7th Pay Commission Report: What does govt ‘really’ spend its money on?

Late last week, the Seventh Pay Commission recommended a 23.6% overall increase in the salaries of central government employees and the pensions of retired central government employees. This increase is likely to cost the government Rs 1,02,100 crore in 2016-2017, the Pay Commission report estimates. 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.

Since the recommendations of the report came out in the public domain, there has been a lot of noise around whether the inefficient government employees need to be paid so much. Or does the government need to employ the number of people that it does? What seems like an obvious answer is not so obvious when you look at the actual numbers. But that is a question I will leave for tomorrow’s edition of The Daily Reckoning. Today I wanted to discuss something else. Something that will set the pretext for tomorrow’s edition of The Daily Reckoning.

The question I want to ask today is how much money does the central government spend on paying salaries and pensions. The accompanying table provides the answer.

Travel Expenses)

Source: www.indiabudget.nic.in; In Rs Crore

Looking at these numbers in isolation doesn’t tell us much, other than the fact that the latest salary plus pensions bill of the central government comes to Rs 2,38,045 crore. Let’s look at them as a proportion of the total expenditure as well as the total receipts of the government, to give us a much better idea how big the spending on salaries and pensions is.

YearSalary + PensionTotal govt expenditureSalary + Pension as a
% of govt expenditure

Source: www.indiabudget.nic.in ; In Rs Crore

As can be seen from the above table, the salary plus pensions bill of the central government as a proportion of the total expenditure has gone up over the years. From making up around 11.56% of the total government expenditure, ten years back, it has jumped to around 13.39% in 2015-2016.

A possible explanation for this might lie in the fact that the number of central government employees has gone up during the last ten years. In 2005-2006, the central government employed around 32.3 lakh people. In 2015-2016, it employs around 35.5 employees.

Further, the number of pensioners has also jumped from around 38.41 lakhs to 51.96 lakh (as on January 2014, I couldn’t find the latest number of pensioners). Given this, it is not surprising that the salary plus pensions bill of the government has gone up.

But that is just one way of looking at it. The other way of looking at is that more than 13% of government’s expenditure is on basically on around 88 lakh individuals (the salaried lot plus the pensioners of the central government). Consider the fact that India’s population is more than 120 crore, you realise that this spending is concentrated on a certain section of the population and their families. But does that mean that the government should be smaller than it currently is? The answer is not so straightforward. As I said, I will answer that question in tomorrow’s column.

It needs to be mentioned here that the total expenditure of the government is met through borrowing because the government doesn’t earn enough to meet all its expenditure. Given this, how do things look when we compare the salary plus pension bill to the total receipts of the government (i.e. tax and non-tax revenue less the borrowings).

YearSalary + PensionTotal receiptsSalary + Pensions as a
proportion of total receipts

Source: www.indiabudget.nic.in ; In Rs Crore

So what does the above table tell us? The government spends around one out of the every five rupees that it earns on paying pensions and salaries. And that is a pretty high portion of what it earns.

So how much money is left with the government to spend on important things like infrastructure, health, education, etc. Before I answer this question, I need to get some more data points in.

The government spends a lot of money in paying interest on the debt that it has taken on to finance its expenditure. And it also spends a lot of money repaying the debt as it falls due.

YearSalary +
Interest on
of Debt

Source: www.indiabudget.nic.in ; In Rs Crore

The above table makes for a very interesting reading. In 2013-2014, the government spent nearly 69.4% of its receipts on paying salaries, pensions and interest on its accumulated debt, and repaying the debt that fell due. In 2015-2016, this had gone up to nearly 75.3%. How does the scene look when we compare this to the total expenditure of the government?

YearSalary +
Interest on
of Debt
TotalTotal govt

Source: www.indiabudget.nic.in ; In Rs Crore

The first thing that the table tells us is that the situation is not as bad as it was in 2005-2006, when more than80% of the expenditure of the government was on salaries, pensions, paying interest on debt and repaying debt. Things have improved since then. Nevertheless, the government still incurs more than half of its expenditure on salaries, pensions, paying interest on debt and repaying debt. What this tells us very clearly is that the government doesn’t have much money left to be spending on the important areas of physical infrastructure, education, health etc.

With a further increase in pensions and salaries on the way, this is only going to get worse. The government will have even lesser money left to be spending on important things like education, health, infrastructure etc.

So what is the way out? For that you will have to wait for tomorrow’s column.

This column originally appeared on The Daily Reckoning on Nov 23, 2015

Point blank: 7th Pay Commission recommendations will hit govt finances hard

The Seventh Pay Commission has recommended a 23.6% increase in salaries of central government employees, as well as pensions of retired central government employees. This largesse will cost the government Rs 1,02,100 crore in 2016-2017, the report estimates.

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 report points out that “while projecting the GDP for 2016-17, we assumed that the real growth rate of GDP will be 7.5 percent and inflation will be 4 percent in 2016-17.” This is perhaps a little overoptimistic, but let me not nit-pick.

Also, the 0.65% of the GDP number may be lower than what the number might eventually turn out to be because it does not take into account the impact of recommending one rank one pension for central government employees as well as para-military personnel.

Further, the trouble with expressing amounts as a percentage of the GDP is that it does not always show the correct picture. It is important to understand what will be the impact of the ‘extra’ Rs 1,02,100 crore on government finances.

In 2005-2006, the total government expenditure had stood at Rs 5,06,123 crore. A decade later in 2015-2016, the total government expenditure is projected to be at Rs 17,77,477 crore. This means an increase in expenditure at around 13.4% per year.

In 2005-2006, the total receipts of the government (less its borrowings) or what it earned, stood at Rs 3,59,688 crore. Ten years later in 2015-2016, the total receipts of the government(less its borrowing) is expected to be at Rs 12,21,828 crore. This means an increase in earnings at around 13% per year.

I am calculating these numbers so as to be make a rough projection for the receipts as well as the expenditure of the government in 2016-2017, the next financial year. Looking at the long-term trend we will assumethat for 2016-2017, the receipts of the government will go up by 13%, whereas its expenditure will go up by 13.4%. While the chances of things playing out exactly like this are low, but please indulge me, in order to understand the broader point I am trying to make.

Hence, the government receipts for the year 2016-2017 are likely to be at Rs 13,80,666 crore (1.13 times Rs 12,21,828 crore, the projected receipts for 2015-2016). The government expenditure for the year is likely to be around Rs 20,15,389 crore (1.134 times Rs 17,774,77 crore, the projected expenditure for 2015-2016).

This expenditure for 2016-2017 does not include the Rs 1,02,100 crore cost of the recommendations of the Seventh Pay Commission. We need to add this.

Hence, the total expenditure is likely to be at Rs 21,17,489 crore. Against this, the government will earn Rs 13,80,666 crore as receipts.

This means that the government will run a fiscal deficit of around Rs 7,36,823 crore. Fiscal deficit is the difference between what a government earns and what it spends. In 2015-2016, the fiscal deficit is projected to be around Rs 5,55,649 crore or 3.9% of the GDP. So what will the fiscal deficit work out to be in 2016-2017 as a proportion of the GDP?

For 2015-2016, the nominal GDP(i.e. not adjusted for inflation) is assumed to be at Rs 14,108,945 crore. The Seventh Pay Commission assumed a real GDP growth of 7.5 percent and an inflation of 4 percent in 2016-17. We will stick to the same numbers and hence assume a nominal GDP growth of 11.5% (7.5% real GDP growth plus 4% inflation).

This would mean the nominal GDP in 2016-2017 would be Rs 15,731,474 crore (1.115 times Rs 14,108,945 crore, the GDP projected for 2015-2016). Hence, the fiscal deficit as a proportion of GDP for 2016-2017 would work out at 4.7% (Rs 7,36,823 crore expressed as a proportion of Rs 15,731,474 crore).

This means the Seventh Pay Commission recommendations if accepted, will push up the fiscal deficit to 4.7% of the GDP from this year’s 3.9%. 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.

The broader lesson here is that if things continue in the way they are now the Seventh Pay Commission recommendations are likely to screw up the government finances big time by pushing up the fiscal deficit.

The way to avoid this situation is by increasing receipts or cutting down on expenditure. If salary expenditure goes up, then other productive expenditure like capital expenditure may have to be cut. And that can’t be good news for the economy.

Further, if the government believes in good economics it needs to shut down loss-making public sector enterprises, but that is unlikely to happen.

On the receipt side the option to raise income tax rates is always there. But that will be a very unpopular move. The finance minister Arun Jaitley in his last budget speech had said: “I, therefore, propose to reduce the rate of Corporate Tax from 30% to 25% over the next 4 years.” So if corporate tax rate is likely to be brought down, that doesn’t leave the government with many options in order to increase its receipts. Perhaps, we may see the service tax rate being raised further in the next budget.

We may also see the government resorting to more standalone surcharges and cesses, like it already has in the form of Swacch Bharat cess. The government will also have to fasten the pace of disinvestment, something most governments haven’t shown interest in doing up until now.

Also, this year the government benefitted substantially from lower oil prices. It captured a major part of the gains by raising excise duty and not passing on the gain to consumers. Next year, any incremental help from falling oil prices may not be available.

All in all, the recommendations of the Seventh Pay Commission, if accepted, will not work out well for the government finances, unless it chooses to change the current way of doing things. Further, it is best that the government instead of accepting an increase of 23.6%, settles at a lower number between 12-15%, to control the damage on its finances.

The government as expected remains optimistic. As the finance secretary Ratan Watal put it: “We will handle this.” I really hope it does.

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

The column originally appeared on Firstpost.com on Nov 20, 2015

Why Indian politicians need to read Charles Dickens and Anand Bakshi

Charles_Dickens_1858The writing of very few writers survives across generations. Charles Dickens is one of them. In his book David Copperfield one of the characters Mr Micawber says: “Annual income twenty pounds, annual expenditure nineteen nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.”
This is something that Indian politicians should be reading and imbibing. If reading Dickens is something that they don’t like, they can try listening to the song
aamdani atthani kharcha rupaiya o bhaiyya na poocho na poocho haal natija than than gopal. This song is from the 1968 movie Teen Bahuraniyan. Given that most of the Indian politicians are “old,” they will definitely relate better to this song from the time when they were young, than to Dickens.
The moral in both what Dickens and Anand Bakshi (who was the lyricist for the
aamdani atthani kharcha rupaiya song) wrote is that when you spend more than you earn there is trouble ahead. This basic lesson is something that the Indian government (and most other governments around the world) has not understood over the last ten years.
The government has constantly spent more than it has earned and run a fiscal deficit. Indeed, the situation continues to remain worrying on this front, even during the course of this financial year. Data released by the
Comptroller General of Accounts(CGA) shows that during the first six months of 2014-2015(i.e. the period between April 1, 2014 and March 31, 2015), the government ran a fiscal deficit of Rs 4,38,826 crore or around 83% of the targeted fiscal deficit of Rs 5,31,177 crore, set at the time of the budget. The number was at 76% during the course of the last financial year.
One reason for this is the fact that the expenditure of the government is front loaded whereas its income is not. Hence, six months into the financial year, the fiscal deficit is not equal to 50% of the annual target.
Between April and September 2014 the total income of the government has risen by only 6.6% in comparison to the same period last financial year. The targeted growth in income in the budget is at 12.6%.So, the income has not grown as fast as it is supposed to grow. On the expenditure front things look a tad better. Between April and September 2014, the total expenditure has risen by 6.6%. The targeted growth in expenditure is at 7.8%.
In fact, with oil prices coming down the oil under-recoveries suffered by the oil marketing companies will come down. For a very long period of time oil marketing companies were selling diesel at a price at which they did not recover their cost of producing it. Cooking gas and kerosene continue to be sold at a price below their cost of production.
The government compensates these companies for their under-recoveries. This pushes up the expenditure of the government and hence, its fiscal deficit.
Kaushik Das and Taumir Baig economists at Deutsche Bank Research expect the under-recoveries for this financial year to be at Rs 85,300 crore against around Rs 1,40,000 crore, during the last financial year. This calculation was made in early October and oil prices have fallen further since then. As seems likely oil prices will continue to remain low in the short run and this will help the government contain its expenditure towards oil under-recoveries.
Nevertheless, before you uncork that bubbly, there are some other points that need to be considered.
Around Rs 50,000 crore of food subsidies remain unpaid. In case of fertilizer subsidies pending bills amount to Rs 38,000 crore. This should largely neutralize the gains on account of oil prices falling. The previous finance minister P Chidambaram had pushed the payment of more than Rs 1,00,000 crore of subsidies into the current financial year, in order to ensure that he met his budget targets.
Also, there are other long term concerns on the fiscal front. The public sector banks are in a mess. They will need regular infusions of capital from the government, if they need to continue to function. This is a ticking time bomb which no one seems to be talking about. In fact, the Report of
The Committee to Review Governance of Boards of Banks in India (better known as the PJ Nayak committee) released in May 2014, goes into the substantial detail regarding this issue. It estimates that between January 2014 and March 2018 “public sector banks would need Rs. 5.87 lakh crores of tier-I capital.”
The report further points out that “assuming that the Government puts in 60 per cent (though it will be challenging to raise the remaining 40 per cent from the capital markets), the Government would need to invest over Rs. 3.50 lakh crores.”
Where is this money going to come from? In fact, there has been very little activity on this front from the government during this financial year. As and when the government allocates money towards this, its expenditure will go up again. The other option is to let the private sector take over some of these banks. But that is a political minefield and also the money required for the capital infusion is not small change exactly.
Another long term issue on the fiscal front are the recommendations of the seventh finance commission which will come into force in 2016. As happened in the case of the sixth finance commission, the salaries of government employees will go up again. This will lead to a greater expenditure for the government and in turn, a higher fiscal deficit.
Immediately after the seventh finance commission recommendations are implemented, state government employees all across the country will ask for hikes as well. The state governments, as has been the case in the past, will be happy to oblige, even though they don’t have the money for it. This will mean that the total government borrowing (states + centre) will shoot up and crowd out the private sector borrowing and push up interest rates, which have only recently started to fall. These are issues that the government needs to tackle if it hopes that interest rates continue to fall.
In fact, during the course of the last financial year, the fiscal deficit crossed its annual target in January 2014. Something similar will happen this year. Nevertheless, by the time March 2015 comes, the government would have managed to bring back the fiscal deficit to the targeted level. This is because tax collections shoot up during the last three months of the year. Further, the government will go in for disinvestment of its holdings in public sector companies at that point of time. This year the government has targeted an income of Rs 58,400 crore through the disinvestment of shares. This seems to have become standard practice over the years. But the danger here is that shares once sold cannot be resold. But the expenditure they are financing is more or less permanent.
To conclude, it is important that the government looks at increasing its income, if it hopes to finance its ever burgeoning expenditure efficiently. In other words, it has to follow the advise of both Charles Dickens and Anand Bakshi.
In order to that the government has to look at increasing the number of income tax payers for one. Currently, only 3.5 crore individuals out of a population of 120 crore pay the income tax. A quick implementation of goods and services tax regime will also help. Hence, the government needs to tackle the black money economy in India seriously. The question is will get around to doing that?

The article originally appeared on www.equitymaster.com on Nov 7, 2014