Casting ‘inflation’ doubts over 7th Pay Commission salary hikes is wrong

A lot has been written about how the Rs 1 lakh crore, or 0.7% of India’ gross domestic product (GDP), will add to inflation in the country. Only that it won’t.

Experts and analysts believe that there is going to be no material impact on India’s inflation due to the salary hikes that the Cabinet, led by Prime Minister Narendra Modi, accepted earlier this week.

Cabinet accepted the proposals made by the Empowered Committee of Secretaries on 7th Pay Commission and agreed to a 23.55% salary hike for its top-level and nearly 15% salary increase for its junior most employees.

The move will benefit over 1 crore central government employees and pensioners.

The recommendations are to be implemented from January 1, 2016 and the Government is yet to take call on how the Rs 12,000-odd crore in arrears are to be paid—in one go or in instalments.

Zeebiz reported how the 7th Pay Commission is likely to boost Indian economy by adding to the already recovering consumption story. Read here; LINK http://www.zeebiz.com/india/news-can-7th-pay-commission-salary-hike-meaningfully-boost-indian-economy-3234

However, there have been many ‘inflation-hawks’ stating that this excess consumption will push up prices.

Reserve Bank of India (RBI) governor Raghuram Rajan during the monetary policy review also pointed out to an upside risk to inflation because of an increase in consumption led by 7th Pay Commission’s implementation.

Although, his worry is valid as the Bank has to adhere to a strict target to control inflation under 5% by 2017. Inflation has already shot past this target and is expected to rally a bit more before cooling off.

So, will pay commission impact inflation in any adverse way possible? If yes, for how long will these inflationary pressures continue?

Moreover, a good monsoon—which is more or less a reality this year—means that food production in India will be sufficient to tame the irking food prices that have been on the upswing off-late.

Kavita Chacko and economist with CARE Ratings believe that the demabd boost provided by the pay commission will not add to inflation. She said, “The pay commission will not have much of an impact on inflation given that there exists excess capacity in Indian manufacturing which can accommodate the additional (staggered) demand that could emerge from the pay hikes.”

“We expect inflation to be on an average in the range of 5-5.5% for this fiscal. Inflation would be primarily driven by food prices which in turn will be influenced by the monsoons and crop output,” she added.

Kotak Mahindra Bank too has somewhat similar views on inflation. It said that although inflation might miss 5% mark by a whisker (5.1% by end of FY17), given the slack in the economy, the impact of 7th Pay Commission is likely to be muted.

However, Elara Capital believes that there will be a direct and indirect risk on inflation.

First directly, as there will rise in Housing Price Index (CPI weight: 10.1) as the assigned rent of government accommodation grows on rise in HRA.

Secondly indirectly, rise in consumption will be encouraged, resulting in increase in aggregate demand without sufficient supply side response.  

This upside risk compounding wider into future stems from states following suit on pay commission rewards with a lag. Typically, this could fuel inflation for more than 2 years, till FY18 before it comes into base, it said.

While 7th Pay Commission is likely to boost consumption demand higher, its impact on retail inflation is likely to be much lower in comparison with previous occasions. 

Around 60% of pay commission outlay has been provided in FY17 budget. The actual payout under allowance for FY17 to be lower, due to be delayed implementation, which will cushion payment of arrears. The additional payout (including One-Rank-One-Pension) required in FY17 would increase tax collections thus leaving a gap to meet the fiscal deficit target, on discussion with market participants and economists.