How will Seventh Pay Commission impact finances of state governments?

According to a study commissioned by the 7th Pay Commission, during the implementation of 6th Pay Commission, eight states opted for switching expenditure to meet additional expenditure demand. Photo: HT

New Delhi: With the central government announcing the implementation of the 7th Pay Commission report which will have an initial impact of Rs.1.1 trillion on government coffers in 2015-16, it is only natural that states will follow suit soon.

After the previous 6th Pay Commission submitted its report in March 2008, except for Andhra Pradesh, Kerala, Punjab and Karnataka, which constituted their own pay commissions, most other states accepted the central pay commission recommendations with some variations.

By 2008, most states had implemented the Fiscal Responsibility and Budgetary Management Act, putting caps on their deficits and compelling them to be more fiscally prudent. However, with the global financial crisis in 2008 after the collapse of Lehman Brothers, revenue collections dipped, affecting state governments for the first few years. Some state governments opted for reduction in other revenue spending and moderation in capital expenditure growth. Deficit indicators for most states deteriorated immediately after adoption of the recommendations. However, fiscal sustainability did not get out of control as within two years, states were able to absorb the initial impact.

According to a study commissioned by the 7th Pay Commission and conducted by the Indian Institute of Management, Calcutta, during the implementation of 6th Pay Commission, eight states opted for switching expenditure to meet additional expenditure demand. Though state-level deficit indicators significantly worsened initially for 22 states, 12 states showed resilience and got out of the fiscal stress within two years of completion of payouts.

However, the study warned that if socially important revenue expenditures are squeezed and capital assets creation foregone, the impact on the nation’s economy could be as adverse as in the earlier case, “perhaps even more so as far as long-term consequences are concerned.”

The 7th Pay Commission in its report urged states to calibrate the speed and the extent of their own awards depending on their fiscal condition. “In the case of states that have been in chronic revenue deficit, there is no doubt that even the awards with the level of fiscal prudence of Seventh CPC will cause a fiscal strain to these states. These states must cut their coat according to their cloth,” it said.

The Reserve Bank of India (RBI) reports that the consolidated revenue deficit of all states (budget estimates) is expected to be -0.4% for 2015-16.

However, states will be in a better position as the Fourteenth Finance Commission has increased the ratio of states’ untied share in the divisible pool of receipts to 42% from 32% earlier. States as a whole are expected to maintain this healthy trend, particularly since the macroeconomic outlook is now expected to be better than in the recent past.

Yes Bank, in an analysis on the impact of 7th Pay Commission on state governments released on 30 June, concluded that Gujarat and Jharkhand are most favourably placed in terms of both having a relatively smaller share of public sector employees and lower liability on pension, wages and salaries, while Kerala and Punjab are most vulnerable due to higher pension and wage liability and relatively higher share of state government employees in the organized sector.

The study said although West Bengal and Maharashtra have a relatively smaller size of public sector employees, their liability in terms of wages, salaries and pensions is high. Chhattisgarh and Haryana, despite being relatively small states, have a relatively high share of public sector employees, making them more vulnerable than large states like Uttar Pradesh and Madhya Pradesh. Haryana has already budgeted for pay scale revision in FY17 and is also expected to post a revenue deficit in 2016-17. The study found that Bihar, Odisha and Rajasthan are states that are relatively more vulnerable to pay scale revisions as they have a higher share of government employees and relatively higher liability in terms of pension, wages and salaries.

Source : http://www.livemint.com/Politics/gAR6dGdlFf8lVp9sdW0seN/How-will-7th-Pay-Commission-impact-finances-of-state-governm.html