Model Answer
0 min readIntroduction
The Fiscal Health Index (FHI), recently introduced by NITI Aayog in January 2025, serves as a comprehensive multi-dimensional tool to evaluate the fiscal performance of Indian states. Developed to go beyond single-metric analyses like fiscal deficit, the FHI provides a holistic framework by assessing various critical aspects of state finances. It covers 18 major states, leveraging data from the Comptroller and Auditor General of India (CAG) for the Financial Year 2022-23. The FHI aims to offer data-driven insights that guide policymakers in implementing reforms for sustainable economic growth, fiscal consolidation, and efficient resource management at the state level, thereby strengthening India's cooperative federalism.
FHI as a Tool for Assessing Fiscal Performance
The Fiscal Health Index (FHI) provides a systematic and comparative assessment of states' fiscal performance through a set of five key sub-indices:
- Quality of Expenditure: This sub-index measures the balance between spending on long-term growth (developmental, e.g., capital investments in infrastructure, health, education) and routine operations (non-developmental, e.g., subsidies, administrative costs). States prioritizing capital expenditure are rated higher, indicating a focus on productive investments.
- Revenue Mobilization: It evaluates a state's ability to generate its own revenue through tax and non-tax sources, indicating its financial self-sufficiency and reduced dependence on central transfers. Higher own revenue generation reflects stronger fiscal autonomy.
- Fiscal Prudence: This parameter monitors fiscal and revenue deficits, as well as borrowing levels, relative to the Gross State Domestic Product (GSDP). It assesses adherence to fiscal responsibility targets and indicates the state's overall fiscal health in managing its budgetary balances.
- Debt Index: It assesses the state's debt burden by focusing on interest payments and total liabilities in relation to its economic size (GSDP). A high ratio indicates heavy indebtedness and potential fiscal stress.
- Debt Sustainability: This sub-index compares GSDP growth to interest payments. A positive difference signifies that the state's economic growth is sufficient to service its debt obligations, indicating fiscal sustainability.
By providing a composite score based on these parameters, the FHI allows for inter-state benchmarking, identifying top performers and laggards. For instance, the FHI 2025 report (FY 2022-23) identified Odisha as the top-performing state, excelling in debt management and sustainability, while Punjab and West Bengal lagged due to concerns over expenditure quality and debt sustainability.
Encouraging Prudent and Sustainable Fiscal Policies
The FHI acts as a crucial incentive mechanism to encourage states to adopt prudent and sustainable fiscal policies through several ways:
- Competitive Federalism: The ranking system fosters healthy competition among states. States aspire to improve their FHI scores for better reputation, attracting investments, and demonstrating efficient governance. This "race to the top" encourages fiscal reforms.
- Benchmarking and Peer Learning: FHI enables states to identify their fiscal weaknesses and learn from the best practices of high-performing states. For example, states struggling with revenue mobilization can study strategies adopted by states like Goa (known for strong revenue generation).
- Policy Nudge and Accountability: The index highlights specific vulnerabilities (e.g., high debt burden, low capital expenditure), prompting states to take corrective measures. Publicly comparable fiscal data enhances transparency and holds governments accountable for their financial decisions.
- Incentivizing Expenditure Quality: By rewarding higher capital expenditure and penalizing non-developmental spending, the FHI nudges states to prioritize investments in infrastructure and human capital, which are crucial for long-term economic growth. States like Madhya Pradesh and Uttar Pradesh have shown stronger capital investment.
- Guiding Borrowing Behavior and Transfers: The FHI's emphasis on debt and fiscal deficits encourages states to adhere to Fiscal Responsibility and Budget Management (FRBM) targets. A healthier FHI score could potentially influence Finance Commission recommendations for grants and transfers, rewarding fiscally disciplined states.
- Promoting Sustainable Welfare Policies: In the context of debates around 'freebies' versus 'welfare,' the FHI encourages states to evaluate the long-term fiscal costs of their policies, balancing immediate welfare needs with fiscal sustainability.
Conclusion
The Fiscal Health Index emerges as a vital diagnostic and prescriptive tool for India's fiscal federalism. By offering a comprehensive, data-driven assessment across multiple dimensions of state finances, it not only highlights fiscal strengths and weaknesses but also actively promotes accountability and informed policy-making. The FHI fosters a spirit of competitive and cooperative federalism, encouraging states to strive for fiscal discipline, efficient resource allocation, and debt sustainability. Ultimately, by incentivizing prudent fiscal management, the FHI aims to ensure robust sub-national finances, which are indispensable for achieving overall macroeconomic stability and inclusive growth for the nation.
Answer Length
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