In response to these demographic and economic realities, the 16th Finance Commission and the Union Budget 2026-27 allocations have clearly prioritized urban growth as a central pillar of the national vision for development, writes Pushpa Pathak
India has undergone a significant transformation in its urban policy narrative, moving away from reluctantly accepting urbanization as inevitable to actively embracing it as a desirable catalyst for improving living conditions across the country. This ideological shift is driven by projections suggesting that India’s urban population is likely to be approximately 951 million and the economic contribution of urban centres is expected to rise from the current 63 percent to 75 percent of GDP by 2050. In response to these demographic and economic realities, the 16th Finance Commission and the Union Budget 2026-27 allocations have clearly prioritized urban growth as a central pillar of the national vision for development.
The 16th FC has proposed an allocation of Rs 7,91,493 crore as grants for rural and urban Local governments for five years from 2026‑27 to 2030‑31, of which Rs 56,100 crore is set aside for a special infrastructure component and Rs. 10,000 crores for urbanisation premium. The remaining amount is distributed between Rural Local Bodies (RLBs) and Urban Local Bodies (ULBs) in 60:40 ratio keeping in mind the projected urbanisation level of about 41 per cent in 2031. The total urban allocation of Rs. 3,56,257 crores, including the two special provisions, effectively amounts to be about 45 per cent of the local government grants, which is huge in comparison to what has been recommended by previous FCs. Even the direct allocation for ULBs of Rs. 2,61,141 crores, as basic plus performance grants, is more than double of Rs. 1,21,055 crores recommended by the 15th FC.
These grants are further reinforced by programmatic allocations from the Union Budget 2026-27, including Rs. 100,000 crores for Urban Challenge Fund, Rs. 5,000 crores per City Economic Regions for seven such regions, an incentive of ₹100 crores for a single bond issuance of more than ₹1000 crores by large cities, and continuation of incentivised issuances of bonds up to ₹200 crores by smaller cities under the ongoing AMRUT scheme. This implies that urban infrastructure development will certainly not fail due to a shortage for funds, which was historically cited as one of the reasons for urban failure, as the financial landscape has been fundamentally altered.
Second, 16th FC has recommended, in the absence of State Finance Commission’s recommendations, 90 per cent of the state grant should be allocated as per each ULB’s population share in the states’ urban population and 10 per cent according to the Own Source Revenue (OSR) based performance criterion. This means 16th FCs has reverted back to the state specific population share based allocation of funds rather than using the national average rural-urban population ratio for all states as was done by the 15th FC, which had the potential of a lopsided distribution of funds where ULBs in more urbanised states were likely to get less per capita funds than those in less urbanised states.
Third, 16th FCs continuation of the conditionality clause offers consistent direction to drive urban performance. The 16th FCs entry level conditions for availing 80 per cent of the ULB allocation under basic grant are: (i) duly constituted local body being in place; (ii) publicly available online provisional and audited accounts of ULBs; and (iii) states’ compliance with the Constitutional provision of forming SFCs. For the remaining 20 per cent grant under performance component, ULBs should record at least 5 per cent compounded annual OSR growth.
Fourth, to ensure a more decentralized and equitable pattern of growth, the Commission has proposed a special infrastructure grant of Rs 10,000 crore for 22 medium-sized cities with populations between 4 and 10 million. These funds are exclusively earmarked for implementing comprehensive wastewater management systems and city-wide drainage master plans. This targeted investment is expected to address the challenge of obsolete and inadequate drainage systems existing in most Indian cities that are not able to meet the needs of growing population and climate change induced erratic and high intensity rainfall.
Fifth, the Commission also addresses the issue of unplanned peri-urban sprawl and delayed municipal boundary expansion. To incentivize the merger of peri-urban villages into larger adjoining urban bodies, a Rs 10,000 crore urbanization premium has been proposed. To access this, states must prepare a Rural-Urban Transition Policy.
Sixth, 16th FC has not just made greater grant allocation for ULBs but has in fact given an urban policy directive to the state governments for better managing future urban growth by providing an infrastructure grant for medium sized cities and statutory incorporation of urban transition areas by formulating a Rural-Urban Transition Policy. I strongly believe that both these initiatives require a coherent state urban policy framework, not only a State level Rural-Urban Transition Policy, to get the best outcome from the massive public investments being made to support urbanization in the country.
Seventh, it’s a great opportunity to pull together all state urban policies to formulate a national urban policy, as urbanization is now recognized as an imperative for national development. Although urban sector is a state subject, there are several cross-border developmental infrastructures that impact urbanization, such as railways, ports, airports and highways. Moreover, incentivised climate change related interventions may also not be bound by state boundaries.
Finally, the success of the unprecedented financial support depends on addressing deep-seated urban governance challenges. Experts highlight issues like institutional multiplicity and the “messy” dual power structure where state-appointed commissioners often hold more authority than elected ceremonial mayors. To rectify this, there are calls for elected executive mayors and councils serving fixed five-year terms. Furthermore, there is a recognized need to move beyond the failures of the 74th Constitutional Amendment to establish a clear Municipal List of Functions. This would ensure full functional and fiscal decentralization making local bodies a true third tier of government. Without these fundamental reforms, increasing the flow of funds could be as ineffective as “putting more water in a small bucket” compelling ULBs to commission state agencies, special purpose vehicles or private consulting firms to execute most of the urban development and management works.
(The author is a Senior Fellow at the Centre for Policy Research, New Delhi. Views expressed are personal).
