Last Updated: August 04, 2015: The 6th Pay Commission played a key role in insulating the Indian economy from the shocks of the Lehman crisis of 2008. According to Bank of America Merrill Lynch, higher salaries - resulting from the implementation of the 6th Pay Commission - drove two-wheeler and car sales, and led to a recovery in cement demand.
Salaries of government employees went up by an average of 35 per cent on the back of the 6th Pay Commission recommendations; employees also got arrears for more than 30 months because of the delayed implementation of the 6th Pay Commission in October 2008.
"The arrears resulted in robust demand for consumer discretionary products that resulted in sustained stock performance over 3-5 years," wrote Jai Shankar, chief India economist of Religare.
It is for these economic linkages that the 7th Pay Commission report is being eyed by analysts. The 7th Pay Commission report is likely to be submitted by August-end or in October, according to media reports.
Pay Commissions are meant to review the salary structure of central government employees and are set up every 10 years. The 7th Pay Commission will revise salaries effective January 1, 2016.
According to Religare, nearly 50 lakh central government employees (including 15 lakh defence personnel) and over 1 crore state and local government employees will benefit from the 7th Pay Commission.
There's no consensus about how much salaries will go up -- Bank of America expects a modest 15 per cent increase, while Religare expects salaries to go up by 28-30 per cent. Credit Suisse says salary hikes can be as high as 40 per cent.
Economists, however, agree that the 7th Pay Commission will help kick-start the domestic economy, which continues to be plagued by weak demand and excess capacity.
How the 7th Pay Commission can fire up the Indian economy
1) A 15 per cent salary increase would push up the central government's salary bill by Rs 25,000 crore (or $4 billion), which is 0.2 per cent of India's GDP, says Indranil Sen Gupta of Bank of America Merrill Lynch. This will help in a consumption-driven recovery in the domestic economy, he added.
2) According to Neelkanth Mishra of Credit Suisse, nearly one-third of India's middle class is employed by the government and as the 7th Pay Commission comes through, there will be an improvement in discretionary spending.
"In Tier 3, Tier 4 towns where government employees are 50-60 per cent of the middle class, it is very likely that real estate markets will take off again," he said.
3) Bank of America Merrill Lynch also expects the 7th Pay Commission to double subsidized loans for cars to Rs 3.60 lakh and housing loans to Rs 15 lakh. This will push up demand for autos and housing.
4) According to Religare, "The most important factor is economic activity itself which is gaining pace and, together with greater employment generation and policy reform, the 7th Pay Commission salary hike may help India enter a larger virtuous cycle."
Large-scale salary hikes, however, are also expected to stoke inflation and fiscal pressures.
"Clearly if you see a third or 35 per cent of your middle class getting a 40 per cent or 30 per cent jump in compensation in one shot, the fears of inflation will rise," Mr Mishra warned. He added that expectations of rate cuts can get pushed out and some possible fiscal pressures can emerge.
According to Jai Shankar of Religare, the salary bill (centre plus state combined) will be much higher at $50 billion or Rs 3.12 lakh crore if the Pay Commission recommend a 28-30 per cent salary hike. "The total amount will be in excess of $50 billion, making deficit reduction extremely challenging in FY17," he said.