Devolving for a Greener Future: A Landmark Opportunity for the XVI Finance Commission
Amit Kapoor and Koyel Kumar Mandal
India is reshaping its growth story, moving from sheer speed to lasting sustainability. The next wave of growth will therefore be driven not by smokestacks, but by green factories, zero-emission transport, renewable power, and digital transformation. By 2047, India aims to be a developed economy and by 2070, a net-zero one. Crossing these milestones would require the country to act on two fronts simultaneously. Investing in clean energy and industries drives growth, jobs, better air quality, and lower emissions; Investing in resilience through climate-smart farming, cooler cities, and flood defences protects people and assets. Financing this dual transition will cost trillions, while the cost of inaction would be even higher, with losses to GDP, competitiveness, and macro-financial stability.
To finance this transition and attract private investments, we propose that the 16th Finance Commission (FC) should introduce a climate change criterion into the Centre-state devolution formula with an initial weight of 5%. It would take into consideration climate exposure, climate sensitivity, and adaptive capacity of states. Over time, new indicators reflecting clean growth investment needs of states should be included and the weight increased.
From heatwaves that push electricity demand to unprecedented peaks every year to the recent floods in Punjab, Delhi-NCR and other regions, climate shocks have become a recurrent feature of India’s development landscape. This challenge is magnified by India’s vast and varied geography, where climate risks are unevenly distributed, and adaptation needs differ sharply. In such a federal system, much of the responsibility for climate-related investment falls on the states. India’s system of Centre–state revenue transfers is designed to balance resources, with the Finance Commission assessing costs both vertically i.e. between Centre and States and horizontally i.e. across states. Yet two imbalances persist. Vertically, the Union collects most revenues, while States bear the bulk of climate-sensitive expenditure. Horizontally, poorer and more climate-vulnerable States face higher risks but have lower revenue capacity, while richer States enjoy both greater resources and stronger capabilities to invest in clean energy and innovation. Unless addressed, these imbalances could deepen inter-state inequality and erode the fiscal foundations of cooperative federalism.
Successive Finance Commissions have aimed to bridge this gap. Early Commissions focused heavily on income equalization, using population and per capita income distance as the principal criteria for horizontal distribution. Over time, efficiency considerations such as tax effort and fiscal discipline were added. The 14th FC marked a turning point by raising states’ vertical share of the divisible pool to 42% and introducing an explicit ecological criterion: the proportion of state area under forest cover. The 15th FC raised the forest and ecology weight from 7.5% to 10%.
Although the FC’s horizontal devolution formula has undergone incremental evolution to improve inter-state fiscal equity, the existing architecture of the 15th FC leaves a significant gap: there is no direct measure of climate change in the devolution formulae. From an adaptation perspective, states recurrently affected by floods, droughts, or heatwaves and those facing chronic risks such as coastal erosion or Himalayan fragility, receive no systematic recognition of the fiscal pressures these hazards impose. From a clean growth perspective, the cost of a just energy transition is different for different states based on the current drivers of economic growth, their potential to diversify the economic base, and the state’s resources and capabilities. The metrics used in the horizontal devolution formulae are reactive rather than anticipatory. The growing structural climate disadvantage only gets reflected in the formula in the form of increased income inequality among states after climate shocks and muted clean energy investments have eroded output, revenues and service delivery capacity. States with climate-exposed agriculture or carbon-intensive industrial bases, for example, face higher adjustment costs and a chronic productivity drag.
The policy challenge today is therefore one of institutionalizing climate change within the fiscal decision-making frameworks ensuring that inter-governmental transfers function not just as mechanisms of income redistribution but as instruments of clean and resilient growth pathway, arguably the most important stated policy goal of the government.
Including climate change in the Centre-state devolution would put clean and resilient growth right at the centre of India’s fiscal federalism, establishing a new standard for policy innovation. It will provide a replicable model for other decentralized countries in the Global South and will provide an additional lever for climate diplomacy, ahead of India’s COP Presidency. Above all, it will fill a critical investment gap for India’s clean and resilient growth by guaranteeing a stable, rule-based, and domestically funded flow of funds consistent with constitutional provisions of fiscal fairness.
Dr. Amit Kapoor is honorary Chairman, Institute for Competitiveness and Mr. Koyel Kumar Mandal is Director, Climate Change at the Children’s Investment Fund Foundation.
The article was published with Business Standard on September 17, 2025.
