What explains the prosperity gap between states?

The difference in price-level increases across states is clearly much lower than the variation in growth performance. What explains this phenomenon?

The CPI in India comprises six broad categories: food and beverages, paan, tobacco and intoxicants, clothing and footwear, fuel and light, housing (urban), and miscellaneous. The weights of these categories differ across states depending on the consumption basket of an average person in each. Nonetheless, one can compare how sub-indices have moved over time to understand inter-state differences in drivers of overall price levels.

It should be noted that one cannot infer absolute prices across states from CPI changes. The CPI provides information on movement over time compared to its base year. Currently, the CPI base year is 2012, which means that the cumulative rise in the price level is as compared with its 2012 level in each state.

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The category of food and beverages is the largest component in the CPI. Kerala’s CPI has the lowest weightage for it, while Bihar has the highest share spent on food and beverages. In this category, Kerala has seen the highest increase in price levels since 2011-12, while Haryana has seen the lowest.

The least variation in the price-level rise across states is in two sub-categories: clothing and footwear and the miscellaneous category, which includes the prices of services such as education, health, transport and communication, and personal care. It is somewhat surprising that services, barring communication, which tend to be produced and consumed locally, have not seen a larger spread in the cumulative price-level increase.

There are two sub-categories where changes in prices are influenced by government taxation policies: paan, tobacco and intoxicants, and fuel and light. West Bengal has seen prices double in the first of these two categories, while the least increase in prices in this category was seen in Jharkhand.

In the fuel and light sub-index, Kerala has seen the highest price rise, while Haryana has witnessed the least increase, as its cumulative price rise has only been 38% in a decade. Except in the case of Jharkhand, in all other states, the price increase in the paan, tobacco and intoxicants group has been higher than the price rise in fuel and light, partially reflecting subsidized electricity prices.

The highest variation in rising prices among states has been seen in the housing sub-index, which represents only urban house prices with rental rates largely serving as their proxy. The highest rise in rental prices in urban India has been recorded in Karnataka, at 76%, while the lowest rise of 37% has been in Punjab since 2011-12. In addition to housing demand, changes in housing prices are also influenced by government policies related to the taxation of real estate and regulations related to the availability of land for real estate development, both of which influence the supply of housing.

Overall, among India’s 16 major states, people in Gujarat have witnessed not only the fastest rise in their real incomes (82%), but also the least rise in the general price level (50%) since the start of the last decade. So feelings of prosperity and related well-being are likely to be the highest among people residing in Gujarat. In Telangana, Karnataka and Odisha, a rise in real incomes have been higher than a rise in the price level, but only marginally. In contrast, in states such as Rajasthan, Uttar Pradesh, Jharkhand and Punjab, the cumulative price rise has been higher than the cumulative per person real income rise, and by a wide margin.

Despite the higher variations in sub-categories of the CPI index, the spread between the overall CPI index, as of March 2021, at the state level was much smaller, at 16, and even if we extend the period till June 2022, the spread in the CPI indices remains only at 18. This suggests that relative price movements at sub-category levels tend to cancel each other out, and along with differences in the weights of sub-categories, the overall spread in the CPI index among Indian states is much lower at the aggregate level.

What does this imply for the central bank and monetary policymaking? Had the variation in the overall CPI indices at the state level been larger, it may have been a signal that inflation based on the all-India CPI measure is not an appropriate policy target under India’s inflation targeting framework. This, however, does not appear to be a worry, given the narrower spreads between state-level CPI overall indices.

What is, however, worrisome is that a rise in economic prosperity as reflected in the rise in per person real state domestic product has differed markedly over the past decade. It is imperative that this trend reverses in the current decade and that India’s growth attains a less uneven distribution across states and thus becomes more inclusive.

Vidya Mahambare & Praveen Kumar are, respectively, a professor of economics and director (research), and graduate of Great Lakes Institute of Management, Chennai.

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