Pay hikes could threaten India’s budget, rate

Pay hikes could threaten India’s budget, rate

A fresh wave of fiscal profligacy threatens to undermine four years of hard-won improvements in India’s public finances. The Sixth Pay Commission, set up last year to recalibrate the wages of 5.5 million Union government workers, will submit its report in April.

If the panel is anywhere near as generous as its predecessor —the Fifth Pay Commission recommended a 31% increase in base salaries in 1997—the economy will pay a heavy price. Such wage increases would crimp the Reserve Bank of India’s ability to cut interest rates next year, should slowing global growth and rising risk aversion warrant monetary easing.

The ruling Congress Party’s alliance with Marxist groups is in trouble over the latter’s opposition to the India-US civilian nuclear agreement, and many analysts expect Prime Minister Manmohan Singh to call for elections sometime in 2008, one year ahead of schedule. It’s quite likely, therefore, that the budget in February will provide some “interim relief" as a sop to voters.

This may be a major reason why there won’t be a quick reversal of the central bank’s hawkish monetary policy stance, even though credit growth is slowing, auto sales are falling and inflation is at a 16-month low of 3.8%.

The wage increases for Central employees will be matched by the 28 state governments and municipalities, even though the latter two have limited scope to boost their own revenue. Government-owned companies, too, will have to pay more. Some of them have already begun making provisions for a hefty increase in their wage bills.

Higher pay

Margins of Bangalore-based Bharat Electronics Ltd, which makes electronic voting machines for the world’s biggest democracy, were hit when it set aside an extra 13% of sales for employee-related costs in the quarter ended 30 June. Steel Authority of India Ltd, the nation’s biggest state-run steel maker, has made similar provisions for a couple of quarters now. Within the government, everyone from aerospace scientists to railway engineers has made a case to the Pay Commission for higher remuneration and perks.

“It would not be surprising if the Sixth Pay Commission came out with an award that made the wage structure in government compatible with that of the private sector in order to enable government to attract and retain talent," economists Adarsh Kishore and A. Prasad wrote in a recent study published by the International Monetary Fund.

Fiscal reversal

That realignment should logically lead to wage cuts for clerks and chauffeurs, who are much better paid than they would be in the private sector. Of course, that would never happen. Pay will go up across the board for everyone.

The consolidated budget deficit of India’s federal and state governments has narrowed to 6.1% of GDP. That’s a 3.5 percentage point improvement from four years ago.

The target, according to a budget-management law that took effect in 2004, is for the deficit to be reduced to 6% by 2009. With tax collections booming, that target should be easily achievable. It will be a shame, therefore, if the Pay Commission spoils it all.

The last Pay Commission was responsible for pushing down overall government savings by 2.9 percentage points of GDP between 1996 and 2000. That kind of slippage, were it to occur now, would leave government authorities with an additional resource shortfall of about $30 billion. Much-needed public investments in infrastructure—roads, ports, airports, power stations, railways and urban amenities—will suffer.

And just like in the last round of pay increases, states will bleed more than the government in New Delhi.

“The Sixth Pay Commission award would most certainly create a pull effect on states, encouraging them to raise wages," say Kishore and Prasad. “This is bound to create additional stress on the financial position of states."

Given the acute need for investments in infrastructure, estimated at a staggering $475 billion over the next five years, the Indian government’s priority should be to pare its budget deficit and improve its credit rating. India’s public-debt-to-GDP ratio is about 0.8; this doesn’t include borrowings guaranteed by the government or accumulated losses of state electricity boards. Almost 27% of the government’s revenue is spent on paying interest. For more than nine years, Moody’s Investors Service has left India’s local currency rating unchanged at Ba2, two levels below investment grade.

Government rating

Once the Indian government has a better rating, it will be able to borrow rupee funds cheaply from a diversified group of global investors without having to rely on financial repression. Indian banks would be more competitive if they didn’t have to invest a quarter of their deposits in government bonds. That would, in turn, lower the cost of credit for companies, spur economic activity, create jobs and reduce poverty. A more balanced budget is also a prerequisite for quicker progress towards dismantling capital controls. All that is now at risk because of a wage increase for civil servants.

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