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7th Pay Commission: Salary hike is fine but why not link it with performance?

Compensation to employees has occupied the centrestage in both the private and public sector. Following the financial crisis the compensation packages for the bankers came under scrutiny and even today one highlights the differential in salaries in public and private sectors. This is one reason as to why the approval of the recommendations of the 7th Pay Commission becomes important.

 7th Pay Commission: Salary hike is fine but why not link it with performance?

Salary going high. Reuters

The idea of a Pay Commission is to revise the pay scales of the government staff, which also increases in the normal course of time through increments which are however not comparable to those in the private sector. The revisions are linked to both the cost of living as well as the parity to be maintained across all scales while giving consideration to tenures. While the recommendations cover the Central government employees and other staff, the state governments have their own commissions, which will also broadly follow this pattern. The thumb rule is that if the cost to the Centre is around Rs 1 lakh, the same will be for the states put together which also increases pension. Presently, an increase of 23.55 percent has been accepted for Central government employees.

If one looks at the Budget for FY17, a back of the envelope calculation shows that the provision made in these accounts was of the order of Rs 50,000 crore with the amount being split evenly between pensions and salaries and allowances. As this would be from 1 January, there would arrears to be paid for six months – i.e. three months of last fiscal too. What are the implications?

The first is that this amount of money will enter the economic cycle, with around 20-30 percent returning to the government in the form of additional tax collections as most of these households will be in this bracket. Further around 30 will be saved in financial instruments as well as property, and the balance spent on other goods and services. Hence, prima facie there will be activity in all economic activity surrounding consumption and savings.

Theoretically two issues which have challenged the economy should be addressed with such generation of money. We can see consumer goods, automobiles and property being the main industries to benefit though assuredly the pensioners would be saving a larger part of this benefit, which will help banks which are witnessing low growth in deposits. In fact in FY16, bank deposits grew at the lowest rate of less than 10 percent - which has not been witnessed for a decade.

Second, there will be concerns on how the deficit will look with these additional payments. The point here is that with a part returning in the form of taxes, the problem should not be acute and this should be absorbed in the system. Both direct tax as well as indirect tax collections on spending on the goods mentioned earlier will help the government to an extent. Further, with global commodity prices being where they are, the net impact should not be very adverse and can be taken in.

Third, such spending, though not very large when the above assumptions are made, will help specific industries and lead to better production in the manufacturing sector. However, this impact too should not be overstated, as households today are paying more for food items which could divert this higher income to non-manufactured products.

Fourth relates to inflation. The first thought is that inflation should go up if Rs 1 lakh crore enters to system. But as explained earlier, with 50 percent moving out of the spending stream, the balance only will be available for consumption. As they will be directed to industries that have surplus capacity there should be no immediate demand-pull inflation forces.

Fourth, the ideology of these revisions is often questioned, which is pertinent. While there is a case for incomes to be increased to keep in line with the times, a corresponding performance scale would have been warranted given the quantum involved. In the private sector where pay scales tend to be high there are also performance parameters to be met every year, which does not exist for the government sector. Therefore, such terms would have been easier to digest if the increase in pay scales could have been kept aside as a variable pay with clear performance objectives. While the Commission has tried to link the two it has not clearly been stated that this will be implemented.

If it were done, it would have made the employees more responsible and efficient, which is desirable for the smooth running of the bureaucracy. For example, if a ministry has goals of constructing roads or toilets or collect taxes, goals could be quantified and linked to the variable part of the compensation just as it is done in the private sector. Hence, the variable pay for officers in the same grade in different ministries could be different if one is performing and the other not. By not doing so, one is creating a system of entitlements which can limit the level of efficiency and productivity. This holds especially at the lower levels rather than the top, where personnel are more responsible.

Fifth, we should also try and move away from this system of pay commissions and have a regular increase every year just as in the private sector which can be linked to the government’s performance so as to stagger such payments. Having a big number like Rs 1 lakh crore paid in one year is a shock for the budget. This time with external conditions being favourable, it may still be absorbed, but once the world economy returns to normalcy and the advantage of low commodity prices gets diluted, then such shocks are hard to assimilate.

To conclude, it may be said that as this dispensation has been approved, the government should consider regularizing such revisions on an annual basis to smoothen out the budgetary shocks. There is nothing amiss in revising salaries as what holds for the private sector should also be right for the government – but the performance part has to be inextricably linked to the same to make the system viable in the long run. As of now the 7th Pay Commission will have certain positive effects on the demand conditions in the economy depending on how the money is spent. Last, the pressure on the budget will be minimal and can be absorbed.

The author is chief economist at CARE Ratings. Views are personal.

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Updated Date: Jun 29, 2016 20:22:58 IST

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