New Delhi: Around four million central government employees can look forward to higher salary packets, if the finance ministry accepts the proposed 40 per cent hike, with retrospective effect from 1 January 2006, as recommended by the Sixth Pay Commission today.

Officials say that the Sixth Pay Commission has recommended higher house rent and travel allowance, besides large benefits personnel in defence and paramilitary forces. The report of the commission was presented to finance minister P Chidamabaram at New Delhi.

A spokesperson for the finance ministry said that the report would now be presented before the union cabinet for appropriate action.

However, investment bank Morgan Stanley has said that this much-anticipated increase in salaries for government employees threatens India's drive to consolidate its public finances, and makes a near-term cut in interest rates difficult. Morgan Stanley economists have said in a research note they anticipate central government salaries and pension costs to jump by Rs30,000 crore or the equivalent of 0.4 per cent of gross domestic product.

The recommendations of the pay commission come at a time when the UPA government has just announced a Rs60,000-crore waiver package for loans taken by farmers, which is proposed to be funded in cash from the national exchequer.

The finance minister claimed to have "left headroom" for himself, when he was asked just after presenting the Budget 2008-09, on how he intended to fund the Pay Commissions' recommendations for higher salaries for central government employees.

The headroom Chidambaram referred to is the low fiscal deficit constituting 2.5 per cent of the country's gross domestic product (GDP), which could potentially allow the government to borrow money to finance pay hikes.

According to Morgan Stanley, this would be a 30 per cent year-on-year increase in salary and pension costs for around 2.9 million central government employees, which is likely to ensure that state governments, and quasi-government agencies follow suit for their 7.2 million -odd employees.

Morgan Stanley says that going by its workings, the mixed effect of the pay commissions recommendation and the Rs60,000 farm loan relief package ''will most definitely reverse the six-year trend of reduction in government deficit.'' It also ventures that consequently, this expansionary fiscal policy would impact the Reserve Bank's ability to cut rates in the near term, thereby loading a  higher fiscal burden at a time when capital inflows may slow.

However, on the positive side, the pay increase would most likely fuel more discretionary and staple consumption, though Morgan Stanely thinks that discretionary spending is likely to face headwinds from tight monetary policy and public sector earnings, and could be negatively affected due to rising long bond yields and losses in treasury portfolios.