The impending pay rises for public-sector employees to be implemented from FY17 are likely to partly redirect the government’s limited fiscal resources from investment to recurrent spending that will boost consumption
We expect consumption to drive India’s GDP growth in FY17 (year starting April 2016), taking over from investment. Impending pay rises for public-sector employees, to be implemented from FY17, are likely to partly redirect the government’s limited fiscal resources from investment to recurrent spending that will boost consumption, says a just released Standard Chartered Bank report.
According to it “The amount and details of the pay revisions – which are implemented once a decade – are expected to be finalised and announced by end-2015. Assuming a 15% hike in public-sector pay and pensions, we estimate total additional recurrent expenditure of 1.2% of GDP by the central and state governments over the next three years”.
This is likely to boost consumption. The impact in FY17 is likely to be limited to 0.7% of GDP, as states usually stagger the pay revisions over two to three years. Urban consumers are likely to benefit the most from the pay rises, leading the consumption recovery in FY17.
While urban consumption improved in H1-FY16, deteriorating rural demand has caused consumption to stabilise at low levels, putting the onus on investment to drive growth this year. Low inflation and the lagged impact of lower interest rates are also likely to boost urban demand, particularly for autos and white goods, in FY17. Rural demand is likely to improve if monsoon rains return to normal after three seasons of unfavourable weather conditions.
While higher government spending on salaries will benefit consumption, the diversion of resources is likely to slow India’s investment recovery, which has been driven entirely by government capital expenditure. “We expect the fiscal burden to be borne mostly by the central government, as it will implement the pay revisions in the first year (FY17), when it also aims to reduce the fiscal deficit by 0.4% of GDP to 3.5% of GDP” says the report.
States’ capex should hold up better given the staggered implementation of pay revisions and more fiscal headroom at the state level. Since the private sector is unlikely to plug the gap created by slower central government investment, the pace of investment is likely to slow unless the central government slows the pace of fiscal consolidation. It aims to reduce the fiscal deficit to 3.5% of GDP in FY17 from 3.9% in FY16.