16Th Finance Commission Reforms May Benefit State Finances In The Long Term: Crisil Ratings

(MENAFN- KNN India) New Delhi, Mar 7 (KNN) The 16th Finance Commission's emphasis on reducing revenue deficits and increasing growth-oriented capital spending is expected to strengthen states' fiscal health over the long term though near-term constraints remain due to limited additional fiscal support, as per Crisil Ratings.

The commission, which recommends fiscal transfers between the Centre and states for fiscal 2027–31, has kept the states' share in central taxes unchanged at 41 per cent. It has also introduced states' contribution to gross domestic product (GDP) as a criterion for tax distribution, encouraging higher growth-focused capital investment.

Revenue deficit (RD) grants recommended by earlier finance commissions have been discontinued to correct adverse incentives and improve fiscal discipline.

Anuj Sethi, Senior Director, Crisil Ratings, said,“Discontinuation of RD grants can compel states to constrain populist spending. The 16th FC has also recommended uniform disclosure and rationalisation of subsidy expenditures, especially unconditional cash transfers, which have been a drain on state finances, primarily in the last couple of years.”

Sethi added,“Social welfare expenditure is estimated to have increased sharply to about 1.9 per cent of gross state domestic product (GSDP) in fiscal 2026, based on budget estimates, from about 1.5 per cent in fiscal 2024, with about 43 per cent of the increase pertaining to direct transfer schemes.”

While RD grants have been removed, allocations for local bodies have been increased by about 81 per cent compared with Rs 4.36 lakh crore during fiscal 2021–26.

Urban local body grants have risen by 145 per cent, aimed at improving civic infrastructure and reducing their dependence on state governments through better revenue mobilisation and financial controls.

The commission has also recommended privatisation of state electricity distribution companies (discoms), noting that past reforms have had limited success. Discom debt stood at about 2.3–2.5 per cent of GSDP in fiscal 2025.

The power sector accounts for around 45 per cent of state guarantees and 5–6 per cent of revenue expenditure, including loss funding, tariff subsidies and debt servicing.

Aditya Jhaver, Director, Crisil Ratings, noted,“With vertical devolution retained at 41 per cent and FC grants budgeted at a similar level for fiscal 2027, incremental revenue support to states from the Centre is limited. This is likely to keep revenue deficit elevated in fiscal 2027 (~0.9 per cent of GSDP estimated for fiscal 2026) on account of moderate revenue growth and sticky committed and welfare expenditures.”

“Further, annual fiscal deficit limit has been retained at 3 per cent constraining any significant growth in capital outlay by states next fiscal,” Jhaver added.

(KNN Bureau)

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