APPROACH
The Introduction: Talk about the importance of states in public spending and NITI Aayog’s FHI
The Body
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- Briefly talk about the construct of FHI
- Elaborate as to how FHI can act as tool for assessing fiscal performances of states
- Highlight how FHI could encourage states to adopt prudent fiscal policies
The Conclusion: Give an appropriate conclusion in this regard.
The Introduction:
Efficient state finances are important to India’s economic resilience. States control about 60% (Rs 72 lakh crore out of Rs 120 lakh crore of total public expenditure by the general government in India) of public spending. In January 2025, NITI Aayog introduced the Fiscal Health Index (FHI) that assesses fiscal performance for 18 major states.
The Body
How FHI Works
The FHI evaluates states on five key dimensions :
1. Quality of Expenditure: Focus on developmental spending and capital outlay relative to GSDP.
2. Revenue Mobilisation: Assessment of own tax and non-tax revenue performance.
3. Fiscal Prudence: Monitoring fiscal and revenue deficits relative to GSDP.
4. Debt Index: Evaluating interest burden and debt-to-GSDP ratio.
5. Debt Sustainability: Measuring whether GSDP growth outpaces interest payments, indicating manageable debt.
These sub-indices are normalised and averaged to produce a composite FHI score. In FHI 2025, Odisha was the leading state at 67.8, followed by Chhattisgarh and Goa.
FHI as a Tool for Assessing Fiscal Performance
1. Holistic measurement: Unlike the Fiscal Responsibility and Budget Management (FRBM) Act targets, which focus narrowly on fiscal deficit and debt, the FHI is a multi-factorial index. This gives a clearer picture of fiscal health beyond traditional numbers.
2. Comparability and ranking: States can be ranked annually, similar to the Ease of Doing Business or SDG Index. For example, the RBI 2023 report showed debt-to-GSDP ratios above 35% for states like Punjab, Kerala and Rajasthan, while fiscally prudent states like Gujarat and Maharashtra were better placed.
3. Data-driven policy insights: Policymakers can identify specific weaknesses like excessive reliance on central transfers, low tax buoyancy or excessive focus on subsidy. Numerous Economic Surveys have highlighted that many states spend more than 50% of their revenue on committed expenses like salaries, pensions and interest, which crowds out developmental expenditure.
How FHI encourages prudent and sustainable fiscal policies
1. Promoting fiscal prudence through competitive federalism: Once states are ranked, fiscal prudence becomes a matter of political prestige among laggard states. FHI would nudge them to keep deficits low and spending efficient.
2. Better access to borrowing and incentives: The Union government can use FHI scores to decide borrowing limits and fiscal transfers. States with healthier scores could get easier access to borrowing and performance-linked incentives.
3. Encouraging sustainable welfare policies: Recent debates on “freebies vs. welfare” show how unsustainable populist schemes can destabilise finances. FHI would push states to evaluate the long-term fiscal cost of such policies, balancing welfare with sustainability.
4. Improves transparency and public accountability: A publicly available FHI will empower citizens, civil society and media to question imprudent fiscal decisions. For example, high subsidies on power and irrigation in some states could be criticised as fiscally unsound, creating pressure for reform.
The Conclusion
The proposed Fiscal Health Index (FHI) is more than just a statistical tool, it is a governance innovation aimed at safeguarding India’s cooperative federalism. By providing a comprehensive, comparable and transparent assessment of state finances, it will enable early detection of fiscal stress and encourage states to compete in adopting prudent, sustainable fiscal policies.
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