Niti Aayog’s recent launch of a fiscal health index, intended as an annual publication, aims to provide data-driven insights into the fiscal health of Indian states. It focuses on guiding fiscal governance and policy reforms for resilient economic growth. However, the guiding philosophy and methodology behind the index warrant careful scrutiny.
While rankings are commonly used to incentivise performance improvement, there is no definitive theoretical basis for favouring one ranking system over another. In the Indian federal system, rankings can shift dynamics from cooperative to competitive federalism. This competitive focus may neglect historical context and diverse processes that contribute to regional differences. Rankings should complement—not replace—a deeper understanding of fiscal drivers. Hence, policymakers must avoid overemphasising ranks and, instead, focus on their region’s unique economic niche, strategic partnerships and strengths.
The Fiscal Health Index (FHI) is a composite measure based on five sub-indices—quality of expenditure, revenue mobilisation, fiscal prudence, a debt index and debt sustainability—constructed from nine fiscal metrics. It uses minimum-maximum normalisation, scaling ‘good’ indicators positively and inverting ‘bad’ ones through a deprivation index to reflect both current performance and historical benchmarks.
This approach introduces biases. Setting benchmarks based on nine-year extremes can distort normalisation—an outlier year may unfairly lower a state’s score, while outdated historical benchmarks could inflate scores. Additionally, equal weighting assumes all fiscal dimensions are equally important, though debt sustainability may be more critical than a single year’s revenue-expenditure ratio. Consequently, a state’s weak performance in one area can be ‘averaged out’ by stronger performance elsewhere, potentially masking vulnerabilities.
Another issue is that the report uses broad definitions for indicators such as quality of expenditure, measuring it mainly through development expenditure ratios and capital outlay as a share of gross state domestic product. The composition of spending beyond development vs non-development is not explicitly measured. A high ratio of committed expenditure (salaries, pensions) to total expenditure can squeeze development spending, which the index does not account for.
Another gap is the absence of a direct measure for a state’s contingent liabilities or off-budget borrowings, which can be substantial—such as power sector debts or guarantees for state-owned enterprises. Despite their potential fiscal risks, the index’s debt category accounts only for official outstanding liabilities and interest payments. Such broad measures provide an easily interpretable snapshot but mask underlying complexities, such as operational efficiency, sector-specific outcomes and long-term socioeconomic impacts.
Academic literature suggests that incorporating nuanced metrics like efficiency assessments or outcome-based analyses could better capture the effectiveness of government spending. The index also doesn’t account for economic volatility or external shocks like a pandemic, which could influence the max-min values. It does not account for cyclical contexts, so a well-intentioned counter-cyclical fiscal expansion during a recession would worsen the index score. Additionally, it does not distinguish between ‘good’ and ‘bad’ deficits, assuming any deviation from balance is a risk, though the balance itself lacks strong analytical or theoretical justification.
The report ranks Odisha at the top spot and Uttar Pradesh at the seventh, notably above Tamil Nadu (11) and Kerala (15). Surprisingly, Bihar (13) outperforms Tamil Nadu in quality of expenditure primarily because it allocates a higher share of total expenditure towards development. This raises concerns: allocating more to development expenditures does not automatically translate into effective outcomes. Despite their higher allocation ratios, states like Odisha, UP and Bihar consistently lag behind Tamil Nadu and Kerala in development indicators such as education quality, healthcare access, infrastructure and per-capita income. Comparing fiscal outcomes without considering spending effectiveness creates a misleading picture.
It also highlights the deeper issue of backward states struggling with lower absorptive capacity and inefficiency in resource utilisation, resulting in suboptimal outcomes. Their higher ranking comes from moderate deficits, lower debt levels and a mere higher allocation of spending on development. In contrast, economically advanced states like Tamil Nadu and Kerala have accumulated debt and run persistent deficits, presenting an important reality—richer states are not automatically fiscally healthier; some have chosen expansionary fiscal policies that result in weaker FHI metrics.
This strengthens concerns regarding the Finance Commission’s redistribution system, which disproportionately benefits backward states at the expense of richer ones investing in long-term growth. For instance, Tamil Nadu receives only 29 paise from the Centre for every rupee it contributes, while UP gets Rs 2.73 and Bihar Rs 7.06. Hence, the fiscally ‘healthy’ backward states receive a larger share of devolution, compromising the share for richer states that are not ranked as fiscally healthy, and lose out on resources in the redistribution. These resources could otherwise help them maintain fiscal balance and continue investing in long-term economic expansion.
While the FHI is designed to assist policymakers in diagnosing fiscally weak and strong states, relying on it in isolation is not optimal. The one-size-fits-all approach ignores that states have different starting points and needs. Moving forward, the report should refine its methodology by expanding data breadth, strengthening variable definitions based on established literature, and adjusting weighting to better reflect risk. It could also incorporate dynamic components capturing trends rather than relying on nine-year extreme values.
Since this will be an annual publication—an important report for state finance departments striving to rise in the rankings—acknowledging and addressing its limitations will make it truly actionable for achieving sustainable state finances.
Samridhi Agarwal
Senior Associate, Centre for Effective Governance of Indian States
(Views are personal)