28/09/2016 3:41 PM IST | Updated 28/09/2016 4:15 PM IST

How Indian States Are Beating Modi In Boosting India's Growth Rate

The efforts could still prove a boon to Modi by improving the nation’s overall economic record

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India can thank its state leaders, rather than the federal government, for its 7 percent-plus growth rate.

Local administrations raised spending on roads, ports and power plants by 29 percent in April to July, according to data from the national auditor. A 1 percent increase in expenditure by states leads to a 0.11 percent lift in gross domestic product compared with a 0.04 percent boost from federal investment, a central bank study showed in 2013.

Spending by Prime Minister Narendra Modi's administration fell 33.7 percent during the period, partly because he's channeling money toward higher civil servant salaries that took effect last month. Borrowing costs for Indian states are falling faster than benchmark sovereign bond yields.

The efforts could still prove a boon to Modi, by improving the nation's overall economic record as he races to create jobs before a re-election contest due in 2019. A Pew survey published last week showed that concern about unemployment has risen to levels seen before Modi swept to power in 2014, though he's still the most favored leader in India.

"State governments are likely to invest in smaller projects with greater focus that also have smaller gestational lags and fewer chances of getting stalled," said Jay Shankar, chief economist at Religare Capital Markets Ltd. in New Delhi, who's studied the trend. "Although we have not yet been able to draw conclusions on its implications for job creation, it is intuitive to assume that such smaller projects of the states would be more labor intensive leading to, among other things, greater spending multipliers vis-à-vis that of the center."

Modi enhanced the states' ability to spend when he decided last year to share a record amount of federal tax revenue with state governments. His administration this month also eased guidelines on how states can use the cash, offering them more freedom to meet local needs.

The state of Maharashtra, home to India's financial capital Mumbai, sold 10-year notes at a cut-off yield of 7.16 percent at an auction Tuesday, 21 basis points lower than what it paid for the same tenure a fortnight earlier. Borrowing costs for Haryana, Uttar Pradesh and Madhya Pradesh declined by 17 to 22 basis points, compared with a six basis point drop in the benchmark sovereign 10-year yield in the period.

Indian states planned to raise as much as 750 billion rupees ($11.3 billion) in the quarter ending Sept. 30, according to an indicative calendar on the central bank's website. That compares with an estimated as much as 600 billion rupees for the three months ended June.

Limited Role

However, the state and federal governments can only play a limited role as about 84 percent of India's total capital expenditure comes from households and corporates. Indebted companies keep private investment weak and gross fixed capital formation -- creation of productive assets such as new factories -- shrank 3.1 percent in April-June.

"The pace of a sustained economic recovery is likely to be slow, despite the push coming from consumption demand," Anuradha Basumatari, associate director at India Ratings & Research Pvt. in Mumbai, wrote in a report this month.

Growth in the construction sector, a key creator of jobs, slowed to 1.5 percent in April-June from 5.6 percent a year earlier. Output from agriculture, which directly employs almost half of the nation's workforce, slowed to 1.8 percent from 2.6 percent.

Nomura Holdings Inc. predicts overall GDP will increase only slightly to 7.3 percent in the year through March 2017 from 7.2 percent in the previous 12 months. It forecasts a pick up to 7.7 percent the following fiscal year as public capital expenditure will gain traction.

Though private capital expenditure pledged for the current fiscal year is less than half that estimated for the previous year, revival of stalled projects and the government's steps to make it easier to do business give "reasons to be optimistic," the Reserve Bank of India said in a separate study published this month.

The pay increase for state employees may kickstart demand and a good monsoon after two back-to-back droughts will also boost farm output and incomes, the report stated. "These factors may help in turning around the investment outlook in the near future."