufacturing or natural resource investments. If they can participate at international governance levels, their natural allies might well be the international development agencies.

Conclusions – The Path Forward Seems Clearer

The contours of the development of India from the perspective of its states seems clearer. Both the scale of the convergence and the speed at which it has happened (in the past three years) is a surprise and holds the promise of further rapid change. The features of this path appear to be as follows:

  1. Continent, Not Country. As one would expect, viewing India as a continent makes far more sense from a policy and investment perspective. It provides a full spectrum of first-world and developing-world opportunities and risk-return profiles, a spectrum that is wider even than those in other heterogeneous markets including the US and China.
  2. Systemic Change Evident to Profile of the States. The two to three-year comparison of states reveals a systemic change in India which are not obvious from the macro 7% GDP growth figure, showing a clustering and readiness for growth and a lower relative risk profile across several large states.
  3. India vis-à-vis China. While China has doubled down on its top-down bet with President Xi instituting an unlimited term as leader and the continued curtailing of information and the internet, India has continued to be open and to leverage its democracy to deliver an enhanced economy, no doubt with much still to do. India’s policy makers, supporters and investors themselves will need to double down on that bet.
  4. Well-trodden Paths for the Next Stage of Development. The states seem to be set on a well-trodden trajectory where the I-5 states follow the Asian Tigers, the New Frontiers become the I-5 and the Laggards look to break their governance challenges to develop their resources, build infrastructure, create large-scale manufacturing opportunities and move into the New Frontiers’ current position.
  5. Macro Matters. The national government at the centre has a critical role to play in continuing to engineer big systemic change, averting lethargy, galvanising the mass population and incentivising the states to achieve their potential. There are analogues around the world that can come to see their Indian counterparts as the natural extension of their own pasts or the natural places to leverage their experiences.

Given the above, India seems far better positioned than the macro figures today suggest. A new generation of systemic change has been initiated, with major new reforms and laws passed, and efforts underway to address both near-term risks such as the stressed banking system, and long-term structural issues such as financial inclusion and the indirect tax code, all of which will lower India’s overall macro risk profile and further increase the growth rate. This shift will play out on the battlefield of India’s states and will help attract more capital, initially in obvious areas (e.g. high growth sectors and the I-5), but eventually for the New Frontiers and for scaled manufacturing, resource and impact investments in the Laggards, too. However, without continued and sustained action, both by the centre (to address the systemic issues and provide overall stimulus) and the states (to rapidly build out infrastructure, foster mass participation, and create the suitable business environment), each state, and India as a whole, will fall short of its potential value.

Mr. Modi’s BJP and its allies now control most of the state legislatures in the country, including in two of the I-5s, many of the New Frontiers (including states like Bihar, Madhya Pradesh and Rajasthan which have recently made the transition from Laggards), and since last year, Uttar Pradesh, thus far the biggest “Laggard” state. The time to blame politics for the slow pace of reforms has now passed, and without continued and accelerated reforms to address even more fundamental issues like the privatisation of nationalised banks, and coordinated state-and-centre level action on critical issues such as labour laws, the risk and growth profile of the country and the capital it is able to attract could revert back to a lower rate.

The Modi government can afford to feel emboldened by its political achievements, the performance of its reforms, and by its economic track record. However, despite its economic and political successes, the government has to date failed to involve a sufficiently broad set of constituencies to design and implement reforms, and therefore access a broader set of ideas from the country, leaving it open to the same charges of crony capitalism that plagued the previous administration. The next phase of leadership must go far beyond the innermost circle of the Prime Minister to be successful. To fully address this, Mr. Modi will need to control the more culturally nationalist elements within his own party (often the same constituencies which are the most resistant to change) and the resist the urge to keep critical decisions to a small inner circle, adopting a radical model of change management for a country, one which is more widely inclusive and truly engages India’s local business, civic and policy communities in providing inputs for and leading change.


1.    Please see the July 2015 Sign of the Times: India’s States: The India Within India

2.    GPC’s earlier analysis of states was based on economic data as of the fiscal year ending March 2014, while the current analysis has been updated for data as the fiscal year ending March 2017 (state-level economic data is not published with the same frequency as national accounts data)

3.    See the October 2013 Sign of the Times: Transforming India’s Slums: A Critical Step in Creating the New India

4.    See the September 2017 Sign of the Times: India’s Transition to the Information Age, and the Sectors Driving This

5.    See appendix for definitions and sources