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Telangana becomes the first Indian state carved out on a linguistic basis, created for speakers of a regional language called Telugu.
The new state will cover 10 of Andhra Pradesh’s 23 districts, including the city of Hyderabad.
Hyderabad is India’s sixth biggest city, home to many major information technology and pharmaceutical companies, as well as the central revenue earner for the state.
Hyderabad will serve as the common capital of the two states for 10 years until Andhra Pradesh develops its own capital.
It is likely to take at least six months to complete the formalities for the new state of Telangana.
A dedicated unit will be set up in the Planning Commission to deal with the reorganised state under the direct charge of the deputy chairman for financial management of the transition.
Many from the residuary state of Andhra Pradesh have been protesting for months against the move to split the state, with members from the ruling Congress party also expressing their disapproval.
Four Union Council ministers have already resigned from the government in protest.
Shops, businesses, transport and educational institutions were closed in all 13 districts of the Seemandhra region in the state, as a 48-hour shutdown began on Friday morning to protest the decision.
Police and paramilitary forces were deployed in large numbers on Friday to maintain law and order across the region.
The Home Ministry has asked the state government to be on high alert in coastal Andhra and Rayalaseema districts in the state following the Cabinet decision.
Thursday’s announcement brings to fruition a promise made by the ruling Congress Party in 2009 about the creation of a new state and the end of the Telangana campaign that has rolled on for decades.
India may have at least 50 states in the future if demands for new ones are to be conceded – the Home Ministry has received presentations for the creation of more than 20 states.
However, the Union Home Minister Sushilkumar Shinde said earlier in August that these demands will not be considered now.