Why the Seventh Pay Commission is an opportunity for PM Narendra Modi, rather than a threat

There could be much fretting over whether the Rs 1.02 lakh crore payout to government employees in 2016-17 due to the Seventh Pay Commission’s report will bust the budget once again. The chances are it won’t, especially in the present context of weak global recovery, low commodity prices, slow domestic revival in consumption, excess capacity in industry and manageable levels of inflation. Viewed correctly, and if backed by the right reforms in the next budget, it could be just what the doctor ordered for a beleaguered NDA government which got almost nothing right in 2015 — neither politics nor reforms. The headline numbers of the Pay Commission’s fiscal impact look worse than they actually are. The average 23.55 percent pay increase to 48 lakh government staff will set the Central government back by Rs 73,650 crore in 2016-17, and the Indian Railways by Rs 28,450 crore — leaving a big gash of over Rs 1,02,100 crore on central finances. The actual bill will be larger since there is also the OROP — one-rank-one-pension — payout to be added to this. [caption id=“attachment_2502900” align=“alignleft” width=“380”] File image of Narendra Modi. PTI[/caption] But while the bill is huge, we also need to balance that with the reality that part of what goes out as pay and perks also comes back as tax revenue. Assuming an average tax rate of 20 percent for government employees, income tax alone will bring back a fifth of the payouts back. (Maybe less or more, but the point is both sides of the government’s ledger are impacted). And then there is the impact of indirect taxes when people spend the balance that jingles into bank accounts. When this money is spent on consumer durables, homes, financial products, everyday necessities and travel, the government’s indirect tax kitty will swell again. As corporate profits improve, they too will pay the government more, and bank profitability will look up as bad loan portfolios shrink. Rising share valuations will make it easier for government and private sector players to raise more money from the market, helping reboot the investment cycle. Put another way, this fortuitous combination of circumstance of low inflation, low commodity prices, excess capacity in industry, moderate inflation, etc, is just the right economic environment in which the Seventh Pay Commission’s bounties will do less damage to the exchequer and fiscal prudence. In fact, this dash of additional expenditure may be just the prod required for restarting the virtuous cycle of consumption, investment, growth, profits and all the related paraphernalia. However, this is no reason to throw caution to the winds. After the Central Pay Commission is done, there will be another round of pay increases at the state and local government levels in 2016 and 2017. This means there will be enough domestic money sloshing about to give Reserve Bank of India governor Raghuram Rajan sleepless nights over the possibility of a revival in consumer inflation in late 2016 or early 2017. The pace of rate cuts may thus have to be slowed down — but that will not halt the revival, for investment depends on profitability more than interest rates. India is in a sweet spot right now on many fronts, and so it is tough to mess the economy up at this stage. If Finance Minister Arun Jaitley looks at the overall scenario, he should take this opportunity to produce a spectacular Union budget for 2016-17 after producing two duds in 2014 and 2015. The time for big bang reforms led by a radical budget — tax cuts, privatisation and subsidy reforms using the JAM trinity (Jan Dhan, Aadhaar. Mobile) — has come. For Modi and Jaitley, this is their last chance to prove their critics wrong and revive the animal spirits of business and markets. It is now or never. If 2016 is not the year of great reform, Modi will not have enough time to show job-creating performance to the electorate. If jobs are not visible for at least two or three years in a row, the electorate will not notice. In the Vajpayee government, revival came in 2003-04, too late for the voter to give him another term. India began shining too late for voters to notice.