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?

Q.11: 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? (15 Marks, 250 Words)

Approach

Start with a brief intro on FHI and its objectives, then cover its five pillars (expenditure quality, revenue mobilisation, fiscal prudence, debt index, debt sustainability) with examples. Conclude by highlighting how it promotes benchmarking, gap analysis, and competitive federalism to ensure prudent fiscal management.

The Fiscal Health Index (FHI) initiative by NITI Aayog aims to evolve an understanding of the fiscal health of states in India. The Fiscal Health Index (FHI) evaluates states on expenditure quality, revenue mobilization, fiscal prudence, debt index and debt sustainability.

Note

Objectives of the Fiscal Health Index

To provide a comparative analysis of fiscal health across Indian states through standardized metrics.
To identify areas of strength and concern in states’ fiscal management practices.
To promote transparency, accountability, and prudent fiscal management through empirical assessment.
To assist policymakers in making informed decisions aimed at enhancing fiscal sustainability and resilience.

Fiscal Health Index (FHI) as a tool for assessing the fiscal performance of States:

Quality of expenditure: FHI tracks the share of capital outlay in total developmental expenditure, thereby assessing whether states are prioritising asset creation over consumption-driven spending.
- E.g.: Kerala and Tamil Nadu show relatively lower capital outlay shares despite large commitments on health and education. FHI highlights this imbalance, nudging them towards infrastructure-oriented expenditure for long-term growth.
Revenue mobilisation: By examining own-tax revenue, tax buoyancy, and dependence on transfers, FHI highlights the capacity of states to sustain welfare and development schemes.
- E.g.: Maharashtra and Gujarat perform better with high tax buoyancy relative to GSDP, showing how industrialised states can fund welfare without over-borrowing.
Fiscal prudence: FHI evaluates fiscal deficit and revenue deficit ratios, assessing alignment with FRBM Act targets and the sustainability of spending patterns.
- E.g.: Haryana’s relatively high revenue deficit signals borrowing for current expenditure. FHI ranking pushes the state to rationalise subsidies (especially in power) and enhance capital expenditure.
Debt Index: By tracking interest payments as a share of revenue receipts, FHI assesses the sustainability of debt and burden of debt servicing.
- E.g.: Rajasthan shows a rising interest-to-revenue ratio, reflecting stress from populist commitments, while Goa demonstrates better debt management through prudent borrowing.
Debt Sustainability: FHI compares GSDP growth with the growth of interest burden, signalling whether states’ economic growth can support debt servicing.

Encouraging the States to adopt prudent and sustainable fiscal policies

Benchmarking & peer learning: Use composite and pillar scores to see who’s doing what right and emulate.
- E.g.: Odisha tops the overall index (score 67.8) with a very strong Debt Index (99.0) and Debt Sustainability (64.0); Chhattisgarh and Goa follow.
Diagnose dimension-specific gaps: Drill into sub-indices to find exactly where to act.
- E.g.: Uttar Pradesh and Bihar score well on Quality of Expenditure but rank lower on Revenue Mobilisation. Focus on widening the own-tax base and user charges, not merely spending mix.
Improve capex quality and prioritisation: Track the share of capex inside developmental spend and against GSDP to protect growth-enabling outlays.
- E.g.: Madhya Pradesh, Odisha, Goa, Karnataka, Uttar Pradesh allocate ~27% of developmental expenditure to capital; West Bengal, Andhra Pradesh, Punjab, Rajasthan are near 10%—useful for reprioritising budgets.
Early-warning on debt stress: Monitor IP/RR and Debt/GSDP alongside the growth-interest spread to prevent crowding out.
- E.g.: West Bengal and Punjab show rising Debt/GSDP and weaker sustainability flagging the need for consolidation plans.
Revenue strategy design: States with weak State-Own-Revenue can study top performers’ playbooks (tax buoyancy, non-tax policy).
- E.g.: Odisha, Jharkhand, Goa, Chhattisgarh average ~21% of total revenue from non-tax sources (e.g., mining premia/auctions) a template for resource-rich states.
Competitive federalism: Labeling states into Achiever / Front-runner / Performer / Aspirational creates a healthy competition that nudges laggards toward fiscal discipline.

Therefore, the Fiscal Health Index offers a valuable tool for assessing the fiscal performance of Indian states. It highlights the need for continuous monitoring, prudent fiscal management, and proactive measures to enhance states’ financial health. The Index underscores the importance of revenue generation, efficient expenditure management, debt control, and adherence to fiscal deficit targets for overall fiscal sustainability.