It’s India’s quiet tug of war – and it plays out every five years. The 16th Finance Commission will soon make recommendations on share of divisible pool of resources between the states and Union for 2026-31. However, this will not be easy because of recent ferment on north-south imbalances and distressed fiscal capacity of states among others. This predicament is not merely anchored by some demographic or political discourse, but there is a fundamental shift and more so right, from the idea of equity to the idea of performance.
15th Finance Commission maintained the conventional structure: In horizontal devolution — that is, among states — 85% of the weightage remained bound to equity-based criteria: population, income distance, area and ecological factors. 15% was tied to performance-based metrics — demographic, tax efforts — in effect, continuing a 6:1 ratio for equity – performance metrics that has held relatively stable for the last three decades.
All this while, these transfers are facing twin tests: On one hand, there is a moral imperative to address structural inequities and deep deprivation that continue to worry poor states, on other hand, states that charted a more prosperous trajectory and achieved disciplined growth, should not met with relative neglect in the arithmetic of distribution. While advocacy for equity-based criteria as bedrock should continue; but without incorporating more rewards for performance, system risks stagnation.
For example, Southern states are demanding larger share in fiscal transfers, owing to their scale and geography of productivity, while for a state like Bihar – there has been a failure to translate its most potent endowment, an abundant labor force, into required productive capacity. What persists instead in Bihar is a politics of palliation: subsidized grains, trains and special trains for migration, and periodic promises of government jobs.
To re-imagine a solution is not to dismantle equity, but to redefine it. A slight modification — say, moving from a 6:1 to a 6:2 ratio — will not be a betrayal of convention but will be a recognition that fiscal transfer must now make more room for political economy of performance. For instance, weightage given to ‘income distance’ criterion – a proxy for identifying and supporting poor states, is presently 45% – this can be reduced to 35% to make room for another performance metric. This new metric could be an indicator of building state capacity for long-term growth and committing to contribute to country’s GDP.
Growth has always relied on trade and an apt integration with trade-based performance indices could be a possible way forward. Consider the case of Export Preparedness Index (EPI) – developed by NITI Aayog, which captures export performance at the state and district level, using 56 indicators for evaluating four pillars – policy, business ecosystem, export ecosystem, and export performance. While it captures aspects like trade infrastructure, growth orientation and institution: this can be a useful metric to locate weak areas for states, strive for competitive federalism and more importantly, facilitate leveraging of the resource endowment of the states.
A wide range of products of everyday life such as footwear, apparel, toys, food products – holds a substantial global market, require less skills, and a relatively lower investment per job; however, what holds a more important place in this discourse – robust value chain and adaptive mechanism, with strong institutional support. If the states manage to anchor these sectors – towards global yardsticks as it is true and fair barometer of productivity and innovation — with the help of EPI or any other metric that aligns with international standards — and conversations may shift from subsidies or biases to innovation and competitiveness.
Also, there is a changing world trade dynamics – let’s take the case of food products as example; significant rise in imports of edible oil and pulses raise serious concerns for Indian economy while in case of exports of dried pepper, India’s global market share has shrunk by more than half during 2013-2023 and there is an accelerating gap between India and the leading world exporter, Viet Nam, owing to pursuing safety standards, sustainability practices and maintaining competitive pricing.
If fiscal transfers are linked to export preparedness, that will nudge states to harness their strengths – for example, Makhana – sourced majorly from Bihar has recently emerged as a superfood in demand in the international market; and if the states strive for export preparedness to match global standards by financing in essential aspects of a robust value chain and market intelligence, that could unlock accelerated inclusive growth; and states will no longer be the passive recipients of fiscal transfers but principal sites of economic dynamism.
Ultimately, the more subtle insight lies elsewhere: that by deepening performance-based incentives tied to export competitiveness, Finance Commission may, in fact, be reinforcing the principles of equity; and to make this happen, India will require an ecosystem; perhaps its own version of sōgō shōsha.
Authors: Dipali Yadav and Shubham Kumar
Dipali Yadav is Assistant Professor at Birla Institute of Management Technology (BIMTECH), and Shubham Kumar is Assistant Professor at Jindal Global Business School, O P Jindal Global University.
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