A possible boost to consumption in India – 7th central pay commission

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What is a pay commission?

India’s government appoints a central pay commission (CPC) once every 10 years to review and make recommendations on the pay structure of national and local public sector civil and military employees and pensioners. The commission typically takes 18 months to submit its report. Since India’s independence (in  1947), there have been six pay commissions and the seventh is due to report towards the end of this year.

Pay commissions study existing pay scales and make recommendations on both pay increases and pay structures. For example, the sixth CPC recommended that the transport allowance, which had been paid as a lump sum, be included as an expense allowance component. Likewise, the housing rent allowance calculation was pegged to a percentage of pay. The 7th CPC is expected to make adjustments to the public sector retirement age, to performance-linked pay and to flexible work hours for women and employees with disabilities, as well as to make recommendations on pay levels.

Why is it important?

For three reasons. Firstly, it has an impact on government spending and India’s fiscal deficit. For example, after the 6th CPC’s recommendations were implemented, the fiscal deficit that year doubled to 6% in 2008-09, partly due to the resulting public sector pay increases.

Central government pay and allowances currently account for 1% of India’s GDP. This could increase if the pay hikes recommended by the 7th CPC are significant. Based on the medium-term expenditure framework presented to Parliament, the 7th CPC is likely to propose a 16% pay increase. This could account for an additional 0.2%-0.3% of GDP in 2016-17.

Secondly, if the government sticks to its fiscal deficit targets, higher expenditure on pay may mean cuts elsewhere, such as in capital expenditure.

The third reason is that pay increases recommended by the CPC can act as a stimulus to the economy by boosting the consumption element of GDP. The impending recommendations of the 7th CPC will apply to 2.5 million central government employees, but this normally leads to India’s state governments announcing similar pay hikes for their employees. It should be noted that the impact on state budgets will be much larger, as the states have nearly three times as many employees as the central government – about 7.2 million people. In addition, there are about 5.7 million quasi-government employees of various public sector units, railways and other entities, as well as a further 2.1 million people employed by local government bodies including municipalities. We believe that many of the trade unions relevant to these organisations and entities will use the pay rises recommended by the 7th CPC to negotiate higher compensation for their members. Overall, we believe the 7th CPC will directly or indirectly affect the salaries of 60% of total organised sector employees.

Why does it matter for investors?

Consumption can be an attractive investment theme as in urban India there is a correlation between pay commission increases and discretionary spending. People having more disposable income could aid automobile, discretionary and property sales.

Whatever the extent of the pay increases that the 7th CPC recommends later this year, we expect the government to try to remain somewhat conservative in its pay hikes. It will, in our view, seek to retain enough funds to boost public capital expenditure, a necessary driver of sustainable growth, rather than using too much just to provide a temporary fillip to consumer-led growth. The fact that inflationary pressures have moderated could soften the level of pay increases. We expect the 7th CPC to recommend average salary hikes for central government employees in the range of 20%-25%, compared to the 28%-40% increase recommended by the 6th CPC.

Positive impact on consumption, led by automotive and building materials segments

Consumption in India has slowed sharply over the past few months. While urban consumption remains supported, rural consumption has slowed significantly both on the back of the government curtailing its spending to meet fiscal objectives and due to the impact of weak monsoons. Indeed, rural wage growth slumped to 3.6% YoY in May 2015 from the recent high of 17% CAGR registered in the five years ending 2013.

Both staple and discretionary consumption should improve, in our view, supporting sales growth particularly in the automotive and building materials market segments.

Bloomberg is the source for all data in this article as of October 2015, unless specified otherwise.
Brijesh Ved

Head Equities - PMS & Offshore Advisory

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