Q11. 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?
Possible Introductions
Definitional framing:
The Fiscal Health Index (FHI), developed by NITI Aayog in 2025, is a composite indicator designed to assess the fiscal performance of major Indian states across parameters of revenue, expenditure, debt, deficits, and sustainability.
Contextual framing (India):
Since states account for nearly two-thirds of public expenditure and one-third of revenues, their fiscal health is critical for macroeconomic stability. The FHI provides an evidence-based tool to evaluate fiscal performance and identify weaknesses.
Current affairs framing:
The first FHI ranked Odisha, Chhattisgarh, and Goa at the top, while Punjab, Andhra Pradesh, and West Bengal struggled with poor debt sustainability and high fiscal deficits—highlighting wide variation in state-level fiscal practices.
Directive Analysis
“Explain how” → requires detailing the FHI framework and indicators used to assess fiscal performance.
“In what way would it encourage” → requires linking the index to behavioural change in states through benchmarking, incentives, and accountability.
Body of the Answer
1. How FHI Assesses Fiscal Performance
-
- Revenue Generation & Mobilization: Evaluates states’ own revenue receipts, tax buoyancy, and non-tax revenue (e.g., mining premiums in Odisha, coal auctions in Chhattisgarh).
- Expenditure Quality: Measures prioritisation of capital expenditure over subsidies, assessing whether spending is developmental and growth-oriented.
- Debt Management: Analyses debt-to-GSDP ratios, interest payment burdens, and sustainability of debt portfolios.
- Deficit Management: Evaluates adherence to fiscal deficit limits and long-term fiscal discipline.
- Overall Fiscal Sustainability: Provides a composite score integrating all parameters to rank states comparatively.
X-Factor: Odisha’s high capital outlay/GSDP ratio and strong debt profile contrasted with Punjab’s rising debt-to-GSDP ratio shows how FHI identifies both best practices and risk zones.
2. How FHI Encourages Prudent and Sustainable Policies
-
- Benchmarking and Peer Pressure: Ranking encourages competitive federalism; lagging states emulate leaders.
- Policy Guidance: Pinpoints weaknesses (e.g., low capital expenditure in Punjab, Andhra Pradesh, West Bengal) to guide targeted reforms.
- Focus on Productive Investment: By emphasizing capital outlay/GSDP ratio, FHI encourages long-term, productive investments over populist measures.
- Incentivisation: Results can inform Finance Commission transfers, borrowing limits, or central assistance, rewarding better fiscal management.
- Transparency and Accountability: Public disclosure increases scrutiny of state budgets, curbing populist giveaways.
- Promotes Long-Term Stability: Encourages states to balance growth with debt sustainability.
X-Factor: Linking FHI to Sustainable Development Goals (SDGs) can push states to align fiscal policies with climate and social equity goals.
Possible Conclusions
Future-oriented:
The FHI is more than an assessment tool—it is a roadmap for resilient, sustainable, and growth-oriented fiscal federalism in India.
Policy-oriented:
Institutionalising FHI within Finance Commission recommendations and NITI Aayog’s monitoring can make it a cornerstone of cooperative and competitive federalism.
Philosophical:
As healthy finances are the foundation of good governance, the FHI represents an attempt to measure and encourage fiscal health as a public good.
Shared national vision:
The FHI aligns states’ fiscal strategies with broader national objectives like “Viksit Bharat @2047”, where fiscal discipline at the state level is seen as crucial for national economic stability.
