The Hindu Business Line : Expensive gift

Even though the Prime Minster’s top-up of the sixth Pay Commission award for central government employees has yet to be notified, it is clear that the Cabinet approval for the substantial pay hike that comes ten years after the last one will leave the employees remembering the nation’s 61st birth anniversary as a memorable one. For very obvious political reasons, the government has thought it apt to ignore expert warnings, including the Prime Minster’s own Economic Advisory Council’s gentle hint that in a year of rising subsidies and the farm waiver, an award of this magnitude would derail the painstakingly built fiscal discipline and spike the fiscal deficit to more than five per cent. Some analysts have expressed confidence that the award will have little impact on the fiscal deficit since it had already been budgeted for. Likewise, States will not feel the burden of similar spikes in their employee pay because healthy revenue flows and attention to fiscal prudence since 2006 have helped them clean their books.

That might be the case for now. But political expediency matters as much in State capitals as in New Delhi. Blend this with the RBI’s observation that only a few States account for the overall fiscal correction with fifteen of them posting a rise in gross fiscal deficit in 2007-08 and one can reasonably expect State finances to be out of kilter sooner than later. But there is a more substantive issue that the Prime Minister’s I-Day gift raises for the economy at large. First, the release of pay arrears and incremental salaries will raise disposable incomes and contribute to the same demand pressure the RBI bemoans, especially at the lower end of the consumer spectrum. For the economy that is beginning to feel the RBI’s tightening credit noose, that is happy news indeed, which will be made happier by the States showering an equal generosity on their employees.

The impact of this heightened liquidity on monetary policy is the issue here. The RBI has declared war on excess money supply since it holds persistent demand pressure responsible for inflation but to date M{-3} is still above the 17 per cent mark. And now it may climb even further with all that extra disposable incomes the Prime Minster has handed out. It could get messy if Mint Street and New Delhi adhere to their contrasting policy perspectives, in effect working at cross purposes. And if past experience is any judge, do not be surprised if the RBI further tightens repo rates or cash reserve ratio (CRR).

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