The abrupt discontinuation of Revenue Deficit Grant (RDG) based on the 16th Finance Commission’s (FC) recommendation has shocked most hill states, particularly Himachal Pradesh. A careful reading of chapter nine of the FC report reveals that all states, including special category hill states, have been treated alike. The reasons for this departure from established principle are general rather than state-specific, as are the calculations. This not only runs contrary to Article 275(1) of the Constitution but also ignores the structural disabilities of states like Himachal Pradesh.
RDG is not charity; it is a response to objective reality. These states possess difficult terrain, low population density, large tribal populations, and strategic border locations. Most are not economically self-sustaining; they were created to fulfil regional aspirations rather than fiscal ones. Discontinuing the RDG will cause a massive dent in state finances, stalling development and potentially leading to regional alienation and discontent.
Constitutional mandate
Article 275(1) mandates sums be paid to states “in need of assistance”, allowing for different sums to be fixed for different states. During the Constituent Assembly debates in August 1949, Dr BR Ambedkar emphasised that “need of assistance” was the paramount metric for grant-in-aid. Significantly, these key words were omitted from the terms of reference of the 16th Finance Commission. While the commission itself observed that determining the “need of assistance” is essential for deciding revenue gap grants, its final recommendations failed to reflect this.
Historically, all commissions provided RDG based on need assessment. Most followed a normative approach to assess the post-devolution gap in state revenue accounts. This fundamental requirement—that the need for assistance for each state be assessed individually—is specifically provided under Article 280(3)(b) of the Constitution. By ignoring this, the commission has undermined the fiscal safety net designed for India’s most vulnerable geographies.
Every state, regardless of size or category, must fulfil constitutional obligations. To do so, they rely on own revenues, tax devolution, and market borrowings capped at 3% of the Gross State Domestic Product (GSDP) under the Financial Responsibility and Budget Management (FRBM) Act. For most special category north-eastern and Himalayan states, a persistent gap remains between revenue and expenditure. Historically, the RDG has bridged this chasm.
Cost of topography
The cost of providing services and infrastructure in hill states is two to three times higher than in the plains. These regions suffer frequent natural disasters, exacerbated by climate change, which threaten a fragile topography. Himachal Pradesh has suffered year after year; in the last three years alone, losses reached ₹20,000 crore. It is ironic that disasters like landslides, cloud bursts, and Glacial Lake Outburst Floods (GLOF) carry little weight in central relief packages, and assistance norms for affected families remain abysmal.
Furthermore, hill states provide invaluable ecological services to the nation. A study by the Indian Institute of Forest Management (IIFM) assessed that Himachal Pradesh alone provides services, including natural carbon sinks, watershed sustenance, and biodiversity, worth ₹90,000 crore. These benefits accrue to other states, yet the costs are borne by the host state through the opportunity cost of not utilising its forest land, which covers 68% of its territory. Himachal Pradesh even maintains a self-imposed ban on scientific felling under silviculture operations to protect this green cover.
There are also physical limits to revenue generation. Himachal has suffered under the GST regime because it is not a consumer state and possesses a small domestic market. The destination trap built into the GST architecture favours consuming states over producing ones. State revenue growth during the pre-GST period was significantly higher, even accounting for GST compensation. Essentially, states traded their constitutional taxing powers for temporary cash compensation that has now expired. Unlike Uttarakhand, Himachal lacks a wide belt of plains for industrialisation or urbanisation.
Legacy issues, way forward
While committed expenditure on salaries and pensions is high in Himachal, this is due to a unique topography and sparse population that necessitates a higher density of institutions to deliver health, education, and transport services. The state remains a top performer on social indicators, but rationalisation cannot happen in the short term. It is a legacy issue requiring a transition period.
Under the 15th Finance Commission, 17 states received RDG. While its discontinuation affects all, the impact on Himachal is catastrophic, eroding roughly 15% of the state budget. As the FC is a constitutional body and its report has been accepted by Parliament, a formal review may be difficult. However, the Government of India can consider two immediate options:
First, for the 2026-27 budget, provide an ad-hoc allocation from special central assistance to compensate for the post-devolution deficit. Alternatively, allow affected special category states an additional 2% to 3% market borrowing limit to tide over the current crisis.
Second, for the remaining four-year period of the FC, constitute a high-powered committee to bridge the revenue gap. This should include debt restructuring. In Himachal, nearly all open market borrowing is currently consumed by debt servicing, an unsustainable situation. This panel could assess needs realistically while asking states to commit to cutting wasteful expenditure and increasing internal revenue.
The situation is alarming and requires the immediate attention of the Centre before the developmental gains of the Himalayan region are permanently reversed. letterschd@hindustantimes.com
The writer is principal adviser to the Himachal Pradesh chief minister and a former chief secretary. Views expressed are personal.
