Small states no guarantee for good growth

Updated: Apr 19 2014, 08:34am hrs
The government of Indias recent initiative to divide Andhra Pradesh into Seemandhra and Telangana has reignited the demand for new states across the country. The demand for division of states is not a new phenomenon in India. Many states were created through the States Reorganisation Act, 1956. Before that, Andhra Pradesh was carved out of Madras in 1953. Then, in 1956, as many as 14 states and six Union Territories were created. Bombay was split into Maharashtra and Gujarat in 1960. In 1963, Nagaland was carved out of Assam. In 1966, Haryana and Himachal Pradesh were carved out of Punjab, and in 1972 Meghalaya, Manipur and Tripura were formed. The states were initially reorganised along linguistic lines. However, notwithstanding other factors, uprisings in the undivided states have influenced the formation of new states lately.

The growth performance of small states is commendable, but the belief that smaller states necessarily grow faster than large states is flawed. An analysis of the growth performance of Indian states reveals that only 11 states grew faster than the country over FY06-FY13. Of these 11, only five were small statesUttarakhand, Kerala, Haryana, Goa and Himachal Pradesh. States with over 2.5% of all India area are classified as large states and the rest as small.

Economic performance: mixed signal

As the initial reorganisation of Indian states in 1956 was driven by a variety of considerations, an evaluation of the growth performance of the new states formed in 2000 (Uttarakhand, Chhattisgarh and Jharkhand) and their parent states will help in ascertaining whether there is any economic rationale for the division of large states. Our analysis is confined to the FY06-FY13 period as we consider the first five years after the formation of the states to be the period of transition for these states.

The Gross State Domestic Product (GSDP) of Uttarakhand grew by 13.2% over FY06-FY13 compared with Uttar Pradeshs 6.9%. One of the key reasons for this spectacular growth has been tax concessions given to Uttarakhand due to its geographical location. Chhattisgarhs growth was not as remarkable as Uttarakhands. It grew at an annual average rate of 7.7% over FY06-FY13 as against 8.4% of its parent Madhya Pradesh. However, it was three times that Chhattisgarhs growth surpassed the growth rate of its parent Madhya Pradesh between FY06-FY13. Although Chhattisgarh, well-endowed with natural resources, leveraged this advantage and transformed its industrial sector significantly (industrys share in economy is 40%, comparable to Gujarats), it still failed to match the growth performance of its parent state. Jharkhand underperformed as compared to its parent state Bihar over FY06-FY13. One of the key reasons for this underperformance was uncertain political environment prevailing in the state since its birth. Moreover, it also coincided with Bihars high growth phase. Nonetheless, Jharkhands economy has rebounded after the 2008 economic slowdown and grew at 10.8% over FY10-FY13.

Social and infrastructure indicators

It is the literacy rate, not the size of the state, that has influenced the outcome on the infant mortality rate (IMR). Small states with high literacy rates have reduced their IMR faster than others. However, among the parent states, Bihar was the only one to perform remarkably well on the IMR over FY05-FY11. Kerala improved its existing strong social indicators further over this period. Goa, Himachal Pradesh and Punjab also exhibited solid performance during FY05-FY11. The performance of select big states on the IMR front was also driven largely by their high literacy rates.

Then, Kerala on safe drinking water, Jharkhand on rural electrification and Punjab on road length have improved their performance. Jharkhand gradually enhanced its performance on all infrastructure deliverydue to the abysmally low level of infrastructure access in the state. Among select large states, the growth in infrastructure delivery was ordinary except the road length improvement in West Bengal.

Relatively faster road extensions, better access to potable water and higher rural electrification in new states such as Chhattisgarh and Jharkhand signify an increased, equitable and effective expenditure on infrastructure. Although one may argue that the improvement in the infrastructure services in these states could have been delayed in the absence of separation, but to say that division alone is the reason for these improvements is a stretched argument.

Fiscal performance

Fiscal performance of small states has been diverse during FY06-FY13 and has depended on the specifics. Some states were disciplined and followed prudent fiscal policies, others embraced expansive policies. While Chhattisgarh managed to keep its debt-to-GSDP and fiscal deficit-to-GSDP ratio under check, Jharkhand and Uttarakhand slipped on these indicators against their parent states.

In the Indian federal set-up, while the states have limited fiscal powers to raise resources, expenditure responsibilities for most local public goods and services are assigned to the states. As a consequence, there is always a gap between the income and expenditure of the states. This gap is filled by revenue transfer from Centre to states, which includes both grants and a share in the central taxes. However, a states revenue dependence on the Centre is not linked to its size because the grants are determined by a defined formula, which includes factors such as population, per capita income, per capita tax receipts as percentage of states per capita income and level of development, etc. Of the eight small Indian states, the average revenue dependence of four statesHaryana, Goa, Punjab and Keralaon the central government was below 30%, and for the remaining it was over 55% during FY06-FY13.

Small states have shown considerable variation in terms of the size of fiscal deficit or debt and its links with the size of the economy. In our view, the size of the economy is less relevant for prudent management of fiscal and debt metrics. Haryana, with a relative larger economy, managed fiscal balance and debt better than other states during FY06-FY13. This can be attributed to the fact that Haryanas fiscal consolidation was based not on the federal grants but largely on its own revenue sources.

However, Himachal Pradesh, the largest small state geographically, with its small-sized economy, reported high fiscal deficit/GSDP and high debt/GSDP ratios. Goa (smaller geographical area and economy) and Assam outperformed their peers and kept their debt/GSDP and fiscal deficit/GSDP ratios under control. Goas fiscal consolidation was similar to that of Haryana as its dependence on federal grants was less as opposed to Assam (high dependence on federal grants).

Chhattisgarh controlled its fiscal deficit/GSDP and debt/GSDP ratios while its parent Madhya Pradesh was not fiscally disciplined during FY06-FY13. Although Uttarakhand curtailed debt growth, it slipped slightly on the fiscal path while Uttar Pradeshs fiscal policy led to high debt/GSDP. However, the parent has managed to restrict its fiscal deficit/GSDP (average FY06-FY13: 3.32%) below that of Uttarakhand (3.55%).

Despite limiting the debt/GSDP below its parent Bihar, Jharkhands expansive policy and low growth steered its fiscal deficit/GSDP beyond 4% during FY06-FY13. However, Bihars tight fiscal policy and high growth restrained the fiscal deficit exacerbation.

Economic rationale pivotal

Although economic and social performance is uneven across states, creation of a state on the basis of size is not a solution for all the ills plaguing states. Formation of a state should not only assure robust governance to fuel economic growth but also strengthen the institutional framework before the division.

Ideally, a state should be divided/created only after evaluating geographical strength, topography, agro-climatic conditions, socio-cultural factors, economic potential/resources etc. However, since multitude of pressure points including people protests may not offer adequate time to gauge these aspects for the government before the division of a particular state is decided and announced, perhaps it is time to set up a second States Reorganisation Commission.

In short, elaborative administrative and governance framework is necessary before splitting rather than announcing the division and then settling the differences on an ad hoc basis.

Siva Subramanian and Sunil Kumar Sinha are associate director and director & principal economist, respectively, at India Ratings and Research Pvt Ltd (Ind-Ra)