The first-of-its-kind index will enable the cities know where they stand in terms of the quality of life and the interventions required to improve it.
The cities will be assessed on a comprehensive set of 79 paratmeters, including availability of roads, education, healthcare, mobility, employment opportunities, emergency response, grievance redressal, pollution, availability of open and green spaces, cultural and entertainment opportunities.
The ranking will be released in 2018.
Meanwhile, Mr Naidu disbursed Rs 500 crore as incentive to 16 states that performed well in implementing urban reforms during 2016-17.
Andhra Pradesh topped the list with the highest score in implementing urban schemes, followed by Odisha, Jharkhand, Chhattisgarh and Madhya Pradesh.
Mr Naidu said, the reform incentive fund will be increased to Rs 10,000 crore for the next three years to promote next generation urban reforms.
He also announced 30 new cities to be developed as smart cities, taking the total pick to 90 under the Centre's Smart City Mission since its launch in June 2015.
It is left to the city governments and citizens to propose the works to be done, he said.
He said, it is a "huge distortion" to say that 'Area Based Development' under Smart City Mission benefits the people of that area only.
"It will certainly benefit other citizens as well in several ways," he said.
Hitting out at the previous UPA governments, the minister claimed that only 39 per cent of 3,138 basic urban infrastructure projects approved during 2005-14 period were completed in time.
However, he said, 47 per cent of the 11,705 urban projects approved during the last two years are already under implementation and would be completed by the stipulated timeline of 2019-20.