Kerala — a state with first world social indicators — has for years come under severe criticism for fiscal mismanagement. The state, which maintains a high fiscal deficit (revised estimate of 3.5% in FY25), scores poorly in quality of expenditure, and debt sustainability.
The state’s committed expenditure — salaries, pension and interest payments — account for 55% of its total expenditure (as per revised estimate for FY25). It spent a tiny sum of `14,000 crore out of total expenditure budget of `1.79 lakh crore, or just 8% of its total expenditure in FY25. Interest payments gobble up 22% of Kerala's net receipt. Its total outstanding debt is 33% of the GSDP (compared to 15% in Gujarat, 18% in Maharashtra and 26% in Tamil Nadu) and fiscal deficit is 3.5% (compared to less than 3% in many better fiscally-run states).
No wonder in a recent event, finance minister Nirmala Sitharaman said that states which consider themselves developed are ridden with debt.
With these stats, it is no surprise that Kerala ranks among the lowest in the Niti Aayog’s latest Fiscal Health Index 2025, which was released recently. Kerala ranks among the worst four states in the index, which according to the Niti Aayog is ‘a valuable tool for assessing the fiscal performance of Indian states’. Most southern states have cut a sorry figure on the index – which ranks 18 Indian states for their fiscal performance based on a set of five key indicators.
Niti Aayog, the government think tank that has replaced the erstwhile Planning Commission, has launched the index to evolve an understanding of the fiscal health of states in India, and assess their fiscal sustainability in the long term.
According to Niti Aayog, states account for two-thirds of public spending and one-third of total revenue. It is imperative to ensure fiscal well-being of states for achieving long-term fiscal sustainability and overall economic growth of the country. The need to closely monitor states’ finances gave rise to the idea of creating a Fiscal Health Index.
The index gauges fiscal performance of states on five broad parameters — revenue generation and mobilisation, quality of expenditure, debt management, fiscal deficit management and overall fiscal sustainability.
The quality of expenditure parameter sees how states are allocating money on developmental and infrastructure projects for long-term economic growth. The more the spending on creating — social and economic — the better a state’s performance.
Revenue mobilisation ranks states on their ability to generate their own tax and non-tax revenue. Many states depend largely on Central devolution of taxes and grants for their fiscal needs. However, better performing states should be able to generate enough revenue on their own to minimise dependence on Central grants and taxes.
Fiscal deficit management is a straight-forward way of judging a state’s performance on fiscal deficit and revenue deficit as a percentage of GDP. Fiscal deficit happens when the government’s spending surpasses its income, and to manage this gap, it has to borrow. Revenue deficit is a situation when the state’s revenue is not good enough to finance its operational costs — pay salaries, pensions and interest. As per the Fiscal Responsibilities and Budget Management Act (FRBM), the states can have a maximum fiscal deficit of 3% of the Gross State Development Product (GSDP).
The debt management parameter necessarily considers what percentage of the state’s revenue receipt is used in paying interest and what is the outstanding debt vis-a-vis the size of the state’s economy.
Finally, the overall fiscal sustainability measures the state’s economic growth rate in comparison to the growth in interest rate payments. Each parameter is ascribed a score of 100, and the overall rank is arrived at by taking the mean of the scores based on the five indicators.
The Fiscal Health Index 2025, that measures the fiscal performance of states for the financial year 2022-23, throws up some surprising results. Odisha emerged as the best fiscally-governed states outdoing even Gujarat, Maharashtra and Karnataka, which are perceived to be better-run states.
Odisha excels in managing its debt and interest cost, does exceptionally well in revenue mobilisation (only Goa and Telangana score better on this parameter), while performing better in quality of spending than most states. The other surprises are mineral-rich states like Chhattisgarh and Jharkhand – both traditionally not known for fiscally-prudent states. Yet they figure in the top five with Goa and Gujarat.
The top four in the index — Odisha, Jharkhand, Goa, and Chhattisgarh — have effectively mobilised non-tax sources. Their own non-tax revenue as a percentage of total revenue was 21% on an average, with Odisha relying heavily on mining-linked premiums and Chhattisgarh benefitting from coal block auctions.
Laggard states like Punjab, West Bengal and Andhra Pradesh fared poorly in revenue mobilisation. Kerala, which is among the four worst performers in the index, scored 4 out of 100 in terms of quality of expenditure.
When it comes to quality of spending, the focus is on capital expenditure. In states like Odisha, MP, Karnataka, Goa and Uttar Pradesh, capex constituted on an average 27% of the developmental expenditure, while West Bengal, Andhra Pradesh, Punjab and Rajasthan spent only 10% of the developmental expenditure on capex.
Apart from analysing the performance of states in FY23, the FHI also provided past analysis for different periods between 2014-15 to 2021-22 to see improvement made by states in the past decade. Odisha, Goa, Gujarat and Chhattisgarh have been the consistent performers, while Jharkhand has been the most improved state, jumping from 10th rank to 4th. Karnataka has seen its performance taking the biggest hit, falling from 4th rank to 10th largely due to poor performance on the quality of spending parameter.
Curiously, most South Indian states performed poorly in managing their finances. Andhra Pradesh, Kerala, and Tamil Nadu ranked the worst among southern states, scoring below 30 out of 100, and failed to make it to the top 10 in fiscal performance.
Andhra Pradesh and Kerala were among the poorest performers nationwide, alongside Punjab and West Bengal, all facing severe fiscal challenges.
Kerala and Punjab struggle with low expenditure quality and debt sustainability, while Andhra Pradesh grapples with high fiscal deficits.
Tamil Nadu performed relatively better in its own revenue generation but lagged in expenditure quality and fiscal deficit. In 2022-23, the state’s committed expenditure accounted for 52% of revenue spending, limiting flexibility for developmental outlays. The Aayog noted that this share has risen 9.9% annually since 2018-19, with subsidies forming a major part of non-committed expenditure.
Karnataka’s rank fell from 3rd (2014-15 to 2021-22) to 10th (2022-23), dragged down by weak expenditure quality and debt sustainability. Meanwhile, Telangana emerged as the best-performing southern state, owing to strong revenue mobilisation and fiscal prudence.
Southern states have been continuously sparring with the Centre for depriving them of funds, an allegation that the Union government has refuted time and again. Instead, it has pointed out the bad fiscal management by some of the Southern states, particularly Kerala and Tamil Nadu.
An analysis of recent trends shows that the fiscal deficit of the states on an aggregate basis have remained moderate at 2.9% so far in FY25, sharply lower than the revised estimate of 3.5%. The improvement is on account of a cut back on both revenue and capital expenditure.
An analysis by IDFC First Bank economic research shows that expenditure quality has deteriorated with capital expenditure accounting for 14.3% of overall expenditure in FY25 (12-month trailing sum) against 15.8% in FY24. In FY25, the highest capital expenditure (as % of GSDP) is seen in Odisha, MP, Jharkhand and Bihar, according to the IDFC First Bank analysis.
The FHI shows that though states like UP and Bihar have shown tremendous improvement in quality of spending and debt management, they are still struggling on parameters like revenue generation. These insights might help policymakers both at the state and Central levels to pay special attention to areas where the states are lagging.
The fiscal health of the states is key to the success of the sustainable economic growth target of the country. The 16th Finance Commission report notes that states must partner with the Union government for consolidation of debt and firmly place India's sovereign debt-to-GDP ratio on a sustainable footing in the medium term.
It further says that states must partner with the Union government in developing new ways to support their residents, the economy as a whole and India's global engagements.
Hopefully, the Fiscal Health Index results would serve as a reminder for states to keep their extravagant ways in check. This assumes significance amid announcements of all kinds of cash transfer schemes by political parties in the run up to elections. Some of the states will be spending as high as 2.5% of their GSDP on such schemes.