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?

Introduction

The Fiscal Health Index (FHI), released by NITI Aayog for the first time in January 2025, is a composite index that ranks major states on the soundness of their public finances, drawing largely on audited data from the Comptroller and Auditor General.

How the FHI Assesses Fiscal Performance

The index scores states across five sub-dimensions:

• Quality of expenditure—the share going to development and capital outlay rather than committed/revenue spending.
• Revenue mobilization—own tax and non-tax buoyancy and reduced dependence on transfers.
• Fiscal prudence—containment of the fiscal and revenue deficits.
• Debt index / debt sustainability—the debt-to-GSDP burden and its trajectory.

By aggregating these, the FHI offers a single, comparable snapshot of each state's fiscal soundness, turning scattered CAG data into an actionable diagnostic.

How It Encourages Prudent and Sustainable Policy

• Benchmarking and peer pressure: transparent ranking triggers competitive federalism—laggard states are nudged to reform to climb the table.
• Diagnostic targeting: sub-index scores reveal specific weaknesses (say, poor capital spending or high debt), guiding corrective action.
• Accountability: public visibility raises the political cost of populist, unsustainable spending and off-budget borrowing.
• Reward for quality spending: incentivizes a shift from freebies toward capital expenditure with higher multipliers.

Caveats and Conclusion

The FHI's value depends on timely, comparable data and must account for structural differences among states. Used well, it institutionalizes fiscal discipline and cooperative-competitive federalism, steering states toward debt sustainability and better-quality expenditure.