Pay commission's proposals pose a fiscal headwind : DBS Research Report

The Seventh pay commission tabled its recommendations yesterday, under which salaries/remuneration of government employees are reviewed once every ten years. If adopted, bulk of the impact will be absorbed by the FY16/17 Budget and are scheduled to be implemented from Jan16 onwards. Historically, pay commission's rollouts have been positive for consumption trends but negative for fiscal balances.

Highlights of the recommendations are a) near 24% increase in pay and allow­ances; b) salary bands to be redefined; c) 24% hike in pensions; d) one rank one pension proposed to be extended to civil servants; e) revamp of over 50 existing allowances; amongst others. Notably, the government still needs to formally adopt these proposals.

The panel estimates the financial impact of implementing these recommenda­tions at INR 1.02trn, of which 72% will be borne by the central government's budget and rest by the Railway budget. In absolute terms, the additional ex­penditure is expected to be in the tune of 0.65%-0.7% of GDP, slightly less than 0.77% arising from the sixth pay commission.

The previous Sixth pay commission was rolled out in 3Q08, at a time when the economy was reeling under the impact of the global financial crisis. Implementa­tion of the revised salaries/ pensions (plus arrears), along with farm loan waivers and other stimulus measures saw the fiscal deficit balloon from -2.5% of GDP in FY07/08 to -6.0% in FY08/09 and stay high for another year before easing off. Revenue deficits deteriorated from -1.1% in FY08 to -5% over the next two years. In particular, pay/ allowances and pensions rose by 0.8-0.9% of GDP over the span of two years. State finances also came under pressure, with their gross deficit up 1% of GDP in FY09 from year before.

Back to the present, the Finance Ministry had acknowledged earlier in this year's budget that the rollout of the 7th Pay Commission will stress its finances. Pay/ allowances make up less a tenth of overall expenditure, with its impact likely to reflect under the stickier and recurring revenue expenditure. These recommen­dations imply a 0.65-0.7% of GDP jump in spending, but it remains to be seen if these proposals are adopted in a staggered manner or all-at-once.

These higher spending needs will put the FY16/17 fiscal target of -3.5% of GDP at risk. This comes just as other commitments are on the rise, including additional capital infusion into banks, weak divestment proceeds and importantly, absence of the additional windfall from low oil prices. On revenues, the nationwide tax bill is still facing legislative hurdles while corporate tax rates will be lowered in a staggered manner over the next few years.

The likely options for next year's fiscal math point are to restrain spending else­where, source additional tax revenues or renege on the fiscal deficit targets. If the targets are adhered to, allotments towards capital expenditure are likely to fall. This means that a budgeted 25% jump in capital expenditure in FY15/16 might follow with a less 10% increase next year, while revenue spending re­bounds from the small 3% rise this year. Combining these headwinds, there is a risk that next year's fiscal target is raised modestly, limiting the room for ad­ditional monetary stimulus.

Source : Equity Bulls

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