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?

FHI as a Tool to Assess Fiscal Performance

• Revenue mobilisation: Assesses the State's capacity to raise own tax and non-tax revenue, indicating its fiscal autonomy and dependence on transfers.
• Quality of expenditure: Examines whether public spending is directed towards capital expenditure and productive assets rather than predominantly towards routine revenue expenditure.
• Fiscal prudence: Evaluates fiscal deficit in relation to GSDP, helping identify States following sustainable versus excessive borrowing practices.
• Debt sustainability: Examines debt-GSDP and interest burden, indicating whether current borrowing can be serviced without creating a future fiscal crisis.
• Inter-State benchmarking: Provides a common framework to compare States, identify fiscal strengths and weaknesses, and track changes in fiscal performance over time.
• Early-warning mechanism: Annual assessment can highlight fiscal slippages, enabling States to undertake corrective measures before imbalances become severe.
  • Example: Odisha ranked first in the FHI 2025, demonstrating the usefulness of a composite measure beyond simply comparing State economic size.

How FHI Encourages Prudent and Sustainable Fiscal Policies

• Promotes fiscal discipline: Greater visibility of deficits, debt and interest burden creates pressure on States to avoid persistent fiscal profligacy.
• Encourages productive expenditure: Greater emphasis on capital expenditure can shift spending towards infrastructure and other productive assets that support future growth.
• Strengthens own-revenue efforts: States are encouraged to improve tax administration, compliance and non-tax revenue mobilisation, reducing excessive dependence on transfers.
• Promotes sustainable borrowing: Monitoring debt-GSDP and debt-servicing capacity encourages States to borrow within sustainable limits and use borrowed funds productively.
• Encourages competitive federalism: Public rankings create peer pressure and policy learning, enabling weaker-performing States to adopt fiscal best practices from better-performing States.
• Improves budget transparency: A common set of indicators makes fiscal performance more transparent, comparable and evidence-based, strengthening legislative and public scrutiny.
• Supports long-term welfare: Fiscal sustainability creates adequate fiscal space for continuous spending on health, education, infrastructure and other developmental priorities.
  • Example: A State improving own-revenue mobilisation and capital expenditure can strengthen its fiscal position while creating resources for long-term development.

Limitation

• FHI should function as a diagnostic and benchmarking tool, not as a substitute for the Finance Commission or a rigid penalty mechanism, since States differ in their revenue bases, developmental needs and fiscal circumstances.