KJ Joseph
Sumalatha BS
Nirmal Roy VP
The NITI Aayog has come up with a Fiscal Health Index (FHI) 2025 of States for the financial year 2023 with a view to promote best practices among the States.
The index, however, has an element of paradox. States with relatively higher development outcomes are ranked low in fiscal indicators, while less developed States are the top performers in terms of fiscal prudence. The key issue is; whether India will be developed economy in 2047 if the States are to take the FHI seriously and follow the best practices that it highlights.
A deeper examination of the relevance of the analytical foundations of FHI for a developing country like India and a more nuanced understanding of the interplay between fiscal health and development outcomes is called for.
Pillars and Performance
The FHI is computed on five metrics: quality of expenditure, revenue mobilisation, fiscal prudence, debt and debt sustainability. The quality of expenditure is measured using the ratio of total developmental expenditure to total expenditure and the ratio of total capital outlay to Gross State Domestic Product (GSDP).
While revenue mobilisation is measured using the ratio of States own revenue to GSDP and ratio of States own revenue to total expenditure, the ratios of gross fiscal deficit to GSDP and revenue deficit to GSDP are the indicators used for fiscal prudence.
The debt index is estimated using the ratio of interest payments to revenue receipts and the ratio of outstanding liabilities to GSDP.
The difference between the growth rate of GSDP and interest payments is the indicator used for debt sustainability.
FHI divided the 18 major States into four cohorts based on their rank in terms of fiscal performance; achievers, front runners, performers and inspirational States. States such as Odisha, Chhattisgarh, Goa, Jharkhand and Gujarat, holding top ranks, are achievers. Maharashtra, Uttar Pradesh, Telangana, Madhya Pradesh and Karnataka are the front runners. While, Tamil Nadu, Rajasthan, Bihar and Haryana are ranked as performing States, the bottom four States Kerala, West Bengal, Andhra Pradesh and Punjab are diplomatically denoted as inspirational States.
But there seems to be an element of arbitrariness in the ranking and grouping of States. Maharashtra with an index score of 50.3 has been included in the group with lower than 45.9 instead of being included in the group of achievers along with Gujarat with an index score for 50.5.
Similarly, Kerala with an index score of 25.4 has been included among inspirational States with index score lower than 21.8 instead of being included with Haryana having an index of 27.4. Each of these States performed differently in these five metrics. For example, Chhattisgarh has high rank in quality of expenditure and fiscal prudence, but it lags in the debt index.
Similarly, Uttar Pradesh rank high in debt index and debt sustainability but its performance is poor in revenue mobilisation.
The report also presents a picture of State level performance over time by comparing their average rank during 2014-15 to 2021-22 and 2022-23. During both time points Odisha retained the top position and Chhattisgarh, Jharkhand and Rajasthan have improved their rank at least by two positions. Hence these four States may be termed as sustained performers of which all the States, except Rajasthan, belong to the group of achievers.
Fiscal Health versus Development
A key concern in the context of aspirational India is the clear mismatch among States in terms of fiscal prudence and developmental outcomes. Except Goa all the four achievers rank poorly in the Human Development Index (see chart). At the same time among the bottom five, termed as inspirational States, three of them turn out have displayed outstanding human development performance. This paradox raises the question as to why States with higher human development have higher deficits and debt, while the fiscally prudent ones display poor development performance.
Evidently, the present fiscal stress of the inspirational States cannot be delinked from their past investment in human development leading to higher committed expenditure at present. They need to adopt strategies to strengthen their productive sectors by harnessing their human development and improve their tax base while rationalising expenditure where ever possible. The experience of achievers indicates that fiscal prudence need not necessarily translate into development outcomes.
Instead of taking pride in revenue surplus and maintaining fiscal deficit even lower than the FRBM level, while human development leaves much to be desired, these States must embark on higher public expenditure and improve their spending capacity to ensure that they contribute to the national vision of a Vikasit Bharat. Economic history tells us that development went hand in hand with higher public expenditure.
In the OECD countries, for example presently the general government expenditure is as high as 59 per cent of the Gross Domestic Product (GDP) in France and the lowest being 24.4 per cent in Ireland.
The means and ends
Within the fiscal federal context of India where the States shoulder about two-third of the general government expenditure and collect only about one-third of the revenue, the States’ expenditure is contingent on the devolution from the Union government.
In 2022-23 the central transfers accounted for 40.7 per cent, 48.5 per cent, and 52.7 per cent of the total revenue receipts respectively of the achievers like Odisha, Chhattisgarh and Jharkhand indicating the role of devolution in their fiscal performance.
When it comes to poor fiscal performers like Kerala and Haryana, their share in devolution was at a lower level of 34.4 per cent and 19.6 per cent respectively. Punjab’s fiscal stress cannot be delinked from their specialisation in non-taxable agriculture that brought food security to the country. Kerala specialised in non-taxable human resources by which the country benefitted through remittances.
On the whole, if States consider fiscal prudence as an end in itself and follow the best practices of the achievers to be fiscally prudent Vikasit Bharat is likely to remain a distant dream.
An integrated index that combines fiscal health and development indicators is crucial for addressing broader development goals of States and the country.
Joseph is Director; Sumalatha and Nirmal Roy are Assistant Professors at Gulati Institute of Finance and Taxation, Thiruvananthapuram
