COVID-19 and beyond: growth, recovery, and fiscal challenges across Indian states

COVID-19 adversely affected the Indian economy with a differentiated impact at the state-level.

In brief

• While India’s GDP suffered a contraction of (-)5.8% in FY21, the experiences of individual states differed extensively during COVID-19.
• The rates of recovery from COVID-19 across states and their fiscal positions also differ considerably.
• Post the considerable fiscal stimulus provided by central and state governments in FY21, there is now a need to restore fiscal consolidation.

During the COVID year of FY21, India’s real GDP contracted sharply by (-)5.8%. However, there was considerable disparity in the growth experience of individual states with only three states, namely Assam, Sikkim and Tamil Nadu, posting low but positive growth in FY21. In order to combat the deleterious impact of COVID-19, both the Government of India and states deviated sharply from their respective fiscal deficit and debt-GDP benchmarks. Since then, both the Indian economy and individual state economies and their corresponding government finances have improved, although with significant inter-state variation.

States that suffered the most due to the pandemic

For assessing the growth performance, Indian states may be divided into two broad groups namely, medium and large (ML) states and small and hilly (SH) states. States in these two groups may be subdivided into three categories: 

a) states suffering higher rates of contraction than the group average by a margin of more than 1%.

b) states with contraction in the range of +/-1% with respect to the group average.

c) states performing better than the group average by a margin of more than 1%. States in each of these categories are given in Table 1.

States such as Kerala, Maharashtra and West Bengal are the ones that have major ports and airports. These states suffered significantly more than others in terms of a higher COVID-19 incidence which may be attributable to higher international tourist arrivals accompanied by a high population density1 . Among the UTs, Delhi also belongs to this group, and it suffered a growth erosion of (-)6.6%. These states suffered relatively larger economic losses.  

In analyzing the relative recovery from the COVID-19 shock, it would not be appropriate only to look at the magnitude of y-o-y growth rates in FY22 since these growth rates would be reflecting a base effect to a significant extent. Instead, it is better to look at the growth in FY22 over the corresponding FY20 magnitudes. States showing impressive recovery in terms of this growth include Rajasthan (11.4%), Assam (8.1%), Odisha (11.3%), Gujarat (10.6%), Andhra Pradesh (11.2%), and Karnataka (11.0%) among the ML states.  

Sectors that suffered the most during the pandemic: an inter-state perspective

Another characteristic in terms of the relatively larger growth contraction relates to the sectoral output profile of these states. Agriculture remained in the positive territory of growth in the COVID-19 year for all ML states except Haryana. Consequently, states that have a relatively larger share of agriculture in their Gross State Value Added (GSVA) got away with a lower growth erosion. These states include Andhra Pradesh and Madhya Pradesh. Some states showed extraordinarily high growth in agriculture during the COVID-19 year such as Kerala, Maharashtra, Assam, Bihar, Odisha, Jharkhand, and Rajasthan. One possible reason for this buoyant state level performance in agriculture in the COVID-19 year may be a shift of urban labor to agriculture in this year. It is also worth noting that in the case of agriculture, the SH states as a whole suffered a contraction in FY21.

In the case of industrial GSVA, it is worth emphasizing that the contraction in this sector had started in FY20 which was largely due to non-COVID factors including a domestic demand slowdown. The global growth rate had also fallen from 3.6% in 2018 to 2.8% in 2019 and the contribution of net exports to India’s real GDP growth also became negative. It is notable that both for the ML and SH groups, the contraction in terms of magnitude in industry was much less than that in services. 

Within the services sector, trade, transport, and hotels alone had an average weight of 19% in Gross Value Added (GVA) at constant prices during FY18 to FY22. This sector is contact-intensive and is also known to contain a large number of employment-intensive enterprises including the MSMEs. Almost all states except Tamil Nadu and Himachal Pradesh suffered a double-digit contraction in this sector (Table 2). Sikkim was the only state where there was a positive growth in this sector.

As far as recovery from COVID-19 is concerned, there was a notably high growth rate in this sector in FY22 due to a large favorable base effect. When we look at the profile of recovery by calculating growth in FY22 over FY20, it is clear that in case of most states, recovery has not been complete since the FY22 magnitude remained below that of FY20. The only states that showed marginally positive growth rates among the ML group of states are Gujarat, Tamil Nadu and Telangana. The second wave of COVID-19 largely affected 1QFY22. This particularly affected the trade, transport, hotels et al. sector which is indicated by a continued negative growth in the output of this sector in FY22 as compared to that in FY20.

How far did the states stimulate their economies?

With a view to combating the growth erosion resulting from the economic shocks of COVID-19, one major policy instrument available to the central and state governments was fiscal stimulus. At the central level, the fiscal deficit relative to GDP was expanded well above the Fiscal Responsibility and Budget Management (FRBM) threshold of 3% of GDP, taking it to 9.2% in FY21. States also responded by expanding their fiscal deficit to Gross State Domestic Product (GSDP) ratios although in their case, the extent of departure from the FRBM benchmark of 3% was limited. The fiscal deficit to GSDP ratio was 4.1% for the ML states and 3.8% for the SH states.

Paving the way for prosperity  
Policymakers must now prioritize reducing the debt and fiscal deficit relative to GDP of both central and state governments to align with sustainability norms, establishing a firm base for consistent and robust medium-term growth. This would be crucial for achieving India’s ambitious goal of becoming a US$5 trillion economy in the next few years. In this endeavor, states would have a significant role to play.

The combined size of the five largest states namely, Maharashtra, Tamil Nadu, Gujarat, Karnataka, and Uttar Pradesh are projected to reach US$2.6 trillion by FY28 (for details, see the In-focus section of the March 2023 issue of the Economy Watch)5. However, for reaching the US$5trillion target, other larger states such as West Bengal, Rajasthan, Andhra Pradesh, Telangana, Madhya Pradesh, and Kerala would also make a significant contribution.