Explain how the Fiscal Health Index (FHI) can be used as a tool for assessing the fiscal performance of states in India. In what…

The Fiscal Health Index (FHI) is a composite index, released by NITI Aayog, that converts state budget and finance-account data into a fiscal scorecard. It compares states on five parameters—quality of expenditure, revenue mobilisation, fiscal prudence, debt index and debt sustainability—using indicators such as gross debt to GSDP, interest payments to revenue receipts, fiscal deficit to GSDP, own tax revenue growth, capital expenditure as a share of total expenditure, and revenue per capita. Ranking states enables benchmarking: in the first edition (January 2025, covering 18 major states for 2022–23), Odisha ranked first, while Punjab ranked last among the 'aspirational' performers.

The FHI influences behaviour through transparency and incentives. When a state’s debt-to-GSDP or interest burden is high, the ranking signals weak fiscal capacity, which can raise bond yields and borrowing costs. It can also affect the Centre’s decisions on conditional grants, loans and fiscal transfers, because better-ranked states appear lower-risk. This creates competitive federalism: states improve tax administration, reduce revenue deficits and shift spending toward capital works to climb the index.

However, the FHI is not a complete diagnostic. It depends on reported budget data, with data lag, so it may miss off-budget borrowings or contingent liabilities; uniform weightage may not fully reflect states with different resource bases, demographic burdens or disaster exposure. It should therefore be read alongside RBI reports, state finance commissions and reforms such as debt management policies and stronger public financial management. Used as a benchmark rather than a target, the FHI can encourage prudent, sustainable fiscal policies without distorting essential social spending.