HSBC Warns Cash Transfers May Hinder Growth in Emerging States
India’s economic landscape is witnessing a significant shift as lower-income states begin to close the gap with their wealthier counterparts, according to a recent report by HSBC. This trend, characterized by accelerated growth in states like Bihar, Uttar Pradesh, Assam, and Rajasthan, marks a notable change from the pre-pandemic era when richer states consistently outperformed. The report highlights that this convergence is primarily driven by increased public capital expenditure, which enhances infrastructure and attracts private investment. However, the sustainability of this growth may be threatened by rising populist spending and potential fiscal challenges.
Emerging States Lead Economic Growth
The HSBC report reveals that emerging states are experiencing remarkable economic momentum. Between FY23 and FY25, Bihar is projected to achieve a real Gross State Domestic Product (GSDP) growth of 10.3%, while Uttar Pradesh is expected to grow by 9.0%, both surpassing the national average of 7.8%. Notably, Bihar has reached a significant milestone, with the industrial sector’s contribution to Gross Value Added (GVA) exceeding that of agriculture for the first time. This shift indicates a diversification of the economy and a move towards more industrialized growth. Uttar Pradesh has also seen a substantial increase in exports of high-tech goods and services, particularly in electronics and IT, further underscoring its economic advancement.
Factors Driving Convergence
The report attributes this growth convergence to the Solow-Swan growth model, which suggests that regions with lower capital-labor ratios can achieve faster growth. As Pranjul Bhandari, HSBC’s chief India economist, explains, wealthier states are closer to their growth limits, resulting in slower expansion. In contrast, poorer states have more room for growth, and investments in capital yield significant returns. The surge in public capital expenditure has been a crucial factor in this transformation, as states with robust revenue streams are better positioned to invest in infrastructure and attract private sector participation. The increase in central government resource transfers post-pandemic has further bolstered the fiscal positions of these states, enabling them to embark on ambitious investment cycles.
Challenges to Sustaining Growth
Despite the positive trends, the report warns of potential risks that could hinder this growth trajectory. A slowdown in the central government’s tax revenue growth, attributed to rate reductions and weaker nominal GDP growth, may lead to decreased tax transfers to states. Additionally, the introduction of new cash transfer schemes, often tied to electoral cycles, could exacerbate fiscal deficits. While states have managed to maintain capital expenditure levels despite declining revenues, the sustainability of this approach is in question. If revenues continue to weaken or populist spending expands, capital expenditure may be the first area to face cuts, jeopardizing the convergence that has begun.
Strategies for Future Growth
To ensure the continuation of this investment-led growth, both the central and state governments must take proactive measures. The central government can enhance fiscal certainty by expanding its capital expenditure loan program for states, which has seen a significant increase in budget allocation. This would allow states to plan long-term projects with confidence. On the state level, there is an urgent need for improved revenue mobilization and prioritization of spending. States can capitalize on opportunities presented by domestic reforms, such as consolidating labor laws, which could attract large manufacturers. Additionally, as global supply chains evolve, emerging states can leverage their wage-cost advantages to attract foreign direct investment in labor-intensive sectors like textiles and footwear, further integrating into global production networks.
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