The decision by the Cabinet comes following the Supreme Court directive to the Centre last month to form the tribunal within a month to resolve the long-standing dispute.
The Odisha government had moved the court in December, 2016, seeking an order asking Chhattisgarh to stop its construction work in projects on the upstream of Mahanadi, saying it had affected the river flow in the state.
It had also pitched for setting up of the tribunal.
As per provisions of the Inter State River Water Disputes (ISRWD) Act, 1956, the tribunal is required to submit its report and decision within a period of three years, which can be extended for a period not exceeding two years due to "unavoidable reasons".