Uttar Pradesh farmers could benefit from foreign investment in retail.

Photographer: Prashanth Vishwanathan/Bloomberg

India's Two-Speed Economy

Dhiraj Nayyar is a journalist in New Delhi. Trained as an economist, he has worked at the Financial Express, India Today and Firstpost.com. He is editor of "Surviving the Storm: India and the Global Financial Crisis."
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India’s growth rate has been strikingly uneven over the last decade, plunging from over 9 percent in the boom years between 2004 and 2007 to below 5 percent between 2012 and 2014. That’s a large part of the reason new Prime Minister Narendra Modi sailed into office so easily. If Modi wants to fulfill his promises to revive India, though, he’s going to have to address a different kind of disparity, one rooted in geography.

A new McKinsey study lays out some worrying projections. Between now and 2025, the report says, just eight out of India’s 29 states will account for 52 percent of India’s incremental growth. Adding in the four best-performing city-states (out of seven in all), the share grows to 57 percent. Together, these cities and states are home to only a third of India’s billion-plus population.

By 2025, according to McKinsey, those fortunate citizens should enjoy enviable living standards. The richest areas -- Goa and the city of Chandigarh -- will boast a per capita gross domestic product equivalent to Spain today ($32,000), in purchasing power parity terms. The capital region of Delhi will reach Russia’s current level of $24,000, while residents of Maharashtra, Gujarat, Haryana and Kerala will be about as wealthy as present-day Brazilians ($14,000). The rest of the high-growth group should have a per capita GDP of around $10,000, similar to China today.

The problem is that no states from India’s vast, heavily populated central and eastern regions feature in the high-performing category. These states are countries unto themselves: With 200 million residents, Uttar Pradesh is about the same size as Brazil. Just three states (Uttar Pradesh, Bihar and West Bengal) make up 30 percent of India’s population today and, if present fertility trends continue, will account for even more in 2025.

This isn’t a new problem. Throughout the 1990s and 2000s, a combination of states in central India (Bihar, Madhya Pradesh, Rajasthan and Uttar Pradesh) were known by the acronym BIMARU, which means “sick” in Hindi. More recently, new leadership has turned several of them around: Madhya Pradesh has averaged over 10 percent growth for the past three years. Still, they will all need to grow much faster than India’s advanced states in order to catch up.

This presents a challenge for Modi. In theory, in a fiscal and monetary union like India, richer states would in effect subsidize their poorer brethren, through revenue transfers to fund infrastructure, education and health, as well as industrial development. At the same time, migrants would move to where the jobs are -- relieving population pressures at home and sending back remittances that would spur the local economy.

In theory, Modi can force states to share their revenues. In practice, even the best-performing regions still lag far behind income levels in advanced countries, and they will fight to invest their resources closer to home. Several relatively wealthy areas -- Maharashtra and its capital Mumbai, in particular -- have long histories of chauvinist politics, focused on outsiders “stealing” jobs and draining public services. An influx of new migrants would surely spark a backlash.

Nor can Modi easily spur development using federal funds. The key factor holding back poorer states is a lack of infrastructure -- both physical (roads and airports) and social (education and health). State governments control both.

So what can the prime minister do? Several of the laggard states are entirely landlocked, which hardly makes them attractive destinations for industry. But, being located in the fertile Gangetic plains, they do have strong agricultural economies. If Modi’s government reversed its opposition to foreign investment in multi-brand retail, new businesses could link farmers in these states to modern supply chains, boosting incomes. The government could also go further in liberalizing India’s service sectors, particularly banking and insurance. That would create good jobs that could be located anywhere.

Modi can also encourage India’s better-off states, especially those controlled by his own Bharatiya Janata Party, to push ahead with labor and land reforms that would unlock growth. The worst-performing states all suffer from bad leadership. Local powerbrokers have relied on divisive caste politics and wasteful populist polices to cling to office. Seeing other states race ahead might spur voters to demand better leaders. If their problems are local, their solutions will have to be, too.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Dhiraj Nayyar at dhiraj.nayyar@gmail.com

To contact the editor on this story:
Nisid Hajari at nhajari@bloomberg.net