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Demand Booster For Economy, Challenge For Fiscal Consolidation

Monday, November 23, 2015
By Dr Devendra Pant

In a big bonanza for the central employees and pensioners, the Seventh Central Pay Commission last week recommended a 23.55 per cent increase in salaries, allowances and pension, along with a virtual one-rank-one-pension for civilians, involving an additional outgo of Rs 1.02 lakh crore per annum. The proposals, if accepted, are effective January 1, 2016. The move will benefit 42 lakh central staff and 52 lakh pensioners, which will be a drain of Rs 73,650 crore on the general Budget and Rs 28,450 crore on the railway budget.

The Seventh Central Pay Commission (7CPC) has proposed an increase of 23.55% in the pay packet (salary and allowances) of central government employees and pensioners, which will become effective from 1 January 2016. The payout is expected in FY17.

The 7CPC award is likely to cost the central government INR1.021trn in FY17, a 23.55% increase from FY16. However, factoring in the arrears of January-March 2016 to be paid in FY17, the total impact is estimated to be INR1.276trn (0.81% of GDP). However, after factoring in the share of the central government in increased tax collection (direct and indirect), the net impact on the exchequer will be lower at 0.68% of GDP. Yet at a time when the government is pursuing the path of fiscal consolidation, this will pose a serious challenge for the government in terms of not deviating from the fiscal deficit targets as announced in the FY16 budget.

Ind-Ra’s estimate shows that after sharing of central taxes with state governments, the central government’s net tax revenue will increase by INR210bn in FY17. The consumption boost to the economy is estimated to be INR612.6bn (0.39% of GDP) and increased household savings are estimated to be INR408.40bn (0.26% of GDP).

A major difference between the previous pay commissions and the seventh pay commission is that there will be hardly any lag between the day from when the award is to be implemented and the date on which the award was announced. As a result, the size of the arrears to be paid will be negligible compared with the payouts of the fifth and sixth pay commissions. The fiscal impact of the arrears of the sixth pay commission was so onerous that it was spread over two fiscals, FY10 and FY11.

Although 7CPC is applicable to central government employees, the salaries and pensions of state government employees, urban local bodies, central and state public sector undertakings, autonomous bodies and universities will also be revised in FY17 and FY18. Ind-Ra’s estimate shows that the demand boost to the economy as a result of the revision in the salaries/pensions of the above mentioned employees will be at least four times the 7CPC’s award.

Ind-Ra does not see any immediate threat to inflation due to the award of 7CPC. Though CPI inflation may inch up somewhat due to higher prices of services, impact on WPI is likely to be muted due to the counter balance provided by the deflation in commodity prices and the availability of excess capacity in several manufacturing sectors. A rise in demand is likely to not only increase capacity utilisation but may also help revive the investment cycle earlier than expected.

( The Author is , Chief Economist and Head Public Finance, India Ratings and Research)

Other Views
The Government of India's wage bill (excl. railways) is set to increase by Rs 740bn, or 0.46% of GDP, in FY17. Besides, Q4FY16 payouts would be carried forward to the next fiscal, resulting in an additional burden of 0.12% of GDP. Also, the impact of one-rank-one-pension (OROP) is estimated at 0.13% of GDP. Together, the additional fiscal burden for FY17 would be ~0.7% of GDP, making the fiscal deficit target of 3.5% impossible to achieve. We expect GoI to push forward the current fiscal consolidation roadmap by a year in the next budget.

We think the government will have to boost revenue and reduce spending to accommodate higher recurrent expenditure if it accepts the 7PC recommendation. Even in the most optimistic scenario, we think the government would have to reduce capex by 0.2-0.3% of GDP in order to achieve the fiscal deficit target of 3.5% of GDP. We think a more likely scenario is that it will have to both reduce capex and slowdown on fiscal consolidation in order to implement the proposed pay hike.

The government will have to shore up revenue collections to ensure fiscal targets are not met through capital expenditure cuts -- as had happened in the past. For this, the implementation of Goods and Services Tax and relentless efforts to improve revenue mobilisation will be necessary. In the absence of this, the government may have to cut capital expenditure to meet its fiscal deficit target for 2017.

The Pay Commission’s recommendations have the potential to add to the purchasing power of households which should help to prop up demand, though admittedly it would be seen during the course of FY17 when it is implemented. This along with the government’s own capex programme would help in accelerating growth.
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