BackPay panel wage hike: can government achieve the near impossible trinity?
Govt will find it tough to balance higher wage payouts, fiscal consolidation, strong capex in 2016-17a year when it plans to start reducing corporate tax rate, implement GST, say analysts
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New Delhi: When finance minister Arun Jaitley presents the next budget in February, he will face the tough task of salvaging his own fiscal consolidation road map, after the Seventh Pay Commission recommended a higher-than-expected wage hike for central government employees on Thursday.
Most analysts say the government will find it next to impossible to meet the trinity of higher wage payouts, fiscal consolidation and strong capital expenditure in 2016-17—a year in which it plans to start reducing the corporate tax rate and implementing the goods and services tax.
These analysts are betting that the government will defer its fiscal consolidation road map—of reining in the fiscal deficit to 3% of gross domestic product (GDP) by 2017-18—by a year.
Jaitley had deferred the previous government’s road map by a year in his last budget and promised to bring the fiscal deficit down to 3.5% in 2016-17, which now looks difficult.
Fitch Ratings Inc., in a report, said the proposed wage increase would add substantive challenges to achieving the planned medium-term consolidation targets. “The government could seek to cut expenditures in other areas. There may be some room to rein in the subsidy bill, for example. But the government may find cuts in capital expenditure undesirable, especially as investments are intended to play a key role in its efforts to stimulate the economy," it added.
This could also pose challenges to India’s sovereign rating, the ratings agency said.
“The fiscal consolidation plan was postponed by one year in the last budget. Delaying an improvement in India’s fiscal position would underscore a long-standing weakness for the sovereign credit profile. The general government deficit, that includes the budgets of the central and state governments, is above 6% of GDP, while the general government debt burden of close to 65% of GDP is the highest among all ‘BBB–’ rated countries. The ‘BBB’ category median is 43% of GDP," Fitch said.
Standard Chartered Plc also said full implementation of the Seventh Pay Commission’s recommendations will have a slightly negative impact on India’s sovereign rating. “Moody’s currently has a positive outlook on India’s Baa3 rating and has likely factored in part of the impact in its current assessment. Fitch also appears slightly positively biased, although full implementation of 7th Pay Commission will likely delay a positive rating move by the agency. Our key concern is with respect to Standard and Poor’s. While full implementation of the 7th Pay Commission may not immediately trigger a negative rating action, a significant deterioration in macroeconomic fundamentals in FY17 could pose risks to our view," it said.
The Seventh Pay Commission proposed a 23.55% increase in emoluments for 4.7 million government employees and 5.2 million pensioners, which will pose an additional financial burden on central government coffers to the tune of ₹ 1 trillion in 2016-17.
Religare Institutional Research, in a report, said that the combined fiscal burden of the Seventh Pay Commission payout and the implementation of One Rank, One Pension for the Armed Forces would be 0.7 percentage points of GDP, “making the fiscal deficit of 3.5% of GDP impossible to achieve".
“We expect the government to push the current fiscal consolidation road map by a year in the next budget," Religare added.
DBS Bank Ltd, in a research note, said that the higher payout comes at a time when other commitments are on the rise, including additional capital infusion in banks. Weak divestment proceeds and, importantly, the absence of an additional windfall from low oil prices, compound matters.
“On revenues, the nationwide tax bill (GST) is still facing legislative hurdles while corporate tax rates will be lowered in a staggered manner over the next few years," added DBS Bank.
HSBC Securities and Capital Markets (India) Pvt. Ltd said if the government compromises on capital expenditure or leaves its fiscal stance too loose, the gains in growth could quickly translate into inflation.
“The pay revision may make it challenging for the Reserve Bank of India to achieve its consumer price index (CPI) inflation targets of 5% by January 2017 and 4% by January 2018. If housing inflation moves back to double digits (which we think is highly likely if the recommendations are accepted), CPI inflation may increase by more than 50 basis points in FY17," it added. One basis point is 0.01%.
Rating agency Crisil Ltd, however, said the inflationary impact will be transitory and benign as consumer demand remains subdued, and a sharp decline in global commodity prices can offset inflationary pressures.
However, all hope is not lost for the government. Fitch said whether the medium-term consolidation targets can be realized will depend on whether the government can mobilize higher revenue. “An expected pick-up in real GDP growth will help, and increasing government employee wages should stimulate consumption," it added.
Standard Chartered said the government’s best option for raising meaningful revenue next fiscal year is through stake sales in state-owned firms, for which it needs to summon strong political will.
Higher dividends from non-financial public sector units, an expected improvement in revenues, higher service tax and efficient expenditure management can also help the government manage its fiscal situation better next fiscal year, the bank added.
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