Financial Resources of the State Governments: 7th Pay Commission Report
Impact of Central Pay Commissions on State Finances
2.2.1 To address the question of implications of Seventh Central Pay Commission’s recommendations on the States, it was necessary to ascertain the fiscal impact of the previous Commissions’ awards on the states. To this end, Indian Institute of Management Calcutta (IIM, Kolkata) was asked to undertake a study on the subject for the Seventh CPC.
2.2.2 The broad conclusions of the study indicated that the states on the whole were able to manage their finances and absorb the fiscal shock caused by the VI CPC (relative to previous Pay Commissions) better, principally because of the implementation of the FRBM Act by the States.
2.2.3 The study finds that the macroeconomic impact on states depended on the speed and the extent to which individual states implemented their pay awards, which varied considerably. The empirical analysis conducted indicates that the macroeconomic impact on States’ finances tends to taper off in two years in most cases. In this context, it is encouraging to note that States’ finances continue to be reasonably sound at present.
2.2.4 It is clear from the study that a significant number of States follow the recommendations of the Central Pay Commission. Equally, there is significant plurality of States that design their own pay awards based on the recommendations of their own State Pay Commissions, which of course do consider the recommendations the Central Pay Commission and subsequent Government of India award.
2.2.5 The question then is the extent to which these findings continue to hold true at present. RBI (2015)4 reports that the consolidated revenue deficit of all states (budget estimates) is expected to be (-)0.4 percent for the year 2014-15. Further, the Fourteenth Finance Commission has increased the ratio of States’ share in the divisible pool of receipts to 42 percent from the 32 percent that obtained in the Thirteenth Finance Commission. 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. Ceterus paribus, one would expect this situation to remain, if not improve, in 2015-16. States’ own revenues, as a percentage of Gross State Domestic Product (GSDP), are also stable at 7.7 percent for three years now.
2.2.6 Notwithstanding this commendable fiscal performance, it is important to see how states were able to cope with the award of the VI CPC and the impact of the award on the macro fiscal fortunes of the individual states
2.2.7 In the case of Special Category States (SCS) it is generally recognised that these states would, because of their special circumstances, only secure fiscal consolidation if additional resources were made available to them over and above their share of revenues from the divisible pool. Central Governments do not, in normal cases, provide such assistance. Finance Commissions take account of this fact by providing such states with revenue deficit grants. Thus, both the 13th and 14th Finance Commission awarded revenue deficit grants to most of these special category states. In addition, these states also receive special purpose grants that take account their specific cost disabilities and low revenue base. These efforts have been
broadly successful. The RBI (2015) clarifies that the special category states as a whole have not been incurring revenue deficit in recent times.
2.2.8 In the case of the General Category States (GCS), in recent times, only a few states have consistently faced revenue deficits. We find (Table 1) that some states that were normally in revenue surplus did incur revenue deficits following the implementation of their Pay Commission awards. However, these states were able to stabilise and return to revenue surplus within a reasonable period of time. Therefore, there is every reason to expect states that are currently structurally fiscally prudent and in compliance with FRBM to be able to cope with the consequences of increases in pay allowance and pension (PAP), as long as the level of fiscal prudence is broadly in line with that of the Seventh CPC recommendations.
2.2.9 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.” Therefore, just as in the case of all expenditures that states with chronic revenue deficits undertake, they will have to be more restrictive in their pay awards than states which have successfully secured fiscal consolidation.
2.2.10 The FFC has opined as follows, “….the recommendations of the Seventh Central Pay Commission are likely to be made only by August 2015, and unlike the previous Finance Commissions, we would not have the benefit of having any material to base our assessments and projections and to specifically take the impact into account. We have, therefore, adopted the principle of overall sustainability based on past trends, which should realistically capture the overall fiscal needs of the States…” Thus, account has been taken of the Commission’s recommendations at a macro-fiscal level by the FFC.
2.2.11 In this context, it should be borne in mind that the FFC has also provided revenue deficit grants to states to compensate for cost disabilities and shortfalls in their tax base. Such grants have been awarded to key states with chronic revenue deficits after a rigorous assessment of their revenue base and expenditure needs. Hence, these States have already secured additional resources from the divisible pool on this account and this should further enable them to administer pay awards consistent with fiscal prudence and allow them to persist in their path to fiscal consolidation.
2.2.12 It is also clear from the study by IIM, Kolkata that the pace and impact of implication of pay commission award varies quite substantially across the States. The States have deployed a number of options to deal with impact of their pay awards following the awards made by the Government of India based on the recommendations of the previous Central Pay Commissions.
The states used the following options:
states would need to be more prudent than other States.
Impact of Central Pay Commissions on State Finances
2.2.1 To address the question of implications of Seventh Central Pay Commission’s recommendations on the States, it was necessary to ascertain the fiscal impact of the previous Commissions’ awards on the states. To this end, Indian Institute of Management Calcutta (IIM, Kolkata) was asked to undertake a study on the subject for the Seventh CPC.
2.2.2 The broad conclusions of the study indicated that the states on the whole were able to manage their finances and absorb the fiscal shock caused by the VI CPC (relative to previous Pay Commissions) better, principally because of the implementation of the FRBM Act by the States.
2.2.3 The study finds that the macroeconomic impact on states depended on the speed and the extent to which individual states implemented their pay awards, which varied considerably. The empirical analysis conducted indicates that the macroeconomic impact on States’ finances tends to taper off in two years in most cases. In this context, it is encouraging to note that States’ finances continue to be reasonably sound at present.
2.2.4 It is clear from the study that a significant number of States follow the recommendations of the Central Pay Commission. Equally, there is significant plurality of States that design their own pay awards based on the recommendations of their own State Pay Commissions, which of course do consider the recommendations the Central Pay Commission and subsequent Government of India award.
2.2.5 The question then is the extent to which these findings continue to hold true at present. RBI (2015)4 reports that the consolidated revenue deficit of all states (budget estimates) is expected to be (-)0.4 percent for the year 2014-15. Further, the Fourteenth Finance Commission has increased the ratio of States’ share in the divisible pool of receipts to 42 percent from the 32 percent that obtained in the Thirteenth Finance Commission. 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. Ceterus paribus, one would expect this situation to remain, if not improve, in 2015-16. States’ own revenues, as a percentage of Gross State Domestic Product (GSDP), are also stable at 7.7 percent for three years now.
2.2.6 Notwithstanding this commendable fiscal performance, it is important to see how states were able to cope with the award of the VI CPC and the impact of the award on the macro fiscal fortunes of the individual states
2.2.7 In the case of Special Category States (SCS) it is generally recognised that these states would, because of their special circumstances, only secure fiscal consolidation if additional resources were made available to them over and above their share of revenues from the divisible pool. Central Governments do not, in normal cases, provide such assistance. Finance Commissions take account of this fact by providing such states with revenue deficit grants. Thus, both the 13th and 14th Finance Commission awarded revenue deficit grants to most of these special category states. In addition, these states also receive special purpose grants that take account their specific cost disabilities and low revenue base. These efforts have been
broadly successful. The RBI (2015) clarifies that the special category states as a whole have not been incurring revenue deficit in recent times.
2.2.8 In the case of the General Category States (GCS), in recent times, only a few states have consistently faced revenue deficits. We find (Table 1) that some states that were normally in revenue surplus did incur revenue deficits following the implementation of their Pay Commission awards. However, these states were able to stabilise and return to revenue surplus within a reasonable period of time. Therefore, there is every reason to expect states that are currently structurally fiscally prudent and in compliance with FRBM to be able to cope with the consequences of increases in pay allowance and pension (PAP), as long as the level of fiscal prudence is broadly in line with that of the Seventh CPC recommendations.
Table 1: Revenue Deficit of General Category States (GCS) (as % of GSDP)
Source: State Finances- A Study of Budgets, Reserve Bank of India. The numbers for 2014-15 and 2015-16 are from states budget documents.
Note: “*” Andhra Pradesh here refers to erstwhile Andhra Pradesh before Telangana was formed. Data for 2014-15 and 2015-16 is related to the new State of Andhra Pradesh.
Note: “*” Andhra Pradesh here refers to erstwhile Andhra Pradesh before Telangana was formed. Data for 2014-15 and 2015-16 is related to the new State of Andhra Pradesh.
2.2.10 The FFC has opined as follows, “….the recommendations of the Seventh Central Pay Commission are likely to be made only by August 2015, and unlike the previous Finance Commissions, we would not have the benefit of having any material to base our assessments and projections and to specifically take the impact into account. We have, therefore, adopted the principle of overall sustainability based on past trends, which should realistically capture the overall fiscal needs of the States…” Thus, account has been taken of the Commission’s recommendations at a macro-fiscal level by the FFC.
2.2.11 In this context, it should be borne in mind that the FFC has also provided revenue deficit grants to states to compensate for cost disabilities and shortfalls in their tax base. Such grants have been awarded to key states with chronic revenue deficits after a rigorous assessment of their revenue base and expenditure needs. Hence, these States have already secured additional resources from the divisible pool on this account and this should further enable them to administer pay awards consistent with fiscal prudence and allow them to persist in their path to fiscal consolidation.
2.2.12 It is also clear from the study by IIM, Kolkata that the pace and impact of implication of pay commission award varies quite substantially across the States. The States have deployed a number of options to deal with impact of their pay awards following the awards made by the Government of India based on the recommendations of the previous Central Pay Commissions.
The states used the following options:
- deciding to award lower increases than the Centre,
- deciding on a date of implementation different from that of the Centre,
- staggering the payments of arrears suitably,
- generating additional tax and non-tax revenues, and
- compressing expenditures
states would need to be more prudent than other States.
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