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? (Answer in 250 words)

Introduction

The Fiscal Health Index is a comparative framework that evaluates the quality, sustainability and resilience of state finances rather than merely their expenditure size.

How it assesses performance

• It can examine revenue mobilisation, own-tax effort, revenue balance and dependence on transfers.
• Debt burden, interest payments, contingent liabilities and the composition of expenditure reveal solvency and flexibility.
• Capital expenditure, social-sector outcomes and fiscal governance indicate whether borrowing supports productive assets.
• Cross-state benchmarking, trend analysis and peer-group comparison identify persistent weaknesses.

Encouraging prudence

• Transparent scores create reputational incentives for states to widen the tax base, improve compliance and reduce leakages.
• They encourage shifting expenditure from untargeted subsidies to human capital and productive capital formation.
• Medium-term fiscal plans can link borrowing to credible debt and deficit trajectories.
• Better-performing states may receive lower risk premiums, investment confidence and performance-linked support.

Safeguards

FHI must account for different development needs, off-budget borrowings, disaster shocks and quality of spending. It should guide—not mechanically punish—states, while preserving cooperative federalism.

Keywords: debt sustainability, fiscal deficit, own-tax revenue, capital expenditure, cooperative federalism.