Hike and Effect

Pay commission recommendations aren’t inflationary. But the fiscal deficit targets may prove unrealistic.

The Seventh Central Pay Commission has recommended an overall increase of Rs 1.02 lakh crore at a growth rate of 23.55 per cent in pay, allowances, and pension (PAP) for Central government employees. More specifically, the increase is 16 per cent in pay, 63 per cent in allowances and 24 per cent in pensions. This, as per the commission’s calculations, will lead to an increase in the salary bill by about 0.65 per cent of GDP. First, there should be two corrections. One, the increase in the salary bill should be 0.63 per cent of GDP. Two, the increase in the estimated share of the PAP in total revenue expenditure should be 3.81 per cent, as against 4.25 per cent suggested in the commission’s report. These recommendations will benefit about 1.4 crore government employees with effect from January 2016 and are expected to have a significant impact on the overall macroeconomic parameters, such as the GDP, fiscal deficit, as well as inflation.

Let us look at such possible impacts in the coming year.

On the positive front, the commission’s recommendations are based on a strong macro-fiscal framework that focuses on the three core issues: Current macroeconomic conditions, the need for fiscal prudence and fiscal sustainability, and ensuring adequate resources for developmental and welfare projects. Following this, it clearly shows that compared to the Sixth Pay Commission, the latest recommendations would result in minimum macroeconomic shocks to most of the macroeconomic variables. For instance, as compared to a hike of 54 per cent in the minimum pay in the Sixth Pay Commission, the hike this time is just about 14.3 per cent. Apart from this, the report has also removed many of the ambiguities that the previous pay commission had introduced. This has further improved the predictability of the fiscal burden.

The commission assumes a nominal growth of 11.5 per cent with an inflation rate of 4 per cent in 2016-17. At the same time, it sticks to the Fiscal Responsibility and Budget Management (FRBM) target of 2.4 per cent (for revenue deficit) and 3.5 per cent (for fiscal deficit), which, in turn, intrinsically assumes there would be no change (especially no reduction) in the growth of capital expenditure in 2016-17 compared to 2015-16. The share of capital expenditure is pegged at 1.1 per cent of GDP for both FY16 and FY17. But this leads to an inconsistency. The commission’s recommendations will raise the revenue deficit by 0.63 per cent of GDP, with no change assumed in the capital expenditure and yet, it hopes to achieve the fiscal deficit target of 3.5 per cent in FY17. This appears to be grossly inconsistent. The fiscal deficit was targeted to decline by 0.4 percentage points from 3.9 per cent (in FY16) to 3.5 per cent of GDP (in FY17). And considering that the consensus GDP growth forecast for the current financial year is just 7.2 per cent, the commission’s expectation of a 7.5 per cent GDP growth in the next financial year (FY17) looks unrealistic.

Further, an National Institute of Public Finance and Policy analysis (Working Paper No 2015-148) submitted to the 14th Finance Commission suggested that even with an assumption of a modest pay hike of 15 per cent (very close to the actual recommendations without One rank one pension), there is a need to compromise on either the fiscal deficit target or the share of capital expenditure (or perhaps both). The 14th Finance Commission had ignored the Seventh Pay Commission impact (as there were no estimates available during the finance commission period) and the government worked out the FRBM targets without this information. But taking those fiscal targets in the context of the implementation of the Seventh Pay Commission looks unlikely. In sum, one should expect slippage in all the fiscal targets as well as GDP growth rates, as there would be expenditure switching from capital to revenue expenditures.

What could be the impact of the pay hike on inflation? On this front, this commission needs to be applauded for breaking the vicious cycle of higher expenditure-higher inflation-higher expenditure initiated by the Sixth Pay Commission recommendations. We have seen a worse period of high and stubborn inflation and its inertia. By reducing the extent of the hike, the pay commission could ensure a better real income growth across all segments of the population. In addition, the adoption of a 4 per cent inflation target for the medium term looks reasonable. Further, assuming no other exogenous shocks take place, the dearness allowances over the next 10 years may be much lower than the 125 per cent increase witnessed over the past decade. So, overall, the recommendations could result in better macroeconomic stability.

Another important issue that needs clarity is the commission’s claim of a smaller increase in the PAP/ GDP ratio (at 0.63 per cent) as compared to the previous commission (at 0.77 per cent). While the decline in the ratio could be attributed to the recommendations, such a fall could also equally be attributed to the reduction in the share of Central government employees in the total organised sector employment between the two commissions. Data from the economic survey suggests that there is a clear decline in the share of Central government employment (in total employment) from about 12.6 per cent in 1991-92 to 8.5 per cent in 2011-12. Data also suggests that the share of private sector employment actually went up by the same amount and, as such, if the trend continues, the PAP/ GDP ratio could decline further. However, it is not clear whether the trends in unfilled positions are also taken into account while deriving such a ratio.

Lastly, an important suggestion in the report, which was also stressed by the chairman at the press meet, is to undertake the pay revisions at shorter intervals instead of every 10 years. One possibility is allowing

pay revision once every five years and preceding the finance commissions. This would avoid shocks and ensure better macro-fiscal balance.

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