The 7th Pay Commission was cleared by the cabinet on Wednesday, 29th June. For readers who are not acquainted with what it is all about, the 7th Pay Commission is a revision of the pay scale of almost 1 crore Indian government employees. Not surprisingly, this revision of salaries has many far led consequences which we will be discussing through the article.

In order to understand the 7th Pay Commission properly, here are some highlights we must know first:

  • ●  Current and former government employees will be getting an average hike of around 24% in their salaries; effective from the starting of this year.
  • ●  This scheme is to directly benefit about 1 crore government employees; out of which 60 lakh will be pensioners.
  • ●  The last major hike (i.e. 6th Pay Commission) was introduced in the year 2008. The 6th Pay Commission saw an average hike of around 50% in salaries of government employees.
  • ●  The 7th pay commission is expected to cost the government $15 billion every year which equates to 0.7% of the Indian GDP.
  • ●  For the lowest strata workers, the minimum salary paid to a government employee has been increased to Rs. 18000 from Rs. 7000.
  • ●  Arun Jaitley has mentioned that in many cases the salaries in government sector will be significantly higher than those in the private sector. Top government officials will be paid up to Rs.2.5 lakh a month.
  • ●  The housing loan allowance has been increased from Rs. 7 lakhs to Rs. 25 lakhs.

As one can see that because the 7th pay commission comes with a lot of changes, it only makes it necessary to analyze, understand and estimate them and the effect that the 7th Pay Commission will have on the economy.

Understanding the effects of the 7th Pay Commission on Inflation:

The first grave concern was expressed by the Reserve Bank of India. RBI expressed its concern about the country’s persistant inflation and the effects revised pay scales might have on this inflation. Salary hikes undoubtedly come with the risk of inflation.

Inflation is defined as the overall increase in prices of commodities in an economy in a given period of time. Simply put, the 7th Pay Commission will increase the supply of money available in the economy. Excess supply of anything naturally decreases its value; in this case decreasing the value of money in the Indian economy. This means that people will able to buy less goods with the same amount of money.

Now there are three ways the Indian government can get money to fund its 7th Pay Commission.

First: The government will simply transfer the money from taxpayers to government employees.
Second: The government will take external debt. In this case, the central bank will give the government a fixed amount of the INR for every dollar borrowed (determined by the exchange rate) and will withdraw the same amount of INR from the Indian market.

The first two ways will maintain the money supply in the economy.

Third: The government borrows directly from the central bank of the country. This becomes inflationary.

However, since our cabinet is funding the 7th Pay Commission through the first two ways we can say for sure that inflation will not be because of increased money supply in the Indian economy.

What will case inflation then and why is the RBI so concerned? Simply put, it is the age old rule of demand and supply. The 7th Pay Commission will increase salaries of almost 1 crore employees by an average of 24%. This means more money will go in hands of people. More money will mean more demand for goods and services. This is where inflation will kick in. Figures show that the Indian manufacturing sector is not in the condition to meet with extra demand for goods and services. If the manufacturing sector is not able to keep up with the extra demand, prices are bound to rise. Figures reflect the same. Growth in the industrial sector has been a meager 0.1% owing to the poor performance of manufacturing and mining sector. Outflow of capital goods has been very low over the past year. RBI warns that the 7th Pay Commission may lead to a 170 points increase in the CPI (consumer price index).

Reason for lowest hike in pay scales and why India needs it:

Now that we know the root of the problem, we will discuss how the cabinet has designed the 7th Pay Commission keeping inflation in mind. Before we start, we need to understand that the current times demand low inflation in India and the 7th Pay Commission tries to ensure that.

The very first challenge for the government was to determine the percentage increase in salaries. How exactly does one strike a balance between the cost to the public exchequer and government employees’ salaries. The government cannot increase the salaries to an extent that the public exchequer goes bankrupt for any future expenditure. On the other hand, if the revised pay scale does not match the present inflation, government employees will not benefit (in real terms) and protest. So the government has to increase the salaries to a level where there is an increase in the real incomes of employees, but not in the inflationary pressure in the country.

Why can’t India afford more inflation? We need to understand that the 7th Pay Commission comes at a time when the world’s financial markets are in a turmoil. China,

the world’s sweatshop, is facing a major growth and structural crises. European Union’s manufacturing sector is at an all-time low due to concerns over terrorism and Brexit. Manufacturing costs are too high in the US. As the World Bank pointed out in a recent statement, the Indian economy is one of the best working economies as of today. This means that it is a golden opportunity for India to attract all the global investment it can. The Indian government needs to capitalize on their ‘Make in India’ campaign and one way to ensure that is low manufacturing costs; i.e. to make sure that inflation does not increase.

Despite a favorable monsoon season after two years (a major driver for India), RBI governor Raghuram Rajan has been skeptical about cutting the repo rate in order to keep inflation rates under control. The government cannot afford to disturb this delicate scenario by increasing the pay scales by a huge percentage.

Another major reason for the limited increase in pay scale is the nature of India’s financial system. Non-performing assets of Indian banks jumped to 7.6% in March 2016 up from 5.1% according to RBI’s financial stability report. Even though majority of these bad loans are held by the upper strata of the society, one cannot ignore the trickledown effect; in this case a negative one. More money in hands of people means more loan-taking capacity and more loans mean more chances of debtors turning defaulters. The government cannot afford any more bad loans right now.

Comparing it to the 6th Pay Commission:

While one might compare this to the 6th Pay Commission of 2008 and say that the Indian economy actually grew in 2009 despite an increase of almost 50% in pay scales, one needs to understand the background of both the Pay Commissions. In 2008, the world was facing a major global crisis because of the banking disaster in the US. The government needed to induce money in the economy in order to stimulate demand for goods and services and create much needed jobs. During the 6th pay commission, government’s expenditure on payment increased from 2.5% to 6% and salary plus pension accounted for 12% of government’s expenditure. A 6th Pay Commission style expenditure today will not only create unnecessary demand, but also reflect badly on India’s current account deficit (CAD) due to increased external borrowing. A worsening CAD puts India in the bad books of major trade organizations and, as a result, makes her look an unattractive destination for investors to park their money.

Conclusion:

Introduction of the 7th Pay Commission has been received well by many. We saw Nifty and Sensex gain despite stressful markets all around the world; a respite for Indian and foreign investors. Real estate markets are also expected to bounce back (a historical trend). Finance Minister Arun Jaitley has promised that the cabinet has passed the 7th Pay Commission keeping in mind the fiscal deficit targets for the current financial year. All in all,

we can say that the 7th Pay Commission has come in a very complex time with great potential to take the Indian economy forward.

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