Fiscal health check: NITI Aayog's initiative will inform policymaking

Public debate in India over the coming days will be focused on the upcoming Union Budget, which will be presented by Union Finance Minister Nirmala Sitharaman on February 1. Since growth has slowed significantly over the past few quarters and the Indian economy is expected to expand 6.4 per cent this financial year compared to 8.2 per cent in 2023-24, stakeholders would look forward to how the government plans to revive growth. While the public interest in the Union Budget is understandable, the Indian economy and well-being of citizens to a large extent depend on how states perform. State governments in India account for about two-thirds of general government expenditure and one-third of revenue collection. Thus, it is important that state-government finances also get adequate public attention. In this regard, the NITI Aayog’s fiscal health index (FHI), released last week, must be welcomed. It will help improve general understanding and inform policymaking. 

The FHI covers 18 large states and has been developed with a focus on five sub-indices: The quality of expenditure, revenue mobilisation, fiscal prudence, debt index, and debt sustainability. Aside from the rankings, the report has a detailed analysis of individual states. Based on the criteria, Odisha has been judged the best-performing state, followed by Chhattisgarh and Goa. Punjab is at the bottom of the list. The FHI highlights the stark difference in fiscal management among states. The difference in fiscal indicators between the top and bottom states is worth highlighting here. The fiscal deficit in Odisha, for example, came down from 6.9 per cent of gross state domestic product (GSDP) in 2000-01 to 2 per cent in 2022-23. Meanwhile, the fiscal deficit in Punjab increased from 3.1 per cent in 2018-19 to 5 per cent in 2022-23. Consequently, its debt stock has increased over the years and was about 46 per cent of GSDP in 2022-23. As the report notes, the debt stock will continue to rise without intervention. Given that states have vastly different fiscal positions, the policy approach will need to account for this to attain a favourable general government fiscal position.

  Overall, as the recent study of state government finances by the Reserve Bank of India showed, the debt of state governments in 2023-24 was 28.5 per cent of gross domestic product (GDP) — over 8 percentage points above the level recommended by the Fiscal Responsibility and Budget Management Review Committee. Besides, states have issued guarantees worth nearly 4 per cent of GDP, which must be accounted for in any discussion and policy planning. Clearly, states with low scores on the FHI will need to address the situation more actively. India perhaps needs more stringent fiscal rules to maintain debt and deficit at manageable levels. Although the quality of expenditure in states has improved in recent years, competitive political pressures and the growing electoral popularity of cash transfers and other welfare schemes pose a risk to productive expenditure in the medium term. The issue is being widely debated, but there is still no clear understanding of how much of the state or general government expenditure is allocated to such schemes. Since the NITI Aayog has studied and ranked states on fiscal status, it could expand the scope to assess the extent of merit and non-merit subsidies at general government level. Such an exercise will greatly inform public debate and enable suitable policy action.