All States need to prepare an action plan for strengthening the Local Fund Audit Department by filling up existing vacancies and organizing intensive training of the audit personnel on the digital audit platforms of Ministry of Panchayati Raj, writes former IAS officer Sunil Kumar
The report of the 16th Finance Commission (FC), presented to the government in November, 2025, was tabled in the Parliament on 1st February, 2026. The Union Finance Minister announced in her Budget speech that the union government had accepted the recommendations and suitable budgetary provisions had been made in the union budget for 2026-27. In this article the recommendations of the 16th FC relating to the Panchayats would be examined.
Why Local Government
Before delving into the details of the recommendations made, I would like to refer to one jarring note: the 16th FC has referred to Panchayats as rural local bodies (RLB) and Municipalities as urban local bodies (ULB) in the report and the chapter has been captioned ‘Local Body Grants’. The Panchayats and Municipalities have nowhere in the Indian Constitution been referred to as local bodies. On the contrary, the term used is ‘local self-government’. RLB and ULB are ambiguous terms that veil the true nature of local self-governments and tend to diminish it’s significance in the minds of all stakeholders ranging from citizens, bureaucracy to elected representatives of local governments themselves. Being a constitutional body, it would have been ideal if the Finance Commission had used the term rural local governments (RLG) and urban local government (ULG) instead. It may be noted that the 14th FC had used the term ‘Local Government’ in Chapter 8 and the 15th FC had captioned the relevant chapter 7 as ‘Empowering Local Governments’ although both used the term rural local bodies and urban local bodies while discussing grants to local governments.
Major Recommendations
The 16th FC has recommended devolution of Rs.7,91,493 crore to both rural and urban local governments over 2026-31 period. Special provisions of Rs.56,100 crore for ‘special urban infrastructure’ (for revamping sewerage systems in 22 Tier 2 cities) and Rs,10,000 crore for ‘urbanisation premium’ made by 16th FC are to be deducted from the total. The balance Rs.7,25,393 crore has been divided between RLGs and ULGs in 60:40 ratio. Hence, the allocation for RLGs comes to Rs. 4,35,236 crore.
These in turn have been further classified into ‘basic’ and ‘performance’ grants. The basic grant for RLGs is Rs. 3,48,188 crore and ‘performance’ grant is 87,048 crore which again has been subdivided into two equal halves – Rs. 43,524 crore for RLGs and Rs.43,524 crore for state performance component.
Adequacy of Allocation
Coming to the recommendations let us first examine if the report meets the expectations of the Panchayats? I suppose the answer would be in the affirmative. In absolute terms, the allocation for Panchayats (referred to as Rural Local Bodies in the report) has gone up from Rs.2,36,000 crore recommended by the 15th FC (2021-26) to Rs.4,35,236 crore by the 16th FC (2026-31) which is an increase of almost 85 percent. So the increase is substantial for Panchayats.
Block Panchayats & District Panchayats
However, if we examine it from the point of view of the District Panchayat (DP) and Block Panchayat (BP), then perhaps the recommended increase is not so substantial. This is based on the fact that the 15th FC had recommended share of GPs between 70 to 85 percent and had left the decision on the states to determine the actual share of DP and BP. Hence, in a state like Uttar Pradesh, the share of GPs had been fixed at 70 percent and that of BP and DP at 15 percent each. In Chhattisgarh, the shares of GP, BP and DP were 75,15 and 10 percent respectively while in Maharashtra, the GPs received 80 percent and BP and DP 10 percent each.
The 16th FC has fixed the share of GPs at 80 percent for States having three tier structure and 90 percent for states having two tier structure. The share of BP and DP has been fixed at 10 percent each. Thus, the hike would not be as substantial for BPs and DPs as would be seen for GPs. This may act a dampner for elected representatives (ERs) of the Block and District Panchayats.
Performance Grants
Next is the issue of ‘performance’ grants. The 16th FC has resurrected this recommendation from those made by the 14th FC. It has earmarked 80 percent of the funds allocated to rural local governments as ‘basic grants’ and 20 percent of the funds as ‘performance grants’. The performance grants are again linked to attainment of certain conditionalities. These kick in from the third year for RLGs.
The experience of the 14th FC was mixed. The ‘performance’ grant pertaining to RLGs was released for all states for two years and then not released at all to any state for the next two years. Why so? Apparently because the states had worked out a way to ‘game’ the system and even without fulfilling the prescribed norms, certificates of compliance were issued by the state governments. It also became a sort of discretionary fund at the disposal of the state government for favouring certain GPs as happened in Uttar Pradesh. Consequently, 15th FC had steered clear from allocating funds under these two heads.
Conditions for Basic Grants
The three conditions laid down by the 16th FC for availing ‘basic grants’ relate to presence of ‘duly constituted’ local governments; public availability of provisional accounts and audited accounts on the web; and notification of the State Finance Commission (SFC) on the expiry of five years from the formation of the previous SFC and tabling of the ATR in the State legislature within 6 months of submission of the SFC report. All these three conditions were laid down by the 15th FC as well and they yielded positive results. States have come under pressure to hold regular elections. This should act as a deterrent to the tendency to opt for ‘rule by administrators’ in local governments even when there is no such provision in the constitution. Likewise, the challenge now is not availability of data relating to accounts and audit but the quality and reliability of that data. So all these three conditions laid down by the 16th FC seek to further the constitutional mandate relating to local governments and are welcome.
Conditions for Performance Grants
For availing the RLG component of performance grant, the 16th FC has laid down conditions for all three tiers of Panchayats. Simply put, every GP must raise at least Rs.1200 per annum on an average from every household as total own source revenue (OSR) from all streams, including rental income, income from assets, user charges and so on. This would put pressure on Uttar Pradesh and Bihar to permit the GPs to levy and collect property tax and other fees by amending the Panchayat Acts and Rules. Similarly, the Block Panchayats (BP) would become eligible to claim their share of performance grant if at least 75 percent of GPs in the Block fulfill the aforementioned conditions. This paves the way for regular monitoring of the finances of the GP, especially their OSR efforts, by the BP. The District Panchayats (DP) become eligible for their share of the performance grant if they raise, in year T‑1, minimum 1.025 times its OSR in year T‑2 or 2.5 per cent per annum compounded growth applied over OSR of 2025‑26, whichever is lower.
As for the release of state component of performance grant for RLGs, it depends upon the State transferring to local governments from its own resources, grants amounting to 20 percent or more of the basic FC grant recommended by the 16th FC for the base year. It has been clarified that revenues assigned and shared statutorily with the local governments by the State would be included in these transfers for ascertaining the quantum of the transfers for the purposes of this condition. So if a portion of stamp and registration duty or land revenue is stautorily transferred to the local governments, then that would be included in the calculation. If some local governments or states fail to claim their performance grant, then the same would be distributed amongst those who fulfil the conditions.
Tied & Untied Grants
Doing away with ‘tied grants’ had found overwhelming support from the elected representatives (ERs) of local governments. However, the 16th FC chose to stick with ‘tied’ grants for water and sanitation given the strong push from the Ministry albeit with a reduced size. Now 50 percent of the basic grants are ‘tied’ grants while in 15th FC it was 60 percent. Entire performance grant is ‘untied’.
Urbanisation Premium
Likewise, the 16th FC has wisely recognized the need to put in place suitable mechanism for facilitating smooth rural to urban transition. The focus on timely and rule-based identification of urban areas and each state putting in place a clear transition policy from rural to urban administrative units (in place of ad hoc manner of creating new Nagar Panchayats) is welcome. The allocation of Rs.10,000 crore for this purpose is both timely and a very positive step. However, the stipulation that this could be claimed by the State on mergers of peri‑urban villages into adjoining larger ULB with existing population not less than one lakh and formulation of an appropriate rural to urban transition policy raises important issues regarding democratic functioning which perhaps have not been adequately addressed by the 16th FC.
Other Recommendations
Other major recommendations made by the 16th FC relate to continuation and strengthening of the arrangements for technical guidance and supervision of the audit process by the CAG and augmentation of the capabilities of Local Fund Audit Departments (LFADs) by investing in skill development and addressing manpower shortages in all states. It has also stressed on the need for all states to transparently report all transfers, including those from the Consolidated Fund of India on the recommendation of the Finance Commission, transfers under CSS, SFC grants and other grants from the State Government, separately for RLGs in their budgets. It has also recommended that these transfers, with full details, must also be reported in Appendix III of the State Finance Accounts. Additionally it has suggested dropping the constitutional directive to the FC to make its recommendations on rural and urban local governments ‘on the basis of the recommendations made by the Finance Commission of the State’ (Article 280(3)(bb) and 280(3)(c)), as the situation relating to availability and quality of reports of SFCs is not going to improve anytime soon.
In the light of the above, what needs to be done by the local governments and the state governments must be clearly understood by all stakeholders. In my view, the following could be useful:
One, ensure that all RLGs are duly constituted. States and UTs where panchayat elections have been delayed (J&K, Himachal Pradesh) should be held without any further delay.
Two, the State Election Commissions should gear up to hold local government elections before the expiry of their five year term as stipulated in the constitution. Any delay in holding elections is likely to adversely affect release of 16th FC funds.
Three, all States need to prepare an action plan for strengthening the Local Fund Audit Department by filling up existing vacancies and organizing intensive training of the audit personnel on the digital audit platforms of Ministry of Panchayati Raj.
Four, all States need to ensure that all personnel deployed in GPs for maintaining their accounts are suitably trained and certified by the CAG approved training programme on e-GramSwaraj portal being run by the Institute of Chartered Accountants of India (ICAI). Vacancies of accounts personnel in GPs need to be filled on priority by engaging those youth who have received the aforesaid training.
Five, all States must ensure that audit reports of all GPs, BPs and DPs are completed and uploaded on the portal and available in the public domain as stipulated by 16th FC.
Six, the States would need to ensure that the accounts of Panchayats reflect the full details of all their receipts and expenditure from all sources and not just the CFC grants as is the practice in most States.
Seven, states like Uttar Pradesh and Bihar would need to immediately amend the Panchayati Raj Acts and Rules and authorise collection of tax, fees and user charges by the GPs. All others would need to ensure that OSR collection is regularly reviewed in the GP, BP and DP and also by officials of the concerned line departments.
Eight, the BP would need to gear up and demand that suitable reports detailing the OSR collection efforts of each GP in the Block is prepared and presented to them every month. The review results should be shared with GPs regularly so that laggard GPs can take suitable remedial measures in time. They would also need to provide full support to the GP in ensuring compliance.
Nine, the GPs could learn from the experience of different states regarding ways to incentivise OSR collection, levy charges for different categories of residents in the GP etc.
Ten, the state governments should ensure that SFCs constituted by them submit their reports in time and the same is tabled in the state legislature during the ongoing budget session with action taken report (ATR). Suitable provisions would also need to be made in the state budget for releasing SFC grants to all local governments in 2026-27.
Eleven, Ministry of Panchayati Raj should ensure that all the three tiers of Panchayats are able to access and download reports from eGramSwaraj and other portals of the Ministry which facilitate monitoring and supervision of the finances of Panchayats.
Twelve, the state governments could follow the lead of Kerala and set up a Local Government department which handles the affairs of both rural and urban local governments. This would ensure synergy of effort and continuity in policy.
Thirteen, all these would become possible only when this is regularly monitored at the highest level and clear message is sent to the bureaucracy and the line departments that they would need to act as facilitators and provide full support to all local governments in this endeavour.
Conclusion
To conclude, adoption of measures outlined above will ensure that allocated funds are released in full to Panchayats. Relatively better adherence to the conditionalities imposed by the 15th FC especially those relating to audit, availability of financial data, constitution of SFCs by the states, release of report on Panchayat Finances by the Reserve Bank of India in 2025 generated confidence in the 16th FC to recommend substantially higher allocations. Thus, if all the conditions imposed by 16th FC for release of both basic and performance grants are satisfactorily met by the RLGs and the states, then ground would be laid for giving RLGs a higher and dynamic share of the pie in terms of percentage transfer of the divisible pool in future.
However, in the final analysis, the RLGs would need to live upto their USP – of being best placed to provide transparent, accountable and citizen-centric governance. The quality of basic service delivery would need to improve and so also the functioning of democratic institutions like the Gram Sabha in GPs. Accountability and adherence to rule of law are sine qua non for good governance. Once local governments begin to ensure that, their role and position in the democratic and federal system would automatically get recognized.
(Sunil Kumar is a visiting Senior Fellow associated with the Centre for Cooperative Federalism and Multilevel Governance in Pune International Centre and a former civil servant. Views expressed are personal.)
