Will The Pay Commission Hikes Boost Consumption?

The Seventh Pay Commission has recommended an overall 23.6% increase in salaries of central government employees and the pensions of the retired central government employees. The total cost of this increase in 2016-2017 has been estimated at Rs 1,02,100 crore (as can be seen from the following table).


Source: Seventh Pay Commission Report

This increase of Rs 1,02,100 crore has led several analysts and economists to conclude that a consumption boom is on its way. As analysts at Kotak Institutional Equities point out in a research note: “We expect automobiles, consumer durables and real estate sectors to benefit from the largesse. Although current demand conditions are somewhat subdued in both the sectors, the additional funds in the hands of central…government employees should be a positive for volume growth.”

The logic is very simple. If the recommendations of the Pay Commission are accepted the salaries of the central government employees will go up. The pensions of the retired central government employees will also go up. They are likely to spend this money and this spending will benefit the car, consumer durables (refrigerators, washing machines, television etc.) and the real estate companies. QED.

The truth might actually turn out to be a little more nuanced than this. There is no denying that there will be spending and that spending will benefit the economy, but the question is how much?

It is important here to consider those working for the central government and those who have retired from central government, separately. Let’s take the retired lot first. The increase in their case works out to Rs 33,700 crore (see above table). The Pay Commission report points out that as on January 1, 2014, the central government had a total of 51.96 lakh pensioners.

The increase of Rs 33,700 crore will be divided among these pensioners. This works out to Rs 64,858 on an average (Rs 33,700 crore divided by 51.96 lakh pensioners) or around Rs 5,505 per month (Rs 64,858 divided by 12). A portion of this will be taxed (I have no way of estimating how much, given that there is no way of estimating what is the average rate of income tax that India’s pensioners pay).

While this increase is substantial it is not substantial enough to make a huge impact on consumption. It will have an impact on consumer durables sales and two wheeler sales. But I don’t think this increase for pensioners will have an impact on sales of big ticket items like cars or homes for that matter. Also, it is worth mentioning here that pensioners are not as big spenders as those employed, anyway.

Those working for the central government will see a total increase of Rs 68,400 crore (Rs 1,02,100 crore minus Rs 33,700 crore of pensions). A portion of this increase in income will be taxed. Again, I have no way of estimating how much, given that I couldn’t find any data on what is the average rate of income tax that India’s central government employees pay. In fact, I could have used the average rate of income tax paid by individuals as a proxy, but I couldn’t find that number either. (Though the average rate of corporate income tax is available and is shared with every budget).

Assuming that the average rate of income tax paid by India’s central government employees is 10.3% (10% income tax + 3% education cess). This would leave around Rs 61,355 crore (Rs 68,400 crore minus 10.3% of Rs 68,400 crore) in the hands of the employees to spend.

The Pay Commission Report points out that there are currently 33.02 lakh central government employees. This means that Rs 61,355 crore will be shared among them. It works out to Rs 1,85,811 for the year (Rs 61,355 crore divided by 33.02 lakh employees), on an average. This works out to Rs 15,484 per month (Rs 1,85,811 divided by 12).

This is a substantial increase and will have an impact on consumption. It will lead to more two wheeler sales, more consumer durables sales and more car sales as well. But I still have my doubts whether this will lead to substantially more sales in real estate. Perhaps in smaller towns, yes.

Also, it is important to see how big this increase is with respect to the overall size of the economy. The increase of Rs 1,02,100 crore will work out to 0.65% of the gross domestic product (GDP) in 2016-2017.  In comparison, the awards of the Sixth Pay Commission had worked out to 0.77% of the GDP.

Some portion of this increase will be taxed away. Some portion will be saved. I guess it is fair to say that around half to two thirds of this increase will be spent and that works out to around 0.33-0.43% of the GDP. While that is a substantial number, it is not very big in the context of the overall economy.

Also, analysts and economists who have been talking about a huge revival in consumption have the Sixth Pay Commission experience in mind. As Crisil Research points out in a research note: “Sales of automobiles (two-wheelers and passenger vehicles) increased significantly (25-26%) while consumer durables saw a growth of 2.5-3% bps in fiscal 2010 and 2011 after the implementation of the Sixth Pay Commission report.”

The major reason for this big boost in consumption was that the increased payments to central government employees was made in 2009 and 2010, even though it had been due from 2006 onwards. This time the increase is due from January 2016. Even if the payments are made from April 1, 2016, onwards, the arrears will be minimal.

As the Seventh Pay Commission report points out: “The awards of the previous Pay Commissions, both V as well as the VI, involved payment of arrears…However, Seventh Central Pay Commission recommendations entail, at best, payments of marginal arrears.”

Given that central employees will not be receiving bulk payments in the form of arrears, the impact on consumption will not be as much as it was the last time around. Also, sales went up in 2009 and 2010 because of a cut in excise duty and a huge drop in interest rates. Both scenarios are unlikely as of now.

Crisil estimates that: “The Seventh Central Pay Commission to boost sales of passenger vehicles and two-wheelers by 4-5% incrementally in fiscal 2017…Consumer durables, too, are expected to see additional growth of 1-1.5% in volume, while there could be broad-based growth in televisions, washing machines and refrigerators.” And that sounds reasonable.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on SwarajyaMag.com on Nov 21, 2015