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Jun 30, 2016

7th Pay Commission: Here's why the government may just pull it off

One of the questions thrown at Finance Minister Arun Jaitley at the press conference to announce the cabinet decision to implement the Seventh Pay Commission report was: You have given government employees a pay hike but have you thought about how the resultant inflation will break the backs of other groups? But did the government have a choice about whether or not to implement the report? Could it (or any other dispensation in its place) actually have dared to say that it will not implement it?
The previous government cleverly announced the constitution of the commission a few months before the 2014 elections when there was no hurry to do so, putting whichever government that would come to power in a bind. Once the report is out, any government would be in a damned-if-it-did-damned-if- it-didn’t situation.

The very people raising red flags about inflation and the fiscal deficit would have slammed the government for being unfair to government employees. At best, it could have delayed implementation – the Sixth Pay Commission award was implemented after 32 months – but that would only have built up a crippling burden of arrears; the arrear burden this time is much less than that of previous pay commissions.

So, the government had no choice but to walk the tightrope between perking up the economy with a much-needed consumption boost and unleashing the just-tamed inflation dragon as well as wrecking public finances. Will that tightrope walk be successful or will the economy fall into an abyss from which it will be difficult to climb back?

Well, the government may just pull it off.

There is no doubt that this will give a huge consumption boost to the economy; with all kind of global headwinds affecting India’s exports, a domestic demand spurt was necessary. Imagine 1 crore people (47 lakh employees and 53 lakh pensioners) suddenly with more money in their hands to spend. Exciting times could be in store for automobiles, housing, consumer durables.

It is not just central government employees who will have more money in their hands. Pay revisions of state government employees, central and state public sector employees, urban local bodies, autonomous bodies and universities will also happen sooner rather than later. Many state governments follow the Central Pay Commission recommendations, while a few have their own pay commissions.

Karnataka and Kerala revised their salaries in 2012 and 2014 respectively, many have not done so since 2006. According to Devendra Pant, chief economist and head, public finance, of India Ratings, the demand boost to the economy coming from the pay revisions of all these categories could be four times that of the Seventh Pay Commission award. He expects a consumption boost of around Rs 45,000 crore or 0.3 per cent of GDP.

Of course, not all the 1 crore will spend all the money they get. Many of them are going to save as well. Saumya Kanti Ghosh, chief economic adviser, State Bank of India, believes the award will also give a savings boost more than a consumption boost. Looking at the trend of previous pay commission awards, he points out in an Ecowrap report that the growth rate of household savings sees an increase in the year immediately after the submission of the report over the year preceding it. On the other hand, the growth rate of private final consumption expenditure has fallen in all the years following a pay commission award, barring the Sixth Pay Commission. Since that came around the time of the global financial crisis, he argues, risk aversion levels were higher, and people may have preferred to focus on consumption rather than investment.

A likely increase in savings, he writes, is welcome in a year when bank deposits have touched a 53-year low and the impending FCNR (B) redemptions could also lead to outflows from banks in September. He does not put a number on likely savings, but Pant of India Ratings estimates an increase of around Rs 30,000 crore or 0.2 per cent of GDP. For the Indian economy, especially the infrastructure sector, this will be as welcome as a spending boost.

But let’s not overlook the likely flip side. First, the worries on inflation, which could be very real. Earlier pay commission awards have seen a spike in inflation. Inflation levels have come down since the double digit days of two years back, but retail inflation has started inching up recently, and so have global oil prices.

Economists, however, are not losing sleep over this. The increase will be muted and tempered, Saugata Bhattacharya, senior vice-president of Axis Bank pointed out on television, because the new consumer price index is different from the old one in many ways.

It is not just about statistical nuances. Demand push inflation could definitely occur when there is too much money chasing not much supply because factories are not producing more. That is not the case currently. Factories have over-capacity because of lack of demand; capacity utilisation is around 70 per cent. So there is a lot of slack which could keep inflationary conditions under check. Remember, also, that the government could spread out the pay arrears over a period of time and has not yet taken a decision on allowances and when it does it will be implemented with prospective effect. So the effect of a lot of money sloshing around could be staggered.

Besides, the effect of Brexit on global oil and commodity prices is still unknown. Oil prices did fall a bit immediately after Brexit and if the European economy slumps, this could act as a dampener on price rise. “A rise in demand is likely to not only increase capacity utilisation but may also help revive the investment cycle earlier than expected,” according to Pant.

And what of the fiscal deficit? Does the government have the money for this bonanza (there will be an additional burden of Rs 1.02 lakh crore) or will it have to miss the fiscal deficit target of 3.5 per cent? Doing so will be bad news and a wrong signal to send out.

Actually, the government has factored a large part of the pay commission award in the 2016-17 budget. There are varying estimates (from Rs 20,000 crore to Rs 38,000 crore) of how much of a gap there will be in the budget. How the government handles this will be the key.

It is not certain, for example, whether the arrears (from January to July) are to be given as a lump sum or spread out over a couple of years. Most analysts feel it will be staggered over the next two years. In that case the impact on the exchequer and inflation will both be muted. Besides, there will be an increase in tax revenue from more income tax collection (due to higher salaries) and excise duty collections – or GST, if it comes – from increased consumption.

Pant estimates that the tax revenue of the centre (after netting out the states’ share) could be around Rs 14,100 crore or 0.09 per cent of GDP. Along with other means to bump up tax revenues as well as non-tax revenue (spectrum sale, disinvestment) the outgo on account of higher salaries and allowances could be made up to a fair extent.

Sure, things could still go awry. Global oil and commodity prices could go up. The monsoon could fail. There could be other shocks to the economy, meaning lower revenue collections and higher expenditure.

The government’s economic managers will need to keep a close watch on the negative fallouts of the pay commission award implementation and act quickly to neutralise them. Otherwise all the gains will be lost.

SOURCE - firstpost.

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