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Understanding India's regional economics
India's potential growth will be far from homogeneous. Each of the country's 29 states and seven territories essentially has its own economy, its own regulations, and its own attitudes toward economic reform. As a result, there is a high degree of variation in economic and business conditions across the subcontinent.
Everyone loves a comeback tale.
After a decade of high growth, averaging above 8%, India's growth has decelerated dramatically in recent years. Monetary tightening, domestic policy paralysis, the lack of substantive structural reforms, and a global recession converged, and in subsequent years took their toll, leading to decreased global demand for Indian exports as well as reduced capital inflows. The former Asian tiger expanded at its slowest pace in 10 years (just 5%) for the 2012-13 fiscal year. Real fixed investment, as a share of gross domestic product (GDP), fell from more than 35% in 2011-12 to less than 30% in 2013-14.
But the Indian economy is looking up once again-albeit a little slower than many hoped after the May 2014 elections, which saw the highest voter turnout in the nation's history. In fact, India's real growth is expected to outpace that of rival China this year. IHS predicts that China will grow just 6.5% in 2015, while India's economy will expand by 7.4% and should sustain its robust expansion over the next decade. With India Prime Minister Narendra Modi and the majority Bharatiya Janata Party (BJP) government taking office with the strongest national mandate in three decades, promising a slew of new, pro-business economic reforms, investors and businesses are once again looking at opportunities to get in on India's robust growth potential.
However, as most companies that have done business in the world's second-most populous nation quickly realize, there is no single, national Indian economy. Many Indian states are large markets in and of themselves; the population of Uttar Pradesh, for example, exceeds Brazil's, while Maharashtra's rivals Mexico's. More importantly, local government policies toward business and foreign investment vary greatly. Indian states have considerable power both to block national legislation and to adopt reform initiatives, bypassing national approval. What's more, with the BJP government's vision of "competitive and cooperative federalism" for India, and the 2015 budget allotting even more fiscal power to the states, such interstate economic differences may grow.
Successful investment in the subcontinent, therefore, will require a much more granular, sub-national approach given the heterogeneity of India's geographic and socioeconomic conditions. By analyzing past progress made by India's states in advancing their economies, and the various factors contributing to their growth, companies can make more informed business development and investment decisions to take advantage of the country's upward trajectory.
A nation of many parts
India's potential growth, however, will be far from homogeneous. Each of India's 29 states and seven territories essentially has its own economy, regulations, and attitudes toward economic reform. As a result, there is a high degree of variation in economic and business conditions across the subcontinent. Understanding the country's regional economic differences and attitudes toward investment will be crucial for those investing or doing business in India.
India's nine-highest performing states, which are well-diversified and have relatively favorable business climates, account for more than a third (37.3%) of the nation's output. Income per capita in the least-developed state (Bihar) is comparable to Rwanda's, and in the most developed (Goa) to China's only three years ago. Adding to the complexity of this economic geography, even the highest-performing states still contend with significant constraints and, in certain instances, the less developed states have outperformed the national average in recent years. While on the surface there may seem to be clear winners and losers in India's ongoing economic race, the country's recent performance-and future prospects-are much more nuanced. Most high-performing states still lack investment in infrastructure and education, while some low-income states have seen robust growth in recent years with the right local government policies.
In order to paint a more nuanced and useful picture of economic conditions on the ground, IHS splits India's states and union territories into five categories: economic powerhouses, small high performers, high potentials, average -growth states, and growth laggards. The primary criterion for this classification is the average real gross state product (Real GSP) growth during the fiscal years 2005-12, with average per capita income as a secondary criterion (as compared to India's national average on both parameters).
The economic powerhouses and small high performers are poised for the most significant growth. Meanwhile, the average income per capita of the remaining three groups, representing more than 70% of India's total population of 1.2 billion, remains closer to that of neighboring Bangladesh (it stood near $1,200 in 2012-13 compared to Bangladesh's $1,094, according to IHS estimates). However, some states have made significant advances in growth in recent years, indicating their potential to catch up to the nation's leaders in the long term. Identifying this potential may be critical for future investment returns.
Deep dive into India: a state-by-state guide
(Click on the graphic below to see the PDF and for a clearer view)
Four economic powerhouses fuel GDP
Four high-performing states-Gujarat, Haryana, Maharashtra, and Tamil Nadu-together account for about a quarter of India's total population and more than a third of its national output. These economic powerhouses outperformed India's average real GDP by almost 1.5% between 2005 and 2012. Their average income per capita is 1.3 times the national level, ranging from $1,815 in Gujarat to $2,230 in Haryana. These large, diversified economies serve as established manufacturing bases with developed services sectors.
Similar in economic strength, each has developed its own "business brand," Gujarat is considered the petrochemical and manufacturing capital of India; manufacturing accounts for 25% of Gujarat's economy. Maharashtra has gained reputation as a financial and automotive hub. In addition to also being known as a large auto-making state (its capital Chennai has been dubbed the "Detroit of India"), Tamil Nadu has emerged as an important IT services and pharmaceuticals hub. Haryana is known for its strong agriculture-based manufacturing. It also has a significant presence in the automotive, oil-refining, and petrochemicals industries.
However, a shortage of skilled labor is a problem in all four states, and one that could prevent them from realizing their full growth potential. For instance, the country's largest construction and engineering company, Larsen & Toubro, based in Mumbai (Maharashtra), announced last year that it could face a lack of skilled talent at a time when it wanted to ramp up investment. Thus, while developed industry sectors may be an obvious choice for investment in these states, education and vocational training, along with other social services, are quickly becoming an attractive investment area, particularly for technical skills required for higher-value-added manufacturing. In all of India in general and in the economic powerhouse states in particular, focus on education will become even more relevant as India's growing demographics bring in more young people into the labor force and as the manufacturing sector moves further up the value chain.
Small high performers deliver outsized returns
Meanwhile, five states and territories that together contribute less than 5% to India's overall economy outpaced the rest of the country in GDP growth at an average rate of 12.0%, far above the 7.8% national average. Goa, Delhi, Sikkim, Andaman and Nicobar Islands, and Pondicherry are the small high performers. Combined, they are home to 21.5 million people-about the size of Romania. But their average income per capita was almost twice the Indian average of $1,511.60 in 2012-13.
Goa, India's smallest state by area, and fourth-smallest by population, is actually its richest with per capita income approaching $4,000 in 2012-13 (comparable to the per capita income of China in 2009-10). The capital city Delhi, and the two city-state union territories of Pondicherry along with Andaman and Nicobar Islands, are also among India's most affluent. The latter two union territories are well-known tourist meccas, so services are an important driver of their economies.
Notably, these fast-growth areas are much more diversified than many tend to believe, underlining their position as high performers. Goa, for example, has an established iron ore mining industry and, due to its relatively liberal industrial regulations, has emerged as a manufacturing base for fertilizers, tires, cement, and pharmaceuticals. As a result, manufacturing accounts for nearly 35% of the state's economy.
While both India's economic powerhouses and small high performers do better than average on a number of parameters, their recent response to the national reform push is somewhat disappointing. The recent report, released ahead of the World Bank's annual Doing Business ranking, measured progress by the Indian states on the implementation of a 98-point business reform agenda over a six-month period between January and June 2015. Notably, with the exception of Gujarat that was ranked the best place in India for conducting business, the rest of the economic powerhouses ended up closer toward the middle of the ranking. Meanwhile, the small high performers were among the worst reformers, with Sikkim scoring only 7.23% against 71.14% by Gujarat. Perhaps deceived by their past economic success, these states did not make much progress with reforms in the past six months, suggesting that businesses operating there would continue to face difficulties in obtaining land and construction permits; complying with tax, environment procedures, and labor laws; getting access to infrastructure-related utilities; and enforcing contracts, among other key areas.
The past as a guide, not a promise
Of course, past performance does not guarantee future success-or failure-for India's states and territories.
In fact, there are some notable examples of disappointments in India's recent history. Kerala's liberalization efforts boosted its growth above the national average for several years in the early to mid-1990s, and its unique model of social democracy allowed it to outperform the rest of India on social indicators (its literacy rate is 22% higher than the national average). However, in the absence of additional reforms, its economy has struggled, and today its income per capita is $1,657, making it just an average-growth state. It ranks 18th among the 32 Indian states and territories in the World Bank's Doing Business ranking.
Currently, there are a total of 10 average-growth states under the IHS classification. While some-like Kerala, Punjab, West Bengal, and Karnataka-are important players in the economy and likely to remain so, their ability to transition into a high-performing group will require greater liberalization efforts and significant improvements in productivity.
Another seven Indian states and territories had real GDP growth that was more than a percentage point below the national rate, putting them in the growth laggard category. The average per capita income in this group is half the Indian average. With such low baselines, it is doubtful that these geographies will be able to catch up with the rest of the country within the next decade. However, many of these areas are striving to succeed, with some notable progress made in recent months. Thus, Jharkhand, one of the poorest Indian states with an income per capita only half of that of India, is ranked third in the World Bank's Doing Business ranking, just behind Gujarat and Andhra Pradesh. In particular, the state has made commendable advances in the areas of carrying out inspections and enforcing contracts. More generally, many of the growth laggard states are recipients of large central government subsidies, which may present valuable opportunities for public-private partnerships.
Six others areas, while not yet high performers, show significant promise and are classified as high potentials by IHS. Andhra Pradesh, Bihar, Chhattisgarh, Madhya Pradesh, Rajasthan, and Uttarakhand delivered an attractive 9.2% average growth rate between 2005 and 2012. Their per capita income levels, however, varied widely-from half of to more than twice the national average. The economic profile of each state is also very different, from the highly agrarian Madhya Pradesh (agriculture delivering 30% of its GDP), to the much better-diversified Uttarakhand.
Bihar has made the greatest strides toward prosperity, more than tripling its per capita income from a meager $175 in 2004-05 to $533 in 2012-2013. Its strong economic performance has been largely a result of the local government's sound socioeconomic policies and ambitious infrastructure development efforts. Similarly, Uttarakhand's recent advances demonstrate how local government policies can reshape a state's economy in a matter of a few short years. Its leaders introduced a New Industrial Policy in 2003 (extended in 2013 for another four years) that provided capital investment subsidies and other incentives to enable development and improve the availability of capital and access to its markets. Thanks to these efforts, Uttarakhand's share of Indian manufacturing grew from under 13% in 2004-05, to over 22% in 2013-14. Investment generated in the state grew forty-two-fold between 2000 and 2013. The number of new businesses has grown by more than 130%, while employment levels rose more than 490% over the same period.
Interestingly, four out of six high-potential states have made it to the top six states for doing business in India under the World Bank's report. Andhra Pradesh successfully implemented 70.12% of reforms under the World Bank's benchmark agenda, becoming the second-best place in India to do business.
However, while this implies that economic growth is contingent upon the right economic policies and business attitudes, social progress among some of these high-potential states leaves much to be desired. The focus of local governments on industrial reform has not extended to initiatives to spur socioeconomic progress. In fact, Chattisgarh, Madhya Pradesh, and Rajasthan worsened on three development parameters-urbanization, literacy, and infant mortality-when compared to India as a whole. Andhra Pradesh and Uttarakhand improved only their urbanization rate, while Bihar was just able to narrow the gap in literacy and infant mortality between it and the rest of India.
Ultimately, whether current high performers will be able to make their economies more competitive in the global supply chain, or whether growth laggards can reduce poverty, generate more employment, and boost their consumer class will depend on their respective governments' willingness to ride the current wave of reform. State-level progress with the much-anticipated General Sales Tax harmonization effort, and their response to highly contentious land and labor reform initiatives, will be important signifiers to track, among others. Those areas that get-and stay-on board are the most likely to offer significant growth opportunities and become attractive environments for business in the future.
Sidebar: Urbanization fuels India's highest performers
India's urbanization rates vary greatly.
In Bihar, for example, just 11% of the population live in a city, while nearly all (98%) of the inhabitants of city-state New Delhi live in an urban setting. Both India's economic powerhouses and small high performers have much higher urbanization rates (the percentage of the population dwelling in an urban area) than the rest of the country-51% compared to the national average of 31%-indicating that urbanization rates correlate directly to a state's' potential for economic growth.
Naturally, urban areas are preferred locations for investment in manufacturing and services, which may partially explain the success of these sectors in high-performing states. But greater urbanization and investment, combined with the right government policies, often also result in better infrastructure availability-another distinct feature of India's best-performing areas. IHS analysis illustrates that the nation's high-performing states currently own a third of India's total installed power generation capacity, with over 60% equally split between Maharashtra and Gujarat. In addition, the country's four economic powerhouses are home to an extensive network of highways, railroads, and over a hundred ports, providing good connectivity for commerce and a foundation for future growth.
(Click on graphic below to see the PDF and for a clearer view)
Hanna Luchnikava is senior economist, Asia-Pacific, global economics group, IHS
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