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Niti Aayog urges states to adhere to fiscal deficit norms

March 11, 2026 5 min read Economics Polity & Governance GS2 GS3
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What Happened

  • NITI Aayog has urged state governments to adhere to fiscal deficit norms prescribed under the Fiscal Responsibility and Budget Management (FRBM) Act through three main levers: disciplined expenditure management, broadening the GST base, and enhancing own-tax revenue capacity.
  • The advisory accompanies the release of the Fiscal Health Index (FHI) 2026, which assesses the fiscal health of 18 major states and special-category states for the financial year 2023-24.
  • The FHI measures fiscal strength across five sub-indices: Quality of Expenditure, Revenue Mobilisation, Fiscal Prudence, Debt Index, and Debt Sustainability.
  • States with widening revenue deficits were specifically advised to align revenue expenditure with sustainable revenue growth, rationalise subsidies, and implement medium-term fiscal plans.
  • The top 10 fiscally strong states (general category) are: Odisha, Goa, Jharkhand, Gujarat, Maharashtra, Chhattisgarh, Telangana, Uttar Pradesh, Karnataka, and Madhya Pradesh; among special-category states, Arunachal Pradesh leads.

Static Topic Bridges

Fiscal Responsibility and Budget Management (FRBM) Act, 2003

The FRBM Act was enacted to institutionalise fiscal discipline at the central level by setting legally binding targets for fiscal deficit and revenue deficit as a share of GDP. The Act requires the government to eliminate the revenue deficit and reduce the fiscal deficit to 3% of GDP. Following the N.K. Singh Committee recommendations (2017), the framework was reoriented from a deficit-only target to a debt-to-GDP anchor — recommending a combined Centre-State debt of 60% of GDP by 2023 (40% Centre, 20% states). States have enacted their own Fiscal Responsibility Legislations (FRLs) modelled on the central FRBM Act, with the FRBM-prescribed fiscal deficit limit for states set at 3% of State GDP (with a relaxation to 3.5% during COVID-era fiscal support measures).

  • The FRBM Act mandates annual presentation of Medium-Term Fiscal Policy Statement, Fiscal Policy Strategy Statement, and Macro-Economic Framework Statement along with the Union Budget.
  • The "escape clause" in the FRBM Act (post-N.K. Singh Committee) allows a 0.5% of GDP deviation from the fiscal deficit target in years of national security threats, natural calamities, or structural reforms.
  • States can access additional borrowing (up to 0.5% of GSDP above the 3% cap) under conditions tied to power sector reforms and capital expenditure targets.
  • The 15th Finance Commission linked a portion of state grants to fiscal performance, creating incentive compatibility between fiscal prudence and central transfers.

Connection to this news: NITI Aayog's advisory directly references the FRBM framework as the normative standard states must adhere to — framing fiscal deficit compliance not as a suggestion but as a rule-based obligation under existing law.

NITI Aayog's Fiscal Health Index: Methodology and Purpose

The Fiscal Health Index (FHI), introduced in 2025, is NITI Aayog's composite measure of state fiscal health. Unlike the Finance Commission's fiscal performance incentives (which focus on deficit and debt ratios), the FHI takes a broader view — assessing whether states are spending well (Quality of Expenditure), collecting enough revenue (Revenue Mobilisation), maintaining prudent balances (Fiscal Prudence), managing debt stock (Debt Index), and sustaining debt repayment capacity (Debt Sustainability). The FHI is designed to identify structural fiscal weaknesses beyond headline deficit numbers and to prompt reform at the state level through peer benchmarking.

  • FHI 2025 covered 18 large states and used data for FY 2022-23; FHI 2026 covers FY 2023-24.
  • Quality of Expenditure sub-index captures the share of capital expenditure in total developmental expenditure — a proxy for investment-oriented spending vs. consumption spending.
  • Revenue Mobilisation captures own tax and non-tax revenue as a share of GSDP — reflecting a state's fiscal self-sufficiency.
  • Fiscal Prudence captures revenue deficit, fiscal deficit, and primary deficit ratios.
  • The Debt Sustainability sub-index assesses a state's ability to service debt from its revenue base.

Connection to this news: NITI Aayog's advisory is grounded in FHI 2026 findings — the index provides the diagnostic basis for the specific recommendations about revenue mobilisation and expenditure quality directed at poorly-performing states.

Vertical and Horizontal Fiscal Imbalances in India's Federal Finance

Indian federalism creates significant vertical fiscal imbalances — states have large constitutional expenditure responsibilities (education, health, agriculture, rural development under the Seventh Schedule) but more limited own-tax powers compared to the Centre. This imbalance is partly addressed through Finance Commission devolution (currently 41% of divisible pool taxes go to states under the 15th Finance Commission), grants-in-aid, and centrally sponsored schemes (CSSs). However, horizontal imbalances — disparities among states in revenue capacity and expenditure needs — remain acute. High-income states (Gujarat, Maharashtra) generate substantial own revenues; agrarian states (Punjab, Andhra Pradesh) face structural revenue deficits exacerbated by farm subsidies and loan waivers.

  • The 15th Finance Commission (2021-26) recommended 41% devolution to states, down from 42% recommended by the 14th Finance Commission (the reduction accounts for the inclusion of J&K and Ladakh as UTs).
  • Grants-in-aid (Article 275) and Plan grants supplement tax devolution; the FC also introduced performance-linked grants tied to health, education, and urban governance outcomes.
  • Revenue deficit grants are provided to states that cannot balance their revenue accounts even after devolution — 17 states received such grants under the 15th FC.
  • States' fiscal stress is compounded by off-budget borrowings through state-owned enterprises and special purpose vehicles, which often do not appear in headline deficit figures.

Connection to this news: NITI Aayog's emphasis on states broadening their GST base and enhancing own tax capacity reflects the structural challenge of vertical fiscal imbalance — states cannot remain indefinitely dependent on central transfers and must build fiscal self-reliance.

Key Facts & Data

  • FRBM Act (2003) sets the fiscal deficit target at 3% of GDP for the Centre; states are prescribed 3% of GSDP (3.5% with reforms-linked relaxation).
  • FHI 2026 measures 18 major states across 5 sub-indices for FY 2023-24.
  • Top 5 states (general category): Odisha (score 73.1), Goa, Jharkhand, Gujarat, Maharashtra.
  • Top special-category state: Arunachal Pradesh, followed by Uttarakhand, Tripura.
  • N.K. Singh Committee (2017) recommended a debt-to-GDP anchor of 60% (Centre 40% + States 20%) as the medium-term target.
  • 15th Finance Commission devolution: 41% of divisible pool to states (2021-26).
  • Quality of Expenditure sub-index: top states allocate ~27% of developmental expenditure to capital spending; bottom states allocate ~10%.
  • The escape clause under FRBM allows 0.5% of GDP additional deficit for national security, natural calamity, or structural reforms.