Meeting FY17 fiscal deficit target of 3.5 per cent a challenge, says Citigroup

The central government’s target to bring down fiscal deficit to 3.5 per cent in 2016-17 is likely to become even more challenging, considering the rise in wage expenditure, aCitigroup report says.

“Considering the rise in wage expenditure by 0.5 per cent of GDP next fiscal and a likely reduction in corporate tax rate, the central government’s target to reduce fiscal deficit from 3.9 per cent of GDP this fiscal year to 3.5 per cent in 2016-17 becomes even more challenging,” the global financial services major said.

The brokerage sounded a warning that if the fiscal deficit target is achieved through a cut in public investments, it could offset the gains on economic activity somewhat.

“In light of this balancing act, the 3.5 per cent target for 2016-17 looks difficult at the outset,” it added.

In a big bonanza to central employees and pensioners, the 7th Pay Commission has recommended a 23.55 per cent increase in salary, allowances and pension, along with a virtual one-rank-one-pension for civilians, involving an additional outgo of Rs 1.02 lakh crore a year.

The recommendations will benefit 47 lakh central government employees and 52 lakh pensioners, which will impact the central Budget by Rs 73,650 crore and the Railway budget by Rs 28,450 crore.

“The combined wage boost is around Rs 1 trillion, or 0.65 per cent of GDP,” the Citigroup report said.

Moreover, since states tend to implement the central pay commission recommendations, albeit with some modifications and a lag, “the combined wage stimulus (the Centre and states) could be more than 1 per cent of GDP over 2017-18,” the report added.

The report took note of sentimental boost for over 15 million workers/pensioners from both the Centre and states, which could lift private consumption growth to around 8.4 per cent in 2016-17, from 6.3 per cent in 2014-15.

According to Bank of America Merrill Lynch (BofA-ML), the 7th Pay Commission is likely to support consumption recovery in the country.

“The boost to consumption would largely be spent on consumer discretionary items and housing. This stimulus would persist for 2-3 years as the 7th Pay Commission award is implemented by state governments, public sector undertakings and universities,” BofA-ML said in a research note.

“In our view, the Finance Minister will need to retain the 2016-17 fiscal deficit at 3.9 per cent of GDP – higher than 3.5 per cent targeted – to accommodate the 7th Pay Commission and OROP payout.”

According to global financial services major HSBC, If state and local governments follow suit, the pay commissions can increase wages for up to 18 million employees, including the Centre, states and local administration employees, and this can have a “sizeable impact” on consumption.

“If it can absorb wage hikes without compromising on its fiscal consolidation or capex targets, today’s wage increase recommendation could indeed be a net positive for sustainable growth,” HSBC said, adding that “however, if a compromise is made, then the consumption boost could eventually translate into higher inflation”.