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\nThis 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.<\/p>\nAs 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.<\/p>\n
The report estimates that this increase will work out to 0.65% of the gross domestic product (GDP) in 2016-2017.\u00a0 In comparison, the awards of the Sixth Pay Commission had worked out to 0.77% of the GDP.<\/p>\n
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\u2019t be accepted this time around as well.<\/p>\n
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\u2019s edition of The Daily Reckoning).<\/p>\n
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.<\/p>\n
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).<\/p>\n
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\u2019t 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.<\/p>\n
Long story short\u2014the 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\u2019t be a good thing for the Indian economy.<\/p>\n
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\u2019t want to do.<\/p>\n
In fact, the impact of the recommendations of the Seventh Pay Commission don\u2019t 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.<\/p>\n
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.<\/p>\n
These arrears were paid in<\/a> 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).<\/p>\nThere 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.<\/p>\n