A critical mismatch between the 16th Union Finance Commission (UFC) allocations for Kerala’s local bodies and the actual split-up of population between urban and rural local governments may necessitate a total overhaul of local body Plans, according to the 7th State Finance Commission (SFC).

The commission headed by K.N. Harilal has drawn attention to this issue in a Supplementary Report for the 2026-27 fiscal submitted to Governor Rajendra Arlekar on Tuesday. The supplementary report contains recommendations concerning changes needed in the Plan Fund distribution to local governments.

The need for a potential restructuring arises from the scenario where the UFC grants allocated to municipalities and Corporations are disproportionately high, while the grants to rural governments have sharply fallen, the panel said. This presents unique problems for a rapidly urbanising State like Kerala where the urban-rural divide is at best hazy.

The UFC divided local government grants between rural and urban local bodies on the basis of population projections for 2026. Consequently, there is a big jump in the share of the grants earmarked for the urban sector and a corresponding sharp decline in the rural sector. The urban sector allocation has jumped from 39.92% under the 15th UFC to 83.45% under the 16th. Correspondingly, the share of the rural sector registered a sharp fall from 60.07% to 16.55%, the SFC explains.

“A significant proportion of the Census towns, and hence the population covered by them, continues to remain even now under the jurisdiction of rural local governments. This creates a structural problem. A closer examination reveals that much of the urban growth has been occurring within rural local governments rather than urban local governments,” the SFC notes. Besides that the population under statutory urban governments (municipalities and Corporations) has either stagnated or declined.

Resolving the mismatch requires a “complete overhauling” of the State’s local government Plans. “Such adjustment is unavoidable to ensure that the UFC grants are fully availed and utilised in the State,” the panel says.

A second problem to which the SFC has drawn the government’s attention is that Kerala at present is not eligible for the special urban programmes for which the 16th UFC has earmarked funds. This, despite Kerala being one of the fastest urbanising States. The Kerala government may have to build a strong case and demand a just share out of this special programme, according to the SFC.

The supplementary report has been submitted ahead of a White Paper on State finances proposed by the new United Democratic Front (UDF) government and the State Budget.

The SFC had submitted its first report for the 2026-27 fiscal to the Governor in December 2025 and it was tabled in the Assembly in January 2026. The recommendations of the 16th UFC headed by Arvind Panagariya was tabled in Parliament in February. This had necessitated a “thorough review and revision” of the SFC’s recommendations for 2026-27 reflected in the supplementary report.

The UFC recommendations on grants to local governments are confined chiefly to the allocations to the States. The State governments constitute SFCs under clause 1 of Article 243 (I) and (Y) of the Constitution alongside relevant Sections of the Kerala Panchayat Raj Act and the Kerala Municipalities Act to examine the financial position of rural and urban local bodies and make recommendations to the Governor. The 7th SFC is for the period from 2026-27 to 2030-31.