November 2015

CRISIL Opinion
7th Pay Commission: A non-inflationary boost to consumption and investment

Private consumption would rise by 0.4% if households spend 70% of the payouts, lifting GDP growth

Inflationary pressures expected to be transitory and benign because of under-utilised capacities

Fiscal health can be mildly strained, revenue collection and GST implementation key

The Seventh Central Pay Commission (Seventh CPC) report submitted to the Finance Ministry has recommended a 23.5% hike
in the wages, allowances and pension of government employees, which is a tad more than what was expected. But it does
come at an apposite hour with the economy struggling to get the private investment cycle going. Huge under-utilised capacities
and sluggish pick-up in household demand continue to weigh on manufacturing investments.
True, by perking up household consumption demand, CPC revisions will facilitate faster improvement in capacity utilization in
the fiscal 2017. And if supported by normal monsoons, which will lift the sagging rural demand, the private corporate investment
cycle could materially lift towards the second half of fiscal 2017. With the states also implementing wage hikes by a one-to-year
delay as in the past, the consumption demand will get another booster shot. Nothing comes free. There will be adverse fiscal
and inflationary implications- but much lower than experienced when the Sixth Pay Commission was implemented. Here is why:

A support for consumption

According to the Seventh CPC, Pay, Allowances and Pensions (PAP) as a share of GDP would rise to 3.4% compared with
2.77% in fiscal 2016. Total payout under PAP is estimated to be Rs 1021 billion -- or an increase of 23.55% in fiscal 2017 -- and
will provide a boost to consumption.
We estimate the impact on consumption under three scenarios where the percentage of incremental payout spent is 100%
(Scenario 1), 70% (Scenario 2) and 50% (Scenario 3). Accounting for taxes on income and savings by households, it is likely
that spending would be less than 100% of the payout. In a scenario where inflation continues to remain soft, we expect
purchasing power of households to rise next year.
We estimate that if households spend 70% of the payout then private consumption could rise by 0.4%, while spending
of 50% would provide a 0.3% kicker to consumption.
Also, with states expected to implement wage hikes, too, consumption will rise even further.
% of payout spent
Scenario 1: All
Scenario 2: 3/4
Scenario 3: 1/2
Source: CRISIL Calculations

Impact on Consumption (% increase)

0.64%
0.44%
0.32%

CRISIL Opinion

The recovery in consumption has so far been patchy because of weak monsoon, low rural wage growth and poor transmission
of policy-rate cuts. Therefore, the PAP recommendations, if accepted, would provide a much-needed prop to the economy.
Not only will it benefit consumption, but also raise capacity utilisation and hence hasten recovery in the private capex cycle.
We expect this to create an upside for GDP growth in fiscal 2017.
Cars and two-wheeler sales will see 4-5% incremental growth, while consumer durables could see additional
growth of 1-1.5% in fiscal 2017

CRISIL Research expects the Seventh CPC to boost sales of passenger vehicles and two-wheelers by 4-5%
incrementally in fiscal 2017. Small cars are expected to benefit the most because aspirational purchases will get a
boost, followed by the scooter segment, since most employees are located in metros and cities where the share of
scooters is increasing. Consumer durables, too, are expected to see additional growth of 1-1.5% in volume, while there
could be broad-based growth in televisions, washing machines and refrigerators.

Sales of automobiles (two-wheelers and passenger vehicles) increased significantly (25-26%) while consumer durables
saw a growth of 2.5-3% bps in fiscal 2010 and 2011 after the implementation of the Sixth Pay Commission report.
However, demand is unlikely to increase as meaningfully as it did when the Sixth Pay Commissions recommendations
were implemented mainly because this time the pay hike is lesser (~24% versus 35% in fiscal 2008) and the arrears
are likely to be minimal compared with 30 months back. Moreover, sales were also supported by a 4% cut in excise
duty and improvement in the financing scenario.

Inflationary impact would be transitory and benign

CRISIL believes the impact on inflation could be benign compared with previous CPC years for the following reasons:
One, the proposed pay increase is much lower in aggregate terms
The Seventh CPC recommends a 23.5% increase in wage and pension effective January 1, 2016. This is less than the 35%
implemented by the Sixth Central Pay Commission (Sixth CPC). In addition, the Sixth PC payouts also included huge arrear
payments. Payments on account of revised wage and pensions were made in fiscal 2009 and 2010 instead of the scheduled
year of 2006. The accumulated arrears, therefore, inflated the wage and pension bill by an average 40% during these two years.
Such delay (and therefore arrear accumulation) is not expected this time around.
Two, consumer demand is much more subdued this time
Domestic demand, mainly from rural India, is muted given lower increases in rural wages and two consecutive bad monsoons.
This has affected capacity utilisation rates across key sectors, which is at a 5-year low. In auto, specifically in the passenger
vehicles segment, it is about 66% compared with 75% in fiscal 2008, which was the start of the Sixth CPC award year. Similarly
utilisation rates in the cement segment where more than 50% of production is for housing - are at 71% compared with 95%
then.
So the push to income will have less of an inflationary impact compared with the Sixth CPC when consumption demand growth
was relatively robust at 7-7.5% (computed per the old GDP series). So while higher incomes will boost demand, it is unlikely to
lift inflation rates significantly.

Three, inflation impact of CPC payouts is usually transitory and spread overtime
Past experience shows that CPC payouts tend to act as a shock and have a transitory impact on inflation, especially when large
arrear payments are involved. Given this, inflationary pressures may not always push up core inflation. During the Fifth CPC
payout, overall inflation rose by 657 bps on-year in fiscal 1999, while non-food inflation in the same year rose only 141 bps.
During the Sixth CPC payout years, however, overall inflation rate rose by 611 bps on-year between fiscals 2009 and 2010. But
this time the increase in non-food inflation was higher and lagged up 492 bps during fiscals 2010 and 2011. Large arrear
payments coincided with the rapid rise in rural wages adding to core inflationary pressures then. These two factors are expected
to be absent, this time.
Also, pay revision impact on inflation tends to be spread over time. Thats because state governments which have more
employees than the Central government tend to implement these with a lag. Therefore, while there is a push to consumption
demand, it takes place over time allowing supply-side factors to adjust wherever possible.
Fourth, the sharp decline in global commodity prices can offset inflationary pressures
In the terminal years of the Sixth PC payouts global crude oil and commodity prices began to rise sharply after collapsing in
2009. In 2010, global crude oil prices rose 28.7%, while metal and mineral prices rose 39.7% pushing up imported inflation. This
time, however, the outlook on oil and metals is benign: the International Monetary Fund expects global oil prices to fall by 2.4%
in 2016 and stay low. Metal prices are also expected to stay soft in the next 2-3 years given the weakness in global growth
recovery and the slowdown in China. Therefore, easing imported inflation can offset some upside from higher domestic demand.
Fifth, monetary stimulus to growth is missing unlike the last time
Last time, the Fifth PC payouts coincided with sharp reduction in policy interest rates carried out by the Reserve Bank of India
(RBI), to boost spending. The RBI cut rates by 425 bps between 2008 and 2010, which pushed up credit demand, especially
retail credit. This time, however, with an inflation target at hand, policy-rate reductions have been much slower 125 bps in
2015.

Fiscal health can be mildly strained, revenue collection key

The Seventh CPC has recommended an increase in wage and pension bill of government servants by 0.65% of GDP. This will
lift central government expenditure by 0.47% of GDP in fiscal 2017 as rest will get into the railway budget.
Per roadmap set, the fiscal deficit of the central government needs to be reduced to 3.5% and 3% of GDP in fiscal 2017 and
fiscal 2018, respectively, from 3.9% of GDP for fiscal 2016. True, a sharp slowdown in global crude oil prices and the increasing
focus of the government on direct benefit transfer would restrain the governments subsidy burden.
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. For this, the implementation of Goods and Services Tax and relentless efforts to improve
revenue mobilisation will be necessary. In the absence of this, the government may have to cut capital expenditure to meet its
fiscal deficit target for 2017.

CRISIL Opinion

Analytical Contacts:
Dharmakirti Joshi

Rahul Prithiani

Chief Economist, CRISIL Research

Director, CRISIL Research

Email: dharmakirti.joshi@crisil.com

Email: rahul.prithiani@crisil.com

Dipti Deshpande

Sakshi Gupta

Adhish Verma

Senior Economist, CRISIL Research

Economist, CRISIL Research

Junior Economist, CRISIL Research

Email: dipti.deshpande@crisil.com

Email: sakshi.gupta@crisil.com

Email: adhish.verma@crisil.com

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Media Relations

Media Relations

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