Wage burden: Why Jaitley shouldn’t repeat Chidambaram’s mistake

It’s almost certain that the Narendra Modi government will not meet the fiscal deficit target of 3.5 percent targeted by 2016-17 if the proposal of 24 percent rise in government wages is accepted in its entirety, coupled with a planned likely reduction in corporate tax rates ahead. About the 72 percent of the total burden of Rs 1.02 lakh crore of the wage bill will be on the central government. [caption id=“attachment_2516238” align=“alignleft” width=“380”] Finance Minister Arun Jaitley. Reuters[/caption] Most rating agencies and economic analysts have begun issuing warning notes that the government will likely see more stress on the fiscal front post the implementation of the seventh pay panel. “If the recommendations are adopted, they are likely to have a significant negative fiscal impact,” Standard Chartered economists said in a note on Friday. “We think the government will have to cut capex in order to accommodate increased recurrent expenditure; even then, it may still fail to meet the deficit target,” the note said. Similar warning notes were issued by Citi group, India Ratings and CARE Ratigs. Fiscal burden A rough calculation of the expected burden on government finances on account of higher wage bill, based on the last budget roadmap, shows that in fiscal year 2017 the fiscal deficit amount would stand at Rs 6,29,299 crore or 4 percent of GDP. That has already crossed the red line — the 3.5 percent target the government has targeted for that period. The deficit can only be even higher. To attain the 3.5 percent deficit ratio, according to CARE, the government needs to generate approximately Rs 80,000 crore additional money in revenues. Hiking the corporate tax rates wouldn’t be possible since finance minister Arun Jaitley has already committed a phased reduction in corporate taxes to 25 percent from 30 percent in the last union budget. (For this a roadmap has already been made public.) That leaves the possibility of higher service tax rates or increase in individual segments. Second, the government will have to do wonders on the disinvestment plan and raise funds to boost the exchequer. The government has so far raised Rs 12,700 crroe amount this fiscal year through this route, compared with a target of Rs 70,000 through. In fiscal year 2017 too, it has an ambitious target. One needs to wait and see will the government find luck in its divestment plans, especially because the Modi government doesn’t seem to believe in the idea of selling the family silver. The other hidden shock could be in the form of potential rise crude prices. The government shouldn’t hope that it will continue to enjoy the lower crude oil bonanza as last year, since oil can spring surprises at any point. The red line Jaitley has repeatedly said he would strive to stick to the 3.5 percent target no matter what tough measures the government needs to take. True, the rating agencies attach critical importance to the fiscal deficit figure as a measure of the strength of the government’s balance sheet. But, for a developing country like India, the quality of the deficit is equally critical for growth. Jaitley shouldn’t cut the expenditure since the government spending boost is key to keep the revival momentum on, even if it means the fiscal deficit overshoots the target, which anyway seems to be the case. “The government will have to shore up revenue collections to ensure fiscal targets are not met through capital expenditure cuts – as had happened in the past,” Rating agency Crisil said in a note. Getting the Goods and Services Tax (GST) rolling in winter session will be key for the government to improve tax collections in the future years as more people will pay tax when the system is streamlined. But for this to happen, it is critical for the Modi government to build consensus among the opposition to clear the GST bill given the BJP’s weak position in Upper House. In a scenario, where the private sector investments are yet to pick up in the economy, a weak corporate sector and stress in banking industry, the government cannot clearly afford to cut short the public spending. It will be a mistake — something his predecessor P Chidambaram resorted to — if Jaitley chooses for sharp spending cuts to keep the fiscal target intact in a scenario, where recovery is still in early stages. Instead, shoring up the revenue channels and boosting exchequer through better tax collections and divestments should be the way. Jaitley shouldn’t be obsessed with the fiscal deficit figure alone as happened in the UPA regime, where sharp spending cuts were effected even when the economy was reeling under economic slowdown, thus worsening the problem. (Kishor Kadam contributed to this story)