This is the third time this week I am writing a column around the Seventh Pay Commission recommendations. In this column I would like to address the total financial impact of the recommendations of the Seventh Pay Commission.
As I have mentioned in the earlier columns, the Commission has recommended an overall increase of 23.6% in the salary of the central government employees and the pensions of those who have retired from central government jobs. This is likely to cost the government Rs 1,02,100 crore in 2016-2017, the Commission has estimated.
The report estimates that this increase 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.
The question is how much will it impact the finances of the central government, if the recommendations where to be accepted. First and foremost Pay Commission recommendations are usually accepted. And there is no reason that they won’t be accepted this time around as well.
Further, it is very difficult to estimate by exactly how much the government finances will be affected , given that there is no way of figuring out what the budget makers of the government are thinking. Nevertheless, it is safe to say that the government will have to figure out a way of either increasing its earnings or cutting down on its expenditure, in order to be able to finance this expenditure (as we saw in yesterday’s edition of The Daily Reckoning).
If we look at the budget numbers between 2005-2006 and 2015-2016, the government expenditure has gone up at the rate of 13.4% per year. The government receipts (i.e. the tax and the non-tax revenue of the government less its borrowings) have gone up at the rate of 13% per year. The government expenditure has been going up on a larger base at a faster rate.
Of the extra Rs 1,02,100 crore the government will have to spend, Rs 73,650 crore will have to be borne on the general budget and the remaining on the railway budget. Assuming that the trend of the last ten years will continue in 2016-2017, with an extra expenditure of Rs 73,650 crore, the fiscal deficit of the government is likely to jump to 4.5% of the gross domestic product (GDP) (I will spare you the Maths here).
In 2015-2016, the government has targeted a fiscal deficit of 3.9% of the GDP. Fiscal deficit is the difference between what a government earns and what it spends. And this isn’t a good thing, given that the government is trying to achieve a fiscal deficit of 3.5% of the GDP by 2016-2017 and 3% of the GDP by 2017-2018.
Long story short—the government cannot continue operating the way it currently is. It will have to find out ways to cut its expenditure on other fronts as well increase its revenues. If it does not do that there is no way it will be able to finance the extra spending on salaries and pensions without managing to increase its expenditure as well as the fiscal deficit in the process. And that won’t be a good thing for the Indian economy.
A higher fiscal deficit will have to be financed out of higher borrowing by the government. This will leave lesser amount of money for the private sector to borrow and in effect push up interest rates. And that is something the government won’t want to do.
In fact, the impact of the recommendations of the Seventh Pay Commission don’t end at the central government level. As soon as the central government accepts the recommendations of the Seventh Pay Commission, demands will start for the state governments to increase their salary and pension payouts as well.
That is how things had played out after Sixth Pay Commission recommendations were accepted. The Sixth Pay Commission was due from 2006 onwards, but the Pay Commission report was submitted only in March 2008. The recommendations were accepted in August 2008. Given this, the government had to pay arrears to the employees.
These arrears were paid in 2008-2009 and 2009-2010, with a split of 40:60. This pushed up the fiscal deficit of the central government big time. The fiscal deficit in the year 2007-2008 had stood at 2.54% of the GDP. In 2008-2009, it hit 5.99% and then climbed to 6.46% of the GDP in 2009-2010 (as can be seen from the accompanying table).
There were other reasons as well for this massive jump in the fiscal deficit, from debt of farmers being waived off, to the United Progressive Alliance government getting into the pump priming mode in the aftermath of the financial crisis which started in mid-September 2008, to the expansion of the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) to all districts of the country from the original 200 districts.
|Year||Fiscal deficit of the central govt(% of GDP)||Combined fiscal deficit of the state govts (% of GDP)||Total|
After the central government, the state governments also had to start raising salaries as well as pensions. The Seventh Pay Commission had commissioned a study by IIM Calcutta to “ascertain the fiscal impact of the previous Commissions’ awards on the states”.
The study found that: “that a significant number of States follow the recommendations of the Central Pay Commission. Equally, there is significant plurality of States that design their own pay awards based on the recommendations of their own State Pay Commissions, which of course do consider the recommendations the Central Pay Commission.”
Hence, the salaries of the employees of the state government employees also went up after the Sixth Finance Commission recommendations were accepted by the central government. This led to the combined fiscal deficit of the states jumping from 1.51% of the GDP in 2007-2008 to 2.91% of the GDP in 2009-2010.
The combined fiscal deficit of the centre as well as the states jumped from 4.05% of the GDP to 9.37% of the GDP. Things started to improve from 2010-2011 onwards. As the Seventh Finance Commission report points out: “The empirical analysis conducted indicates that the macroeconomic impact on States’ finances tends to taper off in two years in most cases.” So, government finances were impacted for two years.
Will a similar scenario play out this time around as well? While the fiscal deficits of the centre as well as the states are likely to jump up, the quantum of the jump may not be as much, because this time the chances of arrears having to be paid are low (at least in case of the central government).
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.”
This time around the chances are that the recommendations of the Commission will be implemented from April 1, 2016, onwards, and hence will involve payment of marginal arrears. In case of state governments, the arrears will depend on how soon the state governments agree to salary increases.
So can we safely say that the damages of the Seventh Pay Commission will not be as bad as the damages of the Sixth Pay Commission, which screwed government finances for two years? The fact is that the Seventh Pay Commission has recommended one rank one pension for central government employees as well. And that remains the joker in the pack.
The column originally appeared on The Daily Reckoning on Nov 26, 2015