Will the 7th Pay Commission recommendations lead to higher inflation? - The Daily Reckoning

Will the 7th Pay Commission recommendations lead to higher inflation?

Nov 26, 2015

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The advantage of writing regularly is that one can dwell into great detail on issues of national economic importance. Hence, this is the fourth column on the recommendations of the Seventh Pay Commission this week.

When I started writing regularly in the media nearly 12 years back, the communication with the readers was largely one way. One wrote a piece and then forgot about it. There was no feedback coming in from the readers. There was no way of figuring out whether something one had written had actually been read. If it had been read then what had the readers thought about it? Some feedback came from the colleagues, if they did read, what one had written (normally they didn't). The bosses did give feedback once in a while, especially if they didn't like something one had written.

But now with the advent of the social media, feedback (both good and bad) keeps coming in all the time, and questions keep getting asked. Also, if readers like something they share it. This gives some idea of what the readers are actually interested in. There is constant communication with the readers these days and that's a good thing.


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One of the questions that I recently got asked on Twitter was: "Will the 7th Pay Commission recommendations lead to higher inflation?" As I have mentioned multiple times this week, the Pay Commission recommendations will lead to an increased spending of Rs 1,02,100 crore by the government, to pay higher salaries of central government employees and higher pensions of retired central government employees.

How will this lead to inflation? A part of this increase in salary and pensions will be spent to buy goods and services. As this money chases the same amount of goods and services, prices will go up. This logic seems very straightforward-as straightforward as saying, a cut in interest rates leads to people and companies borrowing more, which is something one hears all the time.

In fact, that is how things played out in the aftermath of the Fifth as well as Sixth Pay Commissions, once their recommendations had been accepted. The higher salaries and pensions led to a higher consumption which led to higher inflation.

As Crisil Research points out in a recent research note 7th Pay Commission: A non-inflationary boost to consumption and investment: "During the Fifth Central Pay Commission(CPC) payout, overall inflation rose by 657 basis points[one basis point is one hundredth of a percentage] on-year in fiscal 1999, while non-food inflation in the same year rose only 141 boints. During the Sixth CPC payout years, however, overall inflation rate rose by 611 basis points on-year between fiscals 2009 and 2010. But this time the increase in non-food inflation was higher and lagged - up 492 bps during fiscals 2010 and 2011."

So will this phenomenon play out this time around as well? A major reason for inflation the last two times was the fact that the Pay Commission increases came much after they were due. The Sixth Pay Commission increase was due from January 2006. But the report was submitted only in March 2008 and accepted by the government in August 2008. Hence, arrears had to be paid and they were paid only in 2008-2009 and 2009-2010.

This meant that people suddenly ended up with a lot of money in their hands, as payments were made. As Crisil Research points out with regard to the Sixth Pay Commission: "Large arrear payments coincided with the rapid rise in rural wages adding to core inflationary pressures then. These two factors are expected to be absent, this time."

This time the salary increases are due from January 2016. Unlike the last time, the Pay Commission recommendations have come in before the due date. Also, chances are that the government will implement these recommendations starting from April 2016, the next financial year. Given this, only a limited amount of arrears will have to paid, meaning that people will not suddenly end up with a lot of money in their hands, as they had last time around.

Another factor that needs to be kept in mind is that most factories are not running full steam at this point of time. As Reserve Bank of India governor, Raghuram Rajan, recently pointed out, most factories are running 30% below capacity as of now.

This means that factories can easily ramp up supply if the demand goes up due to higher consumer spending, without leading to higher prices. Typically, if factories are running full steam, a rise in demand cannot be matched immediately with a rise in supply and that leads to prices going up. But that sort of scenario is unlikely to playout as of now.

Over and above this, as and when the recommendations of the Seventh Pay Commission are accepted by the central government, pressure will mount on state governments to increase the salaries and pensions they pay as well. The state government increases won't happen overnight and will take some time to happen. And this will allow the inflation due to increased demand, if any, to spread out over a period of time.

As Crisil Research points out: "State governments - which have more employees than the Central government - tend to implement these with a lag. Therefore, while there is a push to consumption demand, it takes place over time allowing supply-side factors to adjust wherever possible."

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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8 Responses to "Will the 7th Pay Commission recommendations lead to higher inflation?"

Rajesh Kutriyar

Jul 3, 2016

i think pay increase in 7th pay commission will be not responsible for hike in inflation but govt will try to impose for that. rightly said money supply is not responsible to increase inflation actually it is productivity related.

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Sreedhar Krishna Murthy,

Nov 30, 2015

This article departs from the usual biased opinion of a certain section of the media, which tend to decry increase in wages for Govt. sector. The same media cries hoarse whenever issue of corruption in Govt. service is raked up. While corruption in higher levels needs to be PUT DOWN with heavy hand, at lower levels, it needs to be "understood" in the context of their "struggle" to compete with the PRIVATE SECTOR employees and SELF EARNING and the BUSINESS COMMUNITY to make decent living, especially in the matter, of a house, whether OWN OR RENTED, EDUCATION TO CHILDREN and MEDICAL EXPENSES etc. of course, even in the matter of ROTI KAPADHA OUR MAKHAAN'
Always this is TUG of WAR for survival. Therefore, there is always a need for atleast partially matching the THE SALARIES AND BENEFITS WHICH ARE OFFERED to the private sector employees, on an average, if not in the SOFTWARE SECTOR, with whom they have to compete for their ROTI, KAPADHA OUR MAKHAAN.

Money supply may drive inflation in theory. However, it also triggers or kickstarts the economy as the "DEMAND" FOR CONSUMER AND CONSUMER DURABLE GOODS. This helps to improve the present state of "sluggish" economy. of course, 1 lakh crores of additional expenditure is big for the government, but if the economy improvers, it PAYS BACK in terms of TAXES, both DIRECT and INDIRECT TAXES. HOW ONCE WISHES the government employees must increase their productivity and improve their service and help in WISE SPENDING and INCREASED TAX COLLECTION.

Whil

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Gurpinder Singh

Nov 26, 2015

Inflation due to rise in cost of petrolium is also missing these days.

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R V Subramanian

Nov 26, 2015

To start with I appreciate the way Mr Vivek Kaul explains this economic problem of inflation triggered by Salary increases of central govt employees including retired staff.

Let me add, which may be simplistic, based on my observations since independence. Whenever Government announced pay increases everyone down to the corner press wallah would immediately increase their prices/rartes!!

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Pawan

Nov 26, 2015

Nice written Sir...Love your writing style & approach to subject matter..

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Penugonda Prabhakar

Nov 26, 2015

Iam P.Prabhakar all ready i saw small caps dont sent back.all rights.

yours lovelly.
Penugonda prabhakar

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Girish Patkar

Nov 26, 2015

I agree that the 7th pay commission recommendations will not have an adverse impact on prices since there is adequate idle capacity, commodity and energy prices are subdued and production can easily be ramped up to meet additional demand. My sense is that it will give a fillip to GDP growth. There are differing views on the issue though!

Girish

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vijaybdamle

Nov 26, 2015

Its misnomer. The rise in inflation would depend on inefficiency rather than money supply. My worry is not higher wages to government employees. The worse part is this increase is neither linked to increased inefficiency / higher productivity which ,if happened, would take care of inflation automatically.

Government after government have dared not touch highly unionised government sector employees for the fear of repulsive action. Thus such inefficiency gets reflected in higher prices at large.

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