Mumbai: A much-anticipated increase in salaries for government employees will threaten India’s drive to consolidate its public finances and make a near-term cut in interest rates difficult, Morgan Stanley said on Monday.
The Sixth Pay Commission for government workers submitted its report to the finance minister on Monday but details are yet to be announced.
Morgan Stanley economists said in a research note they expected central government salaries and pension costs to rise by Rs300 billion ($7.4 billion or 0.4% of gross domestic product) to Rs1.307 trillion (2.5% of GDP) in the 2008/09 year.
Chetan Ahya, Tanvee Gupta and Sumeet Kariwala said this would be a 30% year-on-year increase in salary and pension costs for some 2.9 million central government workers.
They said the increase was likely to make state governments, with 7.2 million employees, and quasi-government agencies follow suit.
They estimated the combined wage and pension cost increase for central and state governments and quasi-government organizations would be Rs1.4-1.5 trillion spread over the next three years.
”The combined effect of the pay hike and the recent farm loan relief spending of Rs600 billion or 1.2% of GDP will decidedly reverse the six-year trend of reduction in government deficit,” they said.
Such an expansionary fiscal policy would affect the central bank’s ability to cut rates in the near term and a higher fiscal burden would come at a time when capital inflows may slow, potentially pushing up longer-term bond yields and steepening the yield curve.
On the positive side, the pay hike was likely to result in more discretionary and staple consumption, they wrote.
But discretionary spending was likely to face headwinds from tight monetary policy and public sector earnings could be negatively affected due to rising long bond yields and losses in treasury portfolios, they said.