Cabinet clears 7th pay panel: Good for Arun Jaitley, bad for Raghuram Rajan


June 29, 2016

NEW DELHI: The cabinet's decision on Wednesday to clear the 7th pay commission recommendation of 23.5 percent increase in compensation of government employees and pensioners has come at a right time for a growth-hungry economy.

June 29, 2016

NEW DELHI: The cabinet's decision on Wednesday to clear the 7th pay commission recommendation of 23.5 percent increase in compensation of government employees and pensioners has come at a right time for a growth-hungry economy.

It's good news for finance minister Arun Jaitley, who has been looking for his magic tools to reboot the economy, but somewhat bad news for Reserve Bank of India (RBI) governor Raghuram Rajan, who will have to deal with further upside risks on consumer price index (CPI) inflation that has been inching up in the recent months (retail inflation last recorded at 5.76 percent).

But, a good monsoon and lower commodity and oil prices internationally is likely to offer some cushion to inflation. The net impact of higher wages on inflation, in that case, wouldn't be major.

In the current context, the benefits for growth outweigh risks to inflation. This is particularly so when the global economy is facing further downside risks post the Brexit and no adequate growth triggers in the domestic economy in the backdrop of major slowdown in exports, absence of revival in the private investment cycle, the government's decision to put more money in the pockets of people through increased wages would aid a consumption-led recovery, particularly in urban centres.

Over the last several months, the capital goods segment, which mirrors the investment activity on the ground, has not shown any major pick up. Any chance of a substantial revival in the private investment cycle is unlikely any time soon since the world economy is passing through a tough phase.

Domestically, there is a clear absence of sufficient growth-triggers. A stress-ridden banking sector adds to the problem. In this context the economy will have to focus on domestic consumption and higher public-spending in infrastructure to reboot the growth engines.

The 23.55 percent increase in compensation (this includes salary, allowances and pension) will put more money in the pockets of 47 lakh central government employees and 52 lakh pensioners in the fiscal year 2016-17 to spend more. The new pay panel recommendations will come into effect from 1 January.

The increase in the disposable income (even at the lowest level the salary will be a minimum Rs 18,000 monthly while for top bureaucrats it can go up to Rs 2.25 lakh per month), will help revive the consumer demand, especially in urban areas.

Overall, the government will have an additional fiscal burden of Rs 1.02 lakh crore to implement the proposals. One question here is whether the government still continue with the much-needed pubic spending push in infrastructure after accounting for the higher salary outgo.

The government will have to find more resources through higher tax collection and PSU divestments; else the capital expenditure can take a further hit. One can't be so certain about the future of the divestments since the NDA-government hasn't been very enthusiastic to push the process so far even when stock markets were doing very well last year.

But, if the government prepares a clearer roadmap based on the lines of NITI Aayog's proposals to monetise public assets, it'll be a good start.

If one goes by the pay panel's recommendations, the overall impact on the state exchequer from higher pays is expected to entail an increase of 0.65 percentage points in the ratio of expenditure to Gross Domestic Product (GDP) compared with 0.77 percent in case of sixth pay commission proposals in 2006. Out of the total financial impact of Rs 1.02 lakh crore, Rs 73,650 crore will be borne by the general Budget and Rs 28,450 crore by the Railway Budget.

A note issued by Standard Chartered Bank economists prior to the submission of the pay panel report forecast that consumption will take over the role of driving economic growth, especially given the government's obsession to stick to the 2016-17 fiscal target of 3.5 percent.

"While higher government spending on salaries will benefit consumption, the diversion of resources is likely to slow India's investment recovery, which has been driven entirely by government capital expenditure," Saurav Anand and Anubhuti Sahay, economists at the bank said in the 18 November note. Further, urban consumers are likely to benefit the most from pay raises, it notes.

So far the monsoon signals have been encouraging. The current slowdown in rural demand, on account of back-to-back deficient monsoons can improve if the monsoon does well supporting the non-farm income, which is already evident in the rural income pattern.

While the rural employment guarantee schemes started by the UPA regime has led to an increase in wages, the consumption revival there has remained muted mainly on account of weak monsoons and lower spending by the government in rural areas.

The short point here is that a revival in the rural segments will be still dependent a lot on rain gods, but in urban centres, the consumption-revival can be seen much sharper post the pay commission bonanza.

Performance-based pay

Besides the wage impact, one shouldn't miss a slew of other critical mentions made by the Mathur panel in the report. For instance, it has recommended introduction of performance-related pay for all categories of central government employees.

According to the report, this change was suggested by the sixth pay panel too, but did not take off as the system based on results framework document methodology was not set up. But now the systems are in place.

It also seeks to change the bonus mechanism. "We are also of the view that there should not be automatic payment of bonus and all existing schemes of payment of bonuses should be linked to productivity," it said.

Until the time the performance-linked pay scheme is implemented, the existing bonus schemes should be reviewed and linked with increased profitability and productivity under well defined parameters, the panel had proposed.

This recommendation assumes lot of significance since if the pay is linked to performance that can change the very sarkari nature of our sarkari babus and improves productivity of government departments. The Mathur panel also talks about how the civil servants need to be more efficient focusing more on targets and not processes.

The short point is this: At a time when global growth is slowing and sufficient growth triggers are absent in the domestic economy, 7th pay commission can offer a major consumption booster dose, though it may result in upside risks to inflation. It's good news for Jaitley (growth support), but bad news for Rajan (upside risk to inflation).