Will damages of the 7th Pay Commission be as bad as the Sixth? - The Daily Reckoning

Will damages of the 7th Pay Commission be as bad as the Sixth?

Nov 25, 2015

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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.


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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
2007-2008 2.54 1.51 4.05
2008-2009 5.99 2.39 8.38
2009-2010 6.46 2.91 9.37

Source: http://planningcommission.nic.in/data/datatable/1203/table_27.pdf

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.

Vivek Kaul is the Editor of the Diary and The Vivek Kaul Letter. Vivek is a writer who has worked at senior positions with the Daily News and Analysis (DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. The latest book in the trilogy Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System was published in March 2015. The books were bestsellers on Amazon. His writing has also appeared in The Times of India, The Hindu, The Hindu Business Line, Business World, Business Today, India Today, Business Standard, Forbes India, Deccan Chronicle, The Asian Age, Mutual Fund Insight, Wealth Insight, Swarajya, Bangalore Mirror among others.

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6 Responses to "Will damages of the 7th Pay Commission be as bad as the Sixth?"

DDatta

Feb 26, 2016

The Seventh pay Commission will cause irreparable damage to the society and economy. Firstly, the fiscal pressure on the Government will rise and the government will try to control the fiscal deficit by increase in taxes. India is already the highest taxed nation nation among countries of comparable per capita income. High taxes will finish the Indian growth as India will lose whatever export competitiveness it still has. Secondly more taxes will reduce demand and India will start experiencing a prolonged high tax driven recession. This recession as already surfaced in the Indian economy and it will be aggravated after Pay Commission implementation. The social fabric will also suffer as community after community will demand reservations in order to get the coveted government job. Furthermore, the animosity between government employee and common man will increase particularly in rural and semi urban economy. Thirdly, increased salary will force the government to reduce employment and quality of government service will suffer. Moreover unemployment problem will be compounded by government drastically reducing recruitment.
Some state governments will fail to give salary hike at par with Central Government and this will demoralize the employees of those state governments.

When Central government employees get full compensation for price rise and also get annual increment there is no economic logic for pay commission. This is anti economic reforms since reforms mean reduction in cost while Pay Commission increases the cost and make the country inefficient and non competitive.

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DM Padher

Nov 25, 2015

Sir Ji,
I think following should/must be considered while prdicting on impact of 7th pay commision :-

1) Govt. will take back some amount in form of Income-Tax.
2) People will save money in form of NSC or PPF etc, which will be in hands of Govt.
3) No doubt that people will spend more. Additional money to Govt. by way of different taxes.
4) Things have changed drastically from last 10 years. Those time means ten years back people used to be save more and spend less. This generation have more spending tendancy but with balanced view.
5) I think due to this salary rise there will heavy improvements in service industry.
6) People will tend to purchase houses , vehicles which in turn will give rise to very good improvement in reality and automobile sector.
7) Once these sectors improve whole things will change.

Regards,

DM Padher

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R Tayal

Nov 25, 2015

Implementation of 7th Pay Commission's recommendations will cause grievous harm to the nation for following major reasons : a) Past experience shows that performance & accountability doesn't get taken into account while granting the huge raises to govt employees. I would have no problem if bulk of the raise was linked to performance & accountability of each employee. In fact the effective date of implementation should be kept in abeyance till a comprehensive PMS is put in place. b) Even with 6th pay commission's largesse, govt salaries till middle management levels had surpassed most private Cos.' salaries, and it was only for top & senior levels that private sector paid much better. Hence a situation exists even now where industry finds it difficult to attract top quality middle & lower management staff. This problem will only accentuate with 7th pay commission's implementation. c) Finally & perhaps most importantly, it is the idea of OROP which is an invitation to disaster. OROP by definition puts paid to the significant pension reform implemented about a decade ago wherein govt employees pension scheme was (very sensibly & in keeping with international trends) changed from "defined benefit" to "defined contribution". OROP brings back the disastrous "defined benefit" scheme which will destroy nation's economy what with your own report suggesting huge no. of govt employees retiring over the next few years. In fact whether or not the other recommendations are implemented, OROP MUST NEVER BE.

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abhay dixit

Nov 25, 2015

There has been no discussions on Media at prime time about this issue. Why do we need pay commissions every ten years when babus get DA and increaments regularly? Why does it not recommend reduction in number as computerization will reduce the work load? Logic behind the number recommended?

Is there no conflict of interest when a retired/sitting judge recommends increase in pension/salary?

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Sethu

Nov 25, 2015

All that i can say is Common man meaning persons not employed in Govt.sector and not having any political connection are the silent sufferers.in this country.

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Mohan

Nov 25, 2015

The Government of India is being hoodwinked by the senior Babus or IAS guys during every pay revision. On one side they have stopped defined pension benefit for Government employees who have joined after 2004. But inspite of knowing that the defined pension scheme is a very attractive benefit and costly to fund for the Government, during the sixth pay commission an increase in pensions during old age going up by 20% every 5 years from 80 years age and reaching 100% by age 100 was given with no logical reason. The sixth pay commission had recommended increase in old age pension, since they had tried to reduce pension during age 60 to 80 by introducing the grade pay system. But that was modified later but the increase in old age pension was retained.
Now the seventh pay commission has further increased the pension benefits by recommending One rank One Pension. All these benefits will be enjoyed only by the Government employees who have joined before 2004. At the age of 100, the pension will be 100% meaning, pension will be equal to the full salary of somebody working in that rank.
This is a total misuse of tax payer's money for the benefit of the corrupt babus and an injustice for those who have joined after 2004..

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