Explain how the Fiscal Health Index (FHI) can be used as a tool for assessing the fiscal performance of states in India. In what way would it encourage the states to adopt prudent and sustainable fiscal policies?

GS 3

Economy

2025

15 Marks

The Fiscal Health Index (FHI) 2025, developed by NITI Aayog, provides a composite tool to assess the fiscal performance of Indian states and encourages them to pursue sustainable fiscal practices.

Covering eighteen major states, it measures fiscal health through five key parameters using data from the Comptroller and Auditor General of India (CAG).

FHI as a Tool for Assessing Fiscal Performance

Aspect	How FHI Assesses	Examples
Standardised Measurement	Evaluates states on revenue mobilisation, expenditure quality, debt management, fiscal deficit management, and overall sustainability	Provides comprehensive view beyond deficit figures
Revenue Mobilisation	Measures own tax & non-tax revenues, tax buoyancy	Odisha, Jharkhand, Goa, Chhattisgarh mobilised ~21% of total revenues from non-tax sources
Expenditure Management	Tracks efficiency & capital spending priorities	Odisha, Goa, Karnataka allocated ~27% to capital works; Punjab, West Bengal ~10%
Debt & Deficit Analysis	Analyses debt-to-GSDP ratios, fiscal deficit levels	Odisha strong debt profile (score 67.8); Punjab, West Bengal high unsustainable debt
Comparative Benchmarking	Ranks states to show best and worst performers	Odisha, Chhattisgarh, Goa at top; Punjab, Andhra Pradesh, Kerala, West Bengal at bottom
Transparency	Publishes comparable fiscal data	Enables evidence-based policymaking and accountability

How FHI Encourages Prudent and Sustainable Fiscal Policies

Improves Spending Quality: States are nudged to prioritise capital expenditure on infrastructure and social sectors rather than unsustainable revenue expenditure. For example, Odisha and Madhya Pradesh allocated nearly 27% of developmental spending to capital outlay, compared to Punjab and West Bengal at around 10%.
Debt Sustainability Discipline: By exposing rising debt burdens, FHI pushes states to adhere to FRBM targets and avoid excessive off-budget borrowings. Odisha’s debt-to-GSDP ratio at ~22% shows prudence, while Punjab’s ~46% ratio highlights risks.
Revenue Reforms: States with weak mobilisation are encouraged to strengthen GST compliance, widen their tax base, and diversify non-tax revenue. Odisha’s mining premiums and Chhattisgarh’s coal block auctions generated over 20% of revenue from non-tax sources.
Competitive Federalism: Rankings foster competition, motivating states to improve performance to gain reputational and economic advantages. Goa’s strong revenue surplus and Chhattisgarh’s fiscal prudence have set benchmarks.
Policy Replication: Best practices of top performers (e.g., Odisha’s robust debt management, Goa’s capital spending efficiency) create models for weaker states to adopt.
Informed Transfers: FHI can guide Finance Commission transfers and central schemes, linking resource allocation with fiscal responsibility; for instance, 15th FC incentives for power sector and local body reforms can be tied with FHI results.

The Fiscal Health Index is not merely a ranking exercise but a diagnostic and motivational tool. FHI boosts the fiscal health of states by guiding better tax administration, debt management, and expenditure quality, thereby improving their overall economic condition while reinforcing fiscal federalism.

Answer Length

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